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
 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.

2 Corporate insolvency by Vinod Kothari

 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

3 Corporate insolvency by Vinod Kothari

 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

4 Corporate insolvency by Vinod Kothari

 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

5 Corporate insolvency by Vinod Kothari

 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

6 Corporate insolvency by Vinod Kothari

 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.

7 Corporate insolvency by Vinod Kothari

 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

8 Corporate insolvency by Vinod Kothari

 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 10-15 15-20 20-25 25 YEARS TOTAL
YEARS YEARS YEARS YEARS AND
ABOVE

NORTHERN 259 130 86 56 47 66 644

REGION *

EASTERN 126 77 83 73 71 293 723

REGION

SOUTHERN 325 212 89 68 51 78 823

REGION

WESTERN 355 184 224 124 82 36 1005

REGION

1065 603 482 321 251 473 3195

TOTAL

9 Corporate insolvency by Vinod Kothari

 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

10 Corporate insolvency by Vinod Kothari

 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
11 Corporate insolvency by Vinod Kothari
 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

12 Corporate insolvency by Vinod Kothari

 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
13 Corporate insolvency by Vinod Kothari
 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

14 Corporate insolvency by Vinod Kothari

 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
15 Corporate insolvency by Vinod Kothari
 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

16 Corporate insolvency by Vinod Kothari

 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

17 Corporate insolvency by Vinod Kothari

 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)]

18 Corporate insolvency by Vinod Kothari

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]

20 Corporate insolvency by Vinod Kothari

 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

21 Corporate insolvency by Vinod Kothari

 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

22 Corporate insolvency by Vinod Kothari

 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

23 Corporate insolvency by Vinod Kothari