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Here Is Everything You Must Know About Insolvency

Companies / SME Oct 10, 2020 - 03:50 PM GMT

By: Sumeet_Manhas

Companies

When a company commences business in the market, it has set objectives, functions, and roles. No corporation ever dreams of going into liquidation of becoming insolvent. The framework of law provides specific guidelines, rules, and regulations to assist the procedure of insolvency. Usually, insolvency takes place when the company is going in loss; it is not able to manage its finances and is thriving to survive in the market. Insolvency of a company has a lot to do with the law rather than the dynamics of the market. The internal functionality of corporations has to be transparent with the authorities to not land up in any form of legal action. Let us now understand the meaning and procedure of insolvency and legal accompaniments along with it. 


What is insolvency?

Insolvency has been defined in various legal literature and by famous authors and professionals in practice. However, insolvency, in common patience, means when a firm, an individual, or a company is unable to pay their dues advanced by the money lenders. It is essentially a state of financial distress for the individual or company where the financial obligations cannot be fulfilled or satisfied.  

Since the creditors demand their dues along with interest, the companies have to sell their assets, and individuals have to sell their personal property to indemnify the loan amount advanced by lenders. Informal arrangements and dealings are also made with the creditors to reduce the payments and provide cash management. 

Insolvency and Bankruptcy Code 

The most common cause of insolvency is poor cash flow in a company. When the dealings are made purely based on credit with creditors and debtors, it results in an impoverished cash management system that is likely to break. The Insolvency and Bankruptcy Code is a set of rules, regulations, guidelines, and bylaws degrading the procedure to be carried during insolvency. 

This code has come into existence because there was no clear demarcation of insolvency and bankruptcy in several other statutes. The code provides for the provisions for companies and individuals to conduct a regulatory and transparent resolution process for insolvency. It is a legislative framework to safeguard the interests of debtors and claims of creditors about the company. 

Factors leading to insolvency 

Several reasons primarily lead to the bankruptcy of an individual or a company. The following are some of the factors that contribute to insolvency:

  • Hiring inadequate human resources to operate the functions of business

  • Overspending from the allowed company budget in areas that do not require such amount of expenditure

  • Increased costs and prices of material from vendors and suppliers putting them on credit

  • Overdrawn directors loan account causing increased credit 

  • Unpaid bills of the creditors for an extended period leading to increased interests on loans

  • Not adapting the products and services as per the market dynamics; sticking to traditional methods of business

  • Losing revenues from debtors and customers causing low profits

Insolvency professionals and agencies

The code was built to facilitate the process of resolution and insolvency smoothly.  To make sure that there is transparency in the mechanisms and all the legal provisions are being complied, the code calls for the appointment of several institutions. Insolvency professionals and agencies are those institutions that are licensed to practice the work of insolvency for the companies. 

They have the sole responsibility of the management of assets, disbursing, and paying off the creditors, providing information to the stakeholders, and making the right decisions for the company. The insolvency professional handles all the operations of the company until the procedure of insolvency is not completed. 

Procedure of insolvency 

The procedure of bankruptcy has to be strictly followed by insolvency professionals. The following steps must be followed:

  • How to initiate

It is necessary to determine who initiates the process of insolvency. The application for the initiation of the resolution process for bankruptcy can be made either by the debtor or by the creditor. This entire procedure is administered and supervised by the insolvency professional. No legal action is allowed for 180 days of this period by any party against the company. 

  • Decision making

An insolvency professional is obligated to form a committee of financial creditors of the company. The financial creditors are those parties who have lent money to the company. They have the power to decide the further outstanding debts of the company. The most common way of repayment is seeking the assets of the company and paying off the creditors. The decisions have to be taken within 180 days; after that, the assets of debtors can be liquidated. 

  • Process of liquidation 

Once the insolvency process comes at the point of liquidation, the procedure of liquidation commences. In liquidation, the assets of the company are sold off to obtain financial resources to pay off the creditors. There is a sequence in which financial creditors, unsecured creditors, insolvency costs, workers' payment, and equity shareholders have to be paid. 

By Sumeet Manhas

© 2020 Copyright Sumeet Manhas - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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