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What is Insolvency and Bankruptcy Code (IBC)

05 August 20226 mins read by Angel One
What is Insolvency and Bankruptcy Code (IBC)
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With the introduction of the IBC, all existing insolvency laws have been consolidated into one robust, sophisticated and modern framework. Corporate debtors in distress are encouraged to resolve their financial difficulties and, failing that, to liquidate in a time-bound manner.

Insolvency and Bankruptcy Code aims to provide an efficient legal framework to provide quick solutions to Insolvency and Bankruptcy cases. The code will facilitate the development of credit markets, encourage entrepreneurship, and facilitate more private investments to lead to higher economic growth and development.

Insolvency applies to both individuals and organizations. A state of insolvency arises from an inability to pay debts due to a lack of cash flow, and bankruptcy is a legal declaration of insolvency. In IBC, insolvency is a situation in which assets do not meet liabilities. When left untreated, insolvency leads to bankruptcy for noncorporations and liquidation for corporations. Investors put their money into debt investments in exchange for promises of fixed future cash flows. Despite that, the returns on these investments are still uncertain due to the time of repayment. Either the corporation or individual will pay up as promised, or they fail to. Debtors who fall into this category are considered insolvent. In addition to outright fraud, a debtor may be insolvent for the following reasons:

  1. Financial Failure: An apparent mismatch between payments by the enterprise and receivables into the enterprise, despite the business model generating revenues or
  2. Business Failure: The business model fails to generate enough revenue to cover the company’s obligations.

The provision of the IBC applies to:

(1) A company that has been incorporated under either the Companies Act of 2013 or any previous legislation;

(b) A company governed by any special Act in force at the time, except to the extent that the said provisions are inconsistent with such special Acts;

(2) A Limited Liability Partnership incorporated under the Limited Liability Partnership Act of 2008;

(d) Any other corporation authorized under any law currently in force, as specified by the Central Government by notification;

(e) Partnerships and individuals, if they have been insolvent, liquidated, deed in lieu of liquidation, or if they are bankrupt

Key Definitions of IBC:

  1. “corporate applicant” means –

(a) corporate debtor; or

(b) A member of the corporate debtor or partner authorized by the corporate debtor’s constitution to apply for corporate insolvency; or

(c) A person responsible for managing the operations and resources of the corporate debtor; or

(d) A person whose primary responsibility is to supervise and control the corporate debtor’s financial affairs;

  1. “corporate debtor” refers to a corporation that owes a debt to someone else;
  2. “creditor” means a party to whom a debt is owed, including a financial creditor, an operational creditor, a secured creditor, an unsecured creditor, and a decree-holder;
  3. “debt” is a liability or obligation arising from a claim for which a person may be responsible, including both financial debt and an operational debt;
  4. “default” occurs when the debtor, or the corporate debtor, does not pay its debt, whether in whole or in part, when it becomes due and payable and has not been repaid;

A firm’s financial creditor, operational creditor, or the firm itself can initiate a corporate insolvency resolution process as suggested under Chapter II of the IBC.

IBC provides for resolution of the corporate insolvency process (CIRP) within 180 days with an extension of 90 days from the date of admission. For applications made under Sec 45 of IBC, fast-track insolvency, the resolution must be passed within a period of 90 days with an extension of 45 days.

After commencement of the CIRP, the Adjudicating Authority shall by order declare a moratorium on:

  1. Institution of suits and the continuation of pending suits
  2. Liquidating or disposing of any of the assets of the corporate debtor.
  3. Any action to foreclose, recover or enforce any security interest created by the corporate debtor over its property.
  4. Recovery of property by an owner or lessor where such property is under the ownership of the corporate debtor.

However, the provision of essential goods or services to the corporate debtor shall not be halted, suspended, or interrupted during the period of insolvency. The moratorium will last until the completion of the corporate insolvency resolution process.

Meanwhile, the resolution professional shall conduct the entire corporate insolvency resolution process and manage the operations of the corporate debtor during the corporate insolvency resolution process period.

The IBC also requires the resolution professional to examine the resolution plan submitted by the applicant. Post examination, the resolution plan is sent for approval to the Committee of Creditors (CoC). With this, the CIRP ends. CIRP either results in a successful resolution of the issue, or the corporate debtor is liquidated.

The NSW National Company Law Tribunal (NCLT) received information about 4,376 companies between December 1, 2016 (when the CIRP provisions became effective) and March 31, 2021 (when valid data is available). Approximately 23 percent of the cases admitted were settled or withdrawn after the start of the CIRP. It is ironic that out of 1420 cases that were resolved with the CIRP, 3.6 times were liquidated.

79 percent of the 4,376 cases under IBC are pending for more than 270 days, and insolvency resolution takes, on average, 492 days to conclude. One hundred thirty-eight cases of liquidation, which were completed at the end of FY21, only resulted in 3.4%, or Rs 601.7 crore, being paid to creditors.

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