What is insolvency and bankruptcy?
Insolvency, the word itself describes as a – state of confusion or which is unresolved. It is the situation in which an individual or an organization is unable to pay their debts. It shows the financial state of the organization.
So how can we understand that when the individual or organization is unable to repay?
(i) It can be identified from the balance sheet of the organization, like by checking its year by year sales increase or decrease, repayment tracks of the banks (loans), liabilities exceed the total assets.
(ii) If it is irregular, sales are not increasing and the company is in losses for more than 2 years then the firm is considered to be in a state of Insolvency.
(iii) On the other hand, Bankruptcy is when an individual or an organization is unable to pay the debts, then the court declares them as bankrupt. It is a legal status.
Aim– The aim of the Bill is to create an Insolvency Resolution Process (IRP) for the business entity, either by survival mechanism or by their speedy Liquidation.
Why is it important?
In India, the legal and institutional machinery for dealing with debt default has not been in line with global standards. The bankruptcy proceedings in our country are conducted by several laws such as – the Companies Act, SARFAESI Act, Sick Industrial Companies Act, and so on.
There is a lengthy process to finalize any case with courts, debt recovery tribunals and the Board for Industrial and Financial Reconstruction all having a say in the process.
The new code assembles and organizes all these laws to make the process simpler.
Industry anticipates that the change will provide an easy exit option for insolvent and sick firms. The passage of this bill will enable fast and speedy action to be taken in the early stages of the debt default by a firm, maximising the recovery amount. The creditors will not be blocked by official procedures and promoters will directly become responsible for any financial delays.
When and why this bill is proposed?
The Insolvency and Bankruptcy Bill is proposed on Dec 21, 2015, by Finance Minister, Shri Arun Jaitley in Lok Sabha. This is considered the biggest economic reform next only to GST.
The Bill is based on the recommendations of the Joint Parliamentary Committee on the insolvency and Bankruptcy Code, 2015. The government nodded by accepting the Joint Committee report “in toto” (in toto means completely, wholly, entirely) which will help the firm who is in danger to shut their businesses. Parliament passed the bill on 11th May 2016.
According to the World Bank’s Ease of Doing Business report 2016, it takes, on an average, more than four years to resolve insolvency in India. The new code seeks to cut down the time to less than a year.
As per the provisions of the bill, corporate insolvency applications will have to be decided on within 180 days, with an option of extending it by an additional 90 days.
In World Bank Group, “Ease of Doing Business”, 2016 – India ranked at 130thposition out of 189 countries, while India was in 134th position in 2015, only 4 positions up we came in 1 year, hence, this bill is proposed by understanding the importance of Economic Growth through businesses in India.
For the first time ever, India has jumped 30 positions to become the top 100th country in terms of Ease of Doing Business ranking. The World Bank Group’s latest Doing Business 2018 announced this.
The World Bank has credited the change in India ranking to the sustained business reforms it has undertaken ever since Modi government took charge a little over three years ago.
India’s ability to handle insolvency caseshas improved from 136th position last year, to 103 this year. The 33 point jump, which contributed most to help change India’s fortunes when it comes to World Bank’s Ease of doing business rankings this year was the long pending law the country enacted to fasten the process of winding up loss-making companies.
companies.
Now let’s understand this by taking an example of a firm who is doing business in India for 10 years.
For the expansion and to increase its business it recruited employees to the firm to manage the day to day activities and various departments of the firm.
To expand his business in other state or all over India,
the firm took a loan from Bank and the bank sanctioned a loan
on the basis of financials of the firm.
And If Unfortunately, the firm sales go down for more than 2 years, it can survive and salaried its employees for some time on the basis of past turnover but if the firm is not growing then
(i) What should be done?
(ii) How will this be managed?
(iii) Who will provide salary to the employees of the firm? They have to lose Job.
Here the case is with only one firm but in India, there are so many cases which are in the state of Insolvency. If they have to wind up the business, then all dues should be clear first. But if the firm is in loss how they can repay the loan/debt.
So, to resolve this kind of situation, The Insolvency and Bankruptcy Bill Code, 2015 has been passed to help the entities.
It is Applicable to – Individuals, Partnership firms, Companies, Limited Liability Partnerships and any other body specified by the central government.
How will this Bill help the Entities?
Under this Code, the firm can declare itself bankrupt (as it is now unable to repay the debt) and the case will be registered to the court and the process of Insolvency Resolution Process (IRP).
All the details a firm is having should be given to the court for the analysis and to check year by year financial trend.
First, the court will decide what should be done with the assets.
Then, the court will try to resolve the situation either by selling his business to other entities i.e. takeover process or Merger is also possible so that the firm should not get shut down and the employees will not have to lose their jobs.
Negotiation between debtors and creditors will take place during this period. If the negotiation has been done before registering the case, 75% of creditors must agree to a revival plan.
Insolvency Resolution Process
This is the process by which the court decision is going to be implemented.
1. Time period – There is a time period decided by the court to resolve the case, i.e, 180 days which is extendable up to 90 days. During this period, the negotiation will be done between debtors and creditors. If the case remains unresolved up to 180th day the company will go into Liquidation.
(Liquidation – Process of shutting down business and converting all its assets into cash and distributed to all the creditors and shareholders of the company)
2. IRP is managed by –
(i) Insolvency Professionals– They are licensed professionals. They control all the assets of the debtors or the firm during the negotiation process. Assets details like what kind of assets the firm is having, where they have mortgaged, its valuation at present, how many people own it. Whether it is under disputed or undisputed party, any legal case is going on or not, etc.
(ii) Insolvency Utilities- These utilities will maintain a range of financial information about firms, which will help in resolving the case. The financial information includes all the details of the business like income, expenditure, current liabilities, details of the creditors, debts, etc.
(iii) Insolvency Regulators– The code establishes the Insolvency and Bankruptcy Board of India. The board will have 10 members including one from central government and RBI. They will get all the details from the Insolvency Professionals, Insolvency Utilities and regulate all the functioning during the process.
(iv) Insolvency and Bankruptcy Fund– The code creates an Insolvency and Bankruptcy Fund in which all the deposits from central government, amount deposited by the person or firm, interest earned on an investment made from the fund.
(v) Offences and Penalties- There is a penalty for the offences like hiding the assets/property, defrauding, creditors, providing wrong information. The penalty will be imprisonment of up to 5 years, with a fine of 1 crore rupees. For Individuals, imprisonment will be based on the offence.
Who can Initiate the IRP-
1. Business or debtor who has defaulted on dues can initiate the IRP.
2. Lenders, creditors to a firm, including employees.
Why we need this Bill?
India is a capital-starved country. To run any business we need capital, firstly individual put their own money into the business for startups but after some time, they have to look for alternatives to run the business and generate income.
Due to paucity, the business faces losses and ultimately they have to shut the business if it does not run smoothly.
It will help in saving jobs and businesses in India which will lead to Economic Growth of India.
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