Insolvency and directors' duties in India: overview

A Q&A guide to insolvency and directors' duties in India.

The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international group of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors and officers of an insolvent company.

To compare answers across multiple jurisdictions, visit the International Insolvency: Group Insolvency and Directors’ Duties Country Q&A tool.

This Q&A is part of the Insolvency and directors' duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.

Sakate Khaitan, Satyendra Shrivastava and Jyoti Krishnan, Khaitan Legal Associates
Contents

Corporate insolvency proceedings

1. What are the main out-of-court and court-sanctioned insolvency proceedings involving a liquidation of the company's assets?

In India, while the terms "bankruptcy" and "insolvency" are used extensively, the terms are not defined in the statutes that currently deal with the insolvency of companies in India. The laws and regulations dealing with insolvency of companies in India, more frequently use the terms "winding-up", "liquidation", "dissolution" and "restructuring".

Insolvency of companies followed by liquidation of its assets in India is currently dealt with under the following laws:

  • Companies Act 1956.

  • Companies Act 2013.

  • Sick Industrial Companies (Special Provisions) Act 1985 (SICA).

Winding-up

Insolvency of a company is usually due to a company's inability to repay its debts. Once a court is satisfied that a company is unable to repay its debts, the court will order for the company to be wound up. A company in India can be wound up under the Companies Act 1956, or under SICA.

Companies Act 1956. A company can be wound up in the following two ways:

  • Winding-up under the supervision of a court. A court can order for a company to be wound up due to (among other things) its inability to repay debts, failure to hold statutory meetings, if the company resolves to be wound up by the tribunal, or a reduction in the number of shareholders to below the statutory minimum.

  • Voluntarily winding-up. A company can be wound up voluntarily on the completion of a specific time period set out in the company's articles of association, or on the occurrence of a specific event as set out in the company's articles of association (in which case banking companies and non-banking financial companies must comply with additional guidelines provided by the Reserve Bank of India) or if the company resolves to be wound up by a special resolution.

SICA. Under the SICA, the Board for Industrial and Financial Reconstruction (BIFR) has the power to refer an insolvent company to the court for winding-up. Once such an order is passed, the winding-up of the company is dealt with by the court (see above).

Legal change

Company law in India is currently in a state of transition. With the introduction of various provisions of the Companies Act 2013, the corresponding provisions of the Companies Act 1956 are being repealed in a phased manner. However, most provisions involving the court or tribunal, along with winding-up and liquidation processes are currently governed by the Companies Act 1956.

Indian law on insolvency is on the verge of undergoing extensive revisions. The Indian Parliament has enacted the Insolvency and Bankruptcy Code 2016 (Code) which has received Presidential assent and has been notified in the official gazette. The Code aims to harmonise the provisions of the existing complex and disjointed laws covering corporate insolvency in India, including the:

  • Companies Acts 1956.

  • Companies Act 2013.

  • Securitisation and Restructuring of Financial Assets and Enforcement of Security Interest Act 2002.

  • SICA.

The Code intends to consolidate, replace and/or repeal the provisions of the Companies Act 1956, Companies Act 2013 and SICA, to the extent that they relate to the insolvency of companies. The provisions of the Code are being notified in a phased manner and at present, the insolvency and liquidation of companies will continue to be dealt with under the current legislation (see above). The National Company Law Tribunal (Tribunal) has been established and the winding-up proceedings of a company will be adjudicated by the Tribunal once the provisions under the Companies Act 1956 or Companies Act 2013 or the Code, whichever is earlier, have been notified.

Throughout this article, only the provisions of the Companies Act 1956, the Companies Act 2013 and the Code that are currently in force will be referred to. The provisions of these Acts and the Code that are not currently in force will not be referred to.

 
2. Are there statutory proceedings allowing for a rescue/restructuring of the debtor company's operations and debts?

Under Indian law, a company can reorganise its debt through one of the following mechanisms:

  • Amalgamation.

  • Out-of-court restructuring.

  • Restructuring under the Sick Industrial Companies (Special Provisions) Act 1985 (SICA).

  • Restructuring as a part of recovery.

Amalgamation

A company can reorganise its debt structure through an amalgamation. This is where the distressed company merges with another company under a scheme of amalgamation (sections 391 to 394, Companies Act 1956). When a company is merged under an amalgamation with another company, the distressed company is automatically dissolved, without being wound up.

