Insolvency is a state where an entity (person or a company) is unable to pay the money on time that he took from either a bank or another person in terms of a loan. The entity in the state of insolvency is termed as the insolvent
There are two laws in India subjected to the matter of Insolvency.
1. The Presidency Town Insolvency Act, 1909
2. The Provincial Insolvency Act, 1920
Out of these two laws, the one that will be applicable to the entity depends upon the place of business or residence (for individual insolvent). The final decision always remains in the hands of the Law.
There are two forms of Insolvency in India:
1) Cash-Flow Insolvency
2) Balance Sheet Insolvency
Let us discuss both these types in Detail
Cash Flow Insolvency
This form of insolvency occurs when the insolvent person or company has enough assets to pay its debt but do not have the amount in cash. For instance, a person may own a large house, an expensive car, and other proprieties, but, not have enough liquid cash to pay the debt of its creditors.
Cash-flow insolvency is generally resolved in the terms of negotiation like the creditor agrees to wait till the house or the car of the debtor is sold and the debtor agrees to pay the penalty for the waiting time.
Balance Sheet Insolvency
This form of insolvency occurs when a person or a company does not have enough cash or assets to pay to their creditors. In such a case the entity (person or company) might enter bankruptcy in some cases. When a loss is accepted by the party, the situation can be resolved by negotiation often saving the debtor from bankruptcy.
A company that is insolvent under the balance sheet insolvency is still given the right to have enough cash to pay its necessary bills on time (although if it is bankrupted). However, this law applies mainly when the company seeks to pay the bill which is directly in favor of its creditors to obtain their funds. For instance, an insolvent farmer may be allowed to hire people and pay them for harvesting his crops. Because if the crop is not harvested and sold, then the farmer will never be able to pay the debt to its creditors.
It is suggested that Balance Sheet Insolvency should be termed as Technical insolvency in order to be precise with the concept. Technical Insolvency should be used to indicate balance sheet insolvency, which refers to the entity whose liabilities are greater than its assets. While actual insolvency should be used to indicate the first type of insolvency i.e. the inability of a debtor to pay their debt.
Highlights of Insolvency in the current time
The modern insolvency does not only rely solely on the liquidation of the insolvent. The principal focus of modern insolvency legislation and business debt restructuring is remodeling of the financial and organizational structure of the debtors. This practice helps both, the creditors with their funds and relieves debtors of the financial distress and also permits them the rehabilitation and continuation of their business. This is known as Business Recovery or Business Turnaround. Implementing a Business Turnaround may take many forms including restructuring, sale as a going concern or wind-down and exit.