India: Inability To Pay Debts as a Ground for Winding Up the Company

Last Updated: 1 July 2002

Duvva Pavan Kumar* & M. Chandana**

Introduction

Winding up is a process by which the affairs of the company come to an end. It has been described as "...a process whereby its life is ended and its property administered for the benefit of its creditors and members. An administrator, called liquidator, is appointed and he takes control of the company, collects its assets, pays its dues and finally distributes any surplus among the members in accordance with their rights"1.

As understood, the purpose of winding up is to realise the companies assets and pay its dues. However, the courts have through various judicial pronouncements clarified this misnomer. The Bombay High Court in Ambey Flour Mills (P) Ltd. v. Vimal Chand Jain2, held that the machinery for winding up will not be allowed to be utilised merely as a means for realizing due from a company.

The jurisdiction of the High Court under Section 433 is not that of a court which is essentially meant for settling money disputes between parties, but is to subserve the object of winding up of companies which have not paid their debts or which are unable to pay their debts3. Thus, the object of Section 433 is to provide a summary remedy and save the shareholders or creditors of a company, where a company is unable to meet its admitted liabilities4.

Proceedings under Section 433 are not a substitute for a civil suit by a creditor against the company. The mere filing of a civil suit need not be an impediment to proceed with the company petition for winding up5.

Inability to Pay Debts

Section 433(e) of the Companies Act, 1956 provides that in cases where the company is unable to pay its debts the court can order winding up. The expression ‘unable to pay its debts’ has to be taken in the commercial sense of being unable to meet current demands though the company may be otherwise solvent6. The fact that the liabilities exceed the assets does not necessarily mean that the company is unable to pay its debts. It may still be in a position to meet the demands of the creditor when made7. However, where the court is satisfied upon a general perusal of the balance sheet that the company cannot pay its debts i.e., its assets are not sufficient to satisfy its liabilities, the court may order the winding up of the company8.

The inability to pay debts primarily arise under three circumstances9:

  1. Where the company fails to clear the debt of the creditor (a sum exceeding five hundred rupees) within three weeks immediately preceding the date of demand for payment being made10;
  2. Where execution or other process issued on a decree or order of any court in favour of the company is returned unsatisfied in whole or part11 and
  3. Where it is proved to the satisfaction of the court that the company is unable to pay its debts12.

A petition for winding up on the ground of inability to pay debts must contain all the relevant information about the debt13. The petition must disclose the assets of the company and whether they are sufficient to meet the liabilities including contingent and prospective liabilities. Further, the petition must also disclose the position of fixed assets as well as valuation of plant and machinery of the company14.

Where a debt is bona fide disputed by the company and the court is satisfied with the company's defence a winding up order will not be made15. In K. Appa rao v. Sarkar Chemicals (P) Ltd16., the Andhra Pradesh High Court held that where a company has a prima facie sustainable defence or a bona fide dispute of its obligations to discharge the alleged debts or liabilities, the court may not entertain proceedings for the winding up, much less order winding up.

Once there is an admission on part of the respondent company of liability of dues payable, then a petition under Section 433 cannot be dismissed on technical grounds17. Company courts can exercise their discretionary powers of dismissing the petition even before issuing a show cause notice regarding admission18

Inspite of repeated demands if a company neglects to pay its debts, it will be considered as the inability of the company to pay its debts and an order of winding up can be passed by the court19. By non-payment of the undisputed debt within the period of statutory demand, the company is deemed unable to pay its debts and where the company is unable to pay its debts, winding up ought generally to follow in public interest20.

To raise the presumption of companies inability to pay its debts it is not enough merely to show that the company has omitted to pay the debt despite service of statutory notice, it must be further shown that the company omitted to pay without reasonable excuse and conditions of insolvency in the commercial sense exist21. Merely because notice under section 434 was not served, it cannot be said that company was not unable to pay its debts22.

