All About Bankruptcy


What is Bankruptcy?

In simple terms, bankruptcy is a legal proceeding initiated by an individual or a business entity when they cannot repay their debts or honour their financial commitments. Any individual or organisation can declare bankruptcy by filing a petition in court.

After filing a bankruptcy petition, the debtor's (one who owes money) savings/assets are measured and evaluated to repay a part of their debt to creditors (who are due to receive money). In some cases, the debtors work out a deal with creditors so that they pay off the outstanding without any financial strain.

Bankruptcy provides a win-win situation for both debtors and creditors. It helps debtors get a fresh start by allowing them to forgo some of their debts. Meanwhile, creditors get a chance to get some repayments based on an individual's or business' repayment ability.

How does bankruptcy work?

In India, bankruptcy cases are handled by special courts and governed by two laws – The Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. The former applies if you are a Chennai, Kolkata or Mumbai resident, and the latter for residents of other cities.

Both the laws are similar and will be replaced by the IBC (Insolvency and Bankruptcy Code). The court reserves the right to decide which debts you must repay.

Factors that lead individuals/organisations to file for bankruptcy

Many factors can contribute to an organisation's bankruptcy, which are not limited to –

  • The production exceeds demand.
  • The management spends more money than necessary, and there is no actionable financial management plan.
  • The organisation hesitates to evolve, and its products and services don't meet customer requirements or expectations.
  • The continuous increase in operational cost.

Pros and Cons of Bankruptcy

Pros Cons
Protects you from paying off the debts beyond your financial capacity Lowers your credit score
Allows you to get a fresh start and continue the business If you have any secured loans, the creditor may seize the collateral
You can avoid legal judgement

Types of bankruptcy in India

Primarily there are two types of bankruptcy in India, which are –

  • Corporate Bankruptcy
  • As the name suggests, it is a type of bankruptcy filed by corporate organisations when they cannot pay their debts in full. There are two ways to determine the corporate entity's bankruptcy.

    1. Cash flow test – In this method, the court assesses whether a corporation cannot pay off the debts now or in the future due to insufficient cash reserves.

    2. Balance sheet test – Here, the court verifies the financial statements and determines if the company's assets are much less than its liabilities.

  • Personal Bankruptcy
  • Individuals can file for personal bankruptcy when they cannot repay their dues. The Indian personal insolvency law protects the bankrupt debtor in three ways –

    1. Personal protection to the debtor and their family from any form of physical assault or mental torture by the creditors.

    2. Unwarranted division of debtor's property among creditors.

    3. Giving the debtor a fair opportunity to meet the creditor's demands.

Steps to file bankruptcy petition

To file a bankruptcy petition, you must know the steps involved. The steps are discussed below.

  • Step 1
    Carefully review your financial condition and collect all your monetary documents, including bills, receipts, and papers relating to your assets and liabilities. The court overseeing the bankruptcy case requires the debtors to disclose all details of their financial standing.
  • Step 2
    Hire a financial or legal advisor to represent your case in the court. The advisor will work in your interest and behalf to negotiate a deal with the creditor. The advisor will also guide you through the legal proceedings and documentation.
  • Step 3
    Get financial assistance for yourself, family members and business partners. As per the law, in India, you can file for bankruptcy alone or with your family or business associates. However, if you exclude your business partner/s or family, they may be at risk of repaying the debts you owe.
  • Step 4
    Seek your advisor's help to record an appeal under the Provincial Insolvency Act or Presidency Towns Insolvency Act as per your location to prove you are bankrupt.
  • Step 5
    After you record the appeal, the court will investigate and assess your case and pass the verdict on whether you are bankrupt.

To conclude

Bankruptcy helps individuals and corporate entities wipe out the debts they cannot repay and get a new start. However, they face inevitable consequences. Bankruptcy significantly impacts your credit score, and you may face difficulty securing loans in the future.

So, as an individual or a business owner, before you file for bankruptcy, you must assess all your options for repaying the debt, including a debt consolidation program and negotiate the terms with the lender. Also, take professional help to review your finances and guide you to overcome your financial difficulties.

Other Words

  • Balance Transfer
  • Bank Statement
  • Borrower

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