Insolvency vs. Bankruptcy vs. Liquidation – Intro to IBC 2016 & Key Definitions

Table of Contents

1. Insolvency V. Bankruptcy V. Liquidation
2. Introductory Topics of IBC, 2016
3. Important Definitions (Sections 3 and 5)

Check out Taxmann's Corporate & Economic Laws (Law) | Study Material which presents the subject matter in a tabular format by arranging the contents section-wise with a sub-heading for each sub-section. It also covers all past exam questions of ICAI until May 2023, RTPs & MTPs of ICAI and chapter-wise marks distribution. 620+ questions & case studies with hints are also covered along with every topic for easy understanding.

CA Final | Nov. 2023 Exam

1. Insolvency V. Bankruptcy V. Liquidation

1.1 Insolvency

Insolvency is defined as a financial condition or state experienced when:

• a legal entity or a person’s liabilities (debts) exceeds their assets, commonly referred to as ‘balance-sheet’ insolvency or
• when a legal entity or person can no longer meet their debt obligations on time as they become due, commonly referred to as ‘cash-flow’ insolvency.
  Upon becoming insolvent immediate action must be taken to rectify the situation as soon as possible in order to avoid possible bankruptcy, by generating cash, minimizing overhead costs, cutting back on living expenses and settling or renegotiating current debts and debt repayments.

1.2 Bankruptcy

Bankruptcy is defined as a successful legal procedure that resulted from:

1. an application to the relevant court by alegal entity or a person in order to have themselves declared bankrupt; or
2. an application to the relevant court by a creditor of alegal entity or a person in order to have the legal entity or person declared bankrupt; or
3. a special resolution which a legal entity files with the Registrar of Companies in order to be declared bankrupt.

1.3 Insolvency leads to bankruptcy

Insolvency in this Code is regarded as a “state” where assets are insufficient to meet the liabilities. If untreated, insolvency will lead to

• bankruptcy for non-corporates and
• liquidation of corporates.

A state of insolvency can lead to bankruptcy but the condition may also be temporary and fixable without legal protection from creditors.

Hence, it is evident that insolvency is a state and bankruptcy is a conclusion. A bankrupt would be a conclusive insolvent whereas all insolvencies will not lead to bankruptcies. Typically, insolvency situations have two options:

• resolution and recovery or
• liquidation of corporates and bankruptcy of non-corporates.

1.4 Liquidation Relationship

Liquidation is the winding up of a corporation or incorporated entity. There are many entities that can initiate proceedings that will lead to Liquidation, those being:

• the regulatory bodies;
• the directors of a company;
• the shareholders of a company; and
• an unpaid Creditor of a Company.
• Insolvency is common to both bankruptcy and liquidation.
• Insolvency leads to Bankruptcy in case of Natural persons (Individual)
• Insolvency leads to Liquidation in case of corporation or Incorporated entity.

2. Introductory Topics of IBC, 2016

2.1 Regulatory Mechanism

The regulatory mechanism as per IBC, 2016 would be based on the following five pillars:

1. Insolvency and Bankruptcy Board of India (IBBI)
2. Adjudicating Authority
3. Insolvency Professional Agencies (IPA)
4. Insolvency Professionals (IP)
5. Information Utilities (IU)

2.1.1 Insolvency & Bankruptcy Board of India (IBBI)

Function of the Board is to exercise regulatory oversight over insolvency professionals, insolvency professional agencies and information utilities.

2.1.2 Insolvency Professional Agencies (IPA)

These agencies will develop professional standards, code of ethics and be first level regulator for insolvency professional members. This will lead to development of a competitive industry for such professionals.

2.1.3 Insolvency Professionals (IP)

In the resolution process, the insolvency professional verifies the claims of the creditors, constitutes a creditors committee, runs the debtor’s business during the moratorium period and helps the creditors in reaching a consensus for a revival plan. In liquidation, the insolvency professional acts as a liquidator and bankruptcy trustee.

2.1.4 Information Utilities (IU)

The information utility shall provide services as may be specified by Board. Information Utility will collect, collate, authenticate and disseminate financial information to be used in insolvency, liquidation and bankruptcy proceedings.

