Winding Up/ Liquidation process under the Companies Act, 2013 vis-à-vis Insolvency And Bankruptcy Code, 2016

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] https://ibbi.gov.in//webadmin/pdf/legalframwork/2019/Mar/Application_to_Adjudicating_Authority_Rules-upto%2019.03.2019_2019-03-28%2013:12:13.pdf

[4] Binani Industries Ltd. & Ors. Vs Bank of Baroda & Ors., 2019 (3) Comp LJ 53: MANU/NL/0284/2018, decided on 14.11.2018

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