When your business goes through tough times, you may want to explore different options in front of you. Most often, the terms insolvency, bankruptcy, and liquidation are used interchangeably. It is crucial to understand the differences between the three. Insolvency is when you are unable to pay your debts as they come due. Bankruptcy is a legal process you can initiate when you’re insolvent, aiming to either restructure your debts or discharge them completely. Liquidation is the process of selling off your assets to pay your creditors, often occurring as part of a bankruptcy or when winding up a business.
In insolvency, your business undergoes a period of financial stress where you are unable to do proper debt management and do not generate adequate cash flows to meet expenses and generate profits. Bankruptcy is a legal process in which you follow legal procedures set forth by law to close your business.. Liquidation is the final step of the process where you sell off all realisable assets to pay off the creditors.
SingeDebt Business is a reputed financial advisory and debt management company that can provide legal and financial advice on debt management from accounts receivable and consolidating your debts and create viable financial solutions to enable you to stave off the insolvency, bankruptcy, and liquidation processes.
Insolvency is a business state in which your liabilities exceed your assets. Your company is unable to use debt management to pay off the debts and liabilities as they occur, as the cash flows from your business are inadequate to support the financial activities of your business. You are unable to realise your accounts receivable; you are not making adequate sales to pay off your accounts payable.
This is a legal state that is used as a final step after the organisation becomes insolvent. The organisation is unable to do debt management and repay its debts to creditors and vendors and generate adequate cashflows to keep the company as a going concern. It has to go into bankruptcy proceedings under the Insolvency and Bankruptcy Proceedings of 2016, which ends the company’s state as a legal being.
Put it simply, to liquidate means to convert assets into cash. The business is unable to do debt management of its accounts receivable. Assets and properties belonging to the business are liquidated and converted to cash to pay off some portion of the creditor’s debt. During the process of liquidation, the company makes a distress sale and sells assets at a big discount. This is the final step before the winding down or shutting down of the business. Liquidation is a formal process when a licensed insolvency practitioner called liquidator is appointed. All assets are sold off and after the creditor’s share is paid off, the final, residual amount is returned to the liquidators.
In India, there are mainly three types of liquidation processes for companies:
Voluntary Liquidation: Members’ Voluntary Liquidation (MVL): This occurs when the shareholders of a solvent company decide to voluntarily wind up the company. The company must be able to pay its debts in full within a specified period (usually 12 months).
Creditors’ Voluntary Liquidation (CVL): This takes place when the company is insolvent and the shareholders decide to wind up the company, but it is carried out under the supervision of the creditors.
Compulsory Liquidation: This is a court-ordered liquidation process where a company is ordered to wind up by the National Company Law Tribunal (NCLT) based on a petition filed by creditors, shareholders, or other stakeholders. This usually happens when the company is unable to pay its debts or meets other criteria for compulsory liquidation under the Insolvency and Bankruptcy Code (IBC), 2016.
Corporate Insolvency Resolution Process (CIRP): If a company is unable to resolve its insolvency issues through the resolution process, it may proceed to liquidation. The resolution professional appointed during the CIRP can continue as the liquidator.
Fast Track Corporate Insolvency Resolution Process: A faster process available for certain small and medium-sized enterprises (SMEs) or startups, leading to liquidation if resolution plans are not approved within a shorter time frame. Each type of liquidation process has its own procedures and legal requirements, aiming to protect the interests of creditors, shareholders, and other stakeholders involved.
Normally when the business is unable to debt management and becomes insolvent and is unable to rectify the situation, it sets the ball rolling into bankruptcy with liquidation as the final nail in the business’ coffin. After this entire cycle the business ceases to exist legally and financially.
Insolvency | Bankruptcy |
A financial state where you are unable to pay debts as you are unable to do debt management. | This is a legal process for resolving irredeemable debt issues |
There may be no legal intervention | The bankruptcy process is conducted in court |
If you want to resolve an insolvency, you can enter into arrangements with your creditors for restructuring your debt. | In bankruptcy, there is asset liquidation and structured debt discharge. |
Insolvency can be handled privately in a personal domain. | Bankruptcy proceedings are always public and require court supervision. |
Insolvency is a circumstance that arises out of financial distress. | Bankruptcy can be a voluntary bankruptcy that is initiated by you or an involuntary procedure initiated by your creditors. |
Insolvency does not impact your management’s credit rating. | Bankruptcy can have an impact on your organization’s credit ratings. |
Insolvency is a temporary state and can be resolved by debt restructuring and other measures and streamlining the business operations. Prudent financial management can help to stave off insolvency. | In bankruptcy, the organisation’s legal entity ceases to exist and becomes a permanent state, resulting in the company’s permanent dissolution. |
An individual’s or a business’s insolvency is involuntary. | Bankruptcy of a business can be either voluntary or involuntary. |
Insolvency of a business is signalling ba risese in the debt-to-equity ratios and a reduction in quick ratios and liquidity ratios. There is a sharp increase in both accounts receivable and payables. | Insolvency is the starting point for bankruptcy. |
Aspect | Bankruptcy | Liquidation |
Definition | Legal status for individuals/entities unable to repay debts | Process of winding up a company by selling off assets |
Applicability | Individuals and partnerships | Companies and LLPs |
Governing Law | Insolvency and Bankruptcy Code (IBC), 2016 | Companies Act, 2013 and IBC, 2016 |
Initiation | By the debtor or creditors | By the company, creditors, or tribunal |
