Small Businesses

Complete guide to Bankruptcy

Bankruptcy Code

Complete guide to Bankruptcy rules in India

In today’s tough times when we are faced with pandemic worldwide, many businesses are falling apart. Managing running costs and paying the fixed liabilities is becoming challenging. Even if you are able to sail through few months, road ahead is not clear. Amidst all this, if you have debt problems, you as a company might be at the verge of going bankrupt- but what would it mean? It’s important to understand what bankruptcy is and what alternatives are available as per Indian laws. Good news is bankruptcy isn’t permanent, the process in India is such that it might clear your debts and allow you to start again. Here is a complete guide for the company!

What is insolvency?

The inability to pay debts is something which refers to the state of insolvency. So, when you own money to your creditors and are unable to honor the commitments and default by non-payments of dues, it leads to insolvency.

Reasons of insolvency

The Bankruptcy Law Reforms committee observed in their report that insolvency can be due to following reasons:

  • Financial failure- a persistent mismatch between payments by the enterprise and receivables into the enterprise, even though the business model is generating revenues, or
  • Business failure- which is a breakdown in the business model of the enterprise, and it is unable to generate sufficient revenues to meet payments.

Say e.g, if the you are running business and there is a profit of 50000 from the sale of 200000 worth of goods. Now in order to place further orders, you need to receive the sale proceeds but your debtor but he has defaulted. Thus, you are unable to place further orders and run your business. This is called financial failure when you were running profitability but due to the difficulty in realizing your debtors you facing challenges.

Let’s take another example, say from sale of 200000 worth of goods, you have costs of 250000 and thus have a loss of 50000. Even of the debtors have repaid 200000 but still you need to pay to your creditors 250000 and unable to service those commitments. This may be a case of business failure.

Now in order to run your business you may enter into several arrangements with your creditors for instance buy more time to repay the outstanding dues or restructure the debts into equity etc. say you have to pay 100000 to your creditor since you have cash flow issues, you have agreed with your creditor to convert the same into equity thus giving him a share in profit. This may be a simple form of restructuring debts.

What is bankruptcy?

Now even after several efforts if you are not able to service your creditors then you may want to resort to law and declare that you are unable to re-pay your debts or clear your liabilities on time and legal re-course should be taken to arrive at some solution to this problem. In simple words, this stage is bankruptcy. Therefore, bankruptcy is legal process that serves the purpose of resolving the issue of insolvency or inability to your liabilities. Under Indian laws, by way of new IBC code, it also serves as a mechanism to establish and explore the ways to continue the business by bringing a consensus and an arrangement with the creditors or lenders of the company. This process is called corporate insolvency resolution process or CIRP.

What is liquidation?

Bankrupt

If even after the CIRP process no common resolution can be arrived at to revive the company and it is decided to close the business then the company goes for liquidation. The process to close the business, so that the assets can be sold to repay the debts of the company is called liquidation.

Thus, liquidation is the last step and amounts to closure of the entity.

What are the bankruptcy laws governing Indian companies?

The current governing law for bankruptcy in India is “Insolvency and Bankruptcy Code, 2016“(IBC, 2016). All the petitions for bankruptcy lie under the provision of this code. This code was enacted on 28 May 2016. It deals with both, individual and corporate insolvency. So, be it a corporate person or a partnership firm or an individual, whatever is the legal form of applicant, the bankruptcy process is now covered and guided by IBC 2016. Although the sections relating to individual insolvency are yet to be notified.

