Financially Distressed Companies – Options available –

Winding up –
Last Resort?

• Chandaka Jayasundere
What is a Distressed Company?
 Section 57 specifies that a company shall
be deemed to have satisfied the solvency
Legally test, if:

Insolvent a) it is able to pay its debts as they

Section 57 of become due in the normal course of
business; and
the Companies b) the value of the company’s assets is
Act greater than:

(i) the value of its liabilities; and

(ii) the company’s stated capital
 • ‘cash flow’ insolvency

• a company may be insolvent if it cannot meet the

debts as they fall due although having
substantial assets over liabilities

• ‘balance sheet’ insolvency

Financially • a company may be insolvent although it has no

Insolvent
outstanding current debt, but the assets are not
sufficient to cover its present, future and
contingent liabilities.

• The law is not concerned whether the

insolvency is balance sheet insolvency or cash
flow insolvency. The law presumes and acts in
a certain manner if the statutory requirements
as contained in the Companies Act are met.
 • The provisions discussed are only the legal remedies
available under the Companies Act and not other
methods of riding out the distress.

Non-Legal • Before any decision is taken regarding insolvency or

otherwise there are other methods to overcome

Remedies for
difficulties such as:

Companies in • asset liquidation,

• fresh infusion of equity capital by shareholders

Distress or investors; or
• drawing down retained profits or other reserves
etc.; or
• Other financial recourses available which might
entail the restructuring of the capital, assets and
ownership.
Duty towards Creditors and other stakeholders

o A Director’s duty is not exclusively towards the company but is also towards the
shareholders, creditors and other stakeholders.

o The duty towards the creditors become more important in a situation where the
company is in financial distress and is either insolvent or about to be insolvent.

o In exercising their powers, the directors must take into consideration the interest of the
Company’s creditors.

o Thus, if a director acts in a situation of doubtful solvency the directors are not acting in
good faith when the Directors only act in the interest of the Company or its
shareholders and not of its creditors.
 Duty of Directors on insolvency
Section 219
• The fundamental duty of Directors in the case of insolvency is stipulated in section 219 of the
Companies Act.

• These provisions cast a duty upon the directors or a director to take certain steps regarding the
possible insolvency of the Company.

• Section 219 states that a director of a company who believes that the company is unable to
pay its debts as they fall due, shall:

• forthwith call a meeting of the board;

• to consider whether the board should apply to court for the winding up of the company;
and
• the appointment of a liquidator or an administrator or carry on further the business of the
 A company shall be deemed to be
unable to pay its debts where-

(a) a creditor by assignment or otherwise, to whom

the company is indebted in a sum exceeding fifty
thousand rupees then due, has served on the
company, a demand under his hand requiring the

“unable to pay company to pay the sum so due and the company
has for three weeks from the date of so leaving,
neglected to pay the sum or to secure or

its debts” - compound for it to the reasonable satisfaction of

the creditor; or

section 271 (b) execution or other process issued on a judgment,

decree or order of any court in favour of a
creditor of the company, is returned unsatisfied
in whole or in part; or

(c) it is proved to the satisfaction of the court that the

company is unable to pay its debts, and in
determining whether a company is unable to pay
its debts, the court shall take into account the
contingent and prospective liabilities of the
company.
 Repercussions – Section 219 (2)

• Where the directors fail to comply with the above, they would be liable for any loss suffered by
creditors if the company is subsequently put into liquidation.

• Section 219(2), stipulates that:

• where a director fails to comply with the requirement of 219(1) and at the time of that failure,
the company was unable to pay its debts as they fell due, and the company is subsequently
placed in liquidation, the court may on the application of the liquidator or of a creditor of the
company, make and order that the director shall be liable for the whole or any part of any
loss suffered by creditors of the company as a result of the company continuing to carry on its
business.

• Thus, if the Company is unable to pay its debts as they become due, and the Directors do not
comply with the provisions of section 219, and due to that act and the company goes into
liquidation, the Directors will be personally liable for the entire or part of the loss suffered by
 • Section 219 does not mandatorily require that the
company should proceed to liquidation.

