Corporate Insolvency laws

in India
Vinod Kothari
1012 Krishna
224 AJC Bose Road
Calcutta 700 017
Phone 033-23233863/23233864/2281
1276/22817715/22813742
Fax 91-33-23233863/22811276
Email: vinod@vinodkothari.com; vinodk@vsnl.com
Corporate insolvency by Vinod Kothari
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Corporate insolvency by Vinod Kothari
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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

Corporate insolvency by Vinod Kothari
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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

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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
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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

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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.
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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
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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










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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


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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 28
th
June 1976
Criminal proceedings or proceedings against directors
or officers are not stayed
Income tax proceedings will continue against the
liquidator
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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 workmens 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
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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
Workmens 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 workmens claims
To the extent of the sacrifice the secured creditor makes for
workmens portion, his claim becomes a an overriding
preferential claim sec. 529A
Workmens dues, and the claims of secured creditor
sacrificed to workmen are over-riding preferential
claims sec. 529A
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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
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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
Workmens 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
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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

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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

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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
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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]
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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

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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
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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