Out-of-court restructuring

A company can also enter into corporate debt restructuring (CDR) schemes in accordance with the procedures stipulated by the Reserve Bank of India (RBI). The CDR scheme is agreed on mutually by the borrower and lender(s) and provides for a mechanism through which the loan used by the borrower can be restructured to enable the borrower to sustain itself. This will usually involve repayment of the loans during an enhanced repayment period and/or the lenders taking a haircut (that is, a percentage reduction of the amount that will be repaid to creditors). Subject to criteria set out by RBI, lenders can sometimes also decide to commence the process of strategic debt restructuring (SDR), which primarily involves a change in control and management of the borrower company.

Restructuring under the SICA

The Board for Industrial and Financial Reconstruction (BIFR) can also direct an applicant company to undergo restructuring and provide either:

  • A scheme for such restructuring.

  • Direction with regard to creating a plan to assist with the rehabilitation of the company.

Restructuring as a part of recovery

In case of failure to repay debts from banks and notified financial institutions, those banks and notified financial institutions can also initiate appropriate proceedings under the Recovery of Debt Due to Banks and Financial Institutions Act 1993 for recovery and attachment of borrower's assets. Such banks and notified financial institutions holding security interests on properties can also enforce the provisions of the Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 and can seek (among other things):

  • The taking over possession of the secured assets.

  • The management and business of the borrower.

  • The appointment of a person (manager) to manage the secured assets.

 
3. What are the general requirements for commencing insolvency proceedings?

In a winding-up of a company by the court, the procedure commences by presenting a petition before the court seeking such an order.

In a voluntary winding-up, the shareholders or creditors commence proceedings by passing a resolution to voluntarily wind up the company in a creditors' or shareholders' meeting (as applicable) even if the company is solvent.

When dealing with an application relating to a financially distressed industrial company, the BIFR can order for the company to be wound up and forward its opinion to the concerned Honourable High Court with competent jurisdiction, if the Board for Industrial and Financial Reconstruction is of the opinion that:

  • The financially distressed industrial company is unlikely to make its net worth exceed the accumulated losses within a reasonable time while meeting all its financial obligations.

  • As a result, the company is unlikely to become viable in the future.

See also Question 1.

 

Insolvency of corporate groups

4. Are there joint insolvency proceedings available that can apply to a whole group of companies? Do all members of a corporate group have to proceed under the same type of insolvency proceeding?

In relation to a group of companies, the following relationships are recognised under the current provisions of the Companies Act 1956 and the Companies Act 2013:

  • Holding/subsidiary company. When a company (Company A), controls the composition of board of directors of another company (Company B) or exercises or controls more than 50% of the total share capital such other company, either at its own or together with one or more of its subsidiary companies: Company A will be the holding company of Company B and Company B will be the subsidiary company of Company A.

  • Associate company. Company A will be an associate company of Company B if Company B has a significant influence over Company A (for example, controls at least 20% of its total share capital or has the power (by agreement) to make business decisions on its behalf) or if A is a joint venture company of B. However, in such cases Company A is not a subsidiary company of Company B.

Under Indian law, a duly incorporated and registered company is a distinct and independent legal entity (from its shareholders). Companies can own assets and can sue and be sued in their own name.

An Indian company can either be wound up or voluntarily resolve to be wound up under the Companies Act 1956, or apply to the Board for Industrial and Financial Reconstruction (BIFR) for appropriate orders, including restructuring.

Since each company (as part of the corporate family) is a separate and independent legal entity, it can choose the proceeding it intends to commence as it deems fit and as may be decided by the board of directors or shareholders (as applicable).

Therefore, each company is wound up separately under the provisions of the Companies Act 1956 and the Companies Act 2013 (as applicable) or under the Sick Industrial Companies (Special Provisions) Act 1985 (SICA) by the BIFR.

The Companies Act 1956, Companies Act 2013 and SICA do not necessarily provide for the joint winding-up of two or more companies. However, practically if the insolvency of one company affects the insolvency of another company from within the same group of companies, and if the order passed in one directly affects the other proceeding, the applicant in one proceeding can make an application requesting the court to pass necessary directions. Such directions can include (among other things) tagging two or more proceedings together, and/or passing an order based on the order passed in the other proceedings.

The insolvency proceedings for each separate company must be carried out through the court with jurisdiction where the registered office of each respective company is located, unless otherwise directed by the court having jurisdiction to do so.

 
5. Can the same insolvency office holder(s) administer the assets and the liabilities of the entire corporate group? Is a court hearing required to determine whether administration by the same individual(s) is appropriate and, if yes, does notice have to be given to creditors?

Indian law recognises each company as a separate legal entity and each company is therefore wound up as a separate entity. Accordingly, the liquidator (that is, the person authorised to administer the assets of a company after an order for winding-up is issued) for each such company would be appointed separately.