Section 433 cannot be used to coerce a company to make payments even though its liability is admitted23. In I.T.C. Ltd. v. Fomento Resorts & Hotels Ltd24., it was held that a winding up petition is not to be filed as a coercive means of recovery of debt. Similarly, in Agro Anlagewbau GmbH v. Orient Ceramics & Industries Ltd25., the Delhi High Court observed that the winding up jurisdiction is not to be use as an arm twisting device to compel a company to pay up a claim which it is unwilling to pay for legitimate reasons.

The inability of a company to pay its debts has to be proved by the claimant creditor26. A creditor who on demand fails to get amounts due paid to him becomes entitled to obtain an order of winding ex-debito justitiate.

The Gujarat High Court in Tata Iron and Steel Co. v. Micro Forge (India) Ltd27., prepared a chronicle on the points that emerged from the case law under Section 433:

  1. The remedy under section 433 in general and under clause (e) in particular is not a matter of right, as such, and it is the discretion of the company court. It does not confer any right on any person to seek order that the company should be wound up. It is a provision empowering the court by a statutory provision to pass order of winding up in an appropriate case.
  2. Merely because any one of the circumstances enumerated in section 433 of the Companies Act, exists, the court is not bound to order winding up of the company. Nobody can aspire to wind up the company as a matter of course. The court has wide power and discretion. In this connection, inability to pay debts, is required to be judged from various set of facts and circumstances. It may also be stated that inability to pay debts in all cases, ipso facto, could not be construed as an appropriate case for winding up.
  3. The debt is a money which is payable or will be payable in future by reason of person’s obligation. The expression ‘debt’ would refer the liability to pay and it rests on certain contingencies, conditions and casualties. Even if the debt is proved and even if the inability to pay the debt is also shown, it is not a launching pad, in all cases, for successful winding up order. Inability may arise for variety of reasons and the court is obliged to consider whether inability is the outcome of any deliberate or designed action or more temporary shock and effect of economy and market. In a given case, it may happen that a party may become unable to pay its debts for a while, but that by itself is not criterion for exercising the power to wind up, ipso facto.
  4. It is necessary for the company court to consider the financial status, strength and substratum of the company, in overall context. It is possible, at times, there may be a cash crunch. It may be also, possible, at times the temporary cash crisis despite high sale and heavy turnover and, therefore, in such a situation, mere disability or only on the ground of inability to pay would not constitute a ground empowering the court to wind up the company.
  5. If the company is an ongoing concern having regular business and employment of employees, the court cannot remain oblivious of to this aspect. The effect of winding up would be of putting an end to the business or an industry or an entrepreneurship and, in turn, resulting into loss of employment to the several employees and loss of production and effect on the larger interest of the society.
  6. Even dividend declared by the company regularly and having profit in the light of the profit and loss account, though temporary, there may be inability to pay the debt or in case of any eventuality, the company is unable to make the payment of dues and that by itself could not be construed as a ground to winding it up.
  7. Winding up of a company, as such, is nothing but a commercial death or insolvency and, therefore, the company court is obliged to take into consideration not only the temporary inability, or disability to make the payment of debts, but the entire status and position of the company in the market.
  8. When grounds on which the winding up order can be denied, upon an evaluation of the facts of the case, after admission, exists from the record already placed before the court, it would be a sound exercise of discretion to reject the petition instead of admitting it. This view is very much celebrated.
  9. Inability to pay debts in terms of section 433 (e) read with section 434(1) (a), demand of the debt would raise a presumption as to inability to pay its debts. But such a presumption is rebuttable. Such a presumption maybe rebutted on existing material and what evidence is sufficient depends on the facts and circumstance of the case.
  10. If the company has shown considerable growth in a reasonable span and is a growth oriented enterprise, even temporary inability would not be sufficient to drive it to wind up.
  11. Though, ordinarily, an unpaid creditor may aspire for an order of winding up, then ‘ex debito justitiae’ rule is not of inflexible mandate, but is, as such a matter of discretion of the court.
  12. Section 433 is also indicative of the fact that even if one or more grounds mentioned in section 433 exists, it is not obligatory for the court to make an order of winding up. The court has discretionary power. The court must in each case exercise its discretion in deciding whether in the circumstance of the case, it would be in the interest of justice to wind up the company. It is well-known rule of prudence that even in case where indebtedness to the petitioning person is undisputed, the court does not pass order for winding up where it is satisfied that of it would not be in the larger interest of justice to wind up the company.
  13. It is, also, well settled that a winding up order shall not be made on a creditors petition, if it would not benefit him or the companies creditors in general.
  14. The court is also obliged to consider that it would be in the interest of justice to give the company sometime to come out of the momentary financial crisis or any other temporary difficulty as winding up is a measure of last resort.
  15. Winding up course cannot be adopted as a recourse to recovery of the debt.
  16. The court must bear in mind one more celebrated principles and consider whether the company has reached a stage where it is obviously and plainly and commercially insolvent, that is to say, that its assets are such and its existing liabilities are such as to make the court feel clearly satisfied that current assets would be insufficient to meet the current liabilities, along with other principles.
  17. It is also necessary to consider whether the respondent company has become defunct or has closed its business for quite sometime, whether it is commercially insolvent. For the purpose of finding commercially insolvency, a mere look into the financial data is relevant to examine about its soundness. In all matters relating to winding up the court may have regarded to the wishes of the creditors and contributories and may, if necessary, ascertain their wishes appropriately. If the company is solvent, the wishes of the contributories would carry more weight as they are persons, mainly, interested in the assets.
  18. The element of public policy in regard to commercial morality has, likewise, to be taken into account before determining the winding up issue. The court has also to consider the purpose and policy behind section 443 and 557 of the Companies Act.
  19. Winding up is the last thing the court would do and not the first thing to do having regard to its impact and consequences. The winding up of a company would ensure: (a) closing down a company which is engaged in production or manufacture or which provides some services; (b) it would throw out of employment numerous persons and result in gross hardship to the members of families of the employees; (c) loss of revenue to the State by way of collection of taxes which otherwise should have been collected, on account of customs, excise duties, sales tax, income tax etc. (d) scarcity of goods and diminishing of employment opportunities.
  20. Winding up petition has to be submitted in prescribed form highlighting all the facts and emphasising the inability of the company to pay its debts. The form prescribed under the Company Court Rules clearly, indicate that the petitioner should provide all necessary material particulars. The petitioner is obliged to show that the financial status or the monetary substratum or the commercial viability of the company has gone so low and down that winding up is obviously, and evidently, unavoidable.
  21. It is a settled proposition of law that winding up petition is not legitimate means of seeking to enforce the payment of debt which is disputed by the company, bona fide. Winding up petition ought not to be aimed at pressurizing the company to pay the money. Such an attempt would be nothing but would tantamount to blackmailing or stigmatising the concerned company by abusing the process of the court.
  22. Winding up petition is not an appropriate mode enforcing bona fide disputed debts as it is nothing but misuse and abuse of the process of the court.
  23. Winding up petition is not an alternative form for resolving the debt dispute. In certain cases disputes are such that they are fit for resolving through civil court rather than through company court.
  24. What is bona fide and what is not is a question of fact. The expression bona fide would mean genuine, in good faith and when the dispute is based on substantial grounds or when defence is probable and with some substance, it is a bona fide dispute. It must be strictly noted that winding up petition is not an alternate to civil suit.

