This article is written by Oruj Aashna, from Calcutta University. The article addresses the bankruptcy process and how one differs from another.

Introduction

Becoming bankrupt can be complicated and overwhelming for an individual or an organization. It may sound challenging to get over such a debt trap but, with the advent of the Insolvency and Bankruptcy Code pulling through debt and starting afresh has become feasible. There are two ways to resolve bankruptcy:

(i) Voluntary Bankruptcy; and 

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(ii) Involuntary Bankruptcy. 

A debtor can choose to go for voluntary bankruptcy if he has a reason to believe that he is not apt to satisfy his debts. Another way for debt recovery is involuntary bankruptcy, which the creditors perform.

Background 

Bankruptcy was originally formed for the creditor to get their pecuniary value back. It eventually grew, and voluntary bankruptcy came into the picture, which helped debtors get relief from their debt trap.

Primarily, there was this stigma about companies that were not able to pay the debt to their creditors. It was even called unethical and was subject to one’s morality. This perception, with time, changed significantly when cash flow in the Indian economy increased. With flourishing incomes and increased exchange of cash, cases of bankruptcies grew. As a result, a strong law to deal with such defaults was required. 

In 2015, the Bankruptcy Law Reforms Committee was set up under the Chairmanship of Dr. TK Viswanathan. The committee’s main focus was to check the existing policy and form a consistent structure of Insolvency and Bankruptcy of Individuals and other legal entities. The committee submitted its report in Nov 2015 to the then Finance Minister, Late Shri Jaitely. Shri Jaitely introduced the report in Lok Sabha on 21st December, 2015. 

The report was also referred to the Joint Committee on 23rd December, 2015. The Insolvency and Bankruptcy Code was successfully passed with majority in Lok Sabha and Rajya Sabha on 5 May and 11 May 2016 respectively. The code also received the President’s assent on May 28, 2016, and it became an Act thereon. The IBC, 2016 came into effect on December 1, 2016. The Apex Court upheld the Constitutionality of the code. 

In 2016, the Bankruptcy law came into existence. Bankruptcy law, i.e., the Insolvency and Bankruptcy Code, 2016 (IBC), changed the way companies endeavour to seek help with their insolvency and debt resolutions. Going down for bankruptcy became the preferable choice than that of taking a loan from banks that used to be the most common credit culture. Nowadays, it is a common practice of a corporation or person to go for bankruptcy for their outstanding debt solutions. 

The concept of bankruptcy

In layman language, we can define bankruptcy as a legal process by which a person or business that is not able to pay the outstanding debt to their creditors obtains relief from some of their debts. Bankruptcy is a legal position wherein a company, an individual, or an organization is unable to compensate its outstanding debts to the creditors. If the company, individual, or organization cannot pay back its debt, and the proportion of liability is much higher than its assets, then an insolvency proceeding is initiated. Failing to pay debts can build mental distress and sickness as a whole, which needs a remedy for the proper functioning of a company and the individual and defend the rights of those who provide debt.

Involuntary v. voluntary bankruptcy  

Involuntary and voluntary are two different ways in which bankruptcy proceedings take place. The Insolvency and Bankruptcy Code of India underpins the said two procedures of bankruptcy. Voluntary bankruptcy far and away is the standard method of resolving bankruptcy, wherein the debtor initiates the process. Involuntary bankruptcy apparently is rare and is initiated by the debtor’s creditor. Below is the differentiation between voluntary and involuntary bankruptcies based on their meaning, objective and scope, process, and roles and responsibilities.

Meaning of voluntary and involuntary bankruptcy

Voluntary bankruptcy

  • There is no particular definition of voluntary bankruptcy, but precisely it is bankruptcy declared upon petition of the debtor. In voluntary bankruptcy, the debtor himself goes for bankruptcy when there is a financial distress and has a reason to believe that he won’t recoup from such debt. 
  • The debtor files a petition with a court to proceed with the bankruptcy. This is also known as ‘Debtor’s Petition’. When the debtor himself files a petition, it intends that the assets belonging to him, be it his personal property, will be sold out to pay off the creditor or creditors. 

Involuntary bankruptcy

  • Involuntary bankruptcy is a process by which the creditor requests the debtor to go for bankruptcy. Bankruptcy is made involuntarily when the creditor is not optimistic about the recovery of his money. 
  • This is one of the powers given to the creditor that is to force an unwilling debtor to go for involuntary bankruptcy. The creditor can commence the involuntary bankruptcy against the debtor by filing a petition. If the number of creditors is 12 or less, a creditor alone can file a petition. If the number of creditors exceeds 12, the creditors collectively can file a petition against the debtor.

Objective and scope of voluntary and involuntary bankruptcy

  • The objective behind voluntary bankruptcy is to allow the debtor to set free from its debt and reconstruct itself to start a new life. Plus point about voluntary bankruptcy is that it restrains the creditor from taking any action against the debtor. All the petitions against the debtor are kept on hold till the resolution is complete. Once the petition is filed for bankruptcy, an automatic stay is imposed on the debtor. Automatic stay restrains any action or judgment against the debtor.
  • There are situations where the debtor denies to pay even though he is competent to pay back. Involuntary bankruptcy allows the creditor to take legal action against the debtor and compel the debtor to pay it back. Once the petition gets accepted by the competent court, the creditors are repaid by the debtor’s available assets.
  • We can thus conclude two-fold purposes of the bankruptcies mentioned above, ie:
    • To provide relief to the debtor from harassment of his creditors; and
    • To protect the creditors who aren’t being paid back by their debtor.

