Individuals and businesses facing financial distress need to make a well-informed decision of whether to undergo bankruptcy proceedings under the Insolvency and Bankruptcy Code, 2016 (hereon forward known as “the IBC”). Knowing the potential Bankruptcy Under IBC Advantages and Disadvantages is important to understand whether it is the right option for you.
What Is Bankruptcy?
Bankruptcy Under IBC provides a way to discharge overwhelming debt, allowing individuals and companies to start fresh financially. Thus, they can rebuild their credit and access new loans. Before going forward it is important to understand what bankruptcy is and its types:
Although not defined in the IBC, it can be implied that Bankruptcy Under IBC is a legal process allowing individuals or businesses to eliminate or restructure their debts under court supervision. Section 78-187 of the IBC deals with insolvency resolution and bankruptcy for individuals and partnership firms.
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Types of Bankruptcy:
Whether it be insolvency law in India or any other country, there are generally two types of bankruptcy – for individuals and for businesses.Â
For Individuals:
As per Part III of the IBC, for individuals’ bankruptcy, the amount of default should not be less than Rs. 1,000. The creditor can file an application before the Debt Recovery Tribunal (DRT) to initiate the insolvency process against the corporate debtor. Under the US Bankruptcy Code, there are two options available for individuals:Â a liquidation process under Chapter 7 and a repayment plan under Chapter 13.
For Businesses:
Similar to individuals, under section 78 of the IBC, partnership firms should also have a minimum default of Rs. 1,000 to file for Bankruptcy Under IBC. Chapter 7 and Chapter 11 of the US Bankruptcy Code, liquidation process and reorganisation of the business, are related bankruptcy proceedings for individuals.
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Purpose:
The main purpose of Bankruptcy Under IBC in insolvency law is to provide a fresh financial start for debtors while ensuring creditors recover some portion of the debts owed.
Advantages of Declaring Bankruptcy
Bankruptcy allows businesses to restructure debts and continue operations under IBC provisions. Other advantages include:
Debt Relief and Fresh Start:
Bankruptcy enables the corporate debtor to write off most of their debts. It eliminates most unsecured debts like credit card balances and medical bills.
Legal Protection from Creditors:
It essentially stops creditors from taking any legal action to collect on debts. Once the application for initiating bankruptcy proceedings is admitted, an automatic stay is implemented which prevents creditors from pursuing collection actions, including lawsuits, wage garnishments, and harassment.
Retain Essential Assets:
Bankruptcy provisions allow debtors to keep essential property, such as vehicles. Under Chapter 7 bankruptcy, most of the individual’s assets are liquidated to pay creditors. In Chapter 13 the individual can retain more assets but must agree to repay their creditors over a set period.Â
Psychological Relief:
Filing bankruptcy is not only a financial decision it also has emotional implications. Facing financial issues also means the corporate debtor has overwhelming stress and anxiety because of the unmanageable debt. Therefore, bankruptcy reduces stress by addressing financial burdens in a structured legal manner.
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Opportunity to Rebuild Credit:
Bankruptcy provides debtors an opportunity to rebuild credit by essentially giving them a fresh start by eliminating most of their existing debt, allowing individuals and businesses to make timely payments, and eventually reestablishing a positive credit history. Credit is impacted initially, with bankruptcy, debtors can work towards better financial health over time.
Disadvantages of Declaring Bankruptcy
Negative Impact on Credit Score:
This process can bring relief from the stress of insurmountable debt, but has severe negative consequences for the debtor’s credit. Bankruptcy stays on credit reports for an estimated 7–10 years, lowering credit scores significantly.
Loss of Assets:
Corporate debtors may need to sell some of their assets to pay off their debts, leaving them with significantly less finances than when they started bankruptcy. Certain non-exempt assets may be sold to repay creditors, depending on the bankruptcy chapter filed.
Limited Future Borrowing Options:
Filing for bankruptcy will stay on the history of the corporate debtor, making it difficult to borrow in the future. Therefore, securing loans or credit may be difficult and come with higher interest rates.