Earlier the bankruptcy and insolvency process in India was elaborate and multi-layered. The legislative process was covered over multiple laws, and adjudication took place in multiple fora. For example,

  • Individual bankruptcy and insolvency: The Presidency Towns Insolvency Act, 1909 and The Provincial Insolvency Act 1920 covered insolvency of individuals, including individuals as proprietors. Once the sections governing the individual insolvency under IBC code are active, these laws would get repealed.
  • Corporate bankruptcy and insolvency: Companies are registered under the Companies Act, 2013. Limited liability partnerships are registered under the Limited Liability Partnership Act, 2008. The Micro, Small and Medium Enterprise Development Act, 2006, registers MSMEs but does not yet have provisions for resolving insolvency and bankruptcy. The law for rescue and rehabilitation remains the Sick Industrial Companies (Special Provisions) Act (SICA), 1985, although it applies exclusively to industrial companies. All these laws have different provisions depending upon which law is applicable to the entity basis its legal form. Now the SICA has been repealed. The provisions relating to liquidation on account of inability to pay debts under companies act 2013 have been removed and these are now under IBC code.
  • Debt recovery: As a lender, a civil court of relevant jurisdiction is the basic mechanism that is available to any creditor for debt recovery. If the loan is backed by security, this is enforced as a contract under the law. So again, different laws when the applicant is a creditor. This is now bought under IBC to the extent of matters relating to corporate insolvency.

So, with the enactment of a unified code IBC, 2016, the purpose was to consolidate all the laws & provisions relating to insolvency in one place and expedite the process.

Who is covered under bankruptcy code?

The code applies to corporates and individuals. The corporates are called corporate debtor and covers companies and LLPs. Individuals cover individual persons, partnerships, HUF and trusts. It is to be noted that the provisions relating to corporate insolvency have only been notified yet. Therefore, they are applicable. As far as the individual insolvency provisions are concerned, they are yet to be notified. Therefore, old laws are applicable at the movement as far as individual insolvency is concerned.

IBC has 255 sections and is divided in five parts.
Part 1: for definitions & objectives
Part2: for provisions relating to corporate insolvency i.e CIRP
Part 3: for provisions relating to individual insolvency- yet to be notified
Part 4: for regulatory framework
Part 5: for miscellaneous provisions

Who regulates bankruptcy laws in India?

Regulator

IBBA is the Insolvency and Bankruptcy Board of India is the regulatory body which is responsible for implementation of the IBC in India. It also has regulatory oversight over the Insolvency Professionals, Insolvency Professional Agencies, Insolvency Professional Entities and Information Utilities. Like we have RBI for banks to regulate the banking sector, we have IBBA for regulating the insolvency & bankruptcy related affairs governed by IBC.

Adjucating authority

Adjucating authority is the forum where the applications for the insolvency are made. Since the courts in India are already burdened with a variety of cases, therefore these applications are heard and made at National Company Law Tribunal (NCLT) for corporate insolvency cases. The National Company Law Tribunal is a quasi-judicial body in India that adjudicates issues relating to Indian companies.

With respect to individual insolvency cases the right forum although still remains to be courts till the IBC is made applicable for individual insolvency cases. Once that is implemented then these applications with go to the Debts Recovery Tribunal (DRT).

Appeals can be made against the orders of NCLT and DRT to Honorable Supreme court.

What is the trigger for bankruptcy petition?

The IBC code does not anywhere define insolvency or bankruptcy, it rather defines default which can trigger the insolvency. Hence the proceedings under bankruptcy code get triggered once there is any default in the payment of any amount that is due and payable by the company.
You may own the amount to various stakeholders like creditors, lenders, statutory dues, employee dues, etc. If there is default in payment of due amounts, then insolvency code may be get triggered against you.

It is not defined that for many months of defaults can be accepted and bypassed. Like for instance, in banking sector, an asset becomes an NPA (non- performing asset) after 90 days default. However, for the purpose of the IBC, no such time period has been prescribed. Even single default in payment of installment, which has become due and payable, will be sufficient to trigger the insolvency code. So if a loan is taken from bank for 20 years and say one installment which is due, at the end of 4th year, is unpaid , then this is default and thus the banker may initiate insolvency proceedings against the company and in such case, entire amount remaining to be paid over next 16 years, will become payable.

This is so because once the insolvency proceedings are initiated then not only the default amount rather the entire claim against the company the becomes payable to the creditor.