In case of winding-up by a Tribunal, the liquidator is the official liquidator connected with the court before whom the company's petition is pending. If two or more group companies fall within the jurisdiction of the same Tribunal, it is possible that the same person be appointed as liquidator in both cases.

In the case of a voluntary winding-up, the shareholders/creditors of the company (as applicable) resolve and appoint a liquidator. However, once the matter reaches the court for scrutiny and for the passing of the final order for winding up, the official liquidator connected with the court before whom the company's petition is pending, also assists with the liquidation of the company. Therefore, there is no specific provision for appointing a single person to administer the assets and liabilities of multiple companies under the entire corporate family. Given that the Companies Act 1956 requires the admission of a winding-up petition (in the case of winding-up by the court) and the passing of a special resolution approving voluntary winding up to be advertised, in any proceeding dealing with liquidation and/or administration of assets of a company, it would not be unusual for the court to:

  • Give notice to the creditors (both secured and unsecured) of such company.

  • Allow the creditors to make their representation before the court.

 
6. If the law does not permit a single insolvency office holder, are there provisions allowing different office holders to co-ordinate with each other so that the value of the group's assets can be maximised?

There is no specific legislative provision requiring an administrator/trustee/receiver to co-ordinate with each other. If necessary, and provided the court is satisfied that in the facts and circumstance of the case at hand it is necessary, the court can:

  • Direct two or more administrators/trustees/receivers to work in co-ordination with each other.

  • Require the report prepared by one or more administrators/trustees/receivers to be submitted before the court, in order to avoid conflicting orders.

 
7. Can professional advisers work for the entire corporate group?

Generally, there is no restriction on any professional working for two or more companies. This is provided that there is adequate disclosure of interest, waiver of any conflict and their appointment is effected in the manner provided under the Companies Act 1956 or the Companies Act 2013, as applicable or any other applicable law.

The Companies Act 2013 restricts a person from being appointed as an auditor of a company in the following circumstances:

  • If in the case of an individual, they or their relative or partner:

    • is holding any security of, or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company (except if the minimum threshold is not met);

    • is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of the prescribed amount;

    • has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, for the prescribed amount.

  • If the auditor (whether an individual or a firm) has a business relationship with the company, or its subsidiary, or its holding or associate company or subsidiary of such holding company or associate company, of a prescribed nature.

  • If an individual has a relative that is a director or is in the employment of the company as a director or key managerial personnel.

  • If an individual is in full-time employment elsewhere.

  • If an individual or a partner of a firm holds appointment as the firm's auditor, if such individual or partner is at the date of appointment holding appointment as auditor of more than 20 companies.

  • Any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialised services of the nature prescribed.

Subject to the restrictions listed above, professionals working for two or more companies within a corporate family are permitted to work for the entire corporate family provided:

  • Each company waives any conflict.

  • The conflict is not of a nature which makes it impossible for the professional to meet the interest of all their clients.

In relation to liquidators acting for two or more group companies, see Question 5.

 
8. Are the rules regarding members of a corporate group transferring assets to one another different when one or more members are insolvent?

In addition to the restrictions specified in Questions 22 to 23, the following restrictions/prohibitions exist in relation to the transfer of an asset by a company undergoing a winding-up:

  • Any transfer of movable or immovable property, delivery of goods, payment, execution or other act relating to property made, taken or done by or against a company, will be deemed a fraudulent preference over the creditors and will be invalid if, in event of the company being wound up:

    • the transfer was carried out within the six-month period prior to the commencement winding-up; and

    • the transfer was undertaken to fraudulently provide preference to a creditor.

  • Any transfer of movable or immovable property or delivery of goods by a company not made in the ordinary course of business, or made in favour of a purchaser or encumbrance in good faith and for valuable consideration, will be void against the liquidator if the transfer/delivery was carried out within the 12-month period prior to either:

    • being presented with the petition for winding-up by the court;

    • the passing a resolution for voluntary winding-up.

  • Any transfer of shares or alteration made in relation to the shareholders of a company after the commencement of winding-up will be void.

  • Any disposition of property, including any actionable claims of the company made after the commencement of winding-up by the court, will be void (unless the court orders otherwise).

 
9. How are claims of one member of a corporate group against other members of the group treated in a formal insolvency processes for those members?

A company is a separate legal entity, distinct from its shareholders, with the ability to sue and be sued in its own name. Accordingly, the claims of one member of a corporate family against another member of the same family are not treated as invalid or unenforceable, unless they are contrary to any specific provision of law.