2.1.5 Adjudicating Authority

• The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals arising out of NCLT orders lie to the National Company Law Appellate Tribunal and, thereafter, to the Supreme Court of India.
• For individuals and other persons, the adjudicating authority is the Debt Recovery Tribunal (DRT). Appeals arising out of DRT orders lie to the Debt Recovery Appellate Tribunal and thereafter, to the Supreme Court.

2.2 Structure of the Code

The IBC has been divided into Five parts comprising of 255 sections and 12 Schedules.

2.3 Applicability of IBC, 2016 – Sec. 2

Provisions of IBC, 2016 applies to the following, in relation to their insolvency, liquidation, voluntary liquidation or bankruptcy, as the case may be:

(a) Companies incorporated under Companies Act, 2013 or under any previous company law;

(b) Companies governed under special Act (so far as of IBC, 2016 is consistent with those special Acts i.e., provisions of Special Act will prevail over IBC, 2016);

(c) Limited Liability Partnership (LLP)

(d) Other body corporates as may be notified by Central Government

(e) Personal guarantors to corporate debtors;

(f) Partnership firms and proprietorship firms; and

(g) Individuals, other than persons referred to in clause (e).

2.3.1 Code not applicable to financial service providers

• IBC is not applicable to corporates in finance sector.
• Section 3(7) of IBC, 2016 states that “Corporate person” shall not include any financial service provider. Thus, the Code does not cover Bank, Financial Institutions, Insurance Company, Asset Reconstruction Company, Mutual Funds, Collective Investment Schemes or Pension Funds.
• However, NBFC is engaged in various activities and hence NBFC is not ipso facto excluded from definition of ‘corporate person’ under section 3(7) of Insolvency Code. NBFC can be a ‘corporate debtor’ [Jindal Saxena Financial Services v. Mayfair Capital (2018)]
• C.G. in consultation with the RBI notifies that the insolvency resolution and liquidation proceedings of the NBFC (which include housing finance companies) with asset size of ₹ 500 crore or more, as per last audited balance sheet, shall be undertaken in accordance with the provisions of the IBC, 2016 read with the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 and the applicable Regulations.

2.4 Corporate Insolvency Resolution Process (CIRP) Structure of IBC, 2016 – Part II

• CIRP a process during which financial creditors assess whether the debtor’s business is viable to continue and the options for its rescue and revival.
• The Insolvency Resolution Process provides a collective mechanism to lenders to deal with the overall distressed position of a corporate debtor.
• If the insolvency resolution process fails or financial creditors decide that the business of debtor cannot be carried on profitably and it should be wound up, the debtor will undergo liquidation process and the assets of the debtor are realized and distributed by the liquidator.
• Provisions relating to Insolvency and Liquidation process for corporate persons are covered in Part II of the code, which comprises of Secs. 4-77, divided into Seven Chapters.

2.6 Applicability of Part II of IBC, 2016 – Sec. 4

• Provisions relating to the insolvency and liquidation of corporate debtors shall be applicable only when the amount of the default is ₹ 1 Lac or more.
• Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than ₹ 1 crore [First proviso to Sec. 4(1)].
• Central Government may, by notification, specify such minimum amount of default of higher value, which shall not be more than ₹ 1 crore, for matters relating to the pre-packaged insolvency resolution process of corporate debtors under Chapter III-A. [Second proviso to Sec. 4(1)]

2.7 Bankruptcy of individuals and firms – Part III of IBC, 2016

Part III of IBC, 2016 (containing sections 78-187) deals with insolvency resolution and bankruptcy for individuals and partnership firms.

This Part shall apply to matters relating to fresh start, insolvency and bankruptcy of individuals and partnership firms.

Debt Recovery Tribunal (DRT) will be the Adjudicating Authority and Debt Recovery Appellate Tribunal (DRAT) will be the Appellate Authority for individuals and firms.

2.7.1 Flow of insolvency resolution process for individuals

• The process will be managed by ‘resolution professional’ under the direction of ‘Adjudicating Authority’.
• Insolvency Resolution Process will be initiated.
• Finalise ‘repayment plan’ with concurrence of debtor and committee of creditors.
• Upon consensus on repayment plan the individual or firm will get a discharge order.
• On failure to finalize the repayment plan, the creditors/debtor can file an application for ‘bankruptcy’ and the Adjudicating Authority may pass the bankruptcy order.
• The resolution professional who is a bankruptcy trustee will take over estate of the bankrupt. He will sell or dispose it off and satisfy payments of creditors to the extent possible.
• After that, the bankrupt will get a ‘discharge order’.
• The discharge order will be registered with Board (IBBI) in a register referred to in section 196 of the Code.

