Bidding Goodbye to Creditors’ Voluntary Liquidation

[The following post is contributed by Vinod Kothari of Vinod Kothari &
Co. The author may be contacted at vinod@vinodkothari.com]
Voluntary
winding up under the Companies Act, 1956 has been segregated into two different
types, i.e. members’ voluntary winding up and creditors’ voluntary winding up.
But the Companies Act, 2013 eliminated distinction between members’ voluntary
winding up and creditors’ voluntary winding up by making creditors’ approval
necessary in all cases. Part II of Chapter XX of the Companies Act, 2013
comprising sections 304 to 323 deals with voluntary winding up. This sections
have not been notified till date and shall be omitted pursuant to section 255
read with eleventh schedule of the Insolvency and Bankruptcy Code, 2016[1]
(‘the Code’).  
The run-up to voluntary
liquidation option
Irrespective
of the oft-repeated concern about the slow pace of liquidation proceedings in
India, both compulsory and voluntary, the provisions of law on winding up of
companies have continued to evolve.
As
regards methods of winding up, the Companies Act, 1956 followed the provisions
of the UK Companies Act, 1948 in distinguishing between 3 modes of winding up:
(a)  Compulsory
winding up by the court;
(b) Voluntary
winding up, classified into:
(i)  Members’
voluntary winding up;
(ii) Creditors’
voluntary winding up;
(c)  Voluntary
winding up subject to supervision of court.
The
last of these, voluntary winding up subject to supervision of court, had long
back become antiquated and dysfunctional. This actually meant a voluntary
winding up, where the creditors or the members approach the court to bring the
winding up to supervision of the court, presumably to secure justice.
Evidently, the purpose may have been more creditors’ protection, who may feel
insecure in a members’ voluntary winding up. Palmer’s Company Law[2]
mentions that post the introduction of creditors’ voluntary winding up in 1929,
this method had been rarely used. In India, the Eradi Committee also mentioned
that this method had become redundant.[3]
This
leaves us with two options – winding up on orders of the court (or compulsory
winding up), and voluntary winding up. Voluntary winding-up is like private
liquidation proceeding – the intervention of courts is limited, and comes
essentially at the time of obtaining final orders for dissolution. While
normally it will be expected that a company opting to wind up voluntarily is a
solvent company, there are situations where the company may not be solvent –
hence, the law distinguished between members’ voluntary winding up and
creditors’ voluntary winding up. In case of a members’ voluntary winding, the
directors are required to make a declaration of solvency, which, to put
succinctly, is an affirmation that the company has enough assets to pay all its
creditors, and if the company is unable to so pay, it shall be presumed that
the declaration was wrongly made, exposing the directors to prosecution.
There
may be situations where the assets are either insufficient to pay all
creditors, or the directors are unwilling to make the declaration. In such
cases, the company will be put under “creditors’ voluntary winding up”. The
terms “creditors’ voluntary winding up” seems like a self-contradictory
expression, since “voluntary” would mean at the instance of members. However,
while creditors’ voluntary winding up is also initiated at the instance of the
members, it is just that creditors have intrusive control over this process,
since the company is presumably not a solvent company.
The
following table shows the similarities and differences between members’
voluntary winding up and creditors’ voluntary winding up
Particulars
Members’ voluntary
winding up
Creditors’ voluntary
winding up
Initiation of winding up
Resolution
of members – ordinary if the winding up is as per articles or expiry of the
duration for which company was formed, otherwise, special – section 484 (1)
Same
Commencement of winding
up
On
the passing of resolution of shareholders – section 485
Same
Declaration of solvency
by directors
Is
the demarcating line between members’ and creditors’ voluntary winding up
[sec 488 (5)], hence required
Does
not arise; however, the Board makes a statement of financial position [sec
500 (3) (c) ]
Meeting of creditors
Not
required
Mandatory
– sec 500. Resolution to be passed as per Rule 205 of Companies (Court) Rules
Appointment of liquidator
By
the members [sec 490]
By
the company as well as by creditors, but in case of a difference, creditors’
view prevails [sec 502 (2)]
Committee of Inspection
Does
not arise
Creditors
may appoint the Committee of Inspection
Annual meetings
If
liquidation proceedings stretch beyond a year, the liquidator shall call a
general meeting every year [sec 496]
If
liquidation proceedings stretch beyond a year, the liquidator shall call a
general meeting of the company, as well as creditors’ meeting every year [sec
508]
Final meeting
Final
meeting pre-dissolution is general meeting of the company [sec 497 (1) (b)]
Final
meeting pre-dissolution is general meeting of the company as well as meeting
of creditors [sec 509  (1) (b)]
The
distinction between members’ voluntary winding up and creditors’ winding up is
significant, and was retained in section 90 of the UK Insolvency Act as
well.  The distinction exists in Hong
Kong and Singapore as well.
An
issue that arises is – if company is indeed insolvent, why will the creditors
opt for a voluntary winding up, and instead, why would they not force the
company to go into compulsory winding up on the ground of inability to pay?
Several reasons explain this:
– First, the creditors’ voluntary winding
up is not winding up forced by the creditors – it is a members’ option; just
that the company is either not solvent or the directors are unsure of the
solvency.
– Second, and very importantly – where a
creditor goes to court on account of inability to pay, it is taking an
individual action against the company. Where creditors, although at the
instance of members, pass a resolution for liquidation, they are taking a
collective action.  The court petition is
a contested matter, and normally, the company files tooth and nail to have this
petition dismissed. On the other hand, the creditors’ voluntary winding up is
initiated by the members in the first place; hence, this bears full consensus
of the members.
– Third, in case of court-ordered
liquidation, the liquidation is controlled by the official liquidators’
machinery, which may be slow, and may hamper value maximisation. Creditors may,
on the other hand, opt for the voluntary liquidation process where the
liquidator is appointed by the creditors.
While
these alternative options – individual pursuit by creditors before the court,
and collective decision of creditors based on a members’ wishes – has held good
ground in other countries, the Companies Bill 2008 reduced the winding up
options to only two – compulsory and voluntary.[4]
The underlying philosophy seems to have been that if the company is insolvent,
it may be taken to liquidation under compulsory liquidation process. Thus,
under the voluntary winding up option, both a declaration of solvency, as also
creditors’ resolution, were made mandatory. Thus, it be noted that while the
Companies Act, 1956 provided that the directors may make a declaration of solvency [section 488, Companies Act,
1956], the Companies Act, 2013 [section 305] says, the directors shall make a declaration of solvency.
Additionally, the 2013 Act makes the obtaining of creditors’ resolution also
necessary, and provides that if the creditors are of the view that the company
may not be able to pay its debts in full, then the company shall file a
petition for compulsory winding up [section 306 (3) (b)].
Thus,
the process of creditors’ voluntary winding up came to an end, and Indian law
now has only two options – insolvent companies come for liquidation under
compulsory liquidation process, and solvent companies come for liquidation
under the voluntary liquidation process.

