Key Words: Corporate Insolvency, Liquidation, Dissolution, Winding Up, Liability towards Creditors, Liquidator, SICA, SARFAESI, RDDB

Transcription

1 The Legal Regime of Liquidation and Corporate Insolvency Laws in India: An Inquisitive Analysis under The Companies Act, 2013 S. Mohammed Azaad * ABSTRACT The stability of financial market of any nation will depend upon the soundness of its insolvency laws. In general parlance, the term insolvency may be defined as a situation where an individual, corporation, or any other entity recognized by law is unable to meet its financial obligations to pay off its debts which are due to its creditors. The term corporate insolvency has a narrower meaning, since it deals with a situation where a corporate entity becomes insolvent. The eventual consequence of corporate insolvency is winding up of the Company under the provisions of the Companies Act, Once a Company is declared insolvent, the insolvency laws clothes the creditors with certain specific rights which can be exercised against the insolvent company and also against the persons who are responsible for the management of the Company. The issues surrounding corporate insolvency laws have assumed particular significance in the wake of recent passing of the Companies Act, 2013 which has brought in significant changes in insolvency laws in India. It is pertinent to note that the laws relating to liquidation and corporate insolvency in India is not contained in Companies Act alone, since the subject of insolvency is vast and complicated one. Hence, a research study on insolvency laws is imminently necessary to analyse the procedural and operational framework governing the liquidation of various corporate entities in India. A comprehensive study is moreover required to assist the various stakeholders of the Companies about the proper interpretation and application of the laws governing liquidation and insolvency, in the event of liquidation of their Companies. Thus, this Research Paper primarily analyses in depth the numerous procedural and substantive laws governing liquidation and insolvency of corporate entities in India. Key Words: Corporate Insolvency, Liquidation, Dissolution, Winding Up, Liability towards Creditors, Liquidator, SICA, SARFAESI, RDDB * LLM Student, NALSAR University of Law, Hyderabad

2 I. INTRODUCTION The term corporate insolvency refers to a situation where a corporate entity is unable to face its financial obligations towards its creditors. Once a Company is declared insolvent, the insolvency laws clothes the creditors with certain specific rights which can be exercised against the insolvent company and also against the persons who are responsible for the management of the Company. The issues surrounding corporate insolvency laws have assumed particular significance in the wake of the recent passing of the Indian Companies Act, which has brought in significant changes in insolvency laws in India. In this regard, it is pertinent to note that the laws relating to liquidation and corporate insolvency in India is not contained in the Companies Act alone, 3 since the subject of insolvency is very vast, complicated and chameleonic in nature. Post 1990 s, it is a well-known fact that India s policy towards globalization and liberalization has attracted humongous investments from foreign creditors in the Indian securities market and in turn, the Indian Corporates are also making significant investments in Companies incorporated outside India. As more and more entities commenced their business operations in India, it became increasingly necessary to review the existing legislations on insolvency laws in India so us to understand about the financial implications when these Companies eventually get wound up or liquidated in the passage of time. Thus, it would be suffice to say that in a developing economy like India, the soundness and efficacy of insolvency laws will have a direct and substantial impact on the development of financial systems and capital market structures. More often, huge costs and lengthy delays in disposition of liquidation proceedings were the usual criticisms thrown against the efficacy of earlier Indian insolvency laws. 4 Hence, in these circumstances, a research study on the efficacy of the current Indian insolvency regime 2 The Act came into force on 12 th September As on 1 st April 2014, 283 out of 470 Sections of the Act have been notified in a phased manner. 3 Sick Industrial Companies (Special Provisions) Act, 1985; Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; Recovery of Debts Due to Banks and Financial Institutions Act, 1993; Securities Exchange Board of India Act, For instance, the Sick Industrial Companies (Special Provisions) Act, 1985 was repealed and replaced by the Sick Industrial Companies (Special Provisions) Repeal Act, 2003 citing these reasons; See also Kristin Van Zwieten, Corporate Rescue in India: The Influence of the Courts, Forthcoming, Journal of Corporate Law Studies 2015(1), electronic copy available at: (last accessed on Dec. 17, 2014).

