A firm (for convenience
sake called “CD”) regularly supplies
certain raw materials to a partnership firm (for convenience sake called “QR”) carrying out its business of
manufacturing geysers. After 6 months of regular supply of goods, QR fails to clear the outstanding dues
of “CD” amounting to principal
amount of Rs.1,25,00/- with interest accrued thereon.
An individual (for
convenience sake called “XY”) lends
his fleet of trucks to a Company (for convenience sake called “AB”) used for transporting goods to and
fro from the factory of AB; despite
repeated demands AB fails to pay to XY the accumulating dues of
Rs.3,50,000/- payable for the fleet of trucks lent to AB with interest accrued thereon.
In both the cases, CD and XY are advised to initiate winding up process of QR and AB. What does it mean? What does it entail? What are the
implications? Will CD and XY get their dues back? Keeping the
amended provisions of the Companies Act, 2013 and the Insolvency and Bankruptcy
Code, 2016 in mind, let’s examine and understand the current scenario relating
to dues of CD and XY.
First, let us
understand what winding up means. Earlier, neither the Companies Act, 1956 nor
the Companies Act (Second Amendment) Act 2002 defined the term “winding up”.
Under the Halsburys Laws of England, winding-up is defined as a proceeding by
means of which the dissolution of a company is brought about and in the course
of which its assets are collected and realized: and applied in payment of its
debts; and when these are satisfied, the remaining amount is applied for
returning to its members the sums which they have contributed to the company in
accordance with Articles of the Company. In the Indian context, definition of
“winding up” was introduced by the Indian Companies Act, 2013 whereby Section
2(94A) was inserted which stated that it means “winding up under this Act or
liquidation under the Insolvency And Bankruptcy Code, 2016, as applicable”.
In simple terms,
winding up is a legal process by which the life of a company is brought to an
end by taking over the reins of management of the Company from the Board of
Directors of the Company, selling off its assets and the money realized from
such sale is then used for clearing off its debts and the surplus amount, if
any, is then distributed amongst the members of the Company.
It is also important to
understand that winding up of the Company does not result in ending “the legal
existence” of the Company i.e. despite winding up process initiated against the
company, it continues to exist as a “legal corporate entity” – in as much as
its name continues to remain on the Register of Companies. This legal existence
comes to an end only when the Court orders dissolution of the Company – which
is initiated post completion of winding up process. The effect of such an order
of dissolution is that the affairs of the Company come to a halt and no
business can be conducted in its name and its name is struck off the Register
of Companies – thus bringing an end to the “legal corporate entity”.
In the year 2016, the
Insolvency And Bankruptcy Code, 2016 (referred to as “the Code”) came into effect by which the Parliament sought to
consolidate a single law for insolvency and bankruptcy in India. The Code
basically provides for a mechanism, within a time-bound manner, to deal with
and resolve the non-payment of debt to various debtors in a time bound manner
by utilizing the value earned from the sale of its assets, at the same time
balancing the interest of all the stakeholders.
With the coming into
effect of the Code, it brought about certain changes in the laws relating to
winding up of Companies:-
(i) Sick Industrial
Companies (Special Provisions) Act, 1985 (SICA) was repealed – this Act applied
only to Industrial Companies whereas the amendments introduced by the Code
brought all kinds of Companies, partnership firms, proprietorship firms within
its fold.
(ii) It completely
over-hauled the winding-up provisions under the Indian Companies Act, 2013 such
as:
(1) Section 270 which
dealt with modes of winding up was deleted;
(2) Section 271 of the
Act was amended to exclude the term “unable to pay its debts” as a ground
available and specified following 5 grounds available, for persons authorized
by Section 272, to invoke the winding up jurisdiction of the National Company
Law Tribunal (“NCLT” for short)
under the Companies Act:
- Company by special resolution resolves
that it be wound up by the Tribunal – Petition
by the Company;
- If the Company has acted against the
interest of the sovereignty and integrity of the Country, security of the
state, friendly relations with foreign states, public order, decency or
morality – Petition by the Registrar, Central Government or State Government;
- an application whereupon the Tribunal
comes to a conclusion that the affairs of the Company are being conducted in a
fraudulent manner or the company was formed for fraudulent and unlawful
purposes or that the concerned in the formation or management of its affairs
have been guilty of its affairs have been guilty of fraud, misfeasance or
misconduct in connection therewith and that its proper that the Company be
wound up – Petition by Registrar or any person authorised by the Central
Government;
- If the Company has defaulted in filing
its financial statements or annual returns with the Registrar for immediately
preceding 5 consecutive financial years – the Registrar
- If the Tribunal is of the opinion that
it is just and equitable that the company should be wound up.
