Demystifying Insolvency vs Bankruptcy under the Insolvency and Bankruptcy Code, 2016: Why Terminological Confusion Still Persists in Practice

Introduction : Terms in law are not synonymous as even words that might have a similar meaning can be completely different in their impact and therefore, the consequences. One such set of words which are similar in everyday language yet completely different in the legal language are “insolvency”, “bankruptcy”, “liquidation” and “winding up”. A layman might use them synonymously but the issue arises when such usage also happens within the legal world where it has significant ramifications. 

With the advent of the Insolvency and Bankruptcy Code, 2016 (“IBC”), India witnessed a  more concerted and creditor-centric framework. It also proved to be beneficial in the sense that it introduced a time-bound procedural structure for increased efficiency. Despite the skeletal outline provided, terminological confusion continues to persist in the legal practice.

This article aims to clarify the divergence of meanings in terms involving insolvency, bankruptcy, liquidation, winding up and dissolution. It will also elaborate on the reasons behind such confusion in the practical context.

Conceptual Clarity versus Statutory Framework

Insolvency and Bankruptcy can be similar yet clearly distinct. According to Black’s Law Dictionary, insolvency implies that a debtor is unable to pay his debts or his liabilities exceed assets. On the other hand, bankruptcy is a legal declaration of the state of financial inability. A state of insolvency can be revived but a state of bankruptcy results straight into immediate liquidation and is court driven.

Contrastingly, Indian law approaches the concept differently, as is also evident in the Insolvency and Bankruptcy Code, 2016. The status of ‘bankruptcy’ is not formally assigned to the companies or various enterprises. In the corporate context, the process first includes identification of a ‘default’ which leads to the inception of the Corporate Insolvency Resolution Process (“CIRP”).

As can be comprehended, the conceptual difference is noticeable but the applicability of these concepts in the Indian Law takes a separate route as compared to the meaning. This makes it necessary to revisit the current framework.

Insolvency under the IBC : Trigger, Threshold, and Process

The IBC marks “default” as the triggering point in the procedural structure to begin the insolvency proceedings for the company. Both “debt” and “default” have been defined in the Code, particularly in Sections 3(11) and 3(12). When debt becomes due and is not paid, it becomes a default.

“Default” being the triggering point has been well-established in the Supreme Court judgement Innoventive Industries Ltd. v. ICICI Bank. According to the judgement, once the default is shown, the adjudicating authority can admit the application for commencement of CIRP if other procedural requirements are also satisfied. The Court brought the focus on default, despite the financial capability of the debtor concerned.

IBC’s creditor-centric approach is reflected in the fact that only a financial or operational creditor may file an application for CIRP of another company, giving creditors the power to initiate the procedure. IBC also is resolution-oriented which is showcased through the mechanism of CIRP.

This inclination towards the creditor as opposed to the debtor represents a more accurate intention of the IBC in helping to resolve the insolvency issue as and when it arises.

Distinguishing Insolvency, Bankruptcy, and Liquidation

IBC itself requires a clear and distinctive understanding of the terms insolvency, bankruptcy and liquidation, in order to ensure a correct and precise application.

Insolvency, as is provided in the Code, is the stage in which the existence of a default, on the part of the corporate debtor triggers the initiation of  CIRP. It is, therefore, a gateway concept that sets the resolution process in motion.

Bankruptcy is a concept that's different from insolvency, and it mainly applies to individuals and partnership firms under the IBC. When it comes to companies, bankruptcy isn't really used that much. Even though people often use the terms interchangeably, they don't actually mean the same thing in the context of the law.

On the existence of a default, the process of insolvency is triggered for a particular company. Although the main aim of the process is to help the company get back up on its feet financially, if necessary, liquidation is used as the last resort. The decision of whether the liquidation should be done or not rests with the Committee of Creditors. The court case of Swiss Ribbons Pvt. Ltd. v. Union of India showed that the focus lies on saving the companies, not getting rid of them.

This differentiation is crucial in clarifying that insolvency proceedings always end with liquidation. Whereas, the law makes sure to prioritise resolution first over liquidation.

Liquidation, Winding Up, and Dissolution: Navigating Statutory Overlap

The set of words including liquidation, winding up and dissolution are also used synonymously while having different meanings in the legal context, showcasing the complexity of the insolvency terminology. Before the IBC came into existence, winding up proceedings were executed as per the Companies Act, 2013 which had provisions for closure of a company’s operations, realisation of assets, settlement of liabilities and eventual dissolution.

The introduction of IBC has led to a whole separate process of liquidation, governed by a specialised insolvency regime. Both winding up and liquidation coincide on the fact that they lead to stoppage of a company’s operations but their difference lies in the statutory basis, procedures and underlying objectives. Liquidation is governed by the IBC, 2016 and winding up is governed by the Companies Act, 2013.