CONCLUSION

A winding up petition is, therefore, not a legitimate means of seeking to enforce payment of the debt which is bona fide disputed by the company. A petition presented ostensibly for winding up but really to exercise pressure will be dismissed and maybe stigmatised as a scandalous abuse of the process of court. Further, a winding up petition cannot be sustained on the basis of a debt, which was due prior to the incorporation of the company even if one of the objects of the company was to pay off the debt28.

The court is competent, in consideration of circumstances to refuse to pass an order of winding up even if the company is unable to pay its debts. It is equally in its discretion to make a conditional order however, such a discretion has to be exercised judicially29. in Navjivan Trading Finance (P) Ltd., In Re30, the court observed that winding up is the last thing that the court would do and not the first thing the court would do having regard to its impact and consequences, for winding up of a company would result, in (a) closing down of a unit which produces some goods or provides some service; (b) throwing out of employment numerous persons results in grave hardship to the members of the families of such employees; (c) loss of revenue to the state by way of collection that the state could hope to make on account of customs or excise duties, sales tax, income tax etc.; and (d) scarcity of goods and in diminishing of employment opportunities. The court would not be too keen or too anxious to wind up a company by an order of the court only on the ground that the company is unable to pay the debts. In fact, it would be a blow to do so, so long as there is any possibility of resurrecting the company.