(3) Section 304 and
related sections (304-323) which dealt with voluntary winding-up were deleted.
Thus post the
amendments, no creditor of a Company is entitled to invoke the winding up power
of the NCLT provided under the Companies Act, 2013. Hence CD and XY, who are
creditors, are out of the purview of the Companies Act, but have the option to
invoke provisions under the Code to initiate Corporate Insolvency Resolution Process (“CIRP” for short) – a recovery mechanism created for the Creditors
whereby defaulting debtor is assessed whether it is capable or not of repaying
its debt, failing which the debtor is either restructured or else liquidated
and finally dissolved.
Part II of the Code
brings all kinds of Companies, partnership firms, proprietorship firms, or any
other person incorporated with limited liability under any law, who have
defaulted to pay their debt, within its fold – minimum amount of debt payable
being Rs.1 Lakh. A combined reading of
definition of the words “Corporate debtor”, “Corporate person” and “person”
under Sections 3(8), Section 3(7) and 3(23) of the Code makes it clear that
apart from a Company registered under the Companies Act, the Code also applies
to an individual, a Hindu Undivided Family, a trust, a partnership, a limited
liability partnership and any other entity established under a statute.
A creditor, i.e. a
person to whom a debt is owed, can invoke provisions contained in Part II
Chapter II of the Code. Such a creditor is broadly classified into 2
categories:
(a) a “Financial
Creditor” – a person to whom a financial debt is owed and includes a person to
whom such debt has been legally assigned or transferred to [Section 5(7)] –
banks and financial institutions come within its ambit;
- Recently a 3 judge bench of Supreme
Court in the matter of Pioneer Urban Land and Infrastructure
Limited & Ors. Vs Union Of India & Ors[1]
upheld the constitutional validity of amendments made to the Code whereby the
allottees of real estate projects were deemed to be “financial
creditors” so that they can invoke the provisions of Section 7 of the Code
against any real estate developer.
(b) an “Operational
Creditor” – a person to whom an operational debt is owed and includes any
person to whom such debt has been legally assigned or transferred [Section
5(20)]; Section 5(21) further clarifies that any debt arising out of operation
of the Company/ Corporate Debtor – such as goods and services provided to the
Company, dues of employees or any amount due and payable to the government –
come within the purview of an “operational debt”.
Under Section 6 of the
Code, a financial creditor and an operational creditor can file an application
before the NCLT seeking initiation of CIRP. The process to be followed in
respect of a financial creditor and an operational creditor are different and
are specified under Section 7 and 8-9 respectively.
Before we proceed
further, it is relevant to state that the constitutional validity of various
provisions of the Code, including that of Section 7, 21 and 24 of the Code,
were challenged before the Supreme Court in the matter of Swiss Ribbons Pvt. Ltd. &
Ors. Vs Union of India & Ors.[2]
The Supreme Court while upholding the validity of distinction drawn by the Code
between financial creditors and operational creditors, relied upon the
distinction between the 2 classes of creditors and held that “most financial creditors, particularly
banks and financial institutions, were secured creditors whereas most
operational creditors were unsecured, payments for goods and services as well
as payments to workers not being secured by mortgaged documents and like…
Financial creditors generally lend finance on a term loan or for working
capital that enabled corporate debtor to either set up and/or operate its
business. On other hand, contracts with operational creditors were relatable to
supply of goods and services in operation of business. Financial contracts
generally involve large sums of money. By way of contrast, operational
contracts had dues whose quantum was generally less. In running of a business,
operational creditors can be many as opposed to financial creditors, who lend
finance for the set up or working of business. Also, financial creditors had
specified repayment schedules, and defaults entitled financial creditors to
recall a loan in totality. Contracts with operational creditors did not have
any such stipulations.”