Under Indian law, the debts of secured creditors rank pari passu (that is, equal within the same class) to payments due to the company's employees and must be paid before all other debts. Therefore, unless the claimant is a secured creditor (and is not in violation of the law, including in relation to the rules in Question 8), claims from one member of the corporate family against another member (during the winding-up of the latter) must be treated as subordinate to claims of the secured creditors and the employees.

Substantive consolidation

 
10. Is pooling of assets and liabilities of some or all members of a corporate group allowed, so that a creditor of one member becomes, in essence, a creditor of all members?

Pooling of assets and liabilities is not recognised under Indian law. Accordingly, there is no strict guideline in this regard.

Since each company is a separate legal entity, Indian courts do not usually allow for the pooling of assets of two or more group companies so that the creditor of one member becomes the creditor of another.

In certain cases, the courts have lifted the corporate veil and held a holding company liable for the claims against the subsidiary where the court believes the holding/subsidiary relationship to be a smokescreen for perpetrating fraud.

Further, when a company that is a member of a corporate family provides a guarantee on behalf of another member as security for latter's obligations (not being in violation of provisions set out in Question 23), if the latter fails to perform, the guarantee can be invoked and in such cases, the guarantor's assets can also be used to enforce the claim made under the guarantee. Such enforcement is against the member of the group in their capacity as a guarantor and not merely on account of them being a member of a corporate group.

In relation to creditors of the same class (secured creditors), when the assets and liabilities of the company are being liquidated, payment is made to the secured creditors proportionately.

 
11. What proceedings are required for the court to order the pooling of assets and liabilities?

Where a group company is intended to be joined in proceedings against another company, an application (for example, motion) for impleading the group company must be made. In such cases, the assets of the other company can only be held accountable for a claim if the court concludes that the other company is liable in its own capacity (whether as shareholder or otherwise), and not merely because its group company is liable in the absence of an order of a competent court.

 
12. Is the partial pooling of assets and liabilities allowed? What conditions apply?

Not applicable. Pooling of assets is not recognised under Indian law (see Questions 10 and 11).

 
13. If the pooling of assets and liabilities is permitted, are there any protections for certain types of creditors?

Pooling of assets is not recognised under Indian law. In relation to secured creditors, the debts of secured creditors rank pari passu with the payments due to the company's employees, which must be paid before all other debts (section 529A, Companies Act 1956). However, if the assets of the company are insufficient to meet the debts due to both the secured creditors and the employees in full, they will be paid proportionately.

Secured creditors

 
14. How are secured creditors treated in relation to a group of companies?

If a creditor has a security interest in the assets of one member of the corporate family and a guarantee from another member of a corporate family, unless any of the underlying transactions fall within the categories mentioned in Question 8 or other prohibitions under any applicable law, both claims will remain valid.

Further, both claims must be dealt with individually and cannot be joined together, since each claim relates to a different company. Both claims can be dealt with simultaneously (however, the court would usually be cautious not to allow unjust enrichment if both claims are dealt with simultaneously).

 

Insolvency proceedings for international corporate groups

15. What extra considerations are necessary if one or more members of the corporate group is incorporated under or governed by the laws of another jurisdiction?

If one or more members of a corporate family are governed by the laws of another jurisdiction, any companies located in India will continue to be governed by Indian law and will be treated by the Indian courts as separate legal entities.

In relation to the winding-up of a company incorporated and functioning outside of India, the Companies Act 1956 recognises the possibility of such a company being wound up in India as an unregistered company. This is provided the body corporate has been carrying on business in India, ceases to carry on business in India, and regardless of that body corporate having been dissolved or otherwise ceased existing as such under or by virtue of the laws of the country under which it was incorporated. Under the 1956 Act, an unregistered company can be wound up in the following cases:

  • Where the company is dissolved, has ceased to carry on business, or is carrying on business only for the purpose of winding up its affairs.

  • Where the company is unable to pay its debts.

  • Where the court/tribunal is of the opinion that it is just and equitable for the company to be wound-up.

 
16. If insolvency/restructuring proceedings are started for corporate group members in different countries, do international treaties or EU legislation apply?

India has not adopted the UNCITRAL Model Law on Cross-Border Insolvency 1997.

The Companies Act 1956 limited cross-border mergers to only cases where the transferee company is an Indian entity.

The Companies Act 2013 has removed this limitation and the related provisions are expected to be enforced and brought into effect in the near future. Additionally, the Insolvency and Bankruptcy Code 2016 (Code) also enables restructuring of companies incorporated outside India by providing for the execution of bilateral treaties and agreements between the Indian Government and governments of other countries in this regard. It is expected that there will be some movement on this when the relevant provision of the Code is notified.