3 is imminently necessary to analyse the procedural and substantial framework governing the liquidation and insolvency of Companies. A comprehensive study is moreover required to assist the various stakeholders of a Company in the proper interpretation and application of the existing corporate insolvency laws in India. II. LIQUIDATION AND CORPORATE INSOLVENCY MEANING AND RELATIONSHIP The term liquidation and corporate insolvency are interrelated terms which deals with the broad genre of how a Companies life as juristic person comes to an end. Wharton s Law Lexicon defines the term insolvency as the state of one who has no property sufficient for the full payment of his debts. 5 In general parlance, the term insolvency may include any situation where an individual, corporation, or any other entity recognized by law is unable to meet its financial obligations to pay off its debts which are due to its creditors. The term corporate insolvency has a much narrower meaning, since it deals with a situation where a corporate entity becomes insolvent, i.e., it is no longer able to meet its financial obligations towards its creditors. Oxford Dictionary defines the term liquidation as winding up the affairs of the company by ascertaining its liabilities and apportioning assets. 6 A company comes into existence as a separate legal person through a lengthy and formal process of law called as incorporation. 7 If a Company decides to put an end to its legal existence for any reason whatsoever, then it has to again go through a lengthy legal procedure called as liquidation or winding up of a Company. 8 Although the terms liquidation and insolvency are interrelated, yet they do not intend to mean the same thing for three reasons: 9 5 Wharton s Pocket Law Dictionary, Universal Publishing Co. Ltd., 15 th ed., 2010, at p Archie Hobson, The Oxford Dictionary of Difficult Words, at p See Chapter II of the Companies Act, 2013 which deals with Incorporation of a Company and Matters Incidental Thereto ; See also Section 7 in particular which deals with the procedures involved in Incorporation of a Company. 8 See Chapter XX of the Companies Act, 2013 which deals with Winding Up or Liquidation of a Company ; See also Section 270 in particular which deals with the Different Modes of Winding Up of a Company. 9 Ashok K. Bagrial, Company Law, 11 th ed., 2005, Vikas Publishing House Pvt. Ltd., at p. 520 [Bagrial].

4 Firstly, winding up or liquidation order can be made by a Court of Law, even when the Company is in a solvent state. Not all the companies which are being subjected to liquidation proceedings are in financial trouble. For instance, a solvent company may be wound up, if there is a default in filing financial statements with the Registrar or when there is a reduction in the number of membership etc. 10 Secondly, on liquidation, a company does not automatically cease to exist. After liquidation order, its administration is carried on by a company liquidator 11 or an official liquidator. 12 Despite the liquidation order, the property still remains with the Company and it can carry on business for a limited purpose and can file suit in its own name. 13 The position is otherwise in the case of corporate insolvency. Thirdly, even in cases where an insolvent company is eventually wound up, all the provisions of insolvency law do not automatically apply. 14 For example, the principle of reputed ownership applied in personal insolvency cases is not applicable to companies in winding up. 15 To put it in simpler terms, the eventual consequence of corporate insolvency is liquidation or winding up of the company under the provisions of the Companies Act, 2013 read together with other legislations on insolvency and not vice versa. III. LIQUIDATION AND WINDING UP IS THERE A DIFFERNCE BETWEEN THESE TWO TERMS Professor Gower defines the term winding up of a company as the process by which the life of the company is ended and its property is administered for the benefit of its creditors and members. 16 The terms liquidation and winding up are often used interchangeably, since both these terms refers to a process where the management of the company is taken out of the 10 Companies Act, 2013, at Section 271(1) - Circumstances in which Company may be wound up by Tribunal. 11 Ibid, at Section Ibid, at Section Bagrial, supra 13, at p Ibid. 15 Goringe vs. Irwell Works, (1884) 34 Ch. D L.C.B. Gower, The Principles of Modern Company Law, 3 rd ed., at p. 647.

