Corporate Insolvency Laws in India

Corporate Insolvency laws in India

Vinod Kothari1012 Krishna224 AJC Bose RoadCalcutta 700 017Phone 033-23233863/23233864/2281 1276/22817715/22813742Fax 91-33-23233863/22811276

Email: [email protected]; [email protected]

Corporate insolvency by Vinod Kothari2

Copyright information

All rights reserved with Vinod Kothari. The presentation is to be used only for the purpose of the training course/meeting/class for which it is intended and any use of any part of it, other than for distribution at such training course/meeting/class is unauthorized.

No rights of any kind have been transferred in soft copy of the presentation, meant only for the purpose of printing. The soft copy should be purged immediately after printing.

No copying or distribution of this presentation in any form is allowed except with the express permission of the author.


Scheme of corporate insolvency under Indian law

Individuals going insolvency – insolvency laws to apply; consequence: declaration of insolvency and incapacity to contract

Corporate insolvency – corporate laws to apply; consequence – usually, winding up.

Fragmented law of corporate insolvency:– Company unable to pay its debt – discretionary power with Court to

wind up the company [sec 433]– Company having become a “sick company” – mandatory reference to

BIFR [SICA, proposed to be replaced by sec. 424A of Companies Act]

– Default in terms of repayment of debentures: appointment of receiver- provision mirroring English law exist in sec. 424, but rarely practiced

– Quasi-bankruptcy: Compromise and arrangement –sec 391-4: practice evolved includes lot

more cases of healthy companies than insolvency companies Reduction of capital –sec 100 Striking off the name of a defunct company – sec. 560


Basic principles of corporate insolvency

Restoring the company to profitable trading Maximising returns to creditors Fair and equitable system of ranking of claims Identifying causes of insolvency and sanctions against

those responsible therefor Placement of the assets of the company under external

control Substitution of collective action for individual pursuits Statutory distribution Avoidance of certain transactions and fraudulent

conveyances Dissolution and winding up


Scheme of winding up provisions

Circumstances in which company may be compulsorily wound up; meaning of inability to pay debts – sec. 433-434

Procedural issues in compulsory winding up, consequence of winding up – sec. 435-447

Official liquidator, statement of affairs, etc – 448-463 Powers of the court – 466-480 Dissolution – 481 Proof of debt – 528 Priority of claims, insolvency rules, preferential payments

– 529, 529A, 530 Fraudulent preference and avoidance powers – sec 531-

537 Delinquencies and penalties– sec 538-545


Institutional machinery

Winding up handled by District or High Courts; High court is the court of proper jurisdiction:– Power sought to be transferred to NCLT

Official liquidator is the liquidator in compulsory winding up:– currently an officer of the Central govt– Amendment to allow for professional firms or bodies

corporate to be appointed official liquidators

Creditors’ committee of inspection may be appointed


Meaning of “insolvency”

In context of corporate laws, the word “insolvency” has neither been used nor defined

Sec. 433 (e) covers a company which is unable to pay its debts:– Inability to pay debt amplified in sec. 434

A creditor with due of Rs. 500 (amended to Rs 100000, not effective) or more serves a demand by registered post; company neglects to pay, secure or compound the same in 3 weeks;

Execution of a decree returned unsatisfied Court is otherwise satisfied company is unable to pay debts Winding up machinery cannot be used as a device to enforce payments:

Amalgamated Commercial Traders 35 Comp. Cas 456 (SC):– Test is commercial insolvency, based on prevailing assets and prevailing

liabilities; test based on current assets; whether the company can remain a going concern

Analogous to “acts of insolvency” under the Provincial Insolvency Act.


Steps in compulsory winding up

Petition for winding up [sec 439]– Presentation “in chambers” [rule 96]; the judge may notify the company before admission.

