Liquidation – Dutch Uncles

Factoring Regulation (Amendment) Bill, 2021 Will Aid The Ailing MSMEs

Aakash Sharma — Mon, 02 Aug 2021 03:35:11 +0000

The Indian Parliament has passed the Factoring Regulation (Amendment) Bill, 2021, which will help the micro, small and medium enterprises (MSME) sector by ensuring enhanced working capital assistance and cash flow.

According to the finance minister, the bill is essential because it will help Indian MSMEs overcome their default receivables problems. Under the new bill, MSMEs can sell their receivables to a third party. If third parties offer money directly, MSMEs should be able to run their business with ease. There are several such advantages in factoring from the payment of the seller.

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The changed status and definition of “assignment", "factoring business" and "receivables" to align with international rates will help and benefit the small businesses.

What is factoring?

Factoring is a transaction in which an organisation (such as an MSME) sells its receivables (customer claim) to a third party (an “agent” such as a bank or NBFC) for direct funding. This often helps a business meet its initial working capital needs. Despite the growth in recent years, India’s factoring market represents only 0.2% of GDP, lagging behind comparable economies such as Brazil’s 4.1% and China’s 3.2%. The largest factoring market of Europe dominates the global factoring segment at 68% of the international total. The factoring market worldwide is expected to reach a $9.2 trillion valuation by 2025.

Factoring Regulation (Amendment) Bill: Changes in favour of Indian MSMEs

The proposed changes to factoring practices in India aim to increase the lenders’ share of factoring activities, easing restrictions and allowing the central bank (RBI) to bolster norms for better oversight of the $6 billion market. The new bill also aims to enable all non-banking financial companies (NBFCs) to carry out factoring activities, thereby helping to improve MSMEs cash flow.

Under the current law, NBFC’s financial assets and income from factoring activities must exceed 50% of total assets and net income or exceed the threshold before commencing traditional factoring activities. The new law removes this barrier and makes it easier for NBFC to enter the factoring industry. Many MSMEs, whose payments against supplies are stuck, participate in the factoring business with receivables.

What can MSMEs and small businesses expect going forward?

Small businesses will be empowered under the new factoring bill and receive some cash liquidity for operational costs. Moreover, the red tapes will also be diluted as compared to the existing rules. The RBI will make regulations for the manner of granting the certificate of registration, filing of particulars of transactions with the Central Registry on behalf of factors, and any other matter required to be specified by regulations.

The benefits for MSMEs via invoice discounting, recourse and non-recourse factoring, collections, and reverse factoring will give them a much-needed relief, even though authorities can do more for them in the long run.

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Make Exiting by Liquidation a Rewarding Experience

Joseph Varughese — Tue, 16 Mar 2021 10:35:05 +0000

The IBM Institute for Business Value and Oxford Economics conducted a study called ‘Entrepreneurial India’ which found out that 90% of Indian start-ups will fail in the first five years of their establishment.

The study included interviews of 600 start-up entrepreneurs of which 300 were Indian; 100 government leaders along with 100 venture capitalists, 1500 leaders of established companies, and 22 educational institutions.

The scope of this article is not to discuss the ‘why’ of the failures but about one of the exit strategies that can be classified as the last resort exit route though not necessarily so always; liquidation.

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Liquidation is an exit strategy where you close the business and sell all of your assets - typically at a lower cost than the market price or book value.

What is an Exit Strategy in business?

Before we get into the topic of liquidation, let us explore various exit strategies available to start-ups. An exit strategy is a plan to exit a situation in the event of certain circumstances at a certain point in time. In business, exit strategy is about exiting the business or investment. The difference between these two is that in the first case it is the strategy to close or sell the company and the second case of exiting investment is of diluting the investment of the owners keeping the business alive. Many of the start-ups have an exit strategy as part of their business plan at the conceptual stage itself.

