Understanding Insolvency and Bankruptcy Code Processes
Insolvency is a word that haunts many business owners. Entrepreneurs often fear it, mostly because they don’t fully understand the procedures involved in insolvency filings or how to navigate through them. To clarify the processes of the Insolvency and Bankruptcy Code (IBC), we have created this article to explain the basics.
Why Do Companies File for Insolvency?
A company files for insolvency when it cannot repay its debts from its income or revenue. Businesses usually take on debt to enhance their operations, but when the business’s performance declines to the point where it cannot even pay the interest, the company reaches the stage of insolvency or, in extreme cases, bankruptcy.
Two Types of Insolvencies:
- Cash-Flow Insolvency
- Balance-Sheet Insolvency
When Does a Company File an Insolvency Petition?
A company enters cash-flow insolvency when it cannot pay its debts on time but still has enough assets to cover those debts. In contrast, balance-sheet insolvency occurs when the company owes more than the value of its assets. Even in balance-sheet insolvency, a company may have enough liquidity to pay its next bill on time. However, most laws restrict companies from paying bills unless it benefits all creditors.
For example, if you own a company that has entered insolvency and you require more workers to boost production, investors may agree to finance those workers if it helps them recover their debts.
India’s Insolvency and Bankruptcy Code (IBC)
India introduced the Insolvency and Bankruptcy Code (IBC) in 2016, a law aimed at streamlining insolvency and bankruptcy cases. The IBC serves as a unified law for resolving insolvencies, replacing previous systems that were slow and inefficient. The Code protects the interests of small investors and makes business operations simpler and more reliable.
Key Features of the IBC
- Insolvency Resolution Process: The Code outlines distinct procedures for insolvency resolution for individuals, companies, and partnership firms. Debtors and creditors can initiate the process. The Code sets a specific timeline for completing the process, making it efficient for both corporations and individuals.
- Bankruptcy and Insolvency Adjudicator:
The IBC assigns two different tribunals to handle insolvency cases:- The National Company Law Tribunal (NCLT) for corporate debtors and limited liability partnership firms.
- The Debt Recovery Tribunal (DRT) for individuals and partnerships.
Where to File an Insolvency Petition?
For companies and LLPs, creditors or the company itself can submit a plea for insolvency to the National Company Law Tribunal (NCLT). For individuals and partnerships, the petition is submitted to the Debt Recovery Tribunal (DRT). The tribunal has 14 days to accept or reject the plea.
Once accepted, the NCLT appoints an Insolvency Resolution Professional (IRP) to prepare a resolution plan within 180 days, extendable by an additional 90 days if needed. During this time, the Corporate Insolvency Resolution Process (CIRP) begins, and the company’s board of directors is suspended. The promoters lose control over the management of the company, but the IRP can seek the company’s cooperation to manage daily operations. If the company cannot be revived during the CIRP, the liquidation process begins.
Why These New Laws Matter
The government implemented these new laws to expedite insolvency proceedings and reduce risks for investors. The IBC aims to resolve insolvency cases quickly and prevent long-drawn legal battles that deter investors.
If you are facing insolvency as a company owner or suspect that a company you’ve invested in may become insolvent, this article should give you a clearer understanding of what steps to take. While this article provides an overview of the laws, it is highly recommended that you consult an insolvency lawyer for detailed guidance.
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Legal Disclaimer:
The information in this blog is for educational purposes only and should not be taken as legal advice from The Aran Law Firm or its authors. It is not a substitute for professional legal counsel.