 
17. Do domestic courts typically attempt to exercise jurisdiction over all the assets of a company filing locally (regardless of where the assets are located) or do they limit their jurisdiction to local assets?

At the time of winding-up of a company, all the assets of the company that are registered in its name are taken into account in order to satisfy the claims of employees, creditors and so on. As such, even if the winding-up proceedings are commenced in India, any assets of the company located outside of India are also taken into consideration.

However, if the assets are located outside India, the order passed by an Indian court to attach such assets needs to be enforced in the country where the assets are located, in accordance with the law and procedure applicable in such country. The Insolvency and Bankruptcy Code 2016 also has enabling provisions to deal with such an issue.

 
18. Do local courts enforce court orders from foreign jurisdictions that attempt to exercise jurisdiction over assets located in your jurisdiction that are owned by a company subject to foreign insolvency proceedings?

Foreign decrees passed by superior courts outside of India, in notified reciprocating territories are executed in the same way as if they were passed by any District Court in India (section 44A, Code of Civil Procedure 1908 (CPC)). In this context, a "decree" means any decree or judgment of a superior foreign court under which a sum of money is payable, which is not:

  • A sum payable in relation to taxes or other similar charges.

  • A sum payable in relation to a fine or other penalty.

  • An arbitration award.

However, a judgment cannot be enforced in India (and a separate legal action must therefore be filed) if any of the following apply:

  • The foreign judgment/order is not passed by a superior court.

  • The foreign judgment is not a "decree" (see above).

  • The relevant country is not a notified reciprocating country under the CPC.

In such separate legal action, on the production of any document purporting to be a certified copy of a foreign judgment, the Indian court will presume the judgment was pronounced by a court of competent jurisdiction, unless the contrary appears on the record (however, the presumption can be displaced by proving want of jurisdiction).

The court will view the objections raised by the defendant and will pass an order confirming the judgment, and the foreign judgment will be enforced by the Indian court.

An Indian court can refuse to enforce a foreign judgment on account of the judgment not being conclusive in relation to the following matters:

  • The judgment has not been pronounced by a court of competent jurisdiction.

  • The judgment has not been given on the merits of the case.

  • It appears, on the face of the proceedings, that the judgment has been founded on an incorrect view of international law, or on a refusal to recognise the law of India in cases in which such law is applicable.

  • The proceedings in which the judgment was obtained are opposed to natural justice.

  • The judgment has been obtained by fraud.

  • The judgment sustains a claim founded on a breach of any law in force in India.

A foreign judgment is deemed conclusive on any matter directly decided by the court in relation to any claim between the parties, unless any of the rules set out above are applicable.

The burden of proving that the foreign decree does meet the necessary requirements (and should therefore be refused by the court) (see above) is on the defendant or judgment debtor (under a foreign order).

 
19. Can the courts co-operate with foreign courts to co-ordinate the administration of group assets?

India has not legally adopted or informally utilised the Guidelines Applicable to Court-To-Court Communications in Cross-Border Cases as adopted and promulgated by The American Law Institute and The International Insolvency Institute.

However, the Code of Civil Procedure 1908 has set out a provision for executing decrees outside of India. Under this provision, the following must be satisfied (section 45):

  • The decree can only be sent to courts for execution which have been established by the Central Government.

  • The government of the reciprocating jurisdiction has declared that this particular section applies.

Further, an Indian decree/order/judgment can also be enforced in a country outside India in accordance with the procedure provided in the laws of such other country. A decree/order/judgment passed by a court outside India can be enforced in India (see Question 18).

India has also entered into agreements with some other countries in relation to the procedure for enforcement of decrees passed by one jurisdiction in the other jurisdiction. If a decree passed in a contracting country is required to be executed in India, or an Indian decree is required to be executed in such a contracting country, the provisions of such an agreement, if in existence, would apply.

 

Directors' duties

20. Does your jurisdiction encourage or discourage overlapping boards or management teams for separate members of a corporate group?

Indian law does not prohibit overlapping of boards between two or more companies. This is provided each director complies with the cap for acting as director in different companies and the necessary compliances are effected and restrictions are followed in cases of transactions performed between or among such companies.

 
21. What legal consequences are there for the directors of a parent company where they are not directors of the subsidiary but do manage the subsidiary's affairs?

If a director of a parent company manages the affairs of the subsidiary but is not a director in the subsidiary, it will be relevant to understand if such director falls within the definition of an "officer" for the subsidiary.

