Saturday, October 9, 2010

The Supreme Court on the scope of winding-up jurisdiction

It is well-known that one of the grounds for winding up a company under Indian company law is its inability to pay “debts”. S. 433(e) explicitly provides that a company may be wound up by the company court if it is “unable to pay its debts” and s. 434(1)(a) lists three circumstances where a company is deemed to be unable to pay its debts. “Debt” has been construed widely in Indian law, and controversy has arisen recently over the precise scope of the winding-up provision. While the Supreme Court addressed part of this in 2008 in Vijay Industries v. NATL Technologies, it had occasion to consider the law in more detail late last month, in IBA Health v. Info-Drive Systems (CA No. 8230/2010).

IBA Health Systems Ltd. [“IBA”], an Indian company, had developed, inter alia, Hospital Information Software [“HIS-I”]. In 2002, it entered into a Cooperation Agreement with Info-Drive Systems [“IDS”], a Malaysian company, pursuant to which IDS introduced IBA to a third company and facilitated the sale of the HIS-I software to that company. For this service, IBA agreed to pay IDS a commission. Subsequently, disputes arose between the parties on the payment of commission, and they entered into a “Deed of Settlement” in 2003. To further complicate the matter, IBA (it was known as Medicom previously) was to be taken over, which IDS sought to prevent by filing a civil suit in the jurisdictional court in Bangalore. In 2006, the parties filed a compromise petition, reiterating that their relationship would be governed by the terms of the Deed of Settlement. In essence, the Deed of Settlement provided that IBA would pay IDS a specified percentage of certain types of payments it received from its customer, and IDS in turn acknowledged that IBA had paid all its dues to date, and undertook not to make any other claim in respect of the HIS-I transaction.

However, a year later, IDS demanded from IBA its share of a payment it alleged IBA had received from its customer. IBA disputed both the existence of any such receipt and its liability to IDS. At this point, IDS issued notice under s. 434 of the Companies Act, and filed a company petition seeking a winding-up order. The Company Court, over IBA’s objections, admitted the petition, found that IDS had established a prima facie case and indicated that it would pass orders in relation to the customary advertisement to be published. Naturally, this would have caused IBA substantial detriment, both commercially and more generally, and it challenged the order of the Company Judge.

Kapadia C.J. begins his analysis by noting that the Company Court is not required in a winding-up proceeding to examine complex issues of law and fact, or resolve serious disputes between parties, and relied in support on prior decisions of the Court in Amalgamated Commercial Traders, Mediquip Systems etc. As a result, the Supreme Court held that a Company Court cannot proceed with a winding-up petition if the respondent raises a “substantial” or “bona fide” dispute as to the existence of the debt. The following observations are pertinent:

A dispute would be substantial and genuine if it is bona fide and not spurious, speculative, illusory or misconceived. The Company Court, at that stage, is not expected to hold a full trial of the matter. It must decide whether the grounds appear to be substantial. The grounds of dispute, of course, must not consist of some ingenious mask invented to deprive a creditor of a just and honest entitlement and must not be a mere wrangle. It is settled law that if the creditor's debt is bona fide disputed on substantial grounds, the court should dismiss the petition and leave the creditor first to establish his claim in an action, lest there is danger of abuse of winding up procedure. The Company Court always retains the discretion, but a party to a dispute should not be allowed to use the threat of winding up petition as a means of forcing the company to pay a bona fide disputed debt.

Although the Court subsequently uses other expressions to indicate the threshold a company court must use to dismiss a winding-up petition (“hotly contested debt”, “also doubtful” etc.), it seems clear from the above observations and from the context of the judgment that the standard is one of “reasonable” or “bona fide” defence – a standard that appears to be higher than a prima facie case but lower than the standard required to succeed (or resist) in civil court.

