After the severe effect of the Covid-19 pandemic, many big corporate entities reached the verge of insolvency owing to their poor financial condition. Even some big hot-shot companies could not clear their dues to banks and other creditors and subsequently insolvency proceedings commenced against them. For the growth and development of our economy, it is essential to revive those sick entities and bring them back to their foot. To ensure revival, India had a very robust insolvency mechanism with a primary objective of reviving and rehabilitating sick companies.
In this article, we are going to discuss the mechanism of reviving an insolvent company in India. Further, we will do a step-by-step analysis of the entire insolvency process to guide our readers better.
What is insolvency?
Before moving further, it is essential to understand the meaning of insolvency. In simple words, insolvency is a situation of financial distress where a person or an entity is unable to clear the debt belonging to a bank or any other lender. The person who is required to pay the debt is called the debtor and the person to whom the debtor is obliged to pay is called the creditor. If the debtor is a company or a corporate entity, it is known as the corporate debtor. There are a couple of factors which led to the insolvency of a company, such as poor cash flow, fraudulent transfer of money, poor corporate governance, etc. In our country, the most efficient and widely used legislation through which Insolvent companies are resolved is the Insolvency and Bankruptcy Code, 2016 (IBC).
Insolvency Resolution Process under IBC
Under IBC, sick corporate entities are resolved through a process known as Corporate Insolvency Resolution Process (CIRP). It is a special process under the Code which aims to resolve the corporate debtor with the objective of value maximization and protection of the interest of other stakeholders. For initiating the corporate insolvency resolution process, there must be a default on the part of the corporate debtor. As per the Code, default is the situation of non-payment of debt. It is important to note that earlier the minimum amount of default for initiating CIRP was INR 1 Lakh but the government increased the said amount to INR 1 Crore. Thus, for commencing insolvency proceedings against a debtor, there must be a default of INR 1 Crore.
Who can initiate insolvency?
At this juncture, an important question arises – who can commence the insolvency process? The answer to this question is given in the Code itself. It can be commenced by one of the following:
- Financial Creditor under Section 7 – A financial creditor is one to whom a financial debt is owed. In simple words, financial debt has a component of interest and it has a commercial effect of borrowing. For instance – a loan is taken from the bank. Interestingly, the real estate allottees are also treated as financial creditors under the IBC.
- Operational Creditor under Section 9 – As the name suggests, this creditor is related to the day-to-day operations of the corporate debtor. An operational creditor is one to whom an operational debt is owed and this debt is related to the supply of goods, services, etc. For instance – the raw material supplier is an operational creditor under the Code.
- A corporate applicant of a corporate debtor under Section 10 of the Code
How to Resolve an Insolvent Company in India
In this article, we will delve into the step-by-step process of resolving an insolvent company in India.
Identify Insolvency
The first step in resolving an insolvent company is to identify the financial distress and insolvency. Key indicators of insolvency include the company’s inability to pay its debts when they fall due or if its liabilities exceed its assets. It is essential to act promptly when signs of financial distress arise to maximize the chances of successful resolution.
Steps in Formation of a Company
Financial distress can manifest in various ways, such as delayed payments to creditors, mounting debt, declining profitability, or inadequate cash flow to meet operational expenses. As soon as the management or the board of directors become aware of these warning signs, they should consult financial experts and consider the best course of action to avoid further deterioration.
Initiate the Corporate Insolvency Resolution Process (CIRP)
The Corporate Insolvency Resolution Process (CIRP) is a time-bound process aimed at finding a viable resolution for the insolvent company. Any creditor, shareholder, or the company itself can initiate the CIRP by filing an application with the National Company Law Tribunal (NCLT). The application must provide evidence of the company’s default on its debt obligations and establish that the company is insolvent.
Once the NCLT admits the application, it appoints an insolvency professional (IP) to manage the affairs of the company during the resolution process. The IP takes over the powers of the board of directors and becomes responsible for the management and operation of the company. The appointment of a competent and experienced IP is critical to ensure the smooth and efficient conduct of the CIRP.
Formation of Committee of Creditors (CoC)
Once the CIRP begins, the IP convenes a meeting of all financial creditors to form the Committee of Creditors (CoC). The CoC represents the interests of creditors and plays a crucial role in the resolution process. It consists of all financial creditors of the company, excluding the operational creditors.
The CoC determines the course of action during the CIRP. It makes critical decisions such as the appointment or replacement of the IP, approval of the resolution plan, and any other major decisions related to the company’s operations during the CIRP. The IP acts as the convener of the CoC and is responsible for organizing and conducting meetings and obtaining the CoC’s consensus on key matters.
Moratorium Period
During the CIRP, a moratorium is imposed on the company, preventing any legal actions against it by creditors. This moratorium allows the company to focus on the resolution process without facing further legal challenges. The moratorium is a shield that protects the company from enforcement actions by creditors, thereby maintaining the status quo during the resolution period.
