Inability to Pay Debt by the Company

In this case, the Supreme Court of India has added another dimension to the never ending debate over the misuse of Section 433(e) of the Companies Act which allows winding up of a company to be made if there is an ‘inability to pay debt’ by the company. There have been several instances where the jurisdiction of the Company Court has been abused by filing of winding up petitions to pressurize companies to pay debts which are substantially disputed and the Courts have been very casual in issuing notices and ordering publication in the newspapers which may attract adverse publicity. This judgement is a landmark judgement of the Supreme Court in which it has been held that it is the duty of the Company Courts to guard itself against such malicious and vexatious abuse of the winding up process.

Facts of the Case

IBA Health, appellant in the present case, a company based in India entered into a co-operation agreement on 18-2-2002 with a Malaysia based company, IDS, the respondent. In pursuance to the co-operation agreement, IDS introduced IBA to a company ‘S’ which was to provide IBA with assistance in the sale and supply of one of its products called Hospital Information Systems (HIS) software applications. For this service, it was agreed, that IBA will pay certain commission to IDS.

Subsequent to this agreement, dispute arose between the two companies regarding the payment of the commission. The two companies, hence, signed a ‘Deed of Settlement’ on 19-12-2003, and under the terms of this deed, IBA was required to pay a certain sum to IDS which was subject to receipt of payments of sufficient value from ‘S’ on or before cut -off date of 31-12-2006. In the contingency that such payments were not received before the cut-off date, it was decided that IBA will pay a proportion of the total value of all payments received by it to IDS.

Alleging breach of terms of the deed of settlement, the respondent filed a civil suit before the Civil Court to halt the acquisition of the appellant company by two other companies ‘I’ and ‘H’, pursuant to which both the parties entered into a compromise on 18-3-2006, agreeing that they would adhere to the original terms of the deed of settlement.

Soon thereafter, the respondent alleged that despite receiving periodical payments from ‘S’, IBA failed to pay any amount in terms of the settlement, even after receiving a notice to such effect by the respondent. IBA contended that it had not violated any of the terms and conditions of the settlement deed and in fact claimed that whatever amount it had received from ‘S’ had been paid over to IDS. It also claimed that it had received no other payments from ‘S’ till 31-12-2006 after it had made payment to respondent on 20-3-2006. The respondent issued a legal notice under Section 434 calling upon the appellant to pay the amount demanded. When the appellant denied any liability, the respondent filed a winding up petition under Sections 433(e) and (f), 434 and 439 of the Companies Act, 1956 against the appellant.

The Company Judge held that IDS had established a prima-facie case and ordered that the matter be re-listed for orders regarding advertisements to be published in the newspapers. The Judge concluded that the appellant had undertaken to make future payments to the respondent. Aggrieved by this order of the Company Judge, IBA approached the Division Bench of the Hon’ble High Court of Karnataka in appeal. However, the appeal was dismissed. Hence, the present appeal to the Supreme Court of India.

Issues before the Supreme Court

Whether the dispute regarding the liability to pay debt is substantial and bona fide?

Whether a creditor can prefer an application for winding up for discharge of a debt liability when there is a substantial dispute as to liability?

Whether the fact of commercial solvency, per se, is sufficient to reject the petition for winding up?

Whether the threat of winding up petition should be allowed as a means of enforcing the company to pay a bona fide disputed debt?

Decision of the Court

The Supreme Court, after perusing through the deed of settlement and the compromise came to the conclusion that there is a bona fide dispute with regard to the amount of claim made by the respondent company in the company petition and it is substantial in nature. It held that such a dispute can only be adjudicated after a detailed examination of evidence and also interpretation of various terms and conditions of the deed of settlement and the compromise entered into between the parties. The Company Court, while exercising its powers under Sections 433 and 434 of the Companies Act, 1956 would not be in a position to decide who was at fault in not complying with the terms and conditions of the two documents. The Supreme Court held that only the Civil Court is the appropriate forum for redressal of their grievances.

The Supreme Court held that in view of the facts and circumstances of the case, the order passed by the Company Court would definitely tarnish the image and reputation of the appellant company resulting in serious civil consequences. Hence the order of the Company Court and the judgement passed by the Division Bench of the High Court of Karnataka were set aside and the appeal was allowed.

Comments of the Author

The author believes that the decision of the Supreme Court in the present case is just and in favour of public policy. The Court has deliberated the issues before it in detail and has come to a conclusive assessment which is explained below.

