Earliest Signs of Insolvency in Companies
Between 2008 and 2014, banks had started lending loans indiscriminately which led to NPAs escalating throughout this period. In the year 2015, RBI conducted an asset quality review on banks and found that the NPAs had declined from poor to worst. The then Finance Minister Mr. Arun Jaitley had come up with the proposal of introducing the Insolvency and Bankruptcy Code (IBC) to improve the conditions present. The IBC was introduced in the Lok Sabha in December 2015 and passed in May 2016 by both Lok Sabha and Rajya Sabha. The president assent was also received in May 2016 itself. Now the two terms – Insolvency and Bankruptcy are often used interchangeably in common parlance, but these are slightly different from each other.
Insolvency: Is a financial situation of an entity or individual where they are unable to fulfil their financial obligations.
Bankruptcy: It is the condition when a court of competent jurisdiction has declared an entity or individual as insolvent and passed an order to resolve the situation and protect the rights of creditors.
The main reason for the introduction of the IBC was to consolidate the preexisting acts like the Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002 and the Sick industries Companies (Special Provisions) Act,1985. The motive was to have a single window to resolve the IBC issue within a short period. With the introduction of IBC, the process for companies for resolving issues would have taken 180 days with an extension of 90 days, for Startups, small companies – 90 days, could be extended to 45, reducing the total time which earlier used to be at 4 to 5 years.
The Insolvency and Bankruptcy Code (IBC) set up two different bodies, one is the regulator and the other one is adjudicator. The regulator of IBC is Insolvency and Bankruptcy Board of India and Adjudicators are National Company Law Tribunal and Debts Recovery Tribunal.
Adjudicating authorities: The proceedings of the resolution process are adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The responsibilities of the authorities include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
Insolvency and Bankruptcy Board: The Board regulates insolvency professionals, insolvency professional agencies and information utilities set up under the Code. The Board consists of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.
Procedure to resolve insolvency in the Code
The process involves three main steps:
1. Initiation: Initially, the company or individual or a representative of the stakeholder must file a case with adjudicating authorities. Once the case is accepted, the insolvency professional administers the process and provides financial information of the debtor from the information utilities to the creditor and manages the debtor’s assets.
2. The decision to resolve insolvency: The insolvency professionals form a committee consisting of both creditors and debtors. The representative of the creditor will decide the outstanding debt by debtors. The creditors may opt to revive the debt owed to them by changing the repayment schedule or sell (liquidate) the assets of the debtor to repay the debts owed to them.
3. Liquidation: If the debtors are unable to pay the dues, then the insolvency professionals will initiate the liquidation process. The main motto of liquidation procedure is to clear the dues in the respective order:
i) insolvency resolution costs, including the remuneration to the insolvency professional
ii) secured creditors, whose loans are backed by collateral, dues to workers, other employees
iii) unsecured creditors
iv) dues to government
v) priority shareholders
vi) equity shareholders.
Procedure:
Default-->Appointment of Insolvency Professional-->Claim Period/Moratorium Period (180/270 days) -->75% creditors to approve the plan-->Plan Implementation or Liquidation
Sector Wise Companies who approached NCLT
List of Companies that approached NCLT
In the year 2017, RBI has listed the top 12 NPA companies as follows:
Spotting Early Signs of Insolvency
1. Company Cash Flows: Company’s cash flows may be one of the indications to evaluate the performance of a company, although irregular cashflows may be caused due to temporary problems like a drop in sales, lack of credit control etc., but it is always mindful to have an eye on cashflows regularly.
2. Maximum borrowings: Maximizing borrowing is least advised for a company. If a company has regularly borrowed and is unable to clear the debts, the company needs to work on restructuring their financial conditions.
3. Late payments to creditors: Companies usually get time to pay for their creditors but if a company is delaying the payment beyond a certain time limit, then it is one of the indicators which further signals that the company might be headed towards insolvency.
4. Balance sheet: The key indicator to calculate the performance of a company is to analyze the balance sheet. If a company is continuously showing their liabilities are exceeding the assets, then it is a major issue and one must act upon it.
Few Other Indicators are:
- Loss of major contracts
- Unable to pay salaries to the employees
- Delay in providing financial information
- Resignation of top management
Thus, it is very important to go through all the information about the company before planning any investment. We have recently seen the case of Yes Bank, which has left the investors and customers in deep trouble. An insight into the working and balance sheet of any company should be considered before investing any major portion of amount in it.