Liquidation is • The Section clearly states that at the meeting of

the board of directors that is to be called in terms
not mandatory of section 219 the directors must decide either:

under section (a) to apply to court for the winding up of the

219 (b)
company;
to appointment a liquidator or an
administrator; or
(c) carry on further the business of the company.
 Duty of Directors on serious loss of capital –
Section 220
• Section 220 provides that:

• if at any time it appears to a director of a company that the net assets of the company are less than half of its
stated capital,

• the board shall within twenty working days of that fact becoming known to the director,

• call an extraordinary general meeting of shareholders of the company for the purposes of the section

• The notice calling a meeting under this section shall be accompanied by a report prepared by the board, which
advises shareholders of: (a) the nature and extent of the losses incurred by the company; (b) the cause or causes of
the losses incurred by the company; (c) the steps, if any, which are being taken by the board to prevent further losses
or to recoup the losses incurred.

• Where the board of a company fails to comply with these provisions, every director who knowingly and wilfully
authorises or permits the failure or permits the failure to continue, shall be guilty of an offence and be liable on
Repercussions of not complying
Repercussions of not complying
with the provisions of section
with the provisions of section
219 are monetary in that the
220 are penal and would entail
Directors would have to
committing an offence and
recompense the damage
thereby exposing oneself to a
suffered by Creditors in the
fine.
event of liquidation
Other remedies available while continuing
to trade

PART VIII - COMPROMISE PART IX – PART XIII - ADMINISTRATION

COURT APPROVED ARRANGEMENTS,
AND COMPROMISE
• in all these provisions, the majority of the class of person to
whom the provisions will apply, may by such majority
compel minority dissenting person to be bound by the
arrangement or compromise.
• For example, if the compromise is in respect of a particular
class of creditors (say: non-secured creditors) then if a
majority of such creditors agree to such a compromise, the
minority of such creditors although dissenting will be bound
by the compromise.
• The majority needed to successfully push through an
arrangement or compromise is specified by Court.
• These provisions necessarily involve a compromise – a give
and take. The creditors may have to agree for a restructuring
of the debt, a moratorium on repayment and interest waiver
etc. The Company may have to agree to fresh infusion of
equity, transfer of assets, sale and liquidation of assets and
provision of fresh security as collateral.
• There is no gain without pain!
 Arrangement

• Arrangement is defined widely in section 255 to include a re-

organisation of the share and stated capital of the Company.
• UK Insolvency Act - ‘Arrangement’ is stipulated as a
proposal that is a composition (that is the word they use in
the UK for our ‘Compromise’) in satisfaction of its debts or
a scheme of arrangement of its affairs.
• The IA Act also provides for the Directors to include in a
proposal for arrangement to obtain a moratorium for the
Company
 Compromise

• A ‘compromise’ is defined in section 247 of the Companies Act a

compromise between a company and its creditors, including a
compromise:

• (a) cancelling all or part of any debt of the company;

• (b) varying the rights of its creditors or the terms of a debt;
• (c) relating to an alteration of a company’s articles that affects the likelihood of
the company’s ability to pay a debt;
 • The Administrator can be appointed before attempting an
arrangement or compromise. The Administrator can, as a part
of his proposal propose a compromise or arrangement as
stipulated in the Act.
• Where the board of a company considers that:

• (a) the company is or is likely to become unable to pay its

debts as they fall due; and

• (b) the appointment of an administrator will be likely for:

Administrator • (a) the survival of the company and the whole or any
part of its undertaking as a viable concern;

• (b) the preparation and approval of a compromise

under Part IX or a compromise or arrangement under
Part X; or

• (c) a more advantageous realisation of the company’s

assets than would be likely on a winding up, the board
may resolve to appoint an administrator of a
company.
From and after the appointment of an administrator, until the end of the initial
period (defined in section 400):

(a) no resolution may be passed or order made for the liquidation of the company ;

(b) subject to 402(2), no steps can be taken to enforce any security over any
property of the company or to repossess any goods in the company’s use or
possession under any hire-purchase agreement, except with the consent of the
administrator or with the leave of the court and subject to such terms as the
court may impose;

(c) no other proceedings and no execution or other legal process may be

commenced or continued and no distress may be levied against the company
or its property, except with the consent of the administrator or with the leave of
the court and subject to such terms as the court may impose.

However, this does not stop any person from filing a Petition to wind up the
company.
 Obtaining the approval of
Court

• Compromises and arrangements.