In the present case,
our very own CD and XY fall in the category of Operational
Creditors and thus steps to be followed, as prescribed under the Code are as
under:
A. Issuance of Demand Notice: Operational Creditor to issue and
deliver a demand Notice [Form 3 – Rule 5 of the Insolvency And Bankruptcy
(Application To Adjudicating Authority) Rules, 2016 – “Rules” for short][3] to
the debtor demanding payment of the unpaid debt
- Accompanied
by a copy of the invoice;
- Demand
notice to be delivered at the registered office
- by hand, or
- registered post or
- speed post AD or
- by electronic mail addressed to whole
time director or designated partner or key managerial personnel of the debtor
B. Within 10 days of
receipt of demand notice, the debtor is required to bring to the notice of the
Operational Creditor of the debt being disputed or of the amount paid with
proof of same;
C. Filing of Application before NCLT: After expiry of 10 days from the
date of delivery of demand notice, if payment is not received, Operational
Creditor to file application under Section 9 of the Code (prescribed Form 5 –
Rule No.6) before NCLT for initiating CIRP alongwith a proposal for appointment
of Interim Resolution Professional, if required, accompanied by following
documents and keeping following points in mind:
- Annex.
I – Copy of the invoice / demand notice as in Form 3 served on the corporate
debtor;
- Annex.
II – Copies of all documents referred to in this application.
- Annex.
III – Copy of the relevant accounts from the banks/financial institutions
maintaining accounts of the operational creditor confirming that there is no
payment of the relevant unpaid operational debt by the operational debtor, if
available.
- Annex.
IV – Affidavit in support of the application
- Annex.
V – Written consent from the proposed insolvency professional in prescribed
Form 2 (Rule No.9) (Wherever applicable) [may or may not be suggested by the
Operational Creditor);
- Annex.
V – Proof that the specified application fee has been paid.
- Application
to be filed alongwith a Certificate confirming eligibility of the proposed
insolvency professional for appointment as a resolution professional (Rule
No.9);
- Application
and accompanying documents to be filed in electronic form (Rule No.10);
- An
advance copy of the application filed before NCLT is required to be sent by
registered post or speed post to the debtor at its registered office (Rule 6).
D. NCLT
Order On Application: Within 14 days of receipt of the
application, NCLT is required to pass an order admitting or rejecting the
application.
- If
admitted, a moratorium is declared prohibiting various acts by or against the
debtor (Sections 13-14 of the Code). It shall also appoint an interim
resolution professional [Section 16 R/w Section 16(3)of the Code – in office
till the Committee of Creditors appoint a resolution professional under Section
22(2) of the Code], who replaces the Board of Directors and takes over the
administrative reins of the corporate debtor (Section 17 of the Code) and also
perform, amongst others, following duties:
- Make a public announcement about the
CIRP in respect of the debtor concerned alongwith inviting submission of claims
against the said Corporate Debtor, and thereafter collate all claims submitted
by various creditors (under Section 15 of the Code); [It is here that CD and XY
will step in and submit their claims against QR and AB alongwith supporting
documents]
- Constitute a Committee of Creditors
(Section 18(1)(c) and 21 of the Code) consisting of all the financial creditors
of the Corporate Debtor.
- Monitor, manage, take control and
custody of the assets of the Corporate Debtor and manage its operations as a
going concern till the Committee of Creditors appoints a Resolution
Professional.
E. Appointment
of Resolution Professional: Within 7 days of constitution, the
Committee of Creditors by majority vote
(not less than 66% of voting share) are required to either confirm the interim
resolution professional as a “Resolution Professional” or appoint a fresh
“Resolution Professional” who then takes over the reins of the Corporate debtor
from the interim resolution professional and conduct the entire CIRP as well as
manage the operations of the debtor during such period;
F. Preparation
of Resolution Plan: The resolution applicant, appointed by
the Resolution Professional, prepares a resolution plan (Section 25(2)(h) of
the Code) – which covers the management of affairs of the Corporate Debtor post
approval of the resolution plan alongwith provision for payment of insolvency
resolution process costs in priority to other debts of the corporate debtor as
well as payment of debts of operational debtors (Section 30(2)(b) of the Code);
- National
Company Law Appellate Tribunal in the matter of Binani Industries Ltd. & Ors.
