Most lawyers engaged in the corporate sector would be familiar with this scenario; a disgruntled client, pontificates that a limited company owes them money, either through breach of a contract or reneging on their obligations on financial facilities or loans availed. The client shall inform you that all efforts to contact the directors of the company have been in vain, their repeated notices for repayment have been ignored and that the only recourse that appears to be available is filing a suit to recover the debt.
If your client is commercially battle hardened in such matters, he may balk at the thought of filing such a suit before the Civil/Banking Court (depending upon who your client is), which as the cliché goes, takes years to decide. Alternatively he may instruct you to file a petition for winding up of the debtor Company (hereinafter referred to as the “Company”) before the High Court, as an efficient and quicker way of recovering the debt. Alternatively, he may think that such a Petition may be a masterstroke as it may pressurize the Company into paying the debt just to avoid a loss of reputation in commercial circles, which follows as a necessary consequence. This is where a lawyer needs to be especially cognizant of the law pertaining to windings up, as well as an appreciation of when a Court deems that a company is unable to pay its debts and to risk suffering the ignominy of having his/her petition dismissed at the dreaded pre-admission stage or in limine.
The laws pertaining to winding up of limited Companies in Pakistan is enshrined under Section 305 and 306 of the Companies Ordinance 1984 (hereinafter referred to as the “Ordinance”). Section 305 envisages the circumstances where a Court may wind up companies, the Court being the High Court acting in its Company jurisdiction (the “Court”)[1]. A winding up may be voluntary, such as when 3/4th of the shareholders, present in an extraordinary general meeting of a company, decide to wind up the company or when the Court deems that that the company is carrying on unlawful or fraudulent activities or carrying on any business which is either not authorized by its memorandum or oppressive to its shareholders[2].
Section 306 of the Ordinance is the subject of this piece. It provides, inter-alia that if a Company is indebted to a creditor to a sum of Rs. 50,000 or one percent of its paid up capital and it is proven to the Court that the company is unable is unable to pay its debts, the Court may order winding up of the Company. The Petition is preceded by a formal notice through registered post under Section 306(a) of the Ordinance, requiring the Company to pay its debts within thirty days of receipt thereof, failing which, a petition for winding up against the company would be initiated.
The above is all well and good till the actual Petition is filed in the Court itself. Generally, the Court shall try to ascertain whether the Petition is indeed meritorious or is merely filed to pressurize the debtor Company into payment of its debts. The seminal case in this matter of is M/s Platinum Insurance Company Limited vs. Daewoo Corporation [PLD 1999 SC 1] where the Supreme Court, inter-alia laid down the principles on the basis of under which a company may be deemed unable to pay its debts, (whilst examining a body of judicial precedents from the jurisdictions of Pakistan, India and the United Kingdom). The principles encapsulated from the Platinum Insurance judgment are summarized as follows, which are not exhaustive by any means:
(i) The disputed amount has to be genuine and acknowledged by the debtor Company, not encumbered or challenged through counter claims, which may threaten the veracity of such a dispute.
(ii) There is a distinction between a company “ merely unwilling to pay its debts” from a company that is genuinely insolvent. If it is the former, then a remedy is a suit for recovery and not a petition for winding up.
(iii) In order to determine commercial insolvency, the balance sheet of the company must demonstrate continuous losses each year. A company may also be insolvent if the only way to recoup its losses would be to sell off its existing assets when its normal course of business ceases generating revenue; and
(iv) The fact that a creditor has an alternative remedy under law does not debar or preclude him from filing a winding up petition, subject to all other conditions being satisfied.