3. Important Definitions (Sections 3 and 5)

Claim Sec. 3(6) means

(a) a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured. or

(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.

Corporate Person Sec. 3(7) means

(a) a company as defined u/s 2(20) of the Companies Act, 2013;

(b) a LLP as defined u/s 2(1)(n) of Limited Liability Partnership Act, 2008; or,
any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider.

Corporate Debtor Sec. 3(8) means a corporate person who owes a debt to any person.

Creditor Sec. 3(10) means any person to whom a debt is owed and includes

• a financial creditor,
• an operational creditor,
• a secured creditor,
• an unsecured creditor and
• decree holder.

Debt Sec. 3(11) means a liability or obligation in respect of a claim which is due from any person and includes

• a financial debt and
• operational debt.

Default Sec. 3(12) means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be.

Financial information Sec. 3(13) in relation to a person, means one or more of the following categories of information, namely:

(a) records of the debt of the person;

(b) records of liabilities when the person is solvent;

(c) records of assets of person over which security interest has been created;

(d) records, if any, of instances of default by the person against any debt;

(e) records of the balance sheet and cash-flow statements of the person; and
such other information as may be specified.

Financial Service Provider Sec. 3(17) means a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator.

Base Resolution Plan Sec. 5(2A) means a resolution plan provided by the corporate debtor under clause (c) of Sec. 54A(4).

Corporate applicant Sec. 5(5) means—

(a) corporate debtor; or

(b) a member or partner of the corporate debtor who is authorised to make an application for the corporate insolvency resolution process or the pre-packaged insolvency resolution process, as the case may be, under the constitutional document 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 the control and supervision over the financial affairs of the corporate debtor.

Corporate Guarantor Sec. 5(5A) means a corporate person who is the surety in a contract of guarantee to a corporate debtor.

Dispute Sec. 5(6) includes a suit or arbitration proceedings relating to-

(a) the existence of the amount of debt;

(b) the quality of goods or service; or

(c) the breach of a representation or warranty.

Financial creditor Sec. 5(7) means any person to whom a financial debt is owed and
includes a person to whom such debt has been legally assigned or transferred to.

Financial Debt Sec. 5(8) means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes–

(a) money borrowed against the payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its dematerialised equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;

(e) receivables sold or discounted other than any receivables sold on non-recourse basis;

(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing; 2

Explanation: For the purposes of this sub-clause,

(i) any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing; and

(ii) the expressions, “allottee” and “real estate project” shall have the meanings respectively assigned to them in clauses (d) and (zn) of Sec. 2 of the Real Estate (Regulation and Development) Act, 2016,

(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;

(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clause (a) to (h) of this clause.

Financial position Sec. 5(9) in relation to any person, means the financial information of a person as on a certain date.

Initiation date Sec. 5(11) means the date on which a financial creditor, corporate applicant or operational creditor, as the case may be, makes an application to the Adjudicating Authority for initiating corporate insolvency resolution process or pre-packaged insolvency resolution process, as the case may be.

Insolvency commencement date Sec. 5(12) means the date of admission of an application for initiating corporate insolvency resolution process by the Adjudicating Authority u/s 7, 9 or 10, as the case may be.

Insolvency resolution process period Sec. 5(14) means the period of 180 days beginning from the insolvency commencement date and ending on 180th day.

Interim Finance Sec. 5(15) means any financial debt raised by the resolution professional during the insolvency resolution process period or by the corporate debtor during the pre-packaged insolvency resolution process period, as the case may be, and such other debt as may be notified.

Liquidation commencement date Sec. 5(17) means the date on which proceedings for liquidation commence in accordance with section 33 or section 59, as the case may be.

Operational creditor Sec. 5(20) means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

Operational Debt Sec. 5(21) means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.

Personal Guarantor Sec. 5(22) means an individual who is the surety in a contract of guarantee to a corporate debtor.