The case is also authority for one other interesting proposition. It was argued by IBA that the winding-up petition should be dismissed notwithstanding the court’s finding on the extent of the dispute, because IBA was “commercially solvent” and “able to pay its debts”. The Court rejected this contention, holding that the solvency of a company cannot stand in the way of a winding-up petition if the company does indeed owe an unpaid debt to the creditor. At first sight, this does seem surprising, for s. 433(e) refers to a company that is unable to pay its debts. However, it is submitted that the Court is correct, since s. 434(1)(a) provides that a company shall be deemed to be unable to pay its debts if it has “neglected to pay” a certain sum for three weeks after notice is duly served on it. S. 434(1)(a) refers, therefore, merely to the factum of non-payment. It may be suggested that s. 433(e) is not exhausted by the circumstances enumerated in s. 434(1)(a), and that a company can demonstrate its ability to satisfy debts. The Court, however, addresses this point by noting that “the company of course will have an opportunity on the liquidation application to rebut that presumption.” In addition, commercial solvency is also relevant to determine whether there is a serious dispute between the parties over the existence of liability.

The Court concludes by pointing out that the Company Court cannot be “maliciously” used as a “debt collecting agency”, and that “an action may lie in appropriate Court in respect of the injury to reputation caused by maliciously and unreasonably commencing liquidation proceedings against a company and later dismissed when a proper defence is made out on substantial grounds.” This judgment may ensure that a winding-up petition is scrutinised more carefully before it is admitted.


Renganath said...

I haven't read the whole judgement, but from your excerpt "reasonable" doesn't seem to have been used by the court; the court seems to stick to "substantial" and "genuine". I would think `substantial' refers to the intensity or complexity of the claim, while `genuine' though linked to the dispute may be a transferred epithet in the sense that it actually refers to the conduct or attitude of the respondent i.e. the respondent should not have conjured up the dispute for the sake of a defence in the winding-up petition - thus, a defence though complex may not merit recognition if it seems to the court that it has be built by the respondent merely to wriggle out. Of course, am not sure if the court intended this 2-tier formulation considering that it equates "substantial and genuine" simply to "bonafide". As regards "reasonableness", considering that there is too much jurisprudential baggage riding on it, I'd be circumspect in using it where the court has not; further, "substantial" seems to me to be higher than "reasonable".

V. Niranjan said...

Thanks for your comments. You are right - "reasonable" and "substantial" are not the same thing, if the court has not used those terms synonymously. The Court did use the term "reasonable" though, although not in the extract I set out in the post. The relevant observations are in paragraph 24, where the court held that the company court is required to ascertain whether the company's refusal is "supported by a reasonable cause".

You are right about "bona fide" - in fact, the court uses that term as well in paragraph 24. As to "genuine", you are right that it refers primarily to the conduct of the defendant. The only point I would add to what you said is that one would expect "genuine" to (normally) follow from establishing that the dispute is "substantial", because it cannot be that a serious, complex dispute that needs civil court adjudication is not "genuine". As you say, it may be that the defence is used merely to "wriggle out" but if that appears to be a complex claim, it will normally be relegated to civil courts.

tenzein said...

i have a question to pose against the background of this judgment.Under section 433(e) one of the grounds for a creditor to ask for winding up of a company is its inability to pay its debts. There are many cases which state that winding up is not the legitimate means to enforce payment of debt. More specifically in the context of contractual debts, courts have held that a petition for winding up cannot be maintained since damages crystallize only upon adjudication. So, is there anything concrete on this matter? Whether liquidated damages under a contractual obligation can be claimed as "debt" under section 433(e)?

tenzein said...

Does the scope of winding up jurisdiction extend to debts arising out of contractual claims? A lot of cases have stated that winding up shall not be adopted as a recourse to recovery of debt and further that damages only crystallize upon adjudication, so prior to this, it just remains a claim for damages which the court cannot be expected to look into in cases of winding up. So, can liquidated damages, arising out of breach of contract, be claimed as debt under section 433(e)?

PV said...

The Judgment is of Justice Radhakrishnan not the CJI