The two essential conditions must be fulfilled before a person can be declared insolvent by a competent court. The first condition is that he must be a debtor and he must have inadequate assets for repayment in full of his liabilities. The second condition is that he must have committed an act of insolvency. An act of insolvency can be defined as some act of the debtor which shows that he is not in a position to make the full payment of his liabilities. An act of insolvency may take place in any of the following circumstances :
(1) When the debtor makes a transfer of all or substantially all of his property to a third person for the benefit of his creditors.
(2) When the debtor transfers his property or any part thereof with the intent to defeat or delay his creditors.
(3) When the debtor transfers his property for fraudulent reference. Fraudulent preference takes place when the debtor prefers one creditor to another and pays the preferred creditor more than what he would have received had the assets been proportionately distributed among creditors of the debtor. Upon an order of adjudication the preferred creditor will have to return the money received by him.
(4) When any of the property of the debtors is sold or attached for a period of not less than 21 days in execution of the decree of any court. Under the Provincial Insolvency Act, only a sale in execution is an act of insolvency.
(5) When the debtors notifies any of his creditors that he has suspended, or that he is about to suspend, payment of his debts.
(6) When the debtors petitions the court to be adjudged an insolvent.
(7) When the debtor is imprisoned in execution of a court decree for payment of money.
(8) If with intent to defraud or delay his creditors ;
the debtor departs from or remains out of India ;
the debtor departs from his dwelling house or usual place of business or otherwise absents himself;
the debtor secludes himself so as to deprive his creditors of the means of communicating with him.
Legally a person can be called insolvent only if an order of adjudication is passed against him by a competent court. Before the court can pass an order of adjudication, there must be a petition presented to it either by a creditor or by the debtor himself. Petition by a creditor or creditors can be made only if (1) the debt, singly or jointly, of at least Rs. 500; and (2) the debtors commits an act of insolvency within three months of the petition. After presentation of the petition, the court fixes a date for hearing and then it either rejects the petition or makes an order of adjudication.
Under the Presidency Towns Insolvency Act, the order of adjudication relates back to the first available act of insolvency and under the Provincial Insolvency Act, its relates back to the date of the presentation of the petition. This doctrine is known as Doctrine of Relation Back. So, the insolvency of a person commences, not from the date when the order of adjudication is passed, but from an earlier date.
The official who is appointed to conduct the insolvency proceedings after the order of adjudication is passed is known as Official Assignee in Presidency Towns and Official Receiver in other places. After the order of adjudication is passed, the property of the insolvent vests in the Official, Assignee or Receiver who proceeds to realize the assets and distribute the sale proceeds of the assets in the following order :
(a) Fully secured creditors.
(b) Partly secured creditors to the extent they are secured.
(c) Realization expenses and remuneration of the Official Receiver or Assignee.
(d) Preferential creditors.
(e) Unsecured creditors.
The Order of Discharge. After the order of adjudication, the insolvent debtor may apply to the court for an order of discharge. After hearing the insolvent debtor and examining the conduct of the insolvent as reported by the Official Assignee or Receiver, the court may issue an order of discharge which frees the insolvent from his previous debts except to Government, debt incurred by fraud and liability of maintenance.
Interest. Creditors can claim interest on their debts upto the date of the order of adjudication. If the property of the debtor is sufficient to make the payment of creditors in full and a surplus exists, interest will be paid to the creditors for the period after the order of adjudication at the rate of 6% per annum.
Voluntary Transfers. If a person transfers his property to another without consideration, it is called a voluntary transfer. Under the Presidency Towns Insolvency Act, all voluntary transfers of property made by the-insolvent without consideration during two years preceding the order of adjudication shall be void and inoperative and in case of Provincial Insolvency Act, such transfers are voidable and not void as against the Receiver and may be annualled by the court. But voluntary transfers made by the insolvent will not be void in the following cases :
(a) when the transfer is made before and in consideration of marriage ; and
(b) when the transfer is made in favour of a purchase or encumbrance in good faith and for valuable consideration.
Doctrine of Reputed Ownership. According to this doctrine, goods in the possession, order or disposition of a trading insolvent in his business with the consent of their true owner and under the circumstances the trader insolvent appears to be their true owner, will be treated as assets of the insolvent for distribution to his creditors. The doctrine does not apply in the following cases.
1. Immovable properties.
2. Goods which were in the possession of the insolvent as repairer or carrier.
3. Goods in the possession of the insolvent as trustee or administrator.