Discretion of Court to liquidate companies

An order of winding up is a death sentence against a company that perpetually terminates its artificial personality created by legislation. Winding up is the last resort where no other efficacious remedy can reasonably meet the circumstances. The court on ‘just and equitable grounds’ in the exercise of ‘wide and wise’ discretionary power may pass an order of winding up under section 241(vi) of the Companies Act, 1994.

There is no precise definition or inflexible formula of the principle of the 'just or equitable' clause. Whether or not there are equitable considerations for the application of the principle must necessarily depend upon the facts and circumstances of each case and the judicial discretion of the court. [(1981) 1 BLD (AD) 435]. An exhaustive list of ‘just and equitable grounds’ is not practicable but in cases of the disappearance of substratum, total deadlock in management, fraud or illegality of objects, or extreme loss of confidence a company may be wound up. Particularly, there must be solid grounds for exercising discretion and the reasons of winding up relied on must exist at the date of hearing of the petition.

Loss of substratum of a company implies the disappearance of its basic foundation, i.e. failure to achieve or carry out the basic objectives for which the company is formed. For instance, a company was formed to acquire the aircraft business of a certain person. But the owner subsequently refused to carry out the contract. Hence, the company may be wound up because its substratum had gone. Similarly, a company was incorporated for manufacturing coffee under a patent that was to be granted by the Government. The German patent was never granted and the company embarked upon other patents. A member submitted an application for winding up and the court held that the substratum of the company had failed, and it was impossible to carry out the objects for which it was formed; and, therefore, it was just and equitable that the company should be wound up. [(1882) 20 Ch D 169]

The substratum of a company will be deemed to be disappeared when (a) the subject matter of the company has gone, or (b) the object for which it was incorporated has substantially failed; or (c) it is impossible to carry on business of the company except at a loss, that it, there is no reasonable hope of trading at a profit; or (d) the existing or probable assets are insufficient to meet the liabilities. [(1951) 31 Com Cases 461] If the object clause of a company authorizes to carry on many activities but the company carries on business according to only one of those objects, the stoppage of that business may amount to a failure of substratum of the company. The plea that the company could carry on another business in the future will not prevent the winding up . [(1983) 53 Com Cases 73 (AP)]. But where the company sells its only estate with the object of investing the proceeds in a more profitable venture, it will not be considered a loss of substratum.

Where there was a complete failure of the object for which the company was established, heavy loans required repayment, a considerable carry forward of losses, the machinery which was purchased out of the loans could not be put to any use and there was no possibility in sight of any smooth and efficient functioning of the company on commercial lines, the court had no choice but to order winding up. [(1993) 76 Com Cases 38 (Mad)] But a temporary difficulty or crisis which does not strike the company’s bottom may not be a ground for liquidation. Delay in commencing a business does not amount to of loss of substratum. The real question is whether the main or dominant object has become impossible or there is no reasonable probability of the company being able to carry out the main or dominant object.

Winding up may also be ordered in case of a total deadlock in the management. Deadlock implies a 'situation in which agreement in an argument cannot be reached because neither side will change its demands or accept any of the demands of the other side’. It may usually be caused due to high-handed attitude of some directors, oppression, misappropriation, misutilization of funds and assets, and loss of mutual confidence among the members/directors of the company. Mutual confidence is the essence of the sound functioning of any company. Loss of confidence in some cases may cause the disappearance of substratum. Deadlock may also be created if the members of the company become equally divided into two rival groups. In a joint venture company, the board of directors had stopped meeting. Its capital was inadequate. Its foreign collaborator had declined any further investments. Losses were accumulating. Sales showed a declining curve. Neither shareholder was interested in buying out the other. Considering the stated deadlock, the court ordered winding up. [(2004) 58 CLA 273].

A company of sound financial strength may also suffer winding up due to total deadlock. In a case decided by the Chancery Division, the ownership of six companies was divided between two corporators and their respective interest. Trust and confidence had broken down, the companies were deadlocked. One side had presented administration order petitions and issued motions for the appointment of a receiver, and the other petition for winding up. The court held that the only solution was winding up. [(1988) 4 BCC 684]. A ground that the substratum of the company had gone or that it is impossible to run the company for want of mutual confidence or lack of confidence between the Directors, just and the equitable rule would be attracted but that of lack of confidence must be relatable to the conduct and management, related to the affairs of the Company. [42 DLR (1990) 302]

Where there is a deadlock in the affairs of the company and there is no hope or possibility of running the company smoothly and efficiently the court may wind up the same on an application under section 241 read with section 245 of the Companies Act, 1994 to meet up justice and equity. [(2004) 34 BLD (HCD) 541].

It should be noted that mere existence of a dispute among members or directors is not sufficient for liquidation of a company unless the dispute causes total deadlock or disappearance of the substratum of the company. Winding up is always a remedy of last resort which may be invoked only after exhausting all other available remedies. Liquidation must not merely be just and equitable to the petitioner but also to the company as well as to its shareholders.

Just and equitable rule may also be invoked in case of liquidation of ‘bubble’ companies i.e. companies formed fraudulently and short-lived. The promoters/directors of such ‘fly-by-night’ companies never possess any real intent to carry on business in a proper manner. [(1924) A.C. 783 PC]. The hidden goal of such companies is to earn unlawful gains by means of fraud.

A remarkable observation was made by the Bombay High Court regarding the application of ‘just and equitable’ rule in public interest. It was observed that the court will have to take into consideration not only the interest of shareholders and creditors but also the public interest in the shape of the needs of the community and the interest of the employees. [(1972) 42 Comp Cases 190 (Bom)]. From the perspective of public interest, the facts of Walter L. Jacob & Co. Ltd. are equally important. The company was incorporated in UK in 1984 and it had misled members of the public, by giving them an impression that it was an adviser giving impartial advice, into buying shares of American companies which were of doubtful value and which could not be freely traded. In fact, the company (i.e. Walter L. Jacob & Co. Ltd.) itself was the vendor of the shares, and the real facts were kept secret. It was detected that the company did not adequately maintain records. Under the aforesaid circumstances, on an application by the Secretary of State, the appellate court passed an order of winding up in public interest. [(1989) 5 BCC 244]

Section 25 of the Companies Act, 1994 provides that the issuance of a certificate of incorporation shall be treated as conclusive evidence that all requirements of the law in respect of registration have been complied with. But it is not unusual that some companies are formed with completely unlawful motives like for commission of white-collar crimes, unlawful use of intellectual properties or name of other institution, fraudulent promise of overseas employment, etc. The time has come to consider the ‘just and equitable’ rule for liquidation of these companies. Winding up is the last resort but such activities for sake of public interest should not be permitted to continue.

The companies formed with fraudulent motives may cause severe adverse impacts on society and trigger social as well as economic imbalances. Fraudulent motives once revealed behind the formation of a company should not be considered leniently. The scope and principle of ‘just and equitable’ clause are wide enough to meet the demands of time which may be judiciously used by the court as an efficient weapon to shut down any company incorporated to perpetrate fraud.

The writer is an advocate of the Supreme Court of Bangladesh and Head of Chambers, Corporate Legal Solutions. He can be contacted at nikhan.law.ru@gmail.com