5 hands of its directors and its assets are realised by an administrator called as liquidator for the purpose of settling the outstanding debts of creditors. 17 Although these terms are similar, yet they commonly describe two different things from a technical perspective. In general, a company may shut down its business, as a result of a winding up order issued by a Court 18 on a petition by the company s creditors 19 or because of a voluntary liquidation decision made by the Board of Directors or the Owner of the Company. 20 When used in this context, the term liquidation refers to the process, and winding up refers to the steps involved in closing the business. This is because a voluntary decision to liquidate the Company involves a single step, while winding up is a process with multiple steps. 21 IV. DIFFRENCES BETWEEN LIQUIDATION AND DISSOLUTION The life of a company as a separate legal person comes to an end when it is dissolved. 22 The immediate effect of dissolution is that the company ceases to exist as a corporate entity. The main difference between liquidation and dissolution is that liquidation is one of the methods by which the dissolution of company is brought about. 23 At the end of liquidation, a company will have no formal assets or liabilities and thus it will be a mere formal step to dissolve the Company. Thus, liquidation proceedings will precede dissolution of a company and both these terms are not one and the same. Furthermore, in the case of voluntary liquidation there is no need for an 17 Bagrial, supra 13, at p Companies Act, 2013, at Section 271(1) - Circumstances in which Company may be wound up by Tribunal. 19 Ibid, at Section 272(1)(b). 20 Ibid, at Section Circumstances in which Company may be wound up voluntarily. 21 Jackie Lohrey, Difference between Liquidation & Winding Up, available at: (last accessed on Jan. 1, 2015). 22 Dr. Ashok Sharma, Company Law, ed., V.K. India Enterprises, at p. 253 [Ashok]. 23 Bagrial, supra 13, at p. 520.

6 order from the Court. 24 However, for dissolution of a company, whether voluntary or compulsory, an order from the Court is mandatorily required 25 to carry out the formalities. V. SOURCE OF INSOLVENCY LAWS UNDER THE CONSTITUTION The Seventh Schedule to the Constitution of India, 1950 demarcates the sources of powers between the Federal and the State Governments in three lists, namely, Union List, State List and Concurrent List. 26 As far as insolvency laws are concerned, the relevant field of power is contained in Entry 9 of the Concurrent List under the title Bankruptcy and Insolvency. Thus, the intention of the framers of our Constitution was to empower both the Central and the State Governments to make laws on bankruptcy and insolvency. As far as personal insolvency laws are concerned, India still follows the colonial legislations of Provisional Insolvency Act, 1920 and Presidency Towns Insolvency Act, In relation to corporate insolvency, India first passed the Companies Act, 1956 which was recently repealed and replaced by the Companies Act, Besides this, using the power granted under Entry 9 of the Concurrent List, the Federal Government has passed several laws governing bankruptcy and insolvency of Companies such as SICA, RDDB, SARFAESI and Sick Industrial Companies (Special Provisions) Repeal Act, 2003 etc. With the passing of SEBI Act, 1992, the Securities Exchange Board of India became the prime regulator for capital markets in India. SEBI has passed many regulations governing a variety of investment funds and all these regulations contain a winding up provision. 27 In this connection, it is relevant to note that Article 19(1)(g) of the Indian Constitution of India guarantees to its citizens the freedom to practice any profession or to carry on any occupation, trade or business, subject to any reasonable restrictions imposed by the Central or State Governments. 28 Thus, a Public Company or a Private Company which is in the nature of an industrial undertaking cannot arbitrarily close its business at any time it wishes on the ground of freedom of trade and business. 29 Such restriction to close the Company is justified 24 Ashok, supra 26, at p Companies Act, 2013, at Section Constitution of India, 1950, Article For example, Regulation 29 of the SEBI (Alternative Investment Funds) Regulations, 2012 deals with the winding up of an Alternative Investment Fund vehicle. 28 Constitution of India, 1950, Article 19(6). 29 Excel Wear vs. Union of India, AIR 1979 SC 25.