Preliminary Information Memorandum Sec. 5(23A) means a memorandum submitted by the corporate debtor under clause (b) of Sec. 54G(1).

Pre-packaged Insolvency Commencement Date Sec. 5(23B) means the date of admission of an application for initiating the pre-packaged insolvency resolution process by the Adjudicating Authority under clause (a) of Sec. 54C(4).

Pre-packaged Insolvency Resolution Process Costs Sec. 5(23C) means:

(a) the amount of any interim finance and the costs incurred in raising such finance;

(b) the fees payable to any person acting as a resolution professional and any expenses incurred by him for conducting the pre-packaged insolvency resolution process during the pre-packaged insolvency resolution process period, subject to Sec. 54F(6);

(c) any costs incurred by the resolution professional in running the business of the corporate debtor as a going concern pursuant to an order u/s 54J(2);

(d) any costs incurred at the expense of the Government to facilitate the pre-packaged insolvency resolution process; and

(e) any other costs as may be specified.

Pre-packaged Insolvency Resolution Process Period Sec. 5(23D) means the period beginning from the pre-packaged insolvency commencement date and ending on the date on which an order u/ss 54L(1), or 54N(1), or 54-O(2), as the case may be, is passed by the Adjudicating Authority.

Related party in relation to a corporate debtor Sec. 5(24) means-

(a) a director or partner or a relative of a director or partner of the corporate debtor

(b) a KMP or a relative of a KMP of the corporate debtor;

(c) a LLP or a partnership firm in which a director, partner, or manager of the corporate debtor or his relative is a partner;

(d) a private company in which a director, partner or manager of the corporate debtor is a director and holds along with his relatives, more than two per cent. of its share capital;

(e) a public company in which a director, partner or manager of the corporate debtor is a director and holds along with relatives, more than 2% of its paid-up share capital;

(f) anybody corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;

(g) any limited liability partnership or a partnership firm whose partners or employees in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;

(h) any person on whose advice, directions or instructions, a director, partner or manager of the corporate debtor is accustomed to act;

(i) a body corporate which is a holding, subsidiary or an associate company of the corporate debtor, or a subsidiary of a holding company to which the corporate debtor is a subsidiary;

(j) any person who controls more than twenty per cent. of voting rights in the corporate debtor on account of ownership or a voting agreement;

(k) any person in whom the corporate debtor controls more than 20% of voting rights on account of ownership or a voting agreement;

(l) any person who can control the composition of the board of directors or corresponding governing body of the corporate debtor;

(m) any person who is associated with the corporate debtor on account of-

(i) participation in policy making processes of the corporate debtor; or

(ii) having more than two directors in common between the corporate debtor and such person; or

(iii) interchange of managerial personnel between the corporate debtor and such person; or

(iv) provision of essential technical information to, or from, the corporate debtor.

Related Party in relation to an individual Sec. 5(24A) means-

(a) a person who is a relative of the individual or a relative of the spouse of the individual;

(b) a partner of a LLP, or a LLP or a partnership firm, in which the individual is a partner;

(c) a person who is a trustee of a trust in which the beneficiary of the trust includes the individual, or the terms of the trust confers a power on the trustee which may be exercised for the benefit of the individual;

(d) a private company in which the individual is a director and holds along with his relatives, more than 2% of its share capital;

(e) a public company in which the individual is a director and holds along with relatives, more than 2% of its paid-up share capital;

(f) a body corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of the individual;

(g) a LLP or a partnership firm whose partners or employees in the ordinary course of business, act on the advice, directions or instructions of the individual;

(h) a person on whose advice, directions or instructions, the individual is accustomed to act;

(i) a company, where the individual or the individual along with its related party, own more than 50% of the share capital of the company or controls the appointment of the board of directors of the company.

Resolution Applicant Sec. 5(25) means a person, who individually or jointly with any other person, submits a resolution plan to the resolution professional pursuant to the invitation made u/s 25(2)(h) or pursuant to section 54K, as the case may be.

Resolution Plan Sec. 5(26) means a plan proposed by resolution applicant for insolvency resolution of the corporate debtor as a going concern in accordance with Part II.

Resolution Professional Sec. 5(27) means an insolvency professional appointed to conduct the corporate insolvency resolution process or the pre-packaged insolvency resolution process, as the case may be, and includes an interim resolution professional.