However, there arise situations where exit becomes inevitable though not planned for or at a point in time that was not foreseen to happen. This cannot be strictly called an exit strategy since there is no strategy or plan involved here. It is a decision forced to be taken out of the prevailing circumstances. Such situations normally emerge due to failure thanks to poor management, lack of expertise, negative cash flow, investor disinterest, bad or untested ideas, non-delegation of responsibilities, market conditions, recession, pandemic, adverse tax laws etc. It can also be because the owner believes that she or he has reached the expected and required target or made the required money out of the venture or the product life cycle has reached the end.

What are the common types of exit strategies?

We have heard of different routes to exit and let us briefly discuss a few of the most common of them here.

Merger & Acquisition (M&A): This very common route means merging of your business with another entity or being bought or acquired by another company. This is normally merging with a similar company, or being bought by a larger company, mostly larger company in similar or related business. This is an exit strategy to liquidate the investments of the struggling company and for the company on the other side it may be a growth driver. Such companies acquire other businesses for inorganic growth or economies of scale or cost efficiency or skill set of employees or strategic synergy because setting up a similar business from scratch takes lots of effort and time.

Initial Public Offering (IPO): IPO is about going to the public with an offer of sale of its shares and consequently getting listed on stock exchanges. This may not be an easy option for small and early start-ups as this involves complying with many regulations of SEBI, Companies Act, income Tax, RBI in certain cases etc. which specify stringent rules and regulations for companies going with IPO. In addition, it is not easy for the IPO to get subscribed by the public without good review, visibility and financial metrics in its favour. As far as the start-ups are concerned, this is usually a strategy enforced by non-promoter investors to exit their investment and take advantage of the premium valuation that might come through IPO which is exactly why they invest in the first place. This is not a common feasible route for struggling companies. This works for companies on the growth path looking for funds.

Dilution of equity: This is a common option most start-ups resort to. This is about diluting the promoter investment in the form of equity or capital by allotting shares to new investors against the fund they bring in, based on the valuation of the business as of then. This is not to be confused with an IPO. This may not be mostly a full exit as normally promoters remain in the company with majority or minority shareholding.

Sell to friends or relatives: This is not an M&A or liquidation route. The company does not close down or merge with another company. Yet it’s a great way to “cash out” so you can pay investors, pay yourself, take some time off, or venture into another business. The ideal buyer is someone you know well who has more skills and interest on the operational side of the business, and is confident of scaling it.

Close and Liquidate: This is our topic of discussion in this article. There are many reasons why business owners or investors decide to close down and liquidate their business. One reason can be the decision of the owner that enough is enough. Another can be the plan to exit the current business and try out something else or different. Mostly it is the companies struggling to survive which opt for this route in the form of voluntary liquidation. Other reasons may be that the idea was not tested properly before venturing into it resulting in failure or legal heirs or successors don’t want to continue the business. It can also be forced liquidation initiated by creditors who have not been paid their dues for long, to recover their money.

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In business, exit strategy is about exiting the business or investment. The difference between these two is that in the first case it is the strategy to close or sell the company and the second case of exiting investment is of diluting the investment of the owners keeping the business alive.

So, what is Liquidation?

Liquidation is an exit strategy where you close the business and sell all of your assets – typically at a lower cost than the market price or book value. Do not see this as a bad option, this is a recommended strategy when the time has come to simply move on and/or you have run out of all other options to sustain. If you choose this route, just know that the process is to sell off the assets, use the cash obtained thus to pay off creditors and distribute whatever, if any, remains to the investors and shareholders including the founder owner, based on the contract in palace or share of stake as per the relevant laws.

As discussed elsewhere in this article, one of main reasons why start-ups fail is because the founders did not go through the much-needed procedure of testing the idea before venturing into implementing it. In such eventuality, if you have any protected IP, you must try to monetise it if some other entrepreneur has a better plan, skills and management resources to use your failed idea or IP and run it successfully. You can also consider the royalty route.