As gleaned from the above, at the very outset, a Petition for winding up must palpably demonstrate that the debt is acknowledged without any counter or contingent claims. Usually in banking suits initiated under the Financial Institutions, (Recovery of Finance) Ordinance, 2001, a debtor company will dispute the factum of the claim and may challenge statement of accounts prepared by banks on various grounds including interest on interest, delayed payment charges, liquidated damages etc. Similarly, in a contractual arrangement, a claim against the debtor may be factually thwarted by a separate counter-claim brought against the creditor. Any similar challenges may signal the death knell for any such Petitions initiated as they may render the debt disputed and uncertain. However, it is instructive to note that a simple denial of the debt shall not suffice. The onus shall be on the debtor company to factually provide details that the debt is indeed disputed[3].
One of the first questions that are posed by the Court at the pre-admission stage is whether the company is genuinely insolvent or merely unwilling to pay its debts. If it is the latter, then usually short shrift is given to such petitions, coupled with a liberal dose of judicial criticism levied at the hapless advocate who has not factually demonstrated the commercial insolvency of the company. In such scenarios the Court may dismiss the Petition and instruct the suitably chastened advocate to file a recovery suit against the Company and desist in wasting the Court’s time. This is symptomatic of the general principle that Courts, as a rule, are unwilling to wind up companies simply on the evidence of an unpaid debt, when the company appears to be prima facie solvent.
So how does one demonstrate commercial insolvency? Simply by appending the Company’s yearly balance sheet/profit and loss accounts which is a legal requirement under the Ordinance[4] and publicly available from the Securities and Exchange Commission of Pakistan (the “SECP”). If the balance sheet indicates that the Company has more liabilities than assets and a fair amount of creditors then the Court may decide that it is just and equitable that it may be wound up.
The Court in winding up a company issues notices to all creditors of the company as well as to the general public in leading daily newspapers prior to appointing a liquidator. It is significant to note that a winding up petition should only make sense if the creditor is a secured one i.e enjoys a mortgage/charge over the existing assets of the Company (usually in favour of banks/financial institutions), which can be liquidated in order to satisfy the existing liabilities. In other words, if your client has an unsecured debt, it will be quite low in the pecking order and may sometimes not receive any amounts as the company’s assets may be exhausted in paying off the secured creditors. In such a scenario, it may be the cliché’ of informing one’s client that there is a good news and a bad news. The good news; the Court has ordered the winding up of the Company, the bad news; get in line, because there is a truckload of creditors that have priority over the assets of the Company! It is for such calamitous occasions that a thorough research of a Search Report pertaining to the company may be hugely beneficial. The Search Report is a document maintained by the SECP, highlighting the lists of secured creditors of a company and the priority of the mortgages/charges created by the Company.
Transactional lawyers would also be aware of the liberal use of winding up clauses as a condition precedent to termination in contracts/agreements. Consequently there are certain “boiler-plated” termination clauses, wherein one standard ground for terminating a contract is when a petition for winding up is initiated against the Company. This is at best a carelessly drafted clause and at worst a negligent one, as it entails that filing of such a petition against a Company is usually sufficient ground for terminating an existing contract with the Company, without ascertaining if such petition is a frivolous one, or has been filed to pressurize the Company to pay its debts. Such clauses may be redrafted to read that termination would kick in only when and if a court of competent jurisdiction declares a company insolvent.
The above perhaps demonstrates why proceedings for winding up may be initiated with abundant caution as a variety of requirements need to be satisfied. However, that is not to say that courts have not shown robustness in winding up genuinely insolvent Companies[5]. The onus is on the nature of the Petition initiated and whether it genuinely satisfies the requirements of Section 305 and 306 of the Ordinance. In the absence of the same, the long hard road of filing a recovery suit may be required to be travelled.
[1] Section 14 of the Companies Ordinance 1984
[2] S 305(f) (i) (ii) of the Companies Ordinance 1984
[3] Faysal Bank Limited vs Iram Ghee Mills [2006 CLD 227]
[4] Section 234, Companies Ordinance 1984
[5] Additional Registrar of Companies vs Tri Star Power Ltd [2010 CLD 1115], M/s Aeroflot Russian International Airlines vs M/s Gerry International (Pvt) Ltd, [2003 CLD 1075]
