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Insolvency, Resolution, Bankruptcy and Liquidation

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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:


Benefits of this approach


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.


Also See

Contributed by

Dr. Shashank Saksena (IES 1987) and Ms. Rose Mary K. Abraham (IES 2006)

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