Insolvency is a state where the liabilities of an individual or an organization exceeds its asset and that entity is unable to raise enough cash to meet its obligations or debts as they become due for payment. Technically insolvency could be a financial state when the value of total assets of an individual or a group exceeds its liabilities.
Insolvency is the inability of a person or companies to pay their bills as and when they becomes due and payable. It is a situation where individuals or companies are unable to repay their outstanding debt. If insolvency cannot be resolved, assets of the debtor may be sold to raise money, and repay the outstanding debt.
Green Fruit ltd is a company that sells fruits and vegetables. As part of their financial structure they have to pay their debt service the 15th of each month. The company has been struggling recently with overdue account receivables. As a result the company’s cash flow has been suffering. On February 15th, the company didn’t have enough cash to make its debt payment even though it had more assets than liabilities.
This company is insolvent to a degree. Even though the company assets exceed its liabilities, the inability to meet its monthly obligation indicates that it is insolvent to a degree. Will the entire company go under because of this? Probably not, but if it persists, the company will most likely have to sell off its assets to pay back these obligations.
The term Insolvency is a state whereas Bankruptcy is the effect of that act. In legal terms, insolvency is a state where the liabilities of an individual or an organization exceeds its assets and that entity is unable to raise enough cash to meet its obligations or debts as they become due for payment. When an individual is unable to pay off his liabilities and debts then he generally files for bankruptcy. Here the entity asks for help from government to pay off his debts to his creditors.
The main reasons behind insolvency are primarily poor management and financial constraints. This is much more prevalent in smaller companies. Some common reasons for insolvency are:-
a) Bad debt- obviously money owned by customers
b) Management- failure to acquire adequate skills, imprudent accounting, lack of information system
c) Finance- loss of long term finance, over gearing or lack of cash flow
d) Other- for examples excessive overheads etc.
Bankruptcy is when a person or company is legally declared incapable of paying their due and bills.
When an individual is unable to pay off his liabilities and debts then he generally files for bankruptcy. Here is asks for help from government to pay off his debts to his creditors.
Bankruptcy could of two types, namely,
reorganization bankruptcy and
Usually people tend to restructure the repayment plans to pay them easily under reorganization bankruptcy. And under liquidation bankruptcy, the debtor tends to sell of certain of their assets to pay off their debts for their creditors.
Under bankruptcy law, the condition of a person or firm that is unable to pay debts as they fall due, or in the usual course of trade or business and financial condition such that businesses or persons debts are greater than aggregate of such debtors' property at a fair value.
Insolvency Vs. Bankruptcy - Differences
Insolvency is not the same as bankruptcy. Insolvency is a state of economic distress, whereas bankruptcy is a court order that decides how an insolvent debtor will deal with unpaid obligations. That usually involves selling assets to pay the creditors and erasing debts that can’t be paid. Bankruptcy can severely damage a debtor’s credit rating and ability to borrow for years.
An individual or company can be insolvent without being bankrupt — especially if the insolvency is temporary and correctable — but not the opposite.
Insolvency can lead to bankruptcy if the insolvent party is unable to successfully address its financial condition.
Insolvent companies can reverse course by cutting costs, selling assets, borrowing money, renegotiating debt or allowing themselves to be acquired by a larger corporation that agrees to take over the insolvent company’s debts in return for control of its products or services.
Liquidation is the process of winding up a corporation or incorporated entity. Liquidation in finance and economics is the process of bringing a business to an end and distributing its assets to claimants. It is an event that usually occurs when a company is insolvent, meaning it cannot pay its obligations when they are due.
Default means non-payment of debt when whole or any part or installment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be. In IBC, default means failure to pay whole or any part or installment of amount of debt or interest due of minimum Rs.1 Crore. Default amount under section 4 of IBC was Rs.1 Lakh, but after central govt. notification dated 24.03.2020, minimum default amount raised to Rs.1 Crore.
Corporate Applicant –
Corporate Applicant means
a) Corporate Debtor, or
b) A Member or the partner of the corporate debtor who is authorized to make an application for the CIRP under the constitutional documents of the corporate debtor, or
c) An individual who is in-charge of managing the operations and resources of the corporate debtor, or
d) A person who has control and supervision over the financial affairs of the corporate debtor;
Committee of Creditors (CoC) –
The committee of creditor formed under section 21 of the code and shall consist of all the financial creditors of the corporate debtor. The interim resolution professional after collation of claims and assessing the information of the debtor constitute a committee of creditors. There voting share shall be determined on the basis of the financial debt owed to them. Otherwise provided in the code, all the decisions of the committee of creditors shall be taken by a vote of not less than 51%. It shall require a resolution professional to furnish any financial information in relation to the corporate debtor during the resolution process.
The term Moratorium is nowhere defined in the Code, however, the term in basic parlance means, ”a stopping of activity for an agreed amount of time”. Under the Code, Moratorium is actually described as a period wherein no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or continued against the Corporate Debtor.
The Adjudicating Authority , whilst admitting a petition against the Corporate Debtor is required to declare the moratorium period as described under Section 14 of the Code.
The main purpose of declaring the moratorium period is to keep the Corporate Debtor’s assets intact during the CIRP, which otherwise may be attached by any competent court of law during the pendency of proceedings against the Corporate Debtor. In other words, the moratorium ensures that the time-bound completion of the CIRP and also that the corporate debtor may continue as a going concern.
Apart from staying the pending proceedings, the moratorium also casts a bar upon the directors of the company, who cannot use or take the amount available on the date of declaration of the moratorium in the company. If the moratorium period is not declared, the insolvency process will be frustrated which in turn will fail the objective of the Code.
Punishment - Under Section 74 of the IBC, officials of the corporate debtor who violate provisions of moratorium can be imprisoned for a minimum of three years, which may be extended up to five years. Such officials will also be fined a minimum of Rs 100,000 but not more than Rs 300,000. Officials of creditors who knowingly and willfully authorize or permit such contravention can be jailed for a minimum of one year, with a maximum tenure of five years. Such officials will also be fined a minimum of Rs 100,000, with the maximum penalty of up to Rs 10 million.
Further, the Hon’ble National Company Law Appellate Tribunal, vide its recent judgment has also held that in case any Director withdraws money from the account of the company during the moratorium period, he will be held liable for the criminal offences of misappropriation and breach of trust.
Resolution Applicant –
As per the Code, a Resolution Professional has to appoint a Resolution Applicant who in-turn is required to prepare different resolution plans for different stakeholders in corporate insolvency resolution process. The code defines the resolution applicant under section 5(25) “as a person who submits a resolution plan to insolvency professional”. A resolution plan specifies the details of how the debt of a defaulting debtor can be restructured.
Corporate Insolvency Resolution Process (CIRP) -
The creditor’s committee will take a decision regarding the future of the outstanding debt owed to them. They may choose to revive the debt owed to them by changing the repayment schedule or sell (liquidate) the assets of the debtor to repay the debts