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Roles and responsibilities in voluntary and involuntary bankruptcy

  • The debtor files voluntary bankruptcy in his capacity in a court. The document shall assert that the debtor will not be able to pay his debts, resident of the debtor or where the business is conducted, details of court orders if the debtor is arrested, details of claims against the debtor, and address of creditors.
  • Involuntary bankruptcy is initiated by the creditor by filing a petition with the court. While the creditor can initiate bankruptcy against an organization or a company, it cannot do this against an individual person.
  • Once the application is admitted, the court assigns the officials to hold the property and assets of the defaulting company or debtor. The investments are then distributed to the creditors accordingly. This process discharges the company’s bankruptcy when the creditors get satisfied and give the company a new life.
  • The National Company Law Tribunal (NCLT) initiates a corporate resolution process (CIRP) in the event of default on making payment by the company to creditors. The financial creditor, operational creditor, or corporate is competent to apply to NCLT also known as Interim Resolution Professional (IRP) for initiating insolvency resolution process in the occurrence of non-payment.

Process of bankruptcy under the Insolvency and Bankruptcy Code, 2016

  • As per the Insolvency and Bankruptcy Code, 2016, the process of debt resolution can be initiated by any creditor, whether it is a financial creditor or an operational creditor. 
  • The Code also allows application for resolution by the debtor itself. If the debtor files an application for resolution, he shall also file an application showing the consent of the Board of Directors. 
  • The two processes provided under the Insolvency and Bankruptcy Code, 2016 are:
    • The Corporate Insolvency Resolution Process;
    • Liquidation. 
  • In the Corporation Insolvency Resolution Process, the creditors are required to assess the business’s worth as to whether a business can be recovered or not. When the resolution process fails, the creditors decide on selling the company’s assets to recover their share of dues. The value of default should be more than one lakh INR.

Limitations and exceptions

Although involuntary bankruptcy favours the creditors, one major limitation that a creditor can face is that he can file an application to the adjudicating authority only if the default amount is above the minimum value as prescribed by the law. The disputed amount must be known and not contingent on any future event. Apart from disadvantages, as mentioned earlier, upon filing such a petition, the debtor could resist the involuntary petition by filing an opposition against the creditor’s claim. If the court rejects the creditors’ involuntary petition, it may order the creditor to cure the damage and cost incurred by the debtor due to such proceedings.

There could be a plethora of disadvantages that a debtor can face apart from its advantage. It could be loss of real estate property, credit card, trouble getting a mortgage or loan, and subconscious distress. Especially in a country like India, if a debtor files for bankruptcy, it will affect his credit ratings, which means that the debtor could have a tough time getting a new loan to start anew.

Exception: There is an exception where these bankruptcies can’t be applied. Creditors cannot perform involuntary bankruptcy against the following entities:

  1. Banks, 
  2. Non-profit organizations, and
  3. Insurance companies.

Important provisions 

  • Previously, several laws governed bankruptcy and insolvency, but those laws had an overlapping effect. The laws hence failed to resolve the debt settlement due to overlapping effects and subsisting loopholes. 
  • However, in 2016 all the aforesaid laws were replaced by the Insolvency and Bankruptcy Code, 2016. It provides healthy debt resolutions and that too at a limited period. 
  • Other relevant provisions governing bankruptcy are the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency Act, 1920. The Presidency Town Insolvency Act covers Mumbai, Chennai, and Kolkata, whereas the Provisional Insolvency Act covers other regions.

Applicability of the Insolvency and Bankruptcy Code, 2016

The provisions of the IBC are applicable in bankruptcy in the following entities: 

  1. A company incorporated under the Companies Act, 2013 or any previous laws;
  2. A company governed by any Special Act, provided such provisions are not inconsistent with the Special Act provisions;
  3. Limited Liability Partnership under the LLP Act of 2008;
  4. Partnership firm and individual;
  5. Any other body incorporated under any law which the Central government will designate for the said purpose.

Critical analysis 

As we went through the pros and cons of filing bankruptcy, it is crucial to check some of the data. As per the reports of the Investment Information and Credit Rating Agency (ICRA) only 15% of the cases have been resolved under the new bankruptcy laws, while the rest have gone for liquidation. The resolution process still continues to be a challenge in India. As per the reports submitted by ICRA, out of 2542 cases admitted under the Insolvency and Bankruptcy code, 1497 are still ongoing in the courts.

Conclusion

Although the concept of bankruptcy was formed for securing the interest of creditors, there is a rare time when creditors file a petition with the court to force the debtor to pay back the amount. Wherefore, whenever we talk about bankruptcy it usually means involuntary bankruptcy. When a debtor decides to go for bankruptcy, the court notifies the creditors of the proceedings. 

The bankruptcy trustee pays back the creditor by selling the debtor’s assets. The allocation of repayment is done in order of priority, which means that tax debts and child support get priority over other obligations following overpayments of federal benefit, criminal fines, and other debts. Unsecured debts get the last priority giving those creditors the least chance of recouping money from debtors. Bankruptcy is the best option for getting out of the debt trap as it has a window of protection available for the debtor which may not be available outside bankruptcy.

References

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