If petition is admitted, winding up commences [sec 441] Advertisement of petition [rule 96] Power of the court to stay or restrain proceedings against company [sec. 442] (repealed – not

yet effective) After admission but before final order, court may appoint OL as provisional liquidator [rule 106] Hearing of petition and power on hearing – dismissal, adjournment, interim order or order for

winding up Communication of the order to Official Liquidator [sec 444] Notice to serve statement of affairs [rule 124] and Filing of statement of affairs with the OL –

sec 454 Report of the OL on the statement of affairs – sec 455 Liquidator to take custody of the property of the company – sec 456 Proof of debts: fixation of date by the OL by advertisement; claimants to prove their debt;

liquidator to communicate acceptance or rejection of debt – rules 147-163 Appeal by creditor against decision of OL – rule 164 Proof and list of creditors to be filed in court – rule 167 Application of the assets of the company Application of insolvency rules – sec 528/529; priority

of payments – sec 529/529A/ 530 Dissolution of the company – sec. 481


How much time does it take to wind up?

Justice Balkrishna Eradi committee revealed data of time taken – it may run on an average upto 25 years; Eastern region being the worst

Position as on 31.3.1999

0-5 YEARS 5-10 YEARS

10-15 YEARS

15-20 YEARS

20-25 YEARS

25 YEARS AND ABOVE

TOTAL

NORTHERN REGION *

259 130 86 56 47 66 644

EASTERN REGION

126 77 83 73 71 293 723

SOUTHERN REGION

325 212 89 68 51 78 823

WESTERN REGION

355 184 224 124 82 36 1005

TOTAL

1065 603 482 321 251 473 3195


Effect of winding up order

All suits stayed on making of the winding up order [sec. 446] Advertisement of the order [rule 113] Notice of discharge to all employees, except where business is

continued – sec 445 (3) Board of directors ceases to exist, except for filing of SOA Undertaking and the assets pass under the control of the liquidator – J K

(Bombay) (P) Ltd. 40 Comp Cas 689 (SC):– Liquidator does not acquire ownership of the property (as in case of

insolvency); he merely gets the custody– Amount for which the company is a trustee cannot be regarded as a part of the

bankruptcy estate of the company : Problems may arise in case of commingling of money


Pursuit of individual claims

Winding up procedure implies all personal rights be converted into right to prove debt in winding up

Sec 446 provides for stay on all suits; the winding up court to decide all suits by and against the company

The stay is on suit – a secured creditor may enforce security interest without a suit; therefore, real rights of secured creditors protected:

– Private sale protected: Ranganathan vs Govt of Madras AIR 1955 SC 604

– Appointment of receiver by secured creditor permitted – Department circular 16/76 dated 28th June 1976

Criminal proceedings or proceedings against directors or officers are not stayed

Income tax proceedings will continue against the liquidator


Proof of debts

Right of action – jus in personam – become right to prove a claim in bankruptcy

General rule - insolvency rules are applicable to provable debts, valuation of annuities, future and contingent liabilities etc.

– Sec 49 of the PIA provides for mode of proof All debts are provable – including contingent and future claims:

– The court may direct particular creditors to be admitted without proof, e.g. government dues [Rule 149]

– In case of several workmen’s claims, a single proof may be filed by foreman etc for several workers

How is debt proved:– By affidavit, supported by vouchers/ agreement, where applicable

[Rule 150], Creditor need not appear for investigation unless required Value of the debt is the value as on the date of winding up Interest, if not specifically stated, may be admitted @ 4% upto the

date of winding up


Priority rules: secured creditor

Rule about secured creditors and workmen:– Secured creditor may opt to prove his debt: If yes, secured

creditors and workmen have pari passu interest in the value of a security – proviso to sec. 529 (1):

Workmen defined with reference to Industrial Disputes Act Workmen’s dues include wages, holiday pay, retrenchment

compensation, dues from employee benefit fund maintained by the company

– If secured creditor realises his security, he will cede a rateable proportion for workmen’s claims

– To the extent of the sacrifice the secured creditor makes for workmen’s portion, his claim becomes a an overriding preferential claim – sec. 529A

Workmen’s dues, and the claims of secured creditor sacrificed to workmen are over-riding preferential claims – sec. 529A


The stacking order of priorities

Secured creditors from out of the assets securing their claims, subject to pari passu claim of workmen:

– Court rulings holding government claims resulting into a statutory charge amount put govt in position of a secured creditor

Workmen and secured creditors to the extent they sacrificed their interest to the workmen – overriding preferential claims

Costs and expenses of winding up – sec 530 (6) Preferential creditors – sec 530 (1) Floating charge holders Unsecured creditors