The Companies Act 2013 defines the term "officer", as including any person in accordance with whose instructions or directions the board of directors or any of the directors is accustomed to act.

For offences committed by a company, the officer is said to be liable if the officer had a positive involvement in the commission of the offence. However, the officer will not usually be held liable if he can show:

  • He exercised all possible due diligence to ensure that the offence would not be committed.

  • He was not aware of such offence being committed.

Accordingly, if a director were to qualify as officer for a subsidiary company and be involved in day-to-day affairs of the subsidiary, such person may be held responsible for defaults committed by the subsidiary and be punished and/or fined accordingly.

 
22. What are the main duties and responsibilities of directors and officers to the company, shareholders and third parties? Do they change when the company becomes insolvent?

The directors of a company owe a fiduciary duty to the company, shareholders, employees, community and the environment. The directors must also act in the best interests of the company.

Statutory duties

Under the Companies Act 2013, directors are also under an obligation to adhere to certain statutorily recognised duties, such as:

  • To act in accordance with the company's articles of association.

  • To act in good faith, in order to promote the objects of the company for the benefit of its members as a whole, and to act in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.

  • To exercise his duties with due and reasonable care, skill and diligence and to exercise independent judgment.

  • To not be involved in a situation in which he has a direct or indirect interest that will conflict (or could conflict) with the interest of the company.

  • To not receive (or attempt to receive) any undue gain or advantage to either himself or his relatives, partners, or associates (and if a director is found guilty of making any undue gain, he will be liable to pay an amount equal to that gain to the company).

  • To not assign his office (any assignment will be void).

A director of the company found in contravention of the above provisions is liable to punishment, with a fine of INR100,000 to INR500,000.

In addition, a director can also be held liable (in his capacity as a director) for any statutory or contractual breach committed by the company against a shareholder, creditor or government authority.

Duties when the company is insolvent

When a company becomes insolvent, the duties set out above continue (see above, Statutory duties). Further, the director has some specific duties under various laws, as follows.

Company law. Under Indian company law, a director has the following additional responsibilities once a company becomes insolvent:

  • When a limited company becomes insolvent and is being wound up, any director or manager (whether past or present) whose liability was previously unlimited (as provided in the memorandum of the company), must, in addition to their liability (if any), contribute as an ordinary shareholder and be liable to make any further contribution as if they were, at the commencement of the winding-up, a shareholder of an unlimited company.

  • A director must ensure that the company's accounts are completed and audited up to the date the winding-up order was made by the court, and are submitted to the court at the company's expense. Failure to comply with this provision will make the directors and officers liable for punishment for imprisonment for up to one year.

  • Once winding-up proceedings have commenced, the directors are prohibited from obtaining credit, misappropriating the property of the company, mutilating or destroying the books of the company and so on.

Income tax laws. Under Indian Income tax law, when a company is being wound up and tax assessed on the company cannot be recovered (before, during or after liquidation), the person who was the director of the company at the relevant year will be jointly and severally responsible for the payment of tax.

Liability to creditors and shareholders. Under the Companies Act 1956, during the winding-up of a company, directors/managers/officers can be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company, if it appears that:

  • The directors/managers/officers have carried on business activities with intent to defraud the creditors of the company or any other persons for any fraudulent purpose.

  • The defrauding parties were aware that they were carrying on the business with the intention of defrauding the parties above.

In addition, during the course of winding-up, on an application of the liquidator, contributor or a creditor, the court can examine the conduct of any past or present director of the company (among others) suspected of either:

  • The directors have misapplied, or retained, or become liable for the money/property of the company.

  • The directors are guilty of any misfeasance or breach of trust in relation to the company.

The court can compel such person to repay the money owed or pay damages, even where such person may also be criminally liable.

In the past, Indian courts have held the managing director of a company undergoing the process of winding-up to be liable in cases where, due to the inaction on the part of the director, debts owed to the company have remained unrecovered and have turned time-barred (that is, the limitation period prescribed in statute for initiating any recovery proceedings has expired).

However, in an action against a director for negligence, default, breach of duty, misfeasance or breach of trust, if the court is satisfied the director/officer acted honestly and reasonably, the court can relieve him from liability (in whole or in part).

 
23. How are competing duties addressed where directors and officers of different group company members overlap and there are conflicts of interest between the group members?

The Companies Act 2013 contains various provisions intended to maintain the fiduciary relationship between a director and the company. Specific approvals are required if the company enters into contracts with persons related to the director, or where the director may stand to gain where the transaction is conducted through a related person.

