Legal Information / Articles

Liquidation is the process a debt-laden company initiates to wind up its operations and sell its assets in order to repay said liabilities and other obligations. A company is liquidated when it is ascertained that the business is not in any state to continue.

For example 

1. A firm (for convenience sake called "AA") regularly supplies certain raw materials to a partnership firm (for convenience sake called "BB") carrying out its business of manufacturing geysers. After 6 months of regular supply of goods, BB fails to clear the outstanding dues of "AA" amounting to principal amount of Rs.1,00,00/- with interest accrued thereon. 

2. An individual (for convenience sake called "DD") lends his fleet of trucks to a Company (for convenience sake called "EE") used for transporting goods to and from the factory of EE; despite repeated demands EE fails to pay to DD the accumulating dues of Rs.2,00,000/- payable for the fleet of trucks lent to EE with interest accrued thereon.

In both situation, AA and DD are advised to initiate winding up process of BB and EE. Keeping in mind the amended provisions of the Companies Act, 2013 and the Insolvency and Bankruptcy Code 2016. 

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 basic terms, winding up is a legal process by which the life of a company is brought to a halt 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. 

  

In the year 2016, Insolvency and Bankruptcy Code 2016, 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:

• Section 270 which dealt with modes of winding up was deleted;

• 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) under the Companies Act.

• 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 AA and DD, who are creditors, are out of the purview of the Companies Act, but have the option to invoke provisions under the Insolvency and Bankruptcy Act 2016, the Code to initiate Corporate Insolvency Resolution Process (CIRP). The 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 Insolvency and Bankruptcy Code 2016, bring all kinds of companies like 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 can avail his debt owned, can invoke provisions contained in Part II Chapter, through two categories 

1. 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 three judge bench of Supreme Court in the matter of Pioneer Urban Land Infrastructure limited vs Union of India, 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.

2. Operational Creditor a person 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 Insolvency and Bankruptcy, both can file an application before NCLT seeking initiation of CIRP. In the matter of Swiss Ribbons Pvt. Ltd. & Ors. Vs Union of India & Ors 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. 

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 along with a proposal for appointment of Interim Resolution Professional, if required. 

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. 

The Resolution Professional, prepares a resolution plan, Section 25(2)(h) of the Insolvency and Bankruptcy Code 2016, which covers the management of affairs of the Corporate Debtor post approval of the resolution plan along with 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 Insolvency and Bankruptcy Code 2016. 

Approval of Resolution Plan by COC to be accepted by at least 66% of voting share of the financial creditors, the Committee of Creditors. 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.

• no resolution plan is presented for approval within the time period prescribed for time period prescribed for completion of CIRP

• if the resolution plan is rejected by NCLT

• if the COC recommends liquidation of debtor

• if the Corporation debtor contravenes the resolution plan

• when its mandatory for NCLT to order liquidation of the debtor

Thereafter NCLT appoints a liquidator Section 34 of the Insolvency and Bankruptcy Code 2016 who is required to verify and consolidate claims of all creditors Section 38 of the Insolvency and Bankruptcy Code 2016, 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 and Section 35 of the Insolvency and Bankruptcy Code 2016.

 Secured Creditor can realize it dues either in full or in part from the security in its favor Section 52 of the Insolvency and Bankruptcy Code 2016. Rest of the creditors will receive their dues in the order of preference as stated in Section 53 of the Insolvency and Bankruptcy Code 2016.

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 Insolvency and Bankruptcy Code 2016.  

This sums up the entire process and resolution of a debt-ridden corporate debtor. India currently ranks 136 out of 189 countries in the World Bank's index on the ease of resolving insolvencies. India's weak insolvency regime, its significant inefficiencies and systematic abuse are some of the reasons for the distressed state of credit markets in India today. The Code promises to bring about far-reaching reforms with a thrust on creditor driven insolvency resolution. It aims at early identification of financial failure and maximizing the asset value of insolvent firms.