Know the Basics of Liquidation if You Are Closing Your Business

Check this ready reckoner to understand all liquidation options under India's legal framework, including insolvency, restructuring and dissolution of companies.


India’s rank in the World Bank’s Doing Business list was 142 in 2014. In a matter of just five years, it moved up to 63, and the introduction of a modern insolvency regime has a lot to do with it. For one, it worked as a comprehensive strategy to reform corporate law and helped in increasing the number of reorganizations. And as a result, the World Bank says, the overall recovery rate for creditors has jumped from 26.5 to 71.6 cents on the dollar.  Simply put, liquidation is the process that companies follow as they are winding up their businesses. It includes the course that a company is required to take in collecting its assets, payment of its debts, the surplus amount, if any, is distributed amongst the company members. India has a number of laws to deal with insolvencies. Apart from the Insolvency and Bankruptcy Code, India has the Reserve Bank of India (RBI) Prudential Framework, SARFAESI Act and section 230 of Companies Act 2013. The term “winding up”, in the Indian law, was introduced in the Indian Companies Act, 2013 Section 2(94A). It said “winding up under this Act or liquidation under the Insolvency and Bankruptcy Code, 2016, as applicable”.

This begs the question; why do businesses end up being unviable in the first place? As businesses grow in size, they have a risk of poor management, bad business judgement or plain fraud and may end up being unviable. In such a scenario, liquidation may help run the company better and provides it with a more capable managerial talent in many cases. 

With effect from April 01, 2017, voluntary winding up a company is governed by the Insolvency and Bankruptcy Board of India (Voluntary Liquidation Process), Regulations, 2017. A company is required to pass a special resolution for its voluntary winding up. Also, if a company owes any debt to any person, creditors representing two-thirds in value of the debt shall also be required to approve the resolution. The liquidation proceedings shall be deemed to have been commenced from the date of passing of the resolution by the company. The company shall from the liquidation commencement date cease to carry on its business. 

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Simply put, liquidation is the process that companies follow as they are winding up their businesses. It includes the course that a company is required to take in collecting its assets, payment of its debts, the surplus amount, if any, is distributed amongst the company members.

The liquidator is also required to make a public announcement inviting submission of claims against the company. Within 45 days of the commencement of the winding up proceedings, the liquidator shall submit its preliminary report detailing the estimates of its assets and liabilities as on the liquidation commencement date based on the books of the company. The liquidator shall try to complete the liquidation process within a period of twelve months from its initiation date. Then, the liquidator has to send a final report to Registrar and the Board, and it shall make an application to the Tribunal for dissolution of the company.

Insolvency 

World over, insolvency procedures help entrepreneurs close down unviable businesses and start up new ones. An effective insolvency system works as a key element of financial system stability. It is important that a sound framework is provided for restructuring and rehabilitation of companies along with a framework for winding up and liquidation. 

Any corporate entity can initiate a voluntary liquidation proceeding. However, there are certain conditions under which it’s eligible to do so. The first one being that the entity must not have committed any default. It is also required that a majority of the directors or designated partners give a declaration verified by an affidavit that: 

  • the corporate entity has no debt or can pay its debts in full from the sales of the assets under the proposed liquidation
  • liquidation is not to defraud any person

It will take around four weeks after such a declaration to pass a special resolution by the contributories to liquidate the corporate entity and appoint an insolvency professional as a liquidator. Once the winding up process is done and the assets of the corporate entity fully liquidated, only then the liquidator can apply to the National Company Law Tribunal for its dissolution. 

A liquidator can: 

  • verify the claims of all creditors
  • sell the assets of the corporate debtor
  • conduct the corporate debtor’s business until liquidation
  • investigate the financial affairs of the corporate debtor
  • institute any suits or legal proceedings

Dissolution 

Winding up and dissolution are not the same things. Winding up of the Company does not necessarily mean that the legal existence of the company has ended. It continues to exist as a legal corporate entity and remain on the Register of Companies. Its legal existence ends only when the Court orders dissolution of the Company, which more often than not, is initiated after the winding up process is done with. The process of dissolution of a company is purely administrative function while its winding up is purely a judicial function. In dissolution, liquidator does not have any significant role to play but he/she plays a very important role in the winding up of the company.

