Insolvency, Resolution, Bankruptcy and Liquidation

The terms insolvency, resolution, bankruptcy, and liquidation are interrelated concepts that form the foundation of the modern financial and legal framework for dealing with financial distress in individuals and business entities. These processes are central to ensuring the stability of credit markets, protection of creditor rights, and efficient utilisation of economic resources.
In India, these concepts are governed primarily by the Insolvency and Bankruptcy Code, 2016 (IBC), which provides a comprehensive mechanism for managing financial failure in a time-bound and transparent manner.

Insolvency

Insolvency refers to the financial condition of a person or entity that is unable to meet its debt obligations as they become due. In simple terms, insolvency occurs when liabilities exceed assets, or when a debtor is unable to pay creditors.

Types of Insolvency

1. Cash-flow Insolvency: When an individual or company cannot pay debts despite having sufficient assets, due to lack of liquidity.
2. Balance-sheet Insolvency: When the total liabilities of a person or company exceed total assets, making them technically insolvent.

Causes of Insolvency

• Poor financial management and over-leveraging.
• Decline in market demand or business failure.
• High operational costs and low revenue generation.
• External factors such as economic downturns, policy changes, or pandemics.

Insolvency does not immediately lead to bankruptcy or liquidation; it triggers a process of resolution to attempt revival before final closure.

Resolution

Resolution refers to the process of addressing insolvency through restructuring, reorganisation, or revival of a financially distressed entity. The objective is to restore the debtor to solvency and ensure the maximum possible recovery for creditors while maintaining business continuity.

Under the Insolvency and Bankruptcy Code (IBC):

• The Corporate Insolvency Resolution Process (CIRP) is initiated when a default occurs (currently set at ₹1 crore or more).
• Upon admission by the National Company Law Tribunal (NCLT), a moratorium is declared, halting all recovery and legal actions against the debtor.
• An Interim Resolution Professional (IRP) is appointed to manage the company’s operations and form the Committee of Creditors (CoC).
• The CoC, consisting of financial creditors, invites resolution plans from potential investors or acquirers.
• The best plan is selected by a 66 per cent voting majority and submitted to the NCLT for approval.

Objectives of Resolution

• Revival and continuation of the business as a going concern.
• Maximisation of asset value.
• Protection of employment and stakeholder interests.
• Minimisation of losses to creditors and the economy.

Resolution is the preferred course under the IBC, as it aims to save viable businesses rather than close them down prematurely.

Bankruptcy

Bankruptcy is a legal declaration of insolvency, typically applicable to individuals or partnership firms. It denotes a situation where a debtor is formally adjudged incapable of repaying debts and is subject to a legal process for settlement.

Key Features of Bankruptcy:

• It is declared after attempts at resolution have failed.
• Involves transfer of the debtor’s assets to a bankruptcy trustee or resolution professional.
• The trustee liquidates assets and distributes proceeds among creditors according to a prescribed order of priority.
• Provides the debtor with a discharge after settlement, enabling a fresh start.

Under the Insolvency and Bankruptcy Code, 2016, bankruptcy applies to individuals and partnership firms, and cases are adjudicated by the Debt Recovery Tribunal (DRT).

Stages in the Bankruptcy Process

1. Application to DRT by debtor or creditor.
2. Assessment of insolvency and appointment of a bankruptcy trustee.
3. Preparation of repayment plan or asset liquidation.
4. Distribution of proceeds as per priority order.
5. Discharge order relieving debtor from further liability.

Thus, bankruptcy provides an orderly and lawful mechanism to settle personal financial distress and allow for economic reintegration.

Liquidation

Liquidation refers to the process of winding up a company’s operations, selling its assets, and distributing the proceeds among creditors and shareholders when revival is no longer viable.
It represents the terminal stage of insolvency when no resolution plan is approved within the stipulated timeframe under the IBC.

Process of Liquidation under IBC

1. Trigger: Initiated by the NCLT when the Corporate Insolvency Resolution Process (CIRP) fails to yield an approved resolution plan within 330 days.
2. Appointment of Liquidator: The Resolution Professional may be appointed as the Liquidator.
3. Formation of Liquidation Estate: All assets of the corporate debtor are consolidated for sale.
4. Asset Sale and Realisation: Assets are sold via auction or private sale to maximise recovery value.
5. Distribution of Proceeds: The realisation is distributed among stakeholders as per the waterfall mechanism under Section 53 of the IBC.
6. Dissolution: Upon completion, the NCLT passes an order for dissolution of the company, marking the end of its legal existence.

Order of Priority (Waterfall Mechanism):

1. Insolvency and liquidation costs.
2. Secured creditors and workmen’s dues (for 24 months).
3. Employee wages (for 12 months).
4. Unsecured creditors.
5. Government dues and balance to secured creditors.
6. Shareholders or partners (if any funds remain).

Interrelationship between the Four Concepts

These stages are interconnected, forming a sequential process from financial distress to final closure or recovery, depending on the viability of the debtor.

Economic and Legal Significance

The processes of insolvency, resolution, bankruptcy, and liquidation have far-reaching implications for the economy:

• Credit Market Stability: Encourages responsible borrowing and lending practices.
• Resource Optimisation: Ensures that non-performing assets are restructured or redeployed efficiently.
• Investor Confidence: Predictable and fair insolvency laws attract domestic and foreign investment.
• Ease of Doing Business: Provides clear exit mechanisms for failed enterprises.
• Financial Discipline: Discourages willful defaults and promotes accountability.

By establishing a clear distinction between genuine business failure and deliberate default, these mechanisms uphold the principles of creditor protection and economic renewal.

Contemporary Challenges

Despite the success of the IBC and related frameworks, certain challenges persist:

• Judicial delays due to backlog in NCLT and DRT cases.
• Frequent litigation causing time overruns in resolution.
• High haircuts for creditors in certain cases.
• Limited capacity of insolvency professionals and valuation experts.
• Need for cross-border insolvency framework for multinational corporations.