Consequences of Insolvency in India

Introduction

Insolvency is a state of being unable to pay the debts owed by a person or an entity. Bankruptcy is a legal process that declares a person or an entity as insolvent and discharges them from their liabilities. In India, the insolvency and bankruptcy proceedings for individuals, partnership firms, and companies are governed by the Insolvency and Bankruptcy Code, 2016 (IBC). The IBC aims to provide a time-bound and efficient resolution of insolvency and bankruptcy cases while maximizing the value of the assets of the debtor and protecting the interests of the creditors.

Consequences for Individuals

According to the IBC, an individual can be declared insolvent if he or she is unable to pay a debt of Rs. 1000 or more within three months of the demand notice from the creditor. The creditor can file an application before the Debt Recovery Tribunal (DRT) to initiate the insolvency resolution process (IRP) against the debtor. The DRT will appoint a resolution professional (RP) to manage the affairs of the debtor and prepare a repayment plan with the consent of the creditors. The repayment plan will specify the duration, manner, and amount of repayment by the debtor. The DRT will approve or reject the repayment plan within 180 days of the application. If the repayment plan is approved, the debtor will be discharged from his or her debts after fulfilling the obligations under the plan. If the repayment plan is rejected or fails, the creditor can file an application for bankruptcy before the DRT.

The consequences of bankruptcy for an individual are as follows:

• The bankrupt will lose control over his or her assets, which will be vested in a bankruptcy trustee appointed by the DRT. The trustee will liquidate the assets and distribute the proceeds among the creditors according to their priority.
• The bankrupt will be subject to certain restrictions and disabilities, such as being disqualified from holding certain public offices, being barred from entering into certain contracts, being prohibited from creating any charge on his or her property, being prevented from travelling abroad without permission, etc.
• The bankrupt will be discharged from his or her debts after a period of three years from the date of bankruptcy order, unless extended by the DRT for a maximum of two more years. The discharge will release the bankrupt from all liabilities in respect of his or her debts, except those that are non-dischargeable under the law, such as fraud, wilful default, maintenance obligations, etc.

Some relevant provisions of law and judgments for individuals are:

• Sections 78 to 187 of the IBC deal with insolvency resolution and bankruptcy for individuals and partnership firms.
• In Anand Rao Korada v. Varalakshmi Korada¹, the National Company Law Appellate Tribunal (NCLAT) held that a personal guarantor who has given a guarantee for a corporate debtor can also be subjected to insolvency proceedings under Part III of the IBC.
• In SBI v. Ramakrishnan², the Supreme Court upheld the constitutional validity of Section 14(3) of the IBC, which provides that a moratorium declared under Section 14(1) shall not apply to a personal guarantor of a corporate debtor.

Consequences for Companies

According to the IBC, a company can be declared as insolvent if it defaults on a debt of Rs. 1 lakh or more but the same has been increased to Rs.1 crore with effect from 24.03.2020. The creditor or the company itself can file an application before the National Company Law Tribunal (NCLT) to initiate the corporate insolvency resolution process (CIRP) against the company. The NCLT will appoint an interim resolution professional (IRP) to take over the management and operations of the company and form a committee of creditors (CoC) to decide on its fate. The CoC will evaluate various resolution plans submitted by potential resolution applicants and select one that maximizes the value of the company’s assets and ensures its viability. The NCLT will approve or reject the resolution plan within 180 days of the application, which can be extended by another 90 days in exceptional cases. If the resolution plan is approved, the company will continue as a going concern under the supervision of the resolution professional (RP) and the terms of the plan. If the resolution plan is rejected or fails, the company will go into liquidation.

The consequences of liquidation for a company are as follows:

• The liquidator appointed by the NCLT will take custody of the company’s assets and sell them in a transparent manner.
• The proceeds of the sale will be distributed among the stakeholders according to the priority of their claims, as specified in Section 53 of the IBC.
• The liquidator will also initiate actions to recover any dues from the directors, promoters, or other persons who are responsible for the insolvency of the company.
• The liquidator will dissolve the company after completing the liquidation process and obtaining the approval of the NCLT.
• The dissolution will terminate the existence of the company and release it from all liabilities, except those that are non-releasable under the law, such as fraud, malfeasance, etc.

Some relevant provisions of law and judgments for companies are:

• Section 4 to 77 and 188 to 255 of the IBC deal with insolvency resolution and liquidation for corporate persons.
• In Swiss Ribbons Pvt. Ltd. v. Union of India³, the Supreme Court upheld the constitutional validity of the IBC and its various provisions, such as the role of the CoC, the threshold for initiating CIRP, the exclusion of operational creditors from the CoC, the bar on promoters from submitting resolution plans, etc.
• In Essar Steel India Ltd. v. Satish Kumar Gupta⁴, the Supreme Court held that the NCLT and the NCLAT have limited judicial review over the commercial decisions of the CoC and cannot interfere with the distribution of the resolution plan proceeds among the creditors.

Conclusion

The insolvency and bankruptcy laws in India aim to provide a speedy and efficient resolution of insolvency and bankruptcy cases, while balancing the interests of the debtors and the creditors. The consequences of being declared as insolvent vary depending on whether the debtor is an individual or a company. The debtor may lose control over his or her assets, face certain restrictions and disabilities, and be discharged from his or her debts after a certain period of time. The creditor may recover some or all of his or her dues from the debtor’s assets or from the resolution plan proceeds. The insolvency and bankruptcy laws also seek to promote entrepreneurship, availability of credit, and maximization of value of assets in the economy.