The moratorium commences from the date of admission of the CIRP application and continues until the CIRP concludes with either the approval of a resolution plan or the initiation of liquidation. During the moratorium period, no legal proceedings, including recovery suits, arbitration proceedings, or any other actions to recover debts, can be initiated or continued against the company.
Preparation and Approval of Resolution Plan
The resolution plan is a crucial aspect of the CIRP. It outlines the proposed restructuring or revival plan for the insolvent company. The resolution plan can be submitted by eligible resolution applicants, which may include individuals, entities, or even the existing promoters of the company.
The resolution applicants evaluate the company’s financial position, assets, liabilities, and operational capabilities to create a viable plan for its revival. The plan may involve financial restructuring, infusion of capital, or strategic changes in the business model to improve the company’s prospects. The resolution plan must be submitted to the CoC for evaluation and approval.
The CoC evaluates the resolution plan based on its feasibility, viability, and potential to maximize the value of the company’s assets. The plan must offer reasonable and fair terms to all stakeholders involved, including creditors and shareholders. The CoC may negotiate with the resolution applicants to improve the terms of the plan before reaching a consensus.
Once the CoC approves the resolution plan with a specified majority vote, it is submitted to the NCLT for final approval. The NCLT reviews the plan and ensures that it complies with the provisions of the IBC. If approved, the resolution plan becomes binding on all stakeholders, and the implementation process commences.
Approval by NCLT
The approval of the resolution plan by the NCLT is a crucial step in the CIRP. The NCLT verifies the compliance of the resolution plan with the provisions of the IBC, ensuring that it does not violate any laws or contravene public policy. The NCLT also examines whether the CoC followed the prescribed procedure while approving the plan.
The NCLT has the authority to reject the resolution plan if it finds any irregularities or non-compliance with the IBC. In such cases, the NCLT may grant additional time for the CoC to consider alternative plans or proceed with the liquidation process.
If the NCLT is satisfied with the resolution plan’s compliance and viability, it approves the plan, and the successful resolution applicant can proceed with its implementation. The NCLT’s approval provides legal sanctity to the resolution plan and protects it from any future legal challenges.
Implementation of the Resolution Plan
After NCLT approval, the successful resolution applicant takes over the management and operations of the company. The resolution plan is set into motion, and the IP monitors the implementation process to ensure compliance and the revival of the company’s operations.
The resolution applicant must adhere to the timelines and commitments specified in the resolution plan. It must infuse the necessary funds, restructure the company’s debts, and make strategic changes to optimize the company’s operations. The objective is to steer the company back to financial health and ensure its long-term sustainability.
During the implementation process, the resolution applicant may face various challenges, such as resistance from stakeholders, operational issues, or external market factors. It is the responsibility of the resolution applicant and the IP to address these challenges effectively and maintain transparency with the CoC throughout the process.
Liquidation, if Resolution Fails
In the unfortunate event that the resolution plan fails or is not approved, the company may be subjected to liquidation. Liquidation is the last resort when the revival of the company becomes impracticable, and there is no feasible resolution plan available.
The liquidation process involves selling the assets of the company in a transparent and orderly manner to repay the creditors in a specified order of priority. The IBC specifies the order of distribution, where secured creditors are given precedence over unsecured creditors, and operational creditors are ranked lower than financial creditors.
The liquidation process is supervised by the IP, who acts as the liquidator. The IP is responsible for realizing the value of the company’s assets, settling claims of creditors, and distributing the proceeds according to the IBC’s provisions. The objective of liquidation is to maximize the recovery for creditors and wind up the company’s affairs efficiently.
Conclusion
Resolving an insolvent company in India requires adherence to the legal framework provided by the Insolvency and Bankruptcy Code, 2016. The CIRP offers a structured and time-bound approach to finding a viable resolution for the company’s financial distress. It is essential for all stakeholders, including creditors, shareholders, and the company itself, to cooperate during the resolution process.
The process involves careful identification of insolvency, initiation of the CIRP, formation of the Committee of Creditors (CoC), and the imposition of a moratorium period. The preparation and approval of a viable resolution plan are critical to ensuring a successful revival of the company. If the resolution plan fails, the company may face liquidation.
Understanding the Doctrine of Corporate Veil
By following the steps outlined in this guide, the chances of a successful resolution increase significantly, safeguarding the interests of all involved parties and contributing to a healthier corporate ecosystem in India. Resolving an insolvent company is a complex process, and seeking professional guidance from insolvency experts and legal advisors is highly recommended for the best outcomes. By doing so, all stakeholders can work together to achieve a successful resolution and create a positive impact on the Indian economy and corporate landscape.
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