Modes of closing a business - Series-I: Summary procedure of liquidation

The COVID-19 pandemic situation is challenging the economies of the world, including an impact on large and small businesses. Despite the many relaxations granted by the government of India and various state governments, the impact on businesses is deep. While some large businesses have cash reserves and resources to bide them by, the impact on startups which may not have those resources is many a time, fatal.

Through this blog series, we are covering various modes of closure of a company. In this Series-I, we are providing insights on summary procedure of liquidation of a company which is mostly applicable to the startups which intend to shut down their entity with certain assets and liabilities.

Series-II covers aspects associated with closure of a company under striking off by the RoC.

Series-III will cover matters in relation to obtaining status of dormant for specified period, which is relevant for startups planning on pivoting and not shutting down the company.

Series-IV will cover the voluntary liquidation under the Insolvency and Bankruptcy Code.

About winding up

Winding up means a proceeding by which a company is dissolved. The assets are disposed, the liabilities are paid, and the surplus, if any, is distributed among the shareholders/members in proportion to their shareholding in the company.

Winding up proceedings are governed by the provisions of the Companies Act 2013 as well as Insolvency and Bankruptcy Code 2016. Sections 271 to 275 of the Act govern the mode and process of winding up of companies. The modes of closure of a company are: (a) Summary procedure of liquidation of eligible companies; (b) Striking off of a company by the RoC under Section 248 of the Act. (c) Winding up by the National Company Law Tribunal; (d) Voluntary liquidation under the Code.

The companies can also make an application for remaining in “dormant status” while shutting down the operations, whilst not shutting down the company.

Winding up by tribunal

The process requires very several forms, consents, and documents and is very procedural. Further, the statutory authorities’ duty is to ensure that there is no short-changing of the many stakeholders.

The company may pass a special resolution (with 75 percent of the shareholders’ approval) for its winding up by a tribunal. The tribunal takes up the activities such as appointment of liquidator, and ensuring that there has been no fraud, misconduct, misfeasance etc. Then the liquidator takes over the control of the company and carries out the winding up and the long dissolution processes.

Corporate insolvency resolution process under the Code

In case of inability of a company to pay its debts and on an application by a creditor (where the minimum amount of the default is Rs 1 lakh, which is now revised to Rs 1 crore), the company may be subject to re-organisation or resolution process under the IBC. In case the resolution process is not successful, then the company’s liquidation process is initiated to pay off the creditors from realisation of sale of assets.

Voluntary liquidation

Unlike winding up by tribunal, in case the company is able to pay all its dues to its stakeholders, it can opt for voluntary liquidation process under the Code. In this case, the company will appoint liquidator and thereafter the liquidator will carry out further steps of winding up and dissolution.

Summary procedure of liquidation

With an objective of reducing the burden of the tribunal and to simplify and expedite the winding up process, the concept of summary winding up was introduced. This is a process of winding up with the Central government (delegated to the regional directors of ROC) replacing the tribunal as jurisdictional authority over specific winding up cases.

Section 361 of the Act empowers the Central government to approve the liquidation, while the Act has defined book value of assets as criteria for a company to be eligible for summary winding up under the Companies (Winding Up) Rules 2020, which are effective from April 1, 2020. This has widened the scope of applicability of the summary winding up procedure by providing additional criteria.

Eligibility Criteria

The book value of assets of the company should not exceed Rs 1 crore.

Any one of the below conditions based on the latest audited balance sheet:

1. In case of a company which has taken deposits, the total outstanding deposits should not exceed Rs 25 lakh.
2. Loans including secured loans in a company should not exceed Rs 50 lakh.
3. The turnover of the company is up to Rs 50 crore.
4. The paid-up share capital of the company should not exceed Rs 1 crore

The procedure for summary procedure of liquidation includes:

Declaration of solvency

The board of directors of a company will have to submit a declaration of solvency stating that: (i) the company has no debt or that it will be able to pay its debts in full from the proceeds of assets to be sold in the liquidations; (ii) the entity is not being liquidated to defraud any person.

Corporate resolutions

Upon submission of declaration of solvency, the company, within four weeks from the date of declaration of solvency will have to pass a special resolution adopted by shareholders of the company stating that the company be liquidated under Section 361 of the Act and authorisation to the board of directors to make an application to the regional director.

Filing of application with regional director

Upon passing of a special resolution, the company shall make an application to the regional director in Form RD-1. The company shall attach the detailed application together with the necessary documents and the latest audited financial statements of the company.

Appointment, rights and duties of liquidator

On the basis of application made to the regional director, an official liquidator will be appointed to act as the liquidator of the company to carry out the liquidation proceedings of the company.

The official liquidator shall take into his custody, or control all assets, effects and actionable claims to which the company is or appears to be entitled, and shall submit a report to the regional director within 30 days of his or her appointment.

Upon receipt of the report, the regional director may order the winding up of the company.

Claims of the creditors

The creditors will have to submit their claims with the liquidator for pending dues. The liquidator shall take this into consideration at the time of repayment.

Realisation of assets and payments to the stakeholders

The liquidator shall sell all the assets of the company and consider making payment to the claims received, and prepare the final accounts of the company.

Dissolution order by regional director

Upon the official liquidator filing the final accounts after realising all assets of the company and payment to the creditor and the shareholders as per the rules, the regional director shall pass an order dissolving the company.

Dissolution order to be filed with the RoC

Upon receipt of the dissolution order, the company will have to file the copy of order, received from the regional director, with the RoC.

Conclusion

In India, it takes time to shut down a business and the processes involved are lengthy.

The key advantage of the summary procedure of liquidation is that winding up of eligible companies would be adjudicated by the regional director and not by the overburdened tribunal. Comparatively, this process is less time consuming.

The companies affected due to COVID-19 and intending to shut down, can follow the procedure set out above. However, this is beneficial only in case the company has assets including cash and bank balance and wishes to wind up in an efficient manner.

In case the company has no assets and liabilities and has not carried out business for the last two years, it can follow the striking off of the company procedure which will be captured in our next blog or if the intent is to shut down the operations for temporary period, it may obtain the status of dormant as provided in our Series-III of the blog.

Please Note: In the process of simplifying the reading of this blog, we have excluded many technical aspects/document description, filings, timelines etc to be followed. Please obtain legal advice, since the specific requirements of your company have to be considered.

The series was written with the help and research of the team at NovoJuris Legal.