Corporate Insolvency Resolution Procedure

In common parlance, insolvency and Bankruptcy are often used interchangeably. However, there is a thin line of difference between these two words.

In common parlance, insolvency and  bankruptcy is often used interchangeably. However, there is a thin line of difference between these two words.

THE TERM ‘INSOLVENCY’ AND ‘BANKRUPTCY’:

In common parlance, insolvency and  bankruptcy is often used interchangeably. However, there is a thin line of difference between these two words.
Insolvency is a financial situation, where an entity or an individual is unable to meet the financial obligations due to excess of liabilities over assets, whereas, Bankruptcy is a legal procedure where the court of law passes orders concerning insolvency of an individual or entity and consequently passes orders for its resolution.
Thus, an individual or an entity can be insolvent without being bankrupt and insolvency can lead to bankruptcy if the insolvent individual or entity is unable to overcome the financial catastrophe.

CORPORATE INSOLVENCY - MEANING:

A company is declared insolvent if it is unable to pay its debts to its creditors. Following are two ways to check for corporate insolvency:

1. The Cash-Flow Test: Is the company currently or in future will it be unable to pay its debts as and when they fall due for payment?
2. The Balance Sheet Test: Are the value of the company’s assets less than the number of its liabilities after taking into account as-yet uncertain and future liabilities?

If the answer to any of the above questions is positive then the company is declared insolvent. A company can be declared as insolvent also if:

• A creditor who is owed more than £750 has served a formal demand for an undisputed sum at the company’s registered office, the debt has not been paid for three weeks
• A judgment or other court order has not yet been satisfied.

CORPORATE INSOLVENCY RESOLUTION PROCESS:

Corporate Insolvency Resolution Process (CIRP) is a recovery mechanism for creditors. If a corporation becomes insolvent, a financial creditor, an operational creditor, or the corporate itself may initiate CIRP.

• Financial Creditor could be any person to whom a business debt is owed or a person to whom such amount is legally assigned or transmitted. For example, Banks or other financial institutions
• Operational Creditor could be any person to whom an operational debt is owed and includes any person to whom such amount has been legally assigned or transferred for goods or services done by them. For example, vendors and suppliers, employees, government etc.

The Insolvency and Bankruptcy Code, 2016 provides a provision for an application for insolvency or bankruptcy of start-ups, individuals, partnership firms, limited liability partnerships, and companies. The Code has provided a slab of default amount in each category however the final amount is to be notified by the Government as the trigger point to initiate the proceeding while keeping in view the fluctuation of the economy. It is important to understand that the said amount is not the minimum or maximum fixed amount of debt default but it is a ‘range’.

CIRP is initiated after making an application. CIRP is the process through which it is determined whether the person who has defaulted is capable of repayment or not. If a person is not capable of repaying the debt the company is restructured or liquidated. Following are the steps to be followed for resolution or liquidation of a corporate:

1. Application to NCLT: A financial or operational creditor of the company or the company itself can apply to the National Company Law Tribunal (NCLT). The application is made to admit that the Company (Corporate Debtor as per IBC) is into the corporate insolvency resolution process. For this, the creditor needs to show the default payment of a debt that exceeds INR 1,00,000 and within 14 days the NCLT has to pass an order either admitting or denying the application. There are different obligations that a financial and an operational creditor have to comply with when making their applications before NCLT. A financial creditor needs to submit the record of the default whereas an operational creditor needs to first make a demand for his unpaid debt. Based on an ongoing dispute, it is open to the corporate debtor to defend the claim.

2. Interim Resolution Professional & Moratorium: When a corporate debtor is admitted into the CIRP, it suspends the board of directors. Also, the management is placed under an independent ‘interim resolution professional’.  Further, from this point onward the management ceases to have any control over the company affairs till the end of the CIRP. Simultaneously, a moratorium becomes effective which prohibits:

• Continuation or initiation of any legal proceedings against the corporate debtor
• Transfer of its assets
• Enforcement of any security interest
• Recovery of any property from it by an owner
• Suspension or termination of the supply of essential goods and services, the moratorium lasts till the corporate debtor is in CIRP

However, the moratorium does not extend to key business contracts entered into by the corporate debtor.

3. Verification and Analysis of Claims: At this stage, an interim resolution professional will summon and verify the claims made by the creditors and also classify them. After that, within 30 days of acceptance into CIRP, will form a Committee of Creditors (COC) which comprises of all the financial creditors of the corporate debtor.

4. Appointment of Resolution Professional: Within seven days of forming of the committee, the COC will have to either resolve to appoint the interim resolution professional as a resolution professional or to replace the interim resolution professional with another resolution professional.

5. Approval of the “Resolution Plan”: A resolution plan for the revival of the company must be approved within 180 days from the commencement of CIRP by creditors. The NCLT can extend this period by another 90 days. Any person, management, the creditors or a third party can propose such a plan. The resolution professional is responsible to ensure that the plan meets the criteria set out in the Insolvency and Bankruptcy Code, 2016.

• If a plan is approved within this period and sanctioned by NCLT: The approved resolution plan becomes binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan. It is the duty of the resolution professional to obtain all necessary approvals required under any law for the time being in force within  one year from the date of approval by adjudicating authority.
• If no resolution plan is approved within the said period: In case the resolution plan is not approved then NCLT is obliged to order the liquidation of the corporate debtor. After the approval of liquidation, COC appoints the liquidator to sell the assets of the corporate debtor and share them among the stakeholders. The distribution is made according to section 53 of the Insolvency and Bankruptcy Code 2016.