Inability to settle debts and accountability of companies

Md. Nazrul Islam Khan
03 Feb 2022 00:00:00 | Update: 03 Feb 2022 02:05:21

A company may face winding up for various reasons although the most common reason is the company’s inability to pay its debt to creditors. If the inability is an outcome of intentional or fraudulent acts of its operators the court may justifiably lift the corporate veil to bring the real actors to book.

A company may be wound up by the court if the company is unable to pay its debt. The basic tests of inability to pay debt are the cash flow test and balance sheet test. Under the cash flow, or commercial insolvency test, a company is insolvent when it is unable to pay its debts as they fall due. For this purpose, the fact that its assets exceed its liabilities is irrelevant; if it cannot pay its way in the conduct of its business it is insolvent, for there is no reason why creditors should be expected to wait while the company realises assets, some of which may not be held in readily liquidated form. The court does not examine whether, if the company converts all its assets into cash, it would be able to discharge its liabilities, but would examine whether, in commercial sense, the company is insolvent and whether it is unable to meet its current demands.

The balance sheet test, on the other hand, signifies that the company’s assets are insufficient to clear its liabilities. It is difficult to decide on a balance sheet test because valuation of assets is not an exact science, but to a considerable extent a matter of judgment as to the amount a willing buyer would pay in the market when dealing with a willing seller.

In a narrow sense ‘debt’ means an amount existing and immediately payable. In a broad sense, it denotes “debitum in praesenti, solvendum” in future i.e., an amount payable in future by reason of a present obligation. Ordinarily, a debt payable in the future, contingent and prospective liabilities are not taken into account in considering a winding-up petition. But section 242(1)(iii) provides that “if it is proved to the satisfaction of the court that the company is unable to pay its debt, the court shall take into account the contingent and prospective liabilities of the company”. Therefore, although debts payable in the future and contingent debts have to be excluded in determining whether, at the date of the hearing, the company is able to discharge debts then due and payable, the court also has to consider whether, in relation to debts which will become due and payable in the reasonably near future, the company will be able to pay those debts at the time when payment has to be made.

It will be sufficient if the company can arrange necessary ready cash by borrowing or disposing of assets. So, even if payment cannot be made on the exact date due, it suffices that it can be made within the period that a creditor would consider acceptable, for which purpose the court will have regard to any indulgence customarily granted by that creditor.

Debt should be undisputed. It may be acknowledged by the Managing Director, accountant, and concerned person of the company who usually confirms accounts on its behalf. The date of acknowledgment should be within the period of limitation. Any acknowledgment beyond the period of limitation cannot extend the period of limitation.

Any substantially disputed claim which cannot be decided without oral evidence must not be a ground of winding up petition. The dispute should be bona fide. A mere honest belief by the debtor that it was not liable would not be sufficient if there was no substantial ground of defence. If there is a bona fide dispute on substantial grounds the presentation of a petition is an abuse of the process of the court. When a petition is improperly presented at the hearing another creditor whose claim is not in doubt may apply to be added or substituted as the petitioning creditor that may cause serious prejudice to the company.

After the presentation of the winding-up petition, a solvent debtor can pay the debt before the hearing. Where the company paid off the admitted debt with interest after filing the petition, the court said that it was no longer a case of inability to pay debts and, therefore, the company was not to be wound up. In another case, the company admitted liability in its correspondence, but payment was not being made. Though the balance sheet was showing profits, the court said, it was not sufficient to show that the company was viable. Winding up was ordered. Hence, the presentation of a winding-up petition is a perfectly legitimate debt collection device; it is not an objection that the creditor's motive is to obtain payment of the debt rather than a winding-up order.

Harman J observed: “…it is trite law that the Companies Court is not, and should not be used as (despite the methods in fact often adopted) a debt-collecting court. The proper remedy for debt collecting is an execution upon a judgment, a distress, a garnishee order, or some such procedure.” It does not signify that a creditor having undisputed and admitted claim shall be barred to file a winding-up petition to create pressure as well as to recover money. Very often a petition presented in order to bring pressure on a company to pay a debt which is indisputably due is perfectly proper.

In arbitration winding up order cannot be passed by arbitrators and as such existence of an arbitration clause in an agreement does not create a bar to the jurisdiction of the Company Court for winding up a company when the company is deemed to be unable to pay its debts.

“A winding-up petition is not simply a means of enforcing a debt rather it is also designed to protect the debtor company from harassment and other creditors from piecemeal realisation and unequal distribution.” It is a death sentence of a juristic person which may be granted at the discretion of the court.

The inability of a company to pay its debt may cause serious prejudices to its creditors. If the inability is an outcome of fraudulent acts of its directors or promoters then the court can make them accountable. Section 331 of the Companies Act, 1994 empowers the court to make directors or promoters of a company accountable for a breach of trust or for any amount misapplied or retained by them. The court may pass order to repay or restore the money as the court thinks fit.

It is a reasonable presumption that the directors always discharge functions for the benefits of the company and as such in order to make the directors personally liable it must be shown that they had dishonestly acted and thereby the company incurred loss. Bona fide business decisions of directors should not be condemned. Nominee directors can also be liable for the roles played in the conduct of affairs. They are also subject to usual procedure for trial on merit for finding out whether as directors they performed their statutory duties in good faith.

Directors owe fiduciary duties to the company which demands loyalty and care. They must not exploit for themselves any business opportunity which is available or offered to the company. In many cases infringement of fiduciary duties by directors causes acute crisis in the management of the company which leads to financial constraints. Infringement of fiduciary duties by directors in many cases is the root cause behind the company’s inability to pay the debt. Such inability may miserably affect survival of the company and makes the directors personally liable for the consequences.

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