• Notwithstanding the provisions of the Act or

the provisions contained in the articles of a
company, the court may on the application of
a company; an administrator; or (with the
leave of the court), any shareholder or
creditor of a company, order that an
arrangement or compromise shall be binding
on the company and on such other persons or
classes of persons as the court may specify.
Any such order may be made on such terms
and conditions as the court thinks fit.
• Before making such an order the court
may, make among others:
• an order that notice of the application to such persons or classes of
persons as the court may specify;

• an order directing the holding of a meeting or meetings of shareholders

or any class of shareholders or creditors or any class of creditors of a
company, to consider and if determined fit, to approve in such manner as
the court may specify, the proposed arrangement or compromise.

• The court may for that purpose determine the shareholders or creditors
that constitute a class of shareholders or creditors of a company;

• an order requiring that report on the proposed arrangement or

amalgamation or compromise be prepared for the court by a person
specified by the court, and

• if the court thinks fit, be supplied to the shareholders or any class of

shareholders or creditors or any class of creditors of a company or to any
other person who appears to the court to be interested;
 Modes of Winding Up a
Company -
Section 267.

The winding up of a company may

The Winding Up be either —
Process
(a) by the court;
(b) voluntary; or
(c) subject to the supervision of
the court.
 A company may be wound up by the court, if—

• (a) the company has by special resolution resolved that

the company be wound up by the court;

• (b) the company does not commence its business within a

year from its incorporation or suspends it business for one
Winding Up By year;

Court – • (c) if the number of the members falls below the

minimum number required under subsection (2) of
Section 270 section 4 of the Act;

• (d) the company has no directors;

• (e) the company is unable to pay its debts; or

• (f) the court is of opinion that it is just and equitable

• that the company should be wound up.
Insolvency due to non-honoring of a statutory demand
Section 271(a)

• If a Company fails and/or neglects to pay the sum demanded

by the Petitioner within three weeks of the demand the
Company is deemed to be insolvent.

• Therefore once the conditions stipulated in the said section

have been satisfied, by operation of law a company is
deemed to be unable to pay its debts and accordingly court
must order the winding up of the company.
 Disputed Debt

• In a winding up application made on the basis of failure to honour a

statutory demand it is an accepted defence in law that the debt is bona
fide disputed.

• there must be a bona fide dispute on substantial grounds over whether

the debt actually exists

• A debt disputed on genuine and substantial grounds cannot support a

winding up petition and an attempt to invoke the processes of the
Companies Court in relation to a debt which is known to be disputed on
genuine and substantial grounds is an abuse of the process of court,
the petition will be struck out if the petition has been presented
• The Companies Court must not be used as debt collecting agency, nor
as a means of bringing improper pressure to bear on a Company

• Courts must also be conscious that the winding-up of a company is a

drastic remedy which may have far-reaching consequences, financial,
and commercial and also consequences not only affecting the company
but also those concerned with it-
Tillakaratne J in Colombo Engineering Enterprises (Pvt) Ltd vs.
Hatton National Bank

• The expression ”neglects” to pay the sum demanded” is not the

equivalent of the word “omitted”. Neglect to pay a debt on demand is
omission to pay without cause. Omissions by itself is not reasonable
cause. When a debt is bona fide disputed by the debtor, there is no
neglect to pay
 319 (1). A company may be wound up voluntarily-

(a) when the period if any, fixed for the duration of the company by the
articles expires or the event if any, occurs on the occurrence of which the
articles provide that the company is to be dissolved, and the company at a
general meeting has passed a resolution requiring the company to be
wound up voluntarily;

Voluntary
Winding Up –
(b) where the company resolves by special resolution that the company
be wound up voluntarily;

Section 319 (c) where the company resolves by special resolution to the effect that it
cannot by reason of its liabilities continue its business and that it is
advisable to wind up.”

A voluntary winding up shall be deemed to commence at the time of the

passing of the resolution for voluntary winding up
• Shareholders Voluntary
winding Up – Sections 326
to 332

• Creditors Voluntary
Winding Up – Section 334
to 341
 351.

WINDING UP When a company has passed a resolution for

SUBJECT TO voluntary winding up, the court may make an order that
the
SUPERVISION voluntary winding up shall continue but subject to such
OF COURT supervision of the court, and with such liberty for
creditors,
contributories or others to apply to the court, and generally
on such terms and conditions as the court thinks just.
 • Section 374 in respect of fraud in anticipation of winding up
stipulates that:
•
• when a company is wound up, a person who is a past or present
officer of the company is deemed to have committed an offence
if,

• within the two years preceding the commencement of the

Other consequences of winding up,
continue to trade
• he has done the acts specified in the section which includes the
concealment of property or debt, fraudulent removal of
The malpractices -section company’s property.
374
• Section 374(2) however stipulates that it is a defence that a
person so charged to prove that he had no intent to defraud; to
prove that he had no intent to conceal the state of affairs of the
company or to defeat the law.