Except for companies specifically exempted from these provisions, a company is prohibited from advancing a loan to or security or guarantee in relation to a loan availed by, any of its directors or to any other person in whom a director is interested. The phrase "a person in whom a director is interested" means any of the following:

  • Any director of the lending company, director a company which is its holding company, or any partner or relative of any such director.

  • Any firm in which any such director or relative is a partner.

  • Any private company of which any such director is a director or member.

  • Any body corporate at a general meeting of which not less than 25% of the total voting power can be exercised or controlled by any such director, or by two or more such directors, together.

  • Any body corporate, board of directors, managing director or manager accustomed to act in accordance with the directions or instructions of the board, or of any director or directors, of the lending company.

In addition, every director of the company must disclose his concern or interest in any company both:

  • At the first board of directors' meeting in which he participates as a director.

  • Thereafter, at the first board of directors' meeting in every financial year.

Further, if the director has a concern or interest in a contract or arrangement that the company is entering into with another body corporate (for example, the director holds more than a 2% shareholding of that body corporate, or is a promoter, manager or Chief Executive Officer (CEO) of that body corporate, or with a firm or other entity in which, the director is a partner, owner or member), the director must:

  • Disclose the nature of his concern or interest at the board meeting in which the contract or arrangement is discussed.

  • Not participate in the meeting.

If the transaction is being entered into with a related party (including a director and his/her relatives), the following must be approved by board resolution at a board meeting:

  • The sale, purchase or supply of any goods or materials.

  • Selling or otherwise disposing of, or buying, property of any kind.

  • Leasing of property of any kind

  • Availing or rendering of any services.

  • The appointment of any agent for purchase or sale of goods, materials, services or property.

  • The appointment of the related party to any office or place of profit in the company, its subsidiary company or associate company.

  • Underwriting the subscription of any securities or related derivatives, of the company.

Additionally, in cases of a company having share capital more than the threshold prescribed or if the transaction value exceeds the prescribed sum, under the Companies Act 2013, prior approval is required to be obtained by the company by means of a resolution passed in the shareholders' meeting to approve the above transactions.

 
24. What specific types of conduct are in breach of the duties and responsibilities of directors and officers?

Failure to take reasonable steps to minimise losses to creditors

During the course of a winding-up, the court, on an application by the liquidator, contributor or creditor, is empowered to (among other things) examine the conduct of any past or present director of the company suspected of:

  • Misapplying or retaining the money/property of the company.

  • Being guilty of any misfeasance or breach of trust in relation to the company.

The court can compel such person to repay the money owed or pay damages, in addition to any criminal liability that may be imposed on such person.

In the past, Indian courts have held the managing director of a company undergoing the process of winding-up to be liable in cases where, due to the inaction on the part of the director, debts owed to the company have remained unrecovered and have turned time-barred. In an action against a director for negligence, default, breach of duty, misfeasance or breach of trust, if the court is satisfied that the director/officer has acted honestly and reasonably, the court may relieve him from liability (in whole or in part).

Given the above, a director who fails to take reasonable steps to minimise the losses incurred by a company's creditors will be liable under either the Companies Act 1956 or the Companies Act 2013, as applicable.

Misappropriation of corporate assets

The company's directors owe fiduciary duties to creditors. The position of director in relation to the company's property, and the rights conferred on them to be exercised as a director, is that of a trustee. The directors will therefore be personally liable for the loss if:

  • The directors commit any breach of trust, or indulge in wrongful uses of their rights.

  • The company suffers loss due to the directors' negligence.

Undervaluation of corporate assets to the detriment of creditors

Certain transfers of assets made prior to or during the winding-up are considered void (see Question 8). In addition, if a director or officer misappropriates assets of the company for their personal interests in order to gain a pecuniary advantage, the director/officer must account for the advantage to the company.

Failure to inform creditors of insolvency

If any past or present officer of a company (which includes a director) obtains any credit within the 12 months prior to the commencement of winding-up (or at any time thereafter) by false representation, the officer will be punishable with imprisonment for a term of up to five years, or with a fine, or both (Companies Act 1956).

Preferring payment to one creditor

Under the 1956 Act, an offence will be committed if, during the course of the winding-up, it appears that the company has continued business activities with the intention of defrauding either:

  • The company's creditors.

  • Any other persons or for any fraudulent purpose.

In such cases, all parties who knowingly carry on the business in the above manner will be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company.

Further, any transfer of movable or immovable property, delivery of goods, payment, execution or other act relating to property made, taken or done by or against a company, will be deemed a fraudulent preference over the creditors and will be invalid if, in event of the company being wound up:

  • The transfer was carried out within the six-month period prior to the commencement of the winding-up.