Similarly, in New Swadeshi Mills of Ahmedabad Ltd., v. Dye-Chem Corporation31, the court held that the policy of the court should be to revive the company thought at the moment the company may not be solvent and may not be able to meet its obligations towards its creditors.

* IV Year, B.A.,B.L (Hons) NALSAR University of Law, Hyderabad.

** IV Year, B.A.,B.L (Hons) NALSAR University of Law, Hyderabad.

1 Professor L.C.B. Grover, The Principles of Modern Company Law, 3rd ed, 1969, p. 647.

2 (1991) 70 Comp. Cas. 459 (Bom).

3 B. Viswanathan v. Seshasayee Paper & Boards Ltd., [1992] 73 Comp. Cas. 136 (Mad).

4 Smt. Vijayalakshmi v. Hari Hara Ginning and Pressing (P) Ltd (1999) 96 Comp. Cas. 723 (A.P).

5 Ibid.

6 Concord Finance P. Ltd. v. Rawalpindi TheatersP. Ltd., (1969) 2 Comp L.J. 244.

7 A.C.K. krishnaswami v. Stressed Concrete Constructions (P) Ltd., (1964) 34 Comp. Cas. 6 (Mad).

8 Bombay Cotton Manufacturing Co., Re, (1909) 11 Bom LR 1302 (Bom).

9 Ibid. Section 434.

10 Ibid. Section 434(a). Debts here is any sum exceeding Rs 500/-.

11 Ibid. Section 434(b).

12 Ibid. Section 434(c).

13 Focus Advertising (P) Ltd., v. Ahoora Blocks (P) Ltd., [1975] 45 Comp. Cas. 534 (Bom).

14 Kanchanganga Chemical Indistries v. Mysore Chipboards Ltd., [1998] 91 Comp. Cas. 646 (Kar).

15 Piara Singh (S.) v. S.H.R. Properties Pvt. Ltd., (1993) 10 Corpt. LA 83 (Del).

16 (1995) 84 Comp. Cas. 670 (A.P).

17 G.K.W. Ltd., v. Shriram Bearings Ltd., [1998] 18 SCL 461 (Delhi).

18 Kanchangaga Chemical Industries v. Mysore Chipboard Ltd., [1998] 18 SCL 461 (Delhi).

19 Advent Corporation In Re, 39 CompCas. 463.

20 Dena Bank v. Khatau Dyes and Fibres Ltd., [1997] 5 Comp. LJ 544 (Bom).

21 Kanchanganga Chemical Industries v. Mysore Chipboard Ltd., [1998] 91 Comp. Cas. 646 (Kar).

22 Garodia Hardware Stores v. Nimodia Plantations & Industries (P) Ltd., [1998] 4 Copm. LJ 292 (Gauhati).

23 P.K. Varghese v. J.T.V. Metal Finishers (P) Ltd., [1988] 63 Comp. Cas. 644 (Kar).

24 [1991] 70 Comp. Cas. 459 (Bom).

25 [1986] 60 Comp. Cas. 691 (Del).

26 Trilok chand Jain v. Swastika Stripes Pvt. Ltd., (1992) 75 Comp. Cas. 275 (P&H).

27 2000 CLC 1669 at 1674 to 1677 (Guj-DB).

28 Janbazar Manna Estate Ltd., Re, (1931) 1 Comp. Cas. 243.

29 Dena Bank v. Khatau Dyes and Fibres Ltd., [1997] 5 Comp. LJ 544 (Bom).

30 [1978] 4 Comp. Cas. 402 (Guj).

31 [1986] 59 Comp. Cas. 183 (Guj).

The content of this article does not in any way constitute legal advice by the author and should not be relied on in that way. Specific professional advice should be sought about your specific circumstances.

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