Vs Bank of Baroda & Ors.,[4]
held that a resolution plan is not a sale of the debtor, nor a plan for
recovery of dues of the creditor or a plan for liquidation of the debtor (which
brings the life of the Corporate to an end) but infact is a plan to rescue a
failing but a viable business as a going concern and should aim to maximize the
value of assets of the ‘Corporate Debtor’, and should promote entrepreneurship,
availability of credit, and balance the interests of all the stakeholders. With
regard to the dues of the Operational Creditors, the Appellate Tribunal was of
the opinion that the liabilities of all creditors who are not part of committee of
creditors must also be met in the resolution plan – although the financial
creditors can modify the terms of existing liabilities and take their dues in
future, the Operational creditors cannot take the risk of postponing payment
for better future prospects and need to be paid immediately – as the
Operational Creditors need to provide goods and services. If they are not
treated well or discriminated, they will not provide goods and services on
credit and thus the objective of promoting availability of credit will be
defeated [@para 17(3)(e)].
G. Approval
of Resolution Plan by COC – to be accepted by atleast 66% of voting share
of the financial creditors, the Committee of Creditors;
H. Approval
of Resolution Plan by NCLT – After approval by the Committee of Creditors,
NCLT may either approve or reject the Resolution plan, which shall be binding
on the corporate debtor and its employees, members, creditors, as well.
I. Liquidation Process: In the event
- no
resolution plan is presented for approval within the time period prescribed for
completion of CIRP, or
- if
the resolution plan is rejected by NCLT, or
- if
the COC recommends liquidation of debtor, or
- if
the Corporation debtor contravenes the resolution plan, or
its mandatory for NCLT to order
liquidation of the debtor (Under Chapter III of the Code – Section 33).
J. Appointment
of Liquidator: Thereafter NCLT appoints a liquidator (Section 34 of the
Code) who is required to verify and consolidate claims of all creditors
(Section 38 of the Code), to take into its custody all assets of the debtor and
settle claims of all the creditors and distribute the proceeds in the order of
preference specified under Section 53 of the Code (Section 35 of the Code).
Post initiation of Liquidation process, CD and XY will be required to submit their claims to the Liquidator
alongwith all proof in support of the same.
K. Distribution
of Assets – Secured Creditor can realize it dues either in
full or in part from the security in its favour (Section 52 of the Code). Rest
of the creditors will receive their dues in the order of preference as stated
in Section 53 of the Code.
(a) the insolvency
resolution process costs and the liquidation costs to be paid in full;
(b)the following debts
shall rank equally between and among the following:—
- workmen’s dues for the period of
twenty-four months preceding the liquidation commencement date; and
- debts owed to a secured creditor in the
event such secured creditor has relinquished security in the manner set out in
section 52;
(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;
(d) financial debts owed to unsecured creditors;
(e) following dues shall rank equally between and among the following:—
- any amount due to the Central Government
and the State Government including the amount to be received on account of the
Consolidated Fund of India and the Consolidated Fund of a State, if any, in
respect of the whole or any part of the period of two years preceding the
liquidation commencement date;
- debts owed to a secured creditor for any
amount unpaid following the enforcement of security interest;
(f) any remaining debts and dues;
(g) preference shareholders, if any; and
(h)equity shareholders
or partners, as the case may be
Thus in the case of CD and XY, whofall in the category of Operational Creditors – unsecured creditors – their dues will be ranked 4th in line and will be paid from the sale proceeds of assets of the debtor, after the dues of workmen, secured creditors, and wages and unpaid dues of employees are paid off.
L. Dissolution of Corporate Debtor: Once the assets have been completely liquidated, NCLT, upon application by the Liquidator, shall order dissolution of the debtor from the date of the said order. Within 7 days, copy of said order shall be sent to the authority with which the debtor is registered for appropriate action (Section 54 of the Code).
Thus bringing an end to the entire process and resolution of a debt ridden corporate debtor.
Author: Meenakshi Ogra Mukherjee a Principal Associate in Litigation, at Khurana & Khurana, Advocates and IP Attorneys. In case of any queries please contact/write back to us at litigation@khuranaandkhurana.com .
References:
[1] Pioneer Urban Land and Infrastructure Limited & Ors. Vs Union Of India & Ors., AIR 2019 SC 4055: 2019 (8) SCC 416, Decided on 09.08.2019
[2] Swiss Ribbons Pvt. Ltd. &
Ors. Vs Union of India & Ors., AIR 2019 SC 739: 2019 (4) SCC 17
[3] The Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016
[4] Binani Industries Ltd. & Ors.
Vs Bank of Baroda & Ors., 2019 (3) Comp LJ 53: MANU/NL/0284/2018, decided
on 14.11.2018
