The term insolvency is used for both individuals and organizations. For individuals, it is known as bankruptcy and for corporate it is called corporate insolvency. Both refer to a situation when an individual or company are not able to pay the debt in present or near future and the value of assets held by them are less than a liability. 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. While insolvency is a situation that arises due to the inability to pay off the debts due to insufficient assets, bankruptcy is a situation wherein application is made to an authority declaring insolvency and seeking to be declared as bankrupt, which will continue until discharge. From the above, 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.
Relationship between Bankruptcy, Insolvency & Liquidation
- “Bankruptcy” is a legal proceeding involving a person or business that is unable to repay outstanding debts.
- The bankruptcy process begins with a petition filed by the debtor, or by the creditors.
- All of the debtor’s assets are measured and evaluated, and then these assets may be used to repay a portion of the outstanding debt.
- In lucid language, if any person or entity is unable to pay off the debts, it owes to its creditors, on time or as and when they became due and payable, then such person or entity is regarded as “insolvent”.
- “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.
- In nutshell, insolvency is common to both bankruptcy and liquidation. Not being able to pay debts as and when they became due and payable is the leading cause for Liquidation and is the only way that can cause a natural person to become bankrupt.
The purpose behind the enactment of the Insolvency and Bankruptcy Code, 2016
- The Insolvency and Bankruptcy Code, 2016 is intended to strike the right balance of interests of all stakeholders of the business enterprise so that the corporates and other business entities enjoy the availability of credit and at the same time the creditor do not have to bear the losses on account of default.
- As per the Preamble to the Code, the purpose of this Act is as under:-
(a) To consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals.
(b) To fix time periods for the execution of the law in a time-bound manner.
(c) To maximize the value of assets of interested persons.
(d) To promote entrepreneurship
(e) To increase the availability of credit.
(f) To balance the interests of all the stakeholders including alteration in the order of priority of
payment of Government dues.
(g) To establish an Insolvency and Bankruptcy Board of India as a regulatory body for insolvency and bankruptcy law.