Process for bankruptcy application- CIRP

The petition for bankruptcy starts with filing an application with the relevant authority which is NCLT (National Company Law Tribunal) for corporate insolvency petitions. If the application is accepted then the proceedings will start. The board agenda of the entire process is to find out if the company can be revived. The underlying principal of IBC code is first try and see if the company can be survived and can be brought out of distress by way of some restructuring or giving away the affairs of the company’s management in better hands. If all the revival options are exhausted, then as a last resort company moves to liquidation. But the entire fate of the company from insolvency to its liquidation is decided by creditors of the company as soon as the application is initiated. This process is called CIRP or corporate insolvency resolution process. The application for CIRP can be initiated by:

  • The company itself (i.e. corporate debtor) which the company in distress. So, if the company is in finding difficult to carry on the affairs and decides to go in for bankruptcy then it may file for its on bankruptcy. The entire CIRP process will be followed in the same manner as if the bankruptcy application is filed by any other applicant as below.
  • The lenders (i.e. financial debtor). Any lenders or bankers or financial institutions who have advanced loans to the company and if there are defaults in part or full in any of the installments, then they may file for the bankruptcy application against the company with NCLT. The amount of default originally was Rs. 1 lac and it has been raised to Rs. 1 crore in march 2020. Now it is with NCLT to check the merits of the case and allow and reject the application. If the application is allowed then the CIRP process will begin.
  • The creditors (i.e. operational debtor). Creditors means the operational creditors of the company

Check out this video below that explains the above in deatil.

Can your lenders file for your bankruptcy?

The lenders are called financial creditors in the terms of law laid down in IBC code. So a financial creditor either by itself or jointly with other financial creditors may file an application for initiating corporate insolvency resolution process against the company. Following 3 requirements are there:

  • Default: There should be amount that the company owns to lender and there is a default as per the agreed terms in the repayment of the installment or interest in part or full. They need to furnish the details of the default along with the application
  • Amount of default: it should be minimum default of 1 crore.
  • Resolution professional: They need to propose the name of the resolution professional. Who is a resolution professional? They are the professionals who conduct the insolvency resolution process. Are you looking for one? Let us know.

Even if the default amount is in dispute still the lender can proceed with the petition and it shall be maintainable.

Once bankruptcy proceedings have started, you must co-operate fully even if it’s a creditor’s petition and you dispute their claim. If possible, you should try to reach a settlement before the petition’s due to be heard – doing it later can be difficult and expensive.

Can your creditors file for your bankruptcy?

Creditors are called operational creditor in terms of law laid down in IBC code. Yes, the creditor may file an application for initiating the corporate insolvency resolution process against the company. The requirements are same as in case of lenders.

Only difference is that if the default amount is disputed then the creditor can not file the petition as it is not maintainable.

Can the company file for its own bankruptcy?

Yes, the company can file for its own bankruptcy too. The requirements are again more or less same as in case of lenders or creditors.

  • Default: That the company has defaulted in payment of its dues and is facing financial distress.
  • Amount of default: it should be minimum default of 1 crore.
  • Resolution professional: Propose the name of resolution professional.
  • Pass board resolution with 2/3 majority for proceeding for insolvency.

Where to file for bankruptcy and what is the fees involved?

The applications under IBC code for bankruptcy petition are made to the NCLT in case of corporate insolvency and to DRT for the individual insolvency. These are Adjudicating Authority in the Insolvency Proceedings.

The petition can be made to the tribunal which has jurisdiction of the area, where the registered office of the company is situated.

For example, the registered office is Ghaziabad and place of business is Delhi, then we have to see which tribunal covers the Ghaziabad area since that is the registered office of the company. So it Allahabad NCLT, hence the petition can be made there.

Fees for application is Rs. 25000 if filed by financial creditor or company itself whereas it is Rs,2000 in case filed by operational creditor.

Who deals with your bankruptcy?

Insolvency resolution professionals (IRP) are appointed the movement petition is accepted in tribunal. From thereon the affairs of the company are taken over by them. They report to the committee of creditors (CoC) who act as Board.

Essentially the company’s board and management are taken over and given away to IRP and CoC.

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