Bankruptcy Estate, Distribution, Discharge and Offences

Once a bankruptcy order is made, the trustee's task is to gather the bankrupt's estate, recover what was improperly given away, pay creditors in the statutory order and bring the bankruptcy to an end with a discharge. Part III sets out each of these steps and backs them with offences for dishonest debtors, creditors and trustees. This note explains the estate, avoidance in bankruptcy, distribution under section 178, discharge and the offences.

1. The Bankruptcy Estate, Section 155

• Included. All property belonging to or vested in the bankrupt at the bankruptcy commencement date, and property the trustee may claim under the Code.
• Excluded. Excluded assets of the bankrupt, such as tools and equipment needed for his work, basic household items and a dwelling unit of prescribed value; property held on trust for another person; sums due to workmen or employees from provident, pension and gratuity funds; and other notified assets.
• Dispositions after filing. A disposition of property by the debtor between the filing of the application and the commencement date is void unless made with the authority's consent, subject to protection for persons acting in good faith, for value and without notice (section 158)
• After-acquired property, section 159. The trustee may claim property acquired by the bankrupt after the commencement date by notice within 15 days of becoming aware of it, with exceptions.
• Onerous property, sections 160 to 163. The trustee may disclaim unprofitable contracts and property that is unsaleable or not readily saleable, subject to challenge by affected persons.

2. Avoidance in Bankruptcy

Figure 1: Avoidance periods in bankruptcy and corporate insolvency

• Undervalued transactions, section 164. Transactions in the two years before the application, with a presumption that transactions with associates were undervalued; the bankrupt may show a transaction with a non-associate was in the ordinary course of business.
• Preferences, section 165. Preferences given within two years before the application to an associate, or six months to any other person.
• Extortionate credit, section 167. Credit transactions in the two years before commencement on exorbitant or unconscionable terms, excluding lawful debt from regulated financial service providers.
• Section 164A, 2026. Where an undervalued transaction was deliberately entered into to put assets beyond the reach of a claimant or to prejudice the claimant's interests, the authority shall restore the position and protect the victims, with protection for good faith purchasers for value without notice, mirroring section 49.

3. Proof of Debts and Distribution

• Proof, sections 171 to 173. The trustee estimates debts without a fixed value; a secured creditor that realises its security proves only for the balance, or may surrender the security and prove for the whole; mutual dealings before commencement are set off and only the balance is provable.
• Dividends, sections 174 to 177. The trustee may declare interim dividends, may distribute property in kind with the committee's approval, and declares a final dividend once the estate is realised; any surplus after paying all creditors in full with interest goes to the bankrupt.

Figure 2: Order of priority under section 178

• Section 178(1). The trustee pays, in order: (a) the costs and expenses of the bankruptcy process; (b) workmen's dues for 24 months before the bankruptcy commencement date, equally with debts owed to secured creditors; (c) wages and unpaid dues of other employees for 12 months; (d) amounts due to the Central and State Governments for two years; and (e) all other debts and dues, including unsecured debts.
• Equal ranking. Debts in the same class rank equally and abate in equal proportion if the estate is insufficient.
• Government dues, 2026. An Explanation to section 178(1)(d) provides that government dues for the two years rank there whether or not secured, and whether any security arises by agreement or operation of law, with the balance under clause (e)
• Firms. Partnership property is applied first to partnership debts, and separate property of a partner to his separate debts.

4. Discharge, Sections 138 and 139

• Timing. The trustee applies for a discharge order on the expiry of one year from the bankruptcy commencement date, or within 7 days of the committee approving completion of administration, whichever is earlier.
• Effect. The discharge order releases the bankrupt from all bankruptcy debts, but not from debts incurred through fraud or breach of trust, nor from excluded debts such as fines and maintenance, and it does not affect the trustee's functions or release any person other than the bankrupt, such as a surety.
• End of restrictions. The disqualifications and restrictions under sections 140 and 141 cease on discharge (Topic 70)

5. Offences and Penalties

Figure 3: Offences and penalties in Part III

• Section 184. A debtor or creditor who knowingly provides false information to the resolution professional, or a creditor who accepts money to vote on a repayment plan, is punishable with imprisonment and fine.
• Sections 185 and 187. An insolvency professional who deliberately contravenes Part III, and a bankruptcy trustee who fraudulently misapplies or wilfully causes loss to the estate, are punishable.
• Section 186. A bankrupt who makes false statements or conceals property, falsifies books, breaches the disqualifications or restrictions, fails to deliver property, cannot explain the loss of substantial property, or absconds, is punishable with imprisonment of up to one or two years and fine.
• Section 183A, 2026. The authority may impose a penalty of one lakh to two crore rupees on a person who initiates a frivolous or vexatious proceeding under Part III.
• Appeals. From the DRT, an appeal lies to the DRAT within 30 days and then to the Supreme Court on questions of law within 45 days (sections 181 and 182); for personal guarantors, the NCLT's orders are appealable to the NCLAT under section 61.

6. Frequently Asked Questions

Does a discharge in bankruptcy release a debt arising from the bankrupt's fraud?

No. Section 139 excludes debts incurred through fraud or breach of trust, and excluded debts such as fines and maintenance, from the discharge.

Where do government dues rank in an individual's bankruptcy?

Dues for the two years before the bankruptcy commencement date rank under section 178(1)(d), after workmen, secured creditors and employees, and, since 2026, regardless of any statutory charge; older dues fall in clause (e).

How far back can the trustee challenge a payment by the bankrupt to an unrelated creditor?

Six months before the bankruptcy application, under section 165. For associates, the period is two years.

Who hears an appeal against a DRT's bankruptcy order?

The Debts Recovery Appellate Tribunal, within 30 days under section 181. For personal guarantors to corporate debtors, the NCLT is the authority and appeals lie to the NCLAT.

7. Related Topics

• Topic 57: Section 53. The corporate waterfall compared.
• Topic 70: Bankruptcy Order and Trustee. How bankruptcy begins.
• Topic 88: Fresh Start vs Bankruptcy. The two outcomes compared.