The National Company Law Appellate Tribunal held that liquidation should only be considered when all other options have been tried. In the case of Y. Shivram Prasad v. S. Dhanapal, the NCLAT stressed that companies should try to resolve their issues before opting for liquidation. 

On the other hand, dissolution is the final legal stage which marks the end of the liquidation process under IBC or the winding up process under the Companies Act. Dissolution concludes a corporate entity’s existence in totality.

Role of Creditors and the Primacy of Commercial Wisdom

The IBC has brought a greater say for the creditors as they have been assigned a controlling role through the Committee of Creditors (CoC). The creditors have to mainly evaluate the different proposed resolution plans and consequentially, decide upon the corporate debtor’s future. 

The Supreme Court made a big decision in the case of K. Sashidhar versus Indian Overseas Bank. They said that the people in charge of making decisions about a company's debt, known as the CoC, have the final say in what happens. The decision of the CoC remains binding and uninterred unless some limited grounds make the interference necessary. This point was reemphasised in Committee of Creditors of Essar Steel India Ltd. versus Satish Kumar Gupta. In the latter case, the Court held that the IBC focuses on letting the creditors decide the fate of the company who lent to the company in the first place. Judicial interference will only be in the cases where it is deemed to be absolutely necessary.

The IBC aims to make the approach more creditor-driven as opposed to the previous market-driven procedure. It also clearly distinguishes insolvency under the IBC from the traditional idea of bankruptcy persisting in people’s minds. It favours a solution that brings value maximisation instead of shutting down the company to repay the creditors.

Practical Realities: Why Confusion Persists

Although the introduction of IBC has brought a certain amount of clarity, confusion in the terminological use is still visible. Numerous reports and data as published by the Insolvency and Bankruptcy Board of India relay that most of the CIRP cases end in liquidation. This, in turn, reinforces the misconception that insolvency ultimately means closure of the business.

Terminological misunderstandings still arise due to pre-IBC concepts as well as the use of these terms in the business and media context. This makes it harder to differentiate the terms and their associated meanings in the legal domain. The new concocted overlap due to the mix of the old and the new ideas is resulting in the undermining of the precise meaning of the law.

This existing gap between the written legislation and the practical usage is what needs to be bridged in order to facilitate the effect of the IBC framework.

Critical Analysis

The persistence of this terminological confusion in usage has raised a critical eye towards the implementation of the current insolvency framework in India. Although IBC has modernised the insolvency law, the pre-existing ideas still create ambiguity as to the interpretation and application of the terms.

It’s not just the pre-existing ideas but also other frameworks that lead to the overlapping of the meaning like the Companies Act with IBC. This has created confusion in the usage of winding up and liquidation. Along with that, inconsistent use by stakeholders, businesses and seldomly, adjudicatory bodies as well, dictate how the real issue lies not just in legislative wording but also practical implementation.

In order to get a clear solution, it is crucial to get a thorough understanding of the rules and the judgements passed on the same while making sure the parties are aware of the context. The framework for a better insolvency application will keep evolving so using a more precise and clear language will help in setting the distinction at the outset. This is because clear terminology helps to avoid confusion and ensures that everyone is on the same page. It will ultimately lead to a more coherent communication of the actual meaning and benefit all the stakeholders.

Conclusion

The semantic difference between insolvency, bankruptcy, liquidation, winding up, and dissolution is significant for understanding India’s corporate insolvency framework. The Insolvency and Bankruptcy Code, 2016 has managed to introduce a structured and resolution-oriented approach but the practical ambiguities persist due to real-life usage and ground realities. Maintaining clarity in the meaning and operation of the words in the legal context will aid in a stronger foundation for the future evolutions and frameworks to come.

Author: Priya Gangwani in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

References

1. Insolvency and Bankruptcy Code, 2016, Sections- 3(10)–3(12), 5(8), 5(20).

2. Black's Law Dictionary (11th ed., definitions of “Insolvency” and “Bankruptcy”).

3. Innoventive Industries Ltd. v. ICICI Bank, (2018) 1 SCC 407.

4. Swiss Ribbons Pvt. Ltd. v. Union of India, (2019) 4 SCC 17.

5. Companies Act, 2013, provisions relating to winding up and dissolution.

6. Y. Shivram Prasad v. S. Dhanapal, Company Appeal (AT) (Insolvency) No. 224 of 2018.

7. K. Sashidhar v. Indian Overseas Bank, (2019) 12 SCC 150.

8. The Supreme Court case of Committee of Creditors of Essar Steel India Ltd. versus Satish Kumar Gupta, (2020) 8 SCC 531.

9. Insolvency and Bankruptcy Board of India, CIRP data and reports.