Preferential creditors

The following are defined as preferential creditors:– All revenue, tax, cess and rates due to Central, state or local

authority, which have become due and payable within 12 months next before the effective date:

Conflicting and overriding provisions of sec. 178 of the IT Act and other taxing laws

Other govt dues do not have preference

– Wages and salaries of any employee, for not exceeding 4 months during 12 months prior to effective date: sum not exceeding Rs 20000 per employee

– Holiday remuneration payable to employees– ESI dues– Workmen’s compensation for loss of employment– Employee benefit fund dues out of funds with the company– Expenses of investigation u/s 235-237

The above shall rank pari passu as amongst themselves


Avoidance of fraudulent transfers– sec 531

Any transfer of property, delivery of goods, payment, execution or other act within 6 months prior to commencement of winding up:

– Is a fraudulent preference if it would have been treated, in case of an individual, a fraudulent preference

– Law derives principles from sec. 54 of the PI Act: elaborate body of case law under the PI Act applicable here

– Scope of the section is wide – includes payments, transfers and even creation of charges on properties

– Undue preference is the rule: Knowledge of imminent bankruptcy makes it a fraudulent

preference Burden of proof is on the person alleging a fraudulent preference

6 months’ time frame – need to prefer petition for winding up in proper time to avoid preferences


Avoidance of voluntary transfers – sec 531A

All transfers of property or delivery of goods, not being:– A)

In ordinary course of business, or In favour of a purchaser in good faith AND for valuable consideration

– B) taking place within 12 months prior to commencement of winding up

– Shall be void against the liquidator Floating charges created within 12 months prior to

commencement of winding up are invalid:– Unless it is proved that the company was solvent immediately after

creation of the charge – sec. 534 The liquidator may disclaim any onerous property – sec 535 Any transfer made after commencement of winding up except with

the consent of the liquidator is void – sec. 536


Delinquent directors/officers

Several offences are punishable with imprisonment upto 5 years, or fine or both – sec 538

Falsification of books of a company being wound up – sec 539

Penalty for frauds by officers – imprisonment upto 2 years : sec. 540

Liability for fraudulent conduct of business: personal liability for debts – sec 542; also imprisonment upto 2 years [sec 542 (3)]

Proceedings similar to bankruptcy


Reference under SICA

Sick company – company whose net worth has been eroded [sec 3 (o) of SICA]:

– Difference between winding up and SICA proceedings: Erosion of net worth is surest proof of “inability to pay debts” –

overlap cannot be denied SICA applicable only to industrial undertakings, objective is

curative, corrective SICA reference is mandatory on the part of the company – sec.

15 BIFR to make enquiry whether the company may be made to

turnaround [sec 16]; if so, so make appropriate orders - sec 17; preparation of scheme by the operating agency [sec 18] and its sanction by BIFR [sec 18 (4)]

Suspension of legal proceedings against the company – sec 22 Provision for potentially sick companies (based on erosion of 50%

of net worth – reference to Board and referendum to shareholders; power of shareholders to remove a director [sec 23]


How successful has BIFR been?

From 1987 to 2003, there were 4748 references of which only 407 cases have been revived, and 260 are under revival.

1301 cases dismissed 1222 cases recommended for winding up See details at http://www.bifr.nic.in


Compromise and arrangement

Covers compromise/ arrangement with all creditors/ all members/ class of creditors/ class of members

By sec 390, sections 391/393 apply to “all companies liable to be wound up under the Act”:

– Logically should have meant, cases covered by sec. 433; compromise or arrangement is an alternative to winding up

– However, interpreted in Khandelwal Udyog Ltd 47 Comp Cas 503 (Bom) as including all companies to which winding up provisions apply

The power u/s 391 is to make an arrangement or compromise binding on all, if it is:

– Approved by members/creditors representing 75% in value Court may make orders to enforce the compromise/ arrangement – sec

392 Where a meeting is called u/s 391, certain disclosures shall be made –

sec 393 Court may pass order for transfer of property to another company –

necessary power to facilitate amalgamation, merger and demerger


Reduction of capital

Reduction of capital to the extent the capital is lost, or capital is in surplus, permitted u/s 100 with the approval of the Court

Corporate Insolvency Laws in India

Documents

Transcript of Corporate Insolvency Laws in India