 

Is end to creditors’
voluntary liquidation justified?
While
India has, thus, put an end to out-of-court liquidation of unhealthy companies,
the fact remains that creditors’ voluntary liquidation remains the most
important form of winding up of insolvent companies.[5] In
the UK,[6] as
per the estimates, total of 14,629 companies entered into insolvency in 2015.
Of which, total of 2,874 companies were subject to a compulsory winding-up
order, 9,981 companies entered into creditors’ voluntary liquidation, 357
companies opted for voluntary arrangement and there were an estimated 1,406
administrations in 2015.
Conclusion
The
process of voluntary winding up shifts from the Companies Act/LLP Act to the
Code. However, all the matters are not shifted to the Code; the residual
matters of winding up by the NCLT still remain in section 271 of Companies Act,
2013. Thus, as regards companies, the winding up options are viz. under the Code or the Companies
Act, 2013. The Code does not extend its arm to include financial service
provider. Therefore, in case of financial service providers, until explicit
provisions are enacted, either the Companies Act 2013, and/or the relevant
special laws, will continue to prevail.

Vinod Kothari



[1] Received
the assent of the President on the 28th May, 2016.

[2] 1982 edition, para 86-63.

[3] “There is hardly any matter which is referred for winding up
subject to supervision of the High Court under section 425. The entire
procedure is redundant. Compulsory winding up would take care of winding up
subject to supervision of the Court” – para 4.3

[4] This
seems surprising, since  the N L Mitra
Committee had also appreciated the useful role played by the creditors’
voluntary winding up – “If the members of the company resolving to go for
voluntary winding up can not submit a certificate of solvency the voluntary
winding up procedure is regulated by the creditors with the help of a
liquidator or liquidators appointed by the creditors. Both Members’ voluntary
winding up and creditors’ voluntary winding up are cost and time efficient
modes of liquidation” [Page 16 of the Mitra Committee report, at https://indiacorplaw.in/wp-content/uploads/2016/06/20811.pdf ]

[5] “Creditors’ voluntary liquidation (a form of liquidation usually
initiated by a shareholders’ resolution) is currently by far the most common
form of proceeding.” – Plymouth Law and Criminal Justice Review (2016)  1 at
http://www.plymouthlawreview.org/vol8/Hamish%20anderson.pdf

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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