In its recent judgment in BNP Paribas v UB Holdings, a Division Bench of the Karnataka High Court has considered an important question of insolvency law. The case has been widely reported in the press, of course, for it set aside a sale of shares to Diageo and made some observations about parallel transactions. But it is important to note that all of the High Court’s comments on the merits of the sale are obiter because it concluded that the application under section 536(2) of the Companies Act, 1956, was not maintainable.
The background to the case is well-known but it is convenient to briefly recapitulate. In its capacity as the ultimate parent of Kingfisher Airlines Ltd, UB Holdings had given corporate guarantees to a large number of companies with respect to contractual payments due to them from Kingfisher for the sale of aircraft, maintenance and other transactions related to the airline’s operation. Between 2010 and 2011, as Kingfisher did not pay, these guarantees were invoked. When UB Holdings did not pay either, the creditors filed several winding-up petitions in the Karnataka High Court. These petitions were filed between March and November 2012. UB Holdings entered appearance through counsel and began arguments opposing the admission of the winding-up petitions. In April 2013, that is, before arguments on the admission of the Petitions had concluded, UB Holdings filed an application under section 536(2) of the 1956 Act for leave to sell about 13 lakh equity shares of a subsidiary, United Spirits Ltd [“USL”], to Diageo plc at a price of Rs. 1440 per share. This was in pursuance of a share sale agreement dated 09.11.2012, that is, after some of the winding-up petitions had been presented in the High Court. The Company judge granted this application on certain terms. The creditors challenged that order before the Division Bench and two issues arose: first, whether an application under section 536(2) maintainable before a winding-up petition is passed, and secondly, if it was, whether the Company judge erred in concluding that it was appropriate to give leave for this sale.
Section 536(2) reads as follows:
In the case of a winding up by or subject to the supervision of the Court, any disposition of the property (including actionable claims) of the company, and any transfer of shares in the company or alteration in the status of its members, made after the commencement of the winding up, shall, unless the Court otherwise orders, be void.
This provision is of considerable vintage and has given rise to a large body of case law in common law jurisdictions. It is ultimately traceable to section 153 of the English Companies Act, 1862, and its immediate predecessor is found in section 227 of the English Companies Act, 1948, which, of course, became section 127 of the English Insolvency Act, 1986. The legislative history was considered at great length by the Court of Appeal in the well-known case of Hollicourt (Contracts) Ltd v Bank of Ireland and its object was explained by Lord Cairns LC in one of the earliest cases on the subject, Re Wiltshire Iron Co (1868) LR 3 Ch App 443 in these terms:
…[the section is] a wholesome and necessary provision, to prevent, during the period which must elapse before a Petition can be heard, the improper alienation and dissipation of the property of a company in extremis.
Of the many controversies it has spawned, perhaps the most well-known is the liability in restitution of banks which pay out money (especially on an overdraft, on which the Australian and English courts used to differ). Another is a jurisdictional question and it is this that the Karnataka High Court considered: at what stage does the court acquire jurisdiction to grant the leave that section 536 contemplates a proposed disposition requires? Several cases, including one of a Full Bench of the Rajasthan High Court (cited by Kumar J), hold that the court may grant leave even before an order of winding-up is made. But Kumar J held, after referring to section 443(2), that although the court can grant leave before the order is made, it cannot do so before the petition for winding up is admitted:
72. Before admission of the petition, the question of entertaining the application filed by the Respondent and passing an interim order in favour of the Company would not arise. Only if the Company Petition is admitted, then an occasion for entertaining any such application may arise for consideration. Therefore, even before admission he cannot take advantage of a pendency of a petition and seek [sic] order from the Court under section 536(2) to validate a sale which he intends effecting after the presentation of the petition. If the respondent is confident that the petition presented is frivolous, it has no merit, he has to contest the petition and get it dismissed, even before it is admitted, if notice is given to him before the admission of the petition.
With respect, it is not clear, if the Court was content to follow the case law that the jurisdiction exists before the order of winding-up is made, why it does not exist after the winding-up petition is presented but before it is admitted. No doubt it is conceivable to apply such a rule but it is not obvious that the language of section 536(2) or indeed the provisions of the Companies (Court) Rules to which Kumar J refers contemplates such a result. This is a point of law that is likely to require further consideration, perhaps even in this case, should it travel to the Supreme Court. But Kumar J, it is submitted correctly, rejected the proposition that the court can invoke its inherent power under Rule 9 to grant leave should it lack statutory jurisdiction: clearly, as the learned judge points out, inherent power cannot be exercised in contravention of statute. Kumar J also expressed the concern that exercising jurisdiction prior to admission may make it difficult to stop collusive petitions since creditors are not, at that stage, heard by the court but, with respect, it is submitted that the possibility of collusion cannot alter the meaning of statutory provisions: the possibility exists across the spectrum of civil litigation and the courts deal with it on its own terms.
The Court also made some important observations on the merits, which it proceeded to consider although it decided in favour of the creditors on the jurisdiction point. The Court rightly notes, at , that “any bona fide transaction carried out and completed in the ordinary course of business will be sanctioned by the court under section 536(2)”. However, it is respectfully submitted that its observation at  is not correct:
The expression ‘unless the court otherwise orders’ casts a duty on the judge requiring that each case must be dealt with on its own facts and particular circumstances, special regard being had to the question of good faith and honest intention of the persons concerned and that the court is free to act according to the judge’s opinion of what would be just and fair in each case.
Obviously, no one suggests that the court must permit an unjust or unfair disposition; but it is important not to replace the principles found in the large body of case law in this area (or for that matter in any other) with a case-by-case appeal to ‘commonsense’ or ‘justice’. The cases on the point is, it is submitted, are an accumulated body of ‘justice and fairness’ as to when a court normally grants leave and when it does not, and those factors should be followed unless there is good reason not to. Indeed, it may be that this is what the Court meant since it subsequently observes () that the power under section 536(2) is controlled by ‘general principles which apply to every kind of judicial discretion’.
Applying these principles, the Division Bench found that it would in any event have refused leave to transfer the shares for a number of reasons that collectively demonstrated that it was not a bona fide transaction. Perhaps the most important of these for subsequent cases is the finding that the sale price of Rs. 1440 per share did not necessarily represent market value even though the share price was lower on the day the contract was concluded. The Court thought it significant that the shares might (in conjunction with other transactions) allow Diageo to acquire a controlling interest and that there was ‘no valuation by an approved valuer’ prior to contract.