Bankrupt

When an individual or a partnership firm can no longer pay what they owe, the law provides a formal process to deal with it. Being bankrupt has a precise legal meaning under this process — it is not simply a description of being short of money.

The Insolvency and Bankruptcy Code (IBC), 2016, is the law that governs this, for companies, partnership firms and individuals alike, bringing what used to be several separate laws under one umbrella.

Section 79(4) of the IBC defines 'bankrupt' as: a debtor who has been adjudged bankrupt by a bankruptcy order under section 126; each of the partners of a firm, where a bankruptcy order under section 126 has been made against the firm; or any person adjudged an undischarged insolvent.

The IBC applies broadly — to companies incorporated under the Companies Act, 2013 or earlier company law, Limited Liability Partnerships, other bodies the Central Government may notify, personal guarantors to corporate debtors, and partnership and proprietorship firms. The Code is organised into five parts: Part I, preliminary; Part II, insolvency resolution and liquidation for corporate persons; Part III, insolvency resolution and bankruptcy for individuals and partnership firms; Part IV, regulation of insolvency professionals, agencies and information utilities; and Part V, miscellaneous provisions.

Mahesh, a partner in a small trading firm, personally guarantees a bank loan taken by the firm. The firm defaults, and after the IBC's insolvency resolution process for the firm fails, a bankruptcy order is passed against the firm under section 126.

Under Section 79(4)(b) of the IBC, every partner of that firm, including Mahesh, is treated as bankrupt as a result of the order made against the firm itself, even though no separate bankruptcy order was passed against Mahesh individually. This has consequences for Mahesh's own personal finances and creditworthiness, flowing directly from the firm's bankruptcy order.

Chapter 18 (Key Regulations), section 18.8.5, 'Insolvency and Bankruptcy Code, 2016', gives the Section 79(4) definition of 'bankrupt' and sets out the Code's five-part structure. Expect a question that asks you to identify who qualifies as bankrupt under the IBC, including the rule that a firm's bankruptcy order extends to each of its partners.

• Being bankrupt under the IBC requires a formal bankruptcy order, or being adjudged an undischarged insolvent — informally owing more than you can pay is not, by itself, being 'bankrupt' in this legal sense.
• A bankruptcy order against a firm automatically extends to each partner of that firm under Section 79(4)(b) — this is a specific, testable rule.
• The IBC's five-part structure separates corporate insolvency, Part II, from individual and partnership bankruptcy, Part III — do not assume the same procedural part applies to both.