Public Record:
Whether it be bankruptcy in India or another country, this process calls for transparency. This means the corporate debtor must publish on an official website and, if they have a website, their website. As bankruptcy filing is public, it potentially affects personal and professional reputation.
Restrictions on Multiple Filing:
In India, there are no explicit legal restrictions on filing multiple bankruptcy petitions. But in practice, there is a “cooling off” period between filings, such as potential penalties for frivolous filings, scrutiny by the courts, reasons for repeated proceedings, etc.
Consequences of Bankruptcy in India
Legal Implications:
The legal implications of bankruptcy involve restrictions on the debtor’s ability to engage in certain financial activities. For instance, under the IBC it can lead to disqualification for certain roles, for instance, the director of a company may be dismissed.
Professional Consequences:
Filing for bankruptcy can adversely affect one’s professional life by damaging the corporate debtor’s credit score, making it difficult to obtain future loans. It may also impact their ability to hold certain positions in regulated industries and the loss of licenses or certifications in some professions.
Credit Impact:
As it affects the debtor’s credit score, it makes it difficult to access new credit and potentially results in higher risks on any loans needed to secure due to being viewed as a high-risk borrower by lenders. Therefore, a negative credit rating impacts their future financial opportunities.
Factors to Consider Before Declaring Bankruptcy
Type of Debt:
Before declaring bankruptcy it is important to understand the total amount of debt compared to the corporate debtor’s income. Different types of debt may be handled differently in bankruptcy. To make well-informed decisions, the corporate debtor needs to know that bankruptcy is more effective for unsecured debts like credit card loans.
Future Financial Goals:
Considering the future financial goals before declaring bankruptcy helps the corporate debtor to understand the long-term credit impact and how it aligns with goals.
Alternative Solutions:
Bankruptcy impacts the corporate debtor’s reputation, finances, and well-being. They should explore debt settlement or restructuring before filing for bankruptcy to avoid all such factors.Â
Legal Costs:
Other than procedural costs, filing for bankruptcy involves robust legal fees and court costs.
Alternatives to Bankruptcy
To avoid bankruptcy the corporate debtor includes debt consolidation, debt settlement, credit counseling, and asset liquidation:
Debt Consolidation:
Debt consolidation is a process that combines multiple debts into a single, manageable payment plan. It allows individuals to manage and potentially reduce their debt by such a combination, hence avoiding the legal and credit implications of filing bankruptcy.
Debt Settlement:
This involves negotiating with creditors to reduce the amount owed. Debt settlement allows corporate debtors to resolve significant debt without filing for bankruptcy. However, this can severely damage their credit score as creditors may report the account as settled which is seen negatively.
Credit Counseling:
Credit counseling helps debtor’s debt, and budget, and improves their credit. In credit counseling, it is crucial to work with certified professionals to develop a debt repayment plan.
Asset Liquidation:
Corporate debtors can liquidate their assets to generate cash to pay creditors, potentially avoiding the formal legal process of filing for bankruptcy. They can voluntarily sell non-essential assets to repay debts.
Conclusion: Bankruptcy Under IBC
Bankruptcy can provide a fresh start by eliminating most debts and potentially saving assets, but it comes with significant drawbacks including a severely damaged credit score. It also causes limited access to future credit and a public record of the corporate debtor’s financial situation. Therefore, filing for bankruptcy is a drastic measure to consider only after exhausting other options and careful consultation with a legal professional.
FAQs
What debts cannot be discharged in bankruptcy?
Excluded debts include secured debts, debts incurred through fraud, liabilities for maintenance payments, government dues, damages arising from willful acts of negligence, and any debt not properly listed in the bankruptcy petition.
Can a business recover from bankruptcy?
Yes, a business can recover from bankruptcy through restructuring debt and continuing operations under new ownership or management.
How long does bankruptcy affect credit in India?
In India, bankruptcy can affect an individual or business for up to 10 years.