Once the assets of the company have been fully liquidated, the liquidator is required to file an application with the NCLT which 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). This brings an end to the entire process and resolution of a debt-ridden corporate debtor.

In theory, a company is said to be dissolved when it is ceased to be exist as a corporate entity. After dissolution, the company’s is taken off from the Registrar from the Register of Companies. A liquidator is appointed who takes the control of the entire company in his hands and the owner of the company is required to publish about the dissolution of the company in an official gazette. 

This is the last stage in process of the closure of a company. It can be concluded by a merger, reconstruction, and amalgamation. The dissolution often takes place voluntarily by the shareholders. The assets of the company are realized while its liabilities get paid off, and the surplus gets distributed to the members of the company in accordance with their rights.

Section 248 of the Companies Act, 2013 read with Companies (Removal of Name of Companies from the Register of Companies) Rules, 2016 lays down the procedure and instances where the name of a company can be struck off from the Register of Companies. This can be done in 2 ways:

  • By the Registrar on suo-motu basis in case where (i) a company has failed to commence its business within one year of its incorporation; or; (ii) a company is not carrying on any business or operation for a period of two immediately preceding financial years and has not made any application within such period for obtaining the status of a dormant company; or;
  • By a company upon filing an application with the Registrar on all or any of the grounds mentioned in clause (a) here in above.

Restructuring

Just like start-ups, businesses also need efficient and speedy procedures for exit. This helps in rechanneling the human and economic resources of a country which in turn increases the overall productivity of the economy. According to a report by the government of India, a limited standstill period is essential to provide an opportunity to genuine business to explore re-structuring. “The law should, therefore, impose a prohibition on the unauthorized disposition of the Debtors’ assets and suspension of actions by Creditors to enforce their rights or remedies against the Debtor on the assets for a limited prescribed period to preserve and protect assets besides maximizing its value. This will facilitate unobstructed conduct of Insolvency process by the Tribunal without having to deal with complexities of multiple creditor actions in Debt Recovery Tribunals. This will also encourage creditors to participate in the Insolvency process besides achieving fair and orderly administration and upholding fundamental objectives and policy of the Insolvency Law,” the report said. 

The aim of restructuring is to create a recovery mechanism for the creditors in which the defaulting debtor is assessed whether it is capable or not of repaying its debt. Failing this, the debtor is either restructured or liquidated and finally dissolved. 

Here are the steps that company need to follow under the Indian Insolvency and Bankruptcy law: 

  • Operational Creditor needs to issue and deliver a demand Notice [Form 3 – Rule 5 of the Insolvency and Bankruptcy Rules, 2016] to the debtor demanding payment of the unpaid debt. 
  • Within 10 days of receipt of demand notice, the debtor needs to bring to the notice of the Operational Creditor of the debt being disputed. 
  • If the payment is not received within 10 days from the date of delivery of demand notice, Operational Creditor has to file an application under Section 9 of the Code (prescribed Form 5 – Rule No.6) before NCLT along with a proposal for appointment of Interim Resolution Professional, if required. It needs to have a copy of the invoice / demand notice, copies of documents referred to in this application, copy of the relevant bank accounts of the operational creditor confirming that there is no payment of the relevant unpaid operational debt by the operational debtor, if available, an affidavit in support of the application, written consent from the proposed insolvency professional and proof of application fee paid.
  • Within 14 days of receipt of the application, NCLT is required to pass an order admitting or rejecting the application.
  • Within 7 days of constitution, the Committee of Creditors by a majority vote (of not less than 66% of vote 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. 
  • Then, the resolution applicant, which is appointed by the Resolution Professional, is required to prepare a resolution plan. This needs to cover 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 Code). 
  • The resolution plan, then, needs to be approved by the Committee of Creditors and to be accepted by at least 66% of voting share of the financial creditors. The resolution plan will now be needed to be approved by the NCLT.
  • Then, 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).
  • This is followed by the 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.
  •  The last step is the 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, the copy of said order shall be sent to the authority with which the debtor is registered for appropriate action (Section 54 of the Code).  

This is what successfully brings an end to the entire process and resolution of a debt-ridden corporate debtor.

DU Desk
DU Desk
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