7 on the ground that it is in public interest to prevent unemployment. 30 As a result of such policy, there is a freedom to undertake any industrial activity, but there is no freedom to exit. 31 Therefore, if a Company which is in the nature of industrial undertaking wishes to close its business, then it has to mandatorily follow the elaborate provisions on liquidation under the Companies Act, 2013 to wound up the Company. VI. OUTLINE OF INSOLVENCY LEGISLATIONS IN INDIA The general scheme of insolvency legislations in India can be classified into two types based upon the persons or entities which are affected by insolvency. They are: A. Personal Insolvency Laws - Colonial legislations such as Provisional Insolvency Act, 1920 and Presidency Towns Insolvency Act, 1908 which are applicable to individuals, partnership firms and other unincorporated entities; and B. Corporate Insolvency Laws - It includes several post-independence legislations which are applicable to incorporated companies and other corporate entities. The eventual consequence of corporate insolvency is liquidation of the Company in accordance with the provisions of the Companies Act, The scope of the present seminar paper is confined only to liquidation and corporate insolvency and thus in the forthcoming paragraphs, the legislations on corporate insolvency will be analysed in detail. VII. COMPANIES ACT, 2013 LIQUIDATION & INSOLVENCY PROVISIONS It is submitted that no statutory definition for the term insolvency can be found under the Companies Act, 2013 or in any other Indian insolvency legislations. However, Section 271(1)(a) of the Companies Act provides that a Company may be wound up by the Tribunal if it is "unable to pay its debts". The Act further provides that a company shall be deemed to be unable to pay its debts in the following three cases: 30 Rajkumar S. Adukia, A Study on Insolvency Laws in India Including Corporate Insolvency, available at: at p. 4 (last accessed on Dec. 29, 2014) [Adukia]. 31 Deepti Kanojia, Meenakshi, Insolvency Law in India with Special Reference to Corporate Insolvency, Int. J. of Trade and Commerce - IIARTC, Vol. 3, No. 1 (2014), at p Companies Act, 2013, at Chapter XX containing Sections 270 to 365.

8 A. Demand for Payment Neglected 33 If a creditor, to whom the company is indebted for an amount exceeding one lakh rupees, has served on the company a demand for payment in an appropriate mode, and the company has failed to pay the sum within twenty-one days after the receipt of such demand or to provide adequate security or re-structure or compound the debt to the reasonable satisfaction of the creditor, then the Company may be wound up by the Tribunal. B. Decreed Debt Unsatisfied 34 If any execution or other process issued on a decree or order of any court or tribunal in favour of a creditor of the company is returned unsatisfied in whole or in part, then it means that the unable to pay its debts and thus it may be wound up by the Tribunal. C. Commercial Insolvency 35 If it is proved to the satisfaction of the Tribunal that the company is unable to pay its debts, then a Company may be wound up. The determination of a company s inability to pay its debts is a question of fact and the same may be determined by the Tribunal by taking into account the contingent and prospective liabilities of the company. D. Test To Determine Commercial Insolvency Section 271 of the Companies Act, 2013 which deals with the circumstances in which a Company may be wound up by the Tribunal uses the words "unable to pay its debts" to describe the situation of commercial insolvency of a company. In this regard, the test to determine the commercial insolvency was laid down by the English Courts in the case of In Re European Life Assurance Society Ltd. 36 In this case, the Court held that a company is said to be commercially insolvent, if the existing and probable assets of the Company would be insufficient to meet its existing liabilities. This test has been accepted and followed by the Indian Courts in a plethora of cases Companies Act, 2013, at Section 271(2)(a). 34 Ibid, at Section 271(2)(b). 35 Ibid, at Section 271(2)(c). 36 (1869) L.R. 9 E.Q Registrar of Companies vs. Sohanmath Golcha, (1972) Comp. Cas. 386; Krishna Iyer & Sons vs. New Era Manufacturing Co. Ltd, (1965) I Comp. L.J. 179.