Objective | Restructuring or reorganising debts, or liquidating assets | Liquidation of assets to pay off creditors |
Process | Filing an insolvency petitionand resolution process | Filing a petition for winding up, appointing a liquidator |
Outcome | A debt repayment plan or liquidation is possible. | The company is completely dissolved. |
Debtor’s Role | Can propose a repayment plan | Limited role, overseen by a liquidator |
Creditors’ Role | Involved in the resolution plan approval | Priority claim on liquidation proceeds |
Time Frame | Typically longer, involves resolution process | Generally quicker, focused on asset sale |
Control | Initially remains with business, later with resolution professional | Controlled by liquidator |
Asset Distribution | As per resolution plan approved by creditors and tribunal | According to IBC’s priority order |
Discharge | The business may be discharged from remaining debts upon completion. | After liquidation, the company ceases to exist. |
Law/Act | Description | Applicable Entities |
Insolvency and Bankruptcy Code 2016 (IBC) | Comprehensive law for insolvency and bankruptcy code for individuals and companies | Individuals, partnerships, and companies |
Companies Act (2013) | Covers Companies Law in India, including acts of insolvency and liquidation for companies | Companies |
Recovery of debts due to banks and financial institutions Act 1993 | Provides for the establishment of tribunals for expeditious debt adjudication and recovery. | Banks and financial institutions. |
Securitization and reconstruction of financial assets and enforcement of security interest Act 2002 (SARFAESI) | It allows banks and financial institutions to auction properties in order to recover loans. | Banks and Financial Institutions |
Provincial Insolvency Act 1920 | Governs insolvency procedures for individuals and partnerships not covered under IBC. | Individuals and Partnerships |
Presidency Towns Insolvency Act 1909 | Specific to insolvency of Presidency towns of Mumbai, Kolkata and Chennai | Individuals in Presidency Towns of Mumbai , Kolkata and Chennai. |
Sick Industrial Companies ( Special Provisions Act 1985 )(SICA) Repealed | Provided for revival and rehabilitation of sick industrial companies. Repealed with the advent of IBC | Industrial Companies. |
Each of these Acts have provisions and frameworks designed to address the various aspects of insolvency, bankruptcies and liquidation of different entities. | ||
In India, there are mainly three types of liquidation processes for companies:
Voluntary Liquidation: Members’ Voluntary Liquidation (MVL): This occurs when the shareholders of a solvent company decide to voluntarily wind up the company. The company must be able to pay its debts in full within a specified period (usually 12 months).
Creditors’ Voluntary Liquidation (CVL): This takes place when the company is insolvent and the shareholders decide to wind up the company, but it is carried out under the supervision of the creditors.
Compulsory Liquidation: This is a court-ordered liquidation process where a company is ordered to wind up by the National Company Law Tribunal (NCLT) based on a petition filed by creditors, shareholders, or other stakeholders. This usually happens when the company is unable to pay its debts or meets other criteria for compulsory liquidation under the Insolvency and Bankruptcy Code (IBC), 2016.
In India, remedies against insolvency, bankruptcy, and liquidation are governed by several laws and regulations. The key legislation includes the Insolvency and Bankruptcy Code (IBC), 2016, which consolidates the existing framework by creating a single law for insolvency and bankruptcy. Here’s an overview of the remedies available under different circumstances:
Corporate Insolvency Resolution Process (CIRP)
Initiation: Insolvency proceedings can be initiated by financial creditors, operational creditors, or the corporate debtor itself.
Interim Resolution Professional (IRP): An IRP is appointed to take control of the debtor’s assets and operations.
Committee of Creditors (CoC): A CoC is formed, consisting of all financial creditors.
Resolution Plan: A resolution plan can be proposed, which needs to be approved by at least 66% of the CoC.
Approval: The resolution plan is approved by the National Company Law Tribunal (NCLT).
Individual Insolvency Resolution Process
Initiation: Can be initiated by the debtor or creditors.
Resolution: Involves the appointment of a resolution professional and formulation of a repayment plan.
For Corporates: If the resolution plan is not approved, the corporate debtor may be liquidated. The liquidator is appointed to sell the assets and distribute the proceeds among creditors.
For Individuals: Bankruptcy Order: If insolvency resolution fails, a bankruptcy order can be passed.
Trustee: A trustee is appointed to manage the debtor’s estate and distribute the proceeds among creditors.
Voluntary Liquidation: Companies can opt for voluntary liquidation if they are solvent and able to pay their debts.
Liquidation Process: Initiated by a special resolution and involves appointing a liquidator.
Compulsory Liquidation: Ordered by the NCLT in case of failure of the insolvency resolution process or on other legal grounds.
Liquidator: Appointed to wind up the company’s affairs and distribute assets.
Debt Restructuring: Debt restructuring plans can be negotiated with creditors to avoid insolvency.
Settlement Agreements: Creditors and debtors can enter into settlement agreements to resolve disputes and avoid formal insolvency proceedings. Using a third party financial advisory agency is useful in such cases.
Moratorium: A moratorium period is imposed during the insolvency resolution process, which halts all legal proceedings against the debtor.
Rights of Secured Creditors: Secured creditors have priority over unsecured creditors in the distribution of proceeds from asset sales.
In India, insolvency, bankruptcy, and liquidation are distinct stages in dealing with financial distress. Insolvency occurs when an individual or company’s liabilities exceed its assets, is unable to do debt management thus rendering it unable to meet debt obligations. Bankruptcy is a legal declaration of an individual’s or company’s inability to pay debts, leading to a court process that aims to resolve the financial distress, often involving debt restructuring or asset liquidation. Liquidation, on the other hand, specifically refers to the process of winding up a company’s affairs by selling off assets to pay creditors, which can be voluntary or court-ordered. These processes are governed by the Insolvency and Bankruptcy Code (IBC), 2016, which provides a unified framework for timely resolution and protection of stakeholder interests.
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