Insolvency is an important term in the world of finance. There is a thin line of difference between insolvency and bankruptcy. Insolvency can be defined as a state of financial distress in which someone is unable to pay their bills. It can lead to further proceedings, wherein legal action will be taken against the insolvent entity, and assets may be liquidated to pay off outstanding debt.
Insolvency is a temporary situation, but if it is extended beyond the anticipated time, then it leads to bankruptcy. One solution to this problem is to alter the repayment method or by writing the loan off. If the above problem is not solved, the insolvent assets are sold off in order to pay off. For this, the court appoints an official liquidator whose first job is to liquidate all the assets and pay off the proceeds to the creditors.
Factors Leading to Insolvency
- Company’s hiring of inadequate accounting or human resources management may lead to insolvency.
- When the business has to pay increased prices for goods and services, which in turn makes the company pay to the consumers.
- Some companies become insolvent because they cannot cope up with the changing needs of the consumers. The company loses profits and customers, if it fails to adapt to the changes in the industry.
- The business may end up paying large amount of money in damages which can hamper its operations. And this affects the company’s income. Lack of income results in unpaid bills and creditors requesting the money they lent.
What is bankruptcy?
‘Bankruptcy’ is a legal term used when a person or business cannot repay their outstanding debts. The bankruptcy process begins with a petition filed by the debtor. All the assets of the debtors are measured and evaluated, which in turn may be used to repay the outstanding debt. It offers an opportunity to the individual or company to start afresh by forgiving the debts that cannot be paid. Creditors also get the benefit of repayment of some debts based on the individual’s or business’s assets available for liquidation.
Factors Resulting in Bankruptcy
- Financing is one of the primary challenges that small businesses face. Many business owners take loans to make their company financially strong and continue their operations. If the lender is not willing to grant additional fund, the company may suffer from bankruptcy.
- Another factor which results in bankruptcy is poor decision making. Lack of proper strategies and hasty decisions can lead to business failure.
- Other factors include poor business location, loss of key employees, lawsuits raised by competitors and personal issues like illness or divorce.
The insolvency and bankruptcy code is the bankruptcy law of India which aims to consolidate the existing framework by creating a single law for insolvency and bankruptcy. The code protects the interests of small investors and make the process of doing business a less cumbersome process. The entire process of insolvency is managed by licensed professionals. They also take care of the assets of the debtors during the insolvency process.
Challenges in the Insolvency and Bankruptcy Code
The code intends to provide an efficient resolution to the menace of outstanding debts incurred by the person or the business. The main objective of this legislation is to provide resurrection and resolution for maximization of debtor’s assets in a limited time period. The code provides for fast track insolvency resolution process.
The code faces challenges while working around incomplete records, pending compliances and uncooperative officers of the corporate debtors. The individual resolution professionals (IRPs) also have to undergo various infrastructural and logistical issues while performing their core duties. The IRPs have to approach the tribunals and wait for their directions, thereby making it difficult for them to complete the specific task in prescribed time. They require a working capital in order to run the business of such debtor as a going concern. They have to constantly raise their resources in order to tackle day to day requirement of the corporate debtor.
The IRPs have to approach to the existing lenders of the company to raise more funds in order to clear the debts, to pay pending salaries to the employees and to keep the operations running which were put on hold.
The success of the code can be measured through the viability of the resolution plans and how much haircut financial creditors would have to take and also how flexible can the buyers be to provide some liable deals to save the company. The operational creditors would feel a relief as they have minimal role in the resolution process. During this process, a committee of creditors is formed which is the driving force as all the decisions taken by the IRPs are approved by the creditors which are part of the committee. The IRP takes over the management of the company and the powers of the existing board of directors are suspended.
The code also focuses on how to deal with the interests of the stakeholders including the financial and operational creditors. The process would go a long way as it will address the concerns of all the stakeholders in the industry. The main advantage of the code is that confidentiality is maintained throughout the process. If the process fails and the company goes into liquidation, then the stakeholders will get nothing.
If we consider the positive side of the process, it is likely to have a structural change in the behaviour of borrowers, lenders and concern the interest of smallest stakeholder and even employees. In short, the insolvency and bankruptcy code if carried out in a systematic way can prove beneficial to everyone involved in this field. Consult RNC and bring a smart solution to issues related to insolvency and bankruptcy.