Written by : AK Agrawal

An experiences Chartered Accountant and Techno-Functional consultant working in industry for over 10 years dealing with multinational corporate clients. He is loves reading latest trend of technology trend.

What Is An Insolvent Company And How To Judge Its Insolvency?

AK Agrawal
AK Agrawal, Chartered Accountant

Jul 26, 2021 13:41

Businesses entities and individuals often fail to pay their liabilities, leaving them helpless as insolvent. Insolvency is an adverse situation wherein a firm or individual cannot meet its financial obligations to creditors when debts become due.

Before starting official insolvency procedures, the company or individual may attempt to reach an informal agreement with their creditors, such as designing alternative payment arrangements. Individuals and businesses both can be classified as 'insolvent,' however, bankruptcy is a much more commonly used term for individuals.

In India, the number of companies applying for insolvency has risen by 123 per cent, as per the Insolvency and Bankruptcy Board of India report.

Insolvency Types

There are two forms of insolvency

Cash-flow Insolvency

This occurs when a company or individual has adequate assets to pay its creditors but lacks the appropriate payment method. The absence of a liquid assets portfolio to meet liabilities or debt commitments is referred to as cash flow insolvency. Negotiation works like a charm in such situations. For instance, the supplier or creditor might be fine to wait for the final amount of repayment, allowing the debtor sufficient time to sell assets and convert them to cash.

Balance sheet Insolvency

Balance-sheet insolvency situations occur when a company or individual doesn’t have enough assets to satisfy its financial commitments to creditors. The firm or individual seems to have a net loss. There is a considerably greater chance that bankruptcy proceedings would be filed in such cases. A balance-sheet bankrupt firm may nevertheless have enough cash on hand to pay its next bill on time.

Signs of Insolvency

The proverb "precaution is better than cure" is completely applicable in situations of companies nearing insolvency. As a firm begins to falter, you must recognize some critical warning signals of company insolvency and take action to reduce the risk before it is too late.

Let's look at the warning signs of company insolvency.

  • There is an insufficient cash flow.
  • The company is under creditors' pressure.
  • The firm is operating within the limits of your overdraft.
  • The company fails to pay its employees' salaries.
  • You are defending yourselves against bailiffs.
  • You have a limited understanding of your finances or cash flow reserves daily.

Most businesses ignore or fail to detect warning signs, then wait until it is too late. While it is typically possible to turn around a company, the recommended approach is to intervene early to beat the worst-case scenario. Business owners should maintain a close eye on their operations and act quickly if any warning signs occur.

Which laws oversee the insolvency process in India?

IBC or the Insolvency and Bankruptcy Code, 2016 is India's bankruptcy legislation that attempts to unify the current framework by establishing a single law for bankruptcy and insolvency. The Lok Sabha passed it on May 5, 2016, and the Rajya Sabha on May 11, 2016. Certain Act sections went into effect on the 5th and 19th of August, 2016.
The bankruptcy code is a one-stop-shop solution for resolving insolvencies, which was formerly a time-consuming procedure that did not provide an economically feasible solution. The code's goal is to safeguard the interests of small investors while enabling conducting business easier. The IBC is divided into 255 parts and 11 Schedules.

The code establishes distinct insolvency resolution methods for individuals, companies, and partnership entities. The procedure can be started by either the debtor or the creditors. For corporations and individuals, a maximum time limit for completing the insolvency resolution procedure has been set.

The insolvency process

The Indian Insolvency & Bankruptcy Code establish legally enforceable and long-term corporate, partnership, and individual insolvency procedures. This handbook focuses on the Corporate Insolvency Resolution Process ( referred to as "CIRP"). The code defines CIRP as a process undertaken by a financial creditor, operational debtor, or the corporate debtor itself when the corporate debtor fails to make the payment.

CIRP is completed in six steps, with variable elements remaining constant. The following are the stages:

NCLT Petition

When a firm fails to make payments to its creditors, as mentioned above, the creditors have the right to file a CIRP petition with the Adjudicating Authority- the National Company Law Tribunal (NCLT). The method for starting proceedings and other procedures to be followed differs depending on the creditor category.

The interim resolution professional (IRP)

After a corporate debtor is admitted to the resolution procedure, the Adjudicating Authority (NCLT) appoints an Interim Resolution Professional (IRP) based on financial creditors' suggestions. The IRP takes over the accountability of managing the business entity's affairs. The corporate debtor's current staff will back the IRP, and their term will remain till the Resolution Professional's appointment date.

Moratorium phase

The moratorium period begins once the tribunal approves the petition. According to Section 14 of The Code, when this time is declared, the tribunal forbids:

  • Transfer of its assets
  • The cessation or suspension of the supply or provision of critical goods and services
  • Initiation or continuation of any legal actions against the corporate entity/corporate debtor.
  • Property recovery by the owner from the debtors.

The moratorium period lasts until the CIRP procedure is completed. The period's maximum duration is 180 days, with a 90-day extension permitted in extreme situations.

Collation and analysis of claims

The IRP is in charge of classifying and analyzing the allegations presented in the petition by the petitioner. During this stage of the process, the IRP must examine and analyze all corporate debtors' information, including but not restricted to assets and debts, company activities, financial and operational payments over the preceding two years. The IRP appoints a Committee of Creditors (COC) made up of all of the company debtor's financial creditors.

Plan for Resolution

Following the IRP/collation RP's and verifying the petitioner's claims, the COC must make an official declaration. The declaration is indicative of company insolvency. Thus, by announcing that the corporate debtor is insolvent, all interested candidates or bidders are asked to submit a resolution plan that may ultimately be executed. The COC reviews the proposed resolution plans based on the amount of them. The proposal that receives approval from more than 75% of the COC is guaranteed to be showcased before the NCLT.

The Final Verdict

The COC-approved resolution proposal is presented to the NCLT. If the NCLT approves the resolution plan, it is implemented and legally obligatory on the principal debtor and all parties.
However, suppose the NCLT does not approve the plan of the resolution, or the COC is unable to finalize a joint resolution within the specified time frame. In that case, the Adjudicating Authority must order the company insolvency.

Currently, with the implementation of The Code, the insolvency procedure has been simplified, and a schedule for completion has been created.

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AK Agrawal
AK Agrawal, Chartered Accountant

Jul 26, 2021 13:41

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