• A person who commits an offence under section 374(1) shall be

liable on conviction to a fine not exceeding one million rupees
or to imprisonment for a term not exceeding five years or to
both such fine and imprisonment.
 • Section 375 of the Act in respect of Fraudulent Trading specifies that

• where any business of a company that has been wound up has been
carried on with intent to defraud creditors of the company or
creditors of any other person or for any fraudulent purpose, every
person who was knowingly a party to the carrying on of the business
in that manner, shall be deemed to have committed an offence and
shall be liable on conviction to a fine not exceeding one million
rupees or to imprisonment for a term not exceeding five years or to
both such fine and imprisonment.
The malpractices
- section 375 • Subsection (2) provides that where in the course of the winding up of
a company it appears that any business of the company has been
carried on with intent to defraud creditors of the company or
creditors of any other person or for any fraudulent purpose, the
court may, declare that any persons who were knowingly parties to
the carrying on of the business in that manner, shall be: (a) liable to
make such contribution to the company’s assets; or (b) personally
responsible for such debts or other liabilities of the company, as the
court may think fit.
 • Section 376 stipulates that

• where in the course of the winding up of a company it

appears to the court that a person who has taken part
in the formation or promotion of the company or a
past or present director, manager, liquidator or
receiver of the company, has misapplied or retained
or become liable or accountable for money or
property of the company, or been guilty of
negligence, default or breach of duty or trust in
The malpractices relation to the company, the court may order that
person:
- section 376 • (a) to repay or restore the money or property or
any part of it with interest at a rate the court thinks
just; or
• (b) to contribute such sum to the assets of the
company by way of compensation as the court
thinks just; or
• (c) to pay or transfer the money or property or any
part of it with interest at a rate the court thinks just,
to the creditor.
 •275.

• In a winding up by the court, any disposition of the property

of the company, including things in action and any transfer
of shares or alteration in the status of the members of the
company made after the commencement of the winding up,
Assets, property shall unless the court otherwise orders, be void.

and shares of a •276.

company during • Where any company is being wound up by the court, subject
to the provisions of subsection (2) any attachment,
winding up sequestration, or execution put in force against the estate or
effects of the company after the time of the presentation of
the petition for the winding up, shall be voidto all intents.
 358. (1) A secured creditor may—

(a) seize, attach and realise, issue execution against or

appoint a receiver in respect of property subject to a
charge, if entitled to do so;

(b) value the property subject to the charge and claim

in the liquidation—
Rights of Secured (i) as a secured creditor for the amount of his claim,
Creditors up to the value of the security; and
(ii) as an unsecured creditor for the balance due, if
any; or

(c) surrender the charge to the liquidator for the general

benefit of creditors, and claim in the liquidation as
an unsecured creditor for the whole debt.
 • 365. (1) The liquidator shall pay out of the assets of the
company the expenses, fees, and claims set out in the Ninth
Preferential Schedule to the extent and in the order of priority specified
in that Schedule and that Schedule shall apply to the
payment of those expenses, fees, and claims according to its
Claims tenor.
 • The liquidator shall first pay, in the order of priority in
which
• they are listed:—

• (a) the fees and expenses properly incurred by the

liquidator
NINTH • and the remuneration of the liquidator;

SCHEDULE • (b) the reasonable costs of a person who applied to the

court
• for an order that the company be put into liquidation,
• (c) the actual out-of-pocket expenses necessarily
incurred by
• a liquidation committee.
 • After paying the claims referred to in paragraph 1, the
liquidator
• shall next pay the following claims :—

• (a) all provident fund dues, employees trust fund dues and
• gratuity payments due to any employee;
• (b) income tax charged or chargeable for one complete year
• prior to the commencement of the liquidation,

NINTH • (c) turnover tax charged or chargeable for one complete year
• prior to the commencement of the liquidation;
SCHEDULE • (d) value added tax charged or chargeable for four taxable
• periods prior to the commencement of the liquidation
• (e) all rates or taxes (other than income tax) due from the
• company
• (f) all dues to the Government as recurring payments for any
• services given or rendered periodically;
• (g) industrial court awards and other statutory dues payable
to
• any employee;
• (h) Employee related payments
Thank you