It has been said that in corporate
litigation, a liquidation application is the equivalent of a powerful bomb.
The liquidation process is intended
for the winding up of the affairs of an insolvent business entity or to bring
an equitable end to its existence in certain prescribed circumstances. In the
case of companies, these circumstances are set out in the Companies Act, 1973.
The process is not meant to be used for enforcing payment of a debt or to
enable its controllers to surreptitiously escape the consequences of their
actions, such as to avoid paying creditors.
Yet, not infrequently, one finds
winding up applications being used as a tool to an ulterior motive,
typically to force the debtor to pay or as an endeavour on the part of those in
charge of the business to sidestep creditors.
Our courts frown upon such an abuse
of the process. There is longstanding authority for this, with case law in
this regard going back more than fifty years.
However, in practice this does not
seem to deter those creditors who wish to circumvent the somewhat protracted
procedure prescribed for enforcing payment of debts through the normal court
process, by bringing a liquidation application against the debtor company.
This typically happens through what
is called a section 345 letter of demand. This section in the Companies Act,
1973 provides that a company is deemed to be unable to pay its debts if a
creditor has delivered a written demand at the company’s registered office
requiring the company to pay the sum alleged to be due and the company for
three weeks thereafter fails to pay the sum demanded or to enter into a
settlement arrangement with the claimant.
Frequently one finds that the
creditor’s demand remains unmet, resulting in the institution of an application
to liquidate the debtor company, in circumstances where the creditor knows full
well that the debtor is disputing the debt (which of course means that the
party receiving the letter may not in fact be a debtor). Consider the
Company A enters into an agreement
with company B for delivery of a computer server. The server is duly
delivered, but it turns out that there are various defects which render the
server unusable and oblige company B to incur significant costs in having the
defects repaired. For this reason, company B refuses to pay company A in
full. Correspondence passes between the parties in this regard. Company A
maintains that it is not contractually liable for the defects and claims
payment. Company B refuses to pay. Company A causes a section 345 letter of
demand to be delivered, but company B refuses to pay and refers to the
correspondence which passed between them. If Company A proceeds with a liquidation
application, it would probably amount to an abuse of the process of court.
Why is this so? Winding up
proceedings are not intended for the enforcement of debts or to resolve
disputes as to whether or not the debt claimed exists or not. This is sometimes
referred to as the “Badenhorst Rule”, after the case decided more than fifty
years ago in which this rule was first stated in our law.
Given that the liquidation of a
company affects the interests of all creditors and shareholders, not to mention
employees, especially those with significant numbers of employees, our courts
will not be inclined lightly to order the winding up of a company on the
application in these circumstances. Of course, where a creditor clearly
establishes the debt, the debt is not disputed and the company is unable to
pay, it would be in the interest of creditors and other stakeholders that the
company is placed in liquidation.
If a winding up application is
successful, it means the end of the company. The mere bringing of a winding up
application could substantially prejudice a company or even be fatal. Other
creditors may be reluctant to extend further credit or to continue doing
business with the company. Customers may be reluctant to place orders or make
payment of debts owed to the company.
Hence the analogy drawn
between a winding up application and a bomb. An applicant in liquidation
proceedings should therefore not bring the proceedings to achieve an ulterior
motive. If it does and the court finds the application to be an abuse of the
process of the court, the unscrupulous applicant may well find itself mulct
with a punitive costs order. Therefore, before you drop the bomb, ensure your
aim is true.
The content of this article is intended to provide a general guide
to the subject matter. Specialist advice should be sought about your
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Currently in the UAE, laws related to insolvency are unclear. Companies face harsh penalties in a bankruptcy scenario, and individuals can face criminal sanctions and penal sentences.
Some comments from our readers… “The articles are extremely timely and highly applicable” “I often find critical information not available elsewhere” “As in-house counsel, Mondaq’s service is of great value”
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).