9 E. Commercial Insolvency - Indian Judicial Precedents 1. In Re Jambad Coal Syndicate Case 38 The Calcutta High Court held that in order to wound up a Company on the ground of inability to pay its debts, it is necessary that the debt must be presently payable and the title of the Petitioner demanding it should not be defective. 2. Vanaspati Industries Ltd vs. Firm Prabhu Dayal 39 If the debtor company bonafidely disputes the Petitioners debts, then no order for winding up can be made under this Section. However, if the dispute is not bonafide and if its put forward to hide its inability to pay and to defeat the legitimate claims of the Petitioner, then a petition for liquidation would be entertained by the Court. 3. Modern Dekor Painting Contracts Pvt. Ltd. vs. Jenson and Nicholson India Ltd. 40 In this case, the Bombay High Court held that a time barred claim cannot sustain a winding up provision. However, a debt which becomes time barred by the time of the winding up order does not matter for the purpose of this Section. VIII. REVIVAL AND REHABILITATION OF SICK INDUSTRIAL COMPANIES The Companies Act, 2013 specifically provides that inability of a Company to satisfy its debt obligations will be a valid ground for liquidation. 41 The 2013 Act also contains a separate chapter on revival and rehabilitation of sick companies 42 which was not there in the 1956 Act. A conjoint perusal of both these provisions clearly establish the legal position that before a Company is declared insolvent, a reasonable opportunity should be given to the Company to pay its outstanding debts and thereby revive itself. As the insolvency laws are basically social security legislations, 43 a harmonious interpretation has to be adopted while construing 38 AIR 1936 Cal AIR 1950 E.F (1985) 58 Comp. Cas. 255 (Bom.). 41 Companies Act, 2013, at Section 271(1)(a). 42 Ibid, Chapter XIX containing Sections 253 to Adukia, supra 34, at p. 13.

10 the provisions of the same. Accordingly, a harmonious interpretation would mandate that an insolvent company must be first given an opportunity to revive itself and liquidation should only be used as a last resort. A. Objectives Of SICA Before the passing of the 2013 Act, the provisions relating to revival of Sick Industrial Companies were provided under SICA and Sick Industrial Companies (Special Provisions) Repeal Act, SICA was enacted in India to determine the extent of sickness in industrial units, expedite the revival of potentially viable companies and close unviable units to release investment locked up in them for productive use elsewhere. 44 Further, two Boards were established under SICA 45 for the purpose of regulating and undertaking the determination of sickness and thereafter revival. They are Board of Industrial & Financial Reconstruction ( BIFR ) 46 and Appellate Authority for Industrial and Financial Reconstruction ( AAIFR ). 47 A company which feels sick can make a reference to the BIFR to determine its sickness. 48 Thus, reference to BIFR is made to determine the measures to be taken for a company that is sick and powers BIFR are limited to revival and rehabilitation of sick companies. B. Limitations of SICA The application of SICA is limited to companies that can be called as an industrial company. The term industrial company as per SICA includes those Companies that have an industrial undertaking 49 and which falls under Schedule I of the Industrial Regulation & Development Act, 1951, 50 subject to exceptions provided in SICA. 44 Investopedia, Sick Industrial Companies Act, available at: (last accessed on Jan. 2, 2014). 45 See Chapter II of SICA containing Sections 4 to SICA, at Section Ibid, at Section Ibid, at Section Ibid, at Section 3(f). 50 Ibid, at Section 1(4).

