Insolvency, Resolution, Bankruptcy and Liquidation
Insolvency refers to the inability of a person or corporate to pay up his debt /bills as and when they become due. He may be able to pay at a later date some amount or even in full, but at the promised date of payment, he is unable to make the payment. Insolvency leads to the state of default. Bereft of outright fraud, the default can happen due to financial failure (as evidenced by “cash flow test”) or business failure (as determined by “balance sheet test”).
Resolution refers to a plan proposed by any authorised person/entity for enabling the overdue payments of a corporate debtor through restructuring or through part payments, while allowing the corporate debtor to continue as a going concern.
Bankruptcy is the next state of insolvency where an individual and partnership firm is declared by the relevant authority under a specified law for the purpose, as incapable of paying up his debt / bills at any time in present as well as in the foreseeable future. Generally, failure of resolution process leads to bankruptcy.
Liquidation is the winding up of a corporation or incorporated entity under the supervision of a person or “liquidator”, empowered under law for such operation and for distribution of proceeds to the various creditors as per an agreed formula. Only firms can be liquidated. Defaulting individuals cannot be liquidated.
Insolvency is the trigger that causes a bankruptcy or liquidation. For some, the right answer after default is to take the firm straight into liquidation. But there may be many situations in which a viable mechanism can be found through which the firm can be protected as a going concern. To the extent that this can be done, the costs imposed upon society go down, as liquidation involves the destruction of the organisational capital of the firm. The ideal insolvency and bankruptcy regime may provide for early determination of economic viability or otherwise of an entity, management of the conflicts between the interests of creditors and debtors and provide for predictable, equitable and fair loss allocation to all concerned in economic difficulties and reduce the time taken in resolution, then recoveries would be faster and the capital would be preserved for better allocation.
Insolvency, Bankruptcy and Liquidation Regime in India
The Insolvency and Bankruptcy Code, 2016 was passed by Parliament on 11.5.2016 and published in the Official Gazette on 28.5.2016.
The strategy adopted by the Coderuns as follows:
- When default takes place, an Insolvency Resolution Process (IRP) can be initiated and run for as long as 180 days. The IRP is overseen by an “Insolvency Professional‟ (IP) who is given substantial powers. The IP makes sure that assets are not stolen from the company, and initiates a careful check of the transactions of the company for the last two years, to look for illegal diversion of assets. Such diversion of assets would induce criminal charges.
- While the IRP is in process, the law enshrines a “calm period‟ where the moratorium shall be ordered prohibiting any claim including claims of creditors or transfer by debtor. This gives a better chance for the firm to survive as a going concern. For the 180 days for which the IRP is in operation, the creditors’ committee will analyse the company, hear rival proposals, and make up its mind about what has to be done.
- When 75% of the creditors agree on a revival plan, this plan would be binding on all the remaining creditors and other stakeholders.
- If, in 180 days, no revival plan achieves support of 75% of the creditors, the firm goes into liquidation.
- In limited circumstances, if 75 % of the creditors’ committee decides that the complexity of a case requires more time for a resolution plan to be finalised, a one-time extension beyond180 days’ period for up to 90 days is possible with the prior approval of the Adjudicating Authority. This is starkly different from present arrangements which permit the debtor / promoter to seek extensions beyond any limit.
Benefits of this approach
- Asset stripping by promoters is controlled after and before default.
- The promoters can make a proposal that involves buying back the company for a certain price, alongside a certain debt restructuring.
- Others in the economy can make proposals to buy the company at a certain price, alongside a certain debt restructuring.
- All parties knows that if no deal is struck within the stipulated period, the company will go into liquidation. This will help avoid delaying tactics. The inability of promoters to steal from the company, owing to the supervision of the IP, also helps reduce the incentive to have a slow lingering death.
- The role of the Adjudicating Authoritywill be on process issues: To ensure that all financial creditors were indeed on the creditors committee, and that 75% of the creditors do indeed support the resolution plan.
The bankruptcy of an individual can be initiated only after the failure of the resolution process. The bankruptcy trustee (insolvency professional) is responsible for administration of the estate of the bankrupt and for distribution of the proceeds on the basis of the priority of payments (waterfall) as determined under a law/agreement.Indigent individuals with income and assets lesser than specified thresholds (Gross income <Rs.60,000 p.a. and Total Assets < Rs.20,000) would be eligible to apply for a discharge only from their “qualifying debts” (up to Rs.35,000) under “fresh start process”.
Liquidation will be led by a regulated insolvency professional, the liquidator. In this process, the assets of the company are held in trust. The rights of secured creditors are respected: they have the choice of taking their security interestand realise it on their own. The recoveries that are obtained are paid out to the various claimants through a well-defined waterfall (means who gets paid first). The rights of the Central and State Government in the distribution waterfall in liquidation is given a priority below that of the unsecured financial creditors (in addition to all kinds of secured creditors) for promoting the availability of credit and developing a market for unsecured financing (including the development of bond markets).
It is mentioned in the World Bank Doing Business Report, 2017 (WBDB 2017) that a higher time to resolution is associated with a lower recovery rate. The average time taken in India to resolve insolvency is 4.3 years and the recovery rate is 26 cents to the dollar. Therefore, a lower time for resolution inbuilt in the Code would minimise destruction of value and result in higher recovery rate giving opportunity for more productive allocation of capital.
- Report of the theBankruptcy Law Reforms Committee (BLRC)
- Gazette Notification of The Insolvency and Bankruptcy Code, 2016