Coming back to liquidation, this route is normally selected when all other options like M&A, IPO, Sell-out don’t work out to the benefit of the business owner or become very complex and cumbersome for the owner to manage those routes without bringing in more resources and funds.

It may look like that the more beneficial way to exit a struggling or failed business is to sell it to potential buyers. This is, however, easier said than done especially if it is a struggling business. Hence the feasible and plausible option that will be available to a business owner who wants to exit the struggling business is to close and liquidate the business.

What are the liquidation processes?

This part is discussed here with reference to liquidation processes relevant to India under its applicable statues.

Insolvency and Bankruptcy code, 2016 is a consolidated enactment of various codes like Companies Act, 2013, Sick Industrial Companies (Special Provisions) Repeal Act, 2013, Limited Liability Partnership Act, 2008, Secularization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Recovery of Debts Due to Banks and Financial Institutions Act, 1993. IBC, as it is commonly known, applies to the following entities.

Any company incorporated under the Companies Act, 2013 or any other previous law.

Any other company which is governed by any Special Act like government companies, government corporations

Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008

Partnership firm whether registered or not under the Partnership Act, 1932

Any Individual Person

In a bid to ease recovery of dues from start-ups and enable faster exit, the Central Government in 2017 notified the provisions of the ‘Fast Track Insolvency Resolution Process’ under the Insolvency and Bankruptcy Code, 2016 labelled the Insolvency and Bankruptcy Board of India (Fast Track Insolvency Resolution Process for Corporate Persons) Regulations, 2017. This has come as a solace to start-ups which have been struggling all along and therefore want to exit in a smooth and fast mode.

The Regulations and the Fast-Track Resolution process are applicable to the following categories of corporate debtors meaning entities that want to liquidate the business:

a small company as defined under the Companies Act, 2013;

a Start-up (other than the partnership firm) as defined above; or

an unlisted company with total assets, as reported in the financial statement of the immediately preceding financial year, not exceeding rupees one crore.

The fast-track resolution is meant to expedite the insolvency resolution process of start-ups and small companies by cutting down the time taken to complete an insolvency resolution in a faster mode. The Fast-Track code stipulates that the fast-track process is required to be completed within a period of ninety (90) days, as against one-eighty (180) days in other cases, though can be extended by another 45 days for once under certain circumstances and conditions.

The fast-track process can be initiated by the creditors meaning those to whom business owes dues to pay or by the corporate debtor itself by filing an application to the IBC Adjudicating Authority.

The Regulations as a whole provide for the resolution process from the initiation of the insolvency resolution of the corporate debtors till its conclusion with approval of the resolution plan by the adjudicating authority within the set timelines thereby ensuring a speedy disposal of any application under the fast-track process.

Is Liquidation a rewarding experience?

The answer depends on various factors like whether this route was selected without trying out other exit strategies or it is a voluntary liquidation or one initiated by creditors. Other than in cases where the owners want to call it a day because they or their successors don’t want to pursue this business, owners take to the liquidation route as a last resort after undergoing a long period of struggle and trauma to keep the business alive and running. They are most probably in a mental state to exit the business as fast and smooth as possible. Going through another series of pain in the liquidation process may be something that they want to avoid at that point in time.

The prevailing statutes and codes under IBC ensure that this is avoided as far as possible. It also makes sure that all the stakeholders like creditors, employees, shareholders and investors have a win-win situation.

The liquidation strategy under current Indian laws provides companies particularly start-ups the best way to exit. This helps them by way of not wasting lots of time and effort so that they can pursue other endeavours. This also may provide them some money by way of funds remaining after settling the creditors.

In certain circumstances, that is the best option or only option available to the business owner, especially of failed or struggling start-ups.

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Know the Basics of Liquidation if You Are Closing Your Business

DU Desk — Mon, 22 Feb 2021 10:35:05 +0000

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.

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