11 Besides, the procedure enumerated in SICA is lengthy and tedious. One peculiar provision is that of abatement of reference which suggests that if during the pendency of reference before BIFR, the creditors have gone under SARFAESI Act then there will be abatement of reference. 51 The consequence of this will be that the suit before BIFR will be suspended till the time proceedings under SARFAESI Act are not completed. C. Changes Brought By The Companies Act, 2013 To remove the difficulties created by SICA, the 2013 Companies Act under Chapter XIX dedicates a separate chapter on revival and rehabilitation of sick companies. The first step taken by this chapter is that it has increased the scope of revival for all the companies that will be governed by Companies Act, Also, a new provision in the form of determination of sickness has been laid down. 52 Therefore, now the creditors first need to approach the Tribunal for determining sickness of a Company. Once that is done, the creditors need to approach for revival or winding up of company. Thus, the creditors have the power to determine whether a Company should go for revival or winding up. Further, the creditors will be involved in the formulation of revival scheme under the supervision of interim administrator who will be appointed by the Tribunal. 53 It can be seen from the provisions of Chapter XIX that the Companies Act, 2013 has given more power to the creditors when it comes to revival or winding up of sick companies. IX. CONCLUSION The stability of financial market of a particular nation will depend upon the soundness of its insolvency laws. It is pertinent to note that the Companies Act, 2013 is of very recent origin, and hence, there is always an impending possibility that the insolvency laws might often be scissored, tweaked and altered by way of amendments and circulars so as to suit the changing circumstances. Further, the provisions relating to liquidation and corporate insolvency in the new Companies Act are yet to be notified by the Ministry of Corporate Affairs (MCA). Thus, the legal regime governing the subject of corporate insolvency and liquidation can never be a constant one, since new regulations on liquidation in relation to the Securities market are regularly being 51 Ibid, at 3 rd Proviso to Section Companies Act, 2013, at Section Ibid, at Sections 261 to 263.

12 passed by SEBI. The main objective behind these insolvency legislations is to ensure greater clarity in liquidation procedures in India. Thus, the insolvency provisions in the new Companies Act are undoubtedly a step in the right direction, since they bring about greater transparency in the issues concerning the liquidation of Companies. These comprehensive legislations would also ensure greater clarity for investors, both Indian as well as investors of foreign origin, who are willing to invest in the Indian Securities Market.

13 BIBLIOGRAPHY AND REFERENCES A. Indian Legislations Constitution of India, 1950 Limited Liability Partnership Act, Presidency Towns Insolvency Act, 1908 Provisional Insolvency Act, 1920 Recovery of Debts Due to Banks and Financial Institutions Act, 1993 Securities Exchange Board of India Act, 1992 Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 Sick Industrial Companies (Special Provisions) Act, 1985 The Companies Act, 1956 The Companies Act, 2013 B. Judicial Precedents Excel Wear vs. Union of India, AIR 1979 SC 25 Goringe vs. Irwell Works, (1884) 34 Ch. D In Re European Life Assurance Society Ltd, (1869) L.R. 9 E.Q. 122 In Re Jambad Coal Syndicate Case, AIR 1936 Cal. 628 Krishna Iyer & Sons vs. New Era Manufacturing Co. Ltd, (1965) I Comp. L.J. 179 Modern Dekor Painting Contracts Pvt. Ltd. vs. Jenson and Nicholson India Ltd., (1985) 58 Comp. Cas. 255 (Bom). Registrar of Companies vs. Sohanmath Golcha, (1972) Comp. Cas. 386 Vanaspati Industries Ltd. vs. Firm Prabhu Dayal, AIR 1950 E.F. 142 C. Books and Treatises Ashok K. Bagrial, Company Law, 11 th ed., 2005, Vikas Publishing House Pvt. Ltd. Avtar Singh, Company Law, 2009 ed., Universal Law Publishing Ltd. Dr. Ashok Sharma, Company Law, ed., V.K. India Enterprises Pvt. Ltd. L.C.B. Gower, The Principles of Modern Company Law, 3 rd ed., Sweet & Maxwell Co.