Winding-up under Section 271(a) of the Companies Act and its Impact on the Insolvency and Bankruptcy Code

[Guest post by Anirudh Gotety, who is a 4th year student pursuing B.B.A., LL.B. (Business Law Honours) at National Law University, Jodhpur]

Before the introduction of the Insolvency and Bankruptcy Code, 2016 (the ‘Code’), the winding up of a company took place solely under the Companies Act, 1956 (the ‘1956 Act’). The 1956 Act allowed companies to be wound up voluntarily (Chapter III of Part VII), and under the supervision of the Court or National Company Law Tribunal (“NCLT”), as the case may be (Chapter II of Part VII). The former was a less time-consuming process since it involved minimal intervention of the courts. These provisions were carried over into the Companies Act, 2013 (the ‘2013 Act’) in Chapter XX with limited changes. However, the provisions of the 2013 Act for winding up were never notified in the original form. The Code made sweeping changes to Chapter XX (Winding Up) of the 2013 Act, and consequently the modified chapter was notified in December 2016. One of the most notable changes was the removal of the inability to pay debts as a ground to wind up a company. The part which dealt with voluntary winding up was also omitted. The former became the basis for corporate insolvency resolution proceedings (Part II, Chapter II of the Code) and the latter was covered in section 59 of the Code.

Even after the changes made by the Code, the 2013 Act still contains provisions for compulsory winding up on the five grounds stated in section 271. One ground that has remained as section 271(a) is when the members of a company pass a special resolution mandating that the company be wound up by the NCLT.[1] However, a company can also be voluntarily liquidated under section 59 of the Code on the fulfilment of certain criteria.

This presents an anomaly. When should a company go for winding up under the Companies Act, 2013 and when should it go for voluntary liquidation under the Code? If one draws an analogy to the provisions of the 1956 Act, it seems that a company should opt for voluntary liquidation under the Code when it wants minimal intervention of the NCLT. Alternatively, a company should choose winding up under the 2013 Act when it wants the NCLT to supervise the proceedings. In most cases, a company would choose voluntary liquidation under the Code since it is a much less cumbersome and time-consuming process.

But the issues run deeper. One would imagine that the intent of the Parliament to introduce the Code was to make the liquidation and insolvency resolution process less time-consuming. Then why did the Parliament retain the option for members to file for the cumbersome winding up process under the 2013 Act, especially since it has no explanation as to when a winding up petition on the basis of Section 271(a) should be admitted?

Section 59 of the Code allows a company that has not committed a default[2] to pass a special resolution to liquidate voluntarily. The company also has to make a declaration, supported by affidavits of its majority directors, that it has no debts and that the liquidation is not being done to defraud anyone. If the company has debts, its directors have to make a declaration that it can pay off its debts and, if it cannot, then it must be able to pay its creditors from the proceeds of the liquidation for which it will need approval from 3/4th of its creditors.

Thus, a company cannot undergo voluntary liquidation if it has debts that cannot be paid off on liquidation of its assets, i.e. its liabilities exceed its assets. In these cases, the company will have already committed a default or would commit a default when the debt becomes due and payable. This default allows the company or its creditors to trigger corporate insolvency resolution proceedings under Part II of Chapter II of the Code.

Since the 2013 Act does not explain when a winding up petition on the basis of section 271(a) should be admitted, it seems that a company, which could be a corporate debtor[3] whose assets exceed its liabilities, could seek to wind up by simply passing a special resolution to that effect. Such a corporate debtor is precluded from undergoing voluntary liquidation under the Code. The question that arises is whether this manoeuvre could potentially help the corporate debtor circumvent corporate insolvency resolution proceedings under the Code and proceed directly to liquidation under the 2013 Act.

The possibility of such a manoeuvre appears to be a strategic advantage to the members of such corporate debtors. It allows the members of the corporate debtor to not follow any resolution plan of the committee of creditors had it gone for corporate insolvency resolution proceedings, which could at times means welcoming the creditors into the management of the company.

The question of why the option to wind up on passing of a special resolution by the company was retained in the 2013 Act still remains, and there has been no explanation thus far. Under section 272 of the 2013 Act, a company has to file a statement of affairs of the company, including its books of accounts, when filing a winding up petition. It is unlikely that the NCLT would pass an order to wind up the company if it is used as a ploy to evade the Code. It is likely that the NCLT would dismiss the petition or direct such a company to file an application for corporate insolvency resolution proceedings under section 10 of the Code. Nevertheless, given the possible lacuna, the issue needs to be addressed by appropriate legislative attention and, pending that, through a suitable (and uniform) approach devised by the NCLT to harmoniously construed the winding up provisions of the 2013 Act and the corporate insolvency resolution process under the Code.

– Anirudh Gotety

[1] This ground was earlier contained in section 433(a) in the Companies Act, 1956 and in section 271(1)(b) in the Companies Act, 2013 (before amendments were made to it by the Insolvency and Bankruptcy Code, 2016).

[2] Section 3(12) of the Code defines a default as non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the corporate debtor.

[3] Section 3(8) of the Code defines a corporate debtor as a corporate person indebted to anyone.

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