[The following post is contributed by Vinod Kothari of Vinod Kothari & Co. The author may be contacted at firstname.lastname@example.org]
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 (‘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 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.
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
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)
Commencement of winding up
On the passing of resolution of shareholders – section 485
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
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
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 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. 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 shallmake 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. In the UK, 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.
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.
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