The Court held that a dispute would be substantial and bona fide if it is not spurious, speculative, illusory or misconceived. It is an established point of law that if the creditor’s debt is bona fide disputed on substantial grounds, the court should dismiss the petition and leave the creditor to first establish his claim in an action, lest there is danger of abuse of winding up procedure.

If the Company Court is satisfied that the debt upon which a petition for winding up is founded is a hotly contested debt and also doubtful, it should not entertain such a petition. However, before coming to such a conclusion, it is expected to go into the causes of refusal by a company to pay and also to ascertain that the company’s refusal is supported by a reasonable cause or a bona fide dispute, however, such dispute can only be adjudicated by a trial or a civil court.

If there is a dispute about the debt, the Court has to consider all the facts placed before it, and arrive at a decision whether the dispute is genuine and has been raised bona fide. If the Court arrives at a conclusion that the disputes have been raised only for avoiding payments or for covering its inability to pay or raising a controversy on flimsy grounds, then the Court can reject the company’s contentions.

Where there was a complicated dispute between parties which involved a detailed analysis of the financial liability, if any, of the company, a petition to wind up the company was held to be not proper. [2]

In the present case, the Supreme Court held that there was, in fact, a bona fide dispute regarding the liability to pay debt and hence there would be a need for detailed investigation, recording of evidence and adjudication of the rights and liabilities of third party entities. This would fall beyond the scope of enquiry to be conducted by the Company Court under Sections 433, 434 and 439 of the Companies Act, 1956, and that the only option left for the respondent will be to approach the Civil Court for adjudication of its claims.

The Court referred to the judgment in Amalgamated Commercial Traders (P.) Ltd. V A.C.K. Krishnaswami [3] in which it was held that if the Court is satisfied with the company’s defence, a winding up order will not be made.

It is well settled law that a winding up petition is not a legitimate means of seeking to enforce payment of the debt which is bona fide disputed by the company. A petition presented ostensibly for a winding up order but really to exercise pressure will be dismissed, and under circumstances may be stigmatized as a scandalous abuse of the court. [4]

In Madhusadan Gordhandas & Co. v Madhu Woollen Industries Pvt. Ltd [5] ., it was held that the petition will be rejected and the parties relegated to a Civil Court once the Court is satisfied that the defence is bona fide. The Company Court follows a summary procedure and will not investigate facts and evidence in depth. The case had to be finally adjudicated upon the merits before the appropriate forum which is the Civil Court.

Hence, the final principle laid down in these cases is that if the debt is bona fide disputed, there cannot be ‘neglect to pay’ within the meaning of Section 433(1)(a) of the Companies Act. And if there is no neglect then the deeming provision does not come into play and the winding up on the ground that the company is not able to pay its debts is not substantiated.

In the question that whether the claim by the appellant that it is commercially solvent is enough to reject the petition for winding up, the Court held that an examination of the company’s solvency may be a useful aid in determining whether the refusal to pay debt is a result of a bona fide dispute as to the liability or whether it reflects an inability to pay. However, if there is no dispute as to the company’s liability, then the debt has to be paid. It was reiterated that commercial solvency can be seen as relevant as to whether there was a dispute as to debt, and not as a ground in itself.

The court held that there has been an attempt by the respondent company to force the payment of debt which it knows to be in substantial dispute. A petition with the Company Court cannot be used a means of putting improper pressure on a company to pay a bona fide disputed debt. A creditor’s winding up petition implies insolvency and is likely to damage the company’s creditworthiness and its financial standing with its creditors or customers and even among the public. It may also have other economic and social ramifications. Keeping in view all these points, the Supreme Court observed in the obiter that the Company Courts should be more vigilant lest its medium should be misused. It should act with circumspection, care and caution and examine as to whether an attempt is made to pressurize the company to pay debt which is substantially disputed.

The author concurs with the finding of the Supreme Court and believes that the decision given was fair and equitable. A winding up petition should not be used against a company to put undue and improper pressure to pay a bona fide disputed debt. The Company Court cannot function as a Debt Collecting Agency and should be guarded from such vexatious and malicious abuse of the process. In the instant case, the Company Court was very casual in its approach and did not make any endeavour to ascertain as to whether the company sought to be wound up for non-payment of debt had a defence which was substantial in nature and if not adjudicated in a proper forum, would cause serious prejudice to the company.

Select Bibliography:

Books:

Ramaiyya: The Companies Act, 1956

Cases:

Amalgamated Commercial Traders (P.) Ltd. V A.C.K. Krishnaswami (1965) 35 Com Cases 456 (SC)

Madhusadan Gordhandas & Co. v Madhu Woollen Industries Pvt. Ltd. (1971) 3 SCC 632