  • The transfer was undertaken to fraudulently provide preference to a creditor.

To constitute a fraudulent preference, the dominant motive in the mind of the company (as represented by the directors or shareholders), must be to prefer a particular creditor.

Continuing to trade when there is little prospect of being able to pay when due

Typically, if a company continues to carry on business and to incur debts at a time when there is, to the knowledge of the directors, no reasonable prospect of creditors' ever receiving payment of those debts, it can be inferred that the company is carrying on its business with an intent to defraud its creditors and the company and directors of the company are liable to punishment under the relevant law.

See also Question 8.

 
25. What civil and criminal liability exists for directors and officers if they breach their duties and responsibilities?

If a director contravenes any of the duties set out in Question 22, he will be subject to a fine of at least INR100,000 (which can be extended to INR500,000). The directors or officers of a company can also be exposed to certain criminal or civil penalties, depending on the nature of the violation (Companies Act 2013). In certain cases, the directors/officer can also be held liable for the debts owed by the company.

After a resolution to wind up the company has been passed by the shareholders, or after the Tribunal makes an order for the company to be wound up, a person acting as a director must carry out certain responsibilities. The offences committed for failing to carry out these responsibilities (and the relevant punishments) are set out below:

  • If a director misappropriates, conceals or fraudulently removes company property (or removes any book or paper relating to the property), he commits an offence. The sanctions for the director are a prison sentence of up to two years and/or a fine.

  • If a director obtains any credit on behalf of the company by making a false representation or on false pretence, he commits an offence. The sanctions for the director are a prison sentence of up to five years and/or a fine.

  • If a director, alters, mutilates, destroys any books, papers or securities or makes any fraudulent entry in registers, books of accounts of the company, he commits an offence. The sanctions for the director are a prison sentence of up to seven years and a fine.

  • If the accounts of the company have not been maintained for a period of two years prior to the commencement of the winding-up, every officer in default (including a director) commits an offence. The sanctions for the officer/director are a prison sentence for up to one year.

  • If the business of the company is conducted in a fraudulent manner, the persons who knowingly carried on the business in the fraudulent manner are personally responsible and personally liable for all or any of the debts or liabilities of the company. The sanctions for such persons are a prison sentence for up to two years and a fine of up to INR50,000.

For defences, see Question 30.

 
26. Is potential personal civil or criminal liability a factor in officers and directors deciding if and when to put the company into a formal insolvency/reorganisation procedure?

Generally, the decision to commence any voluntary, formal insolvency proceedings is made by the shareholders of a company. The directors and officers would usually make their recommendations to the shareholders, which can also include insolvency. For non-voluntary insolvency proceedings, the potential of a director being civilly or criminally liable does not normally play any role in the commencement of such proceedings.

However, an application before the Board for Industrial and Financial Reconstruction must be made by the distressed company's board of directors.

Since a director has a fiduciary duty towards the company, the director must take decisions based on the interests of the company and not the possibility of personal liability. This should not to be a factor when a decision to initiate a formal insolvency procedure for a company is being made. Additionally, if a director is of the opinion that taking such a decision affects him, he must, unless the relevant provisions are made non-applicable to such company and/or director:

  • Disclose such interest to the company.

  • Not vote in the meetings where decisions are being made in relation to such interest.

 
27. Is insurance available to protect directors and officers from claims arising while operating a financially distressed company?

A director must abide by his fiduciary duty towards the company. Accordingly, the availability of insurance to protect the director's own interest must not to be taken into consideration when voting on the decision to commence the winding-up of the company.

Directors and officers (D&O) liability insurance is provided for in the Companies Act 2013 and is also gaining popularity in the Indian market.

However, from a practical perspective, if a company is undergoing insolvency or is being wound up, insurance companies may be reluctant to provide insurance to the officers and directors of such a company.

Generally, and based on our review of general insurance policies issued for D&O liability, the following events are usually not insured:

  • Prior and pending litigation and claims submitted under previous policies.

  • Bodily injury, sickness, disease, emotional distress, death, damage or destruction of tangible property including loss.

  • Insured verses insured (that is, directors suing each other).

  • Illegal personal profit and remuneration.

  • Deliberate, dishonest or fraudulent acts.

  • Pollution and/or contamination.

  • Insider trading.

However, the above list is not exhaustive.

 
28. Can directors and officers resign from their positions if the company becomes financially distressed and what difference will this make to their potential liability?

Indian law does not prohibit the directors or officers from resigning once the company becomes insolvent. Notwithstanding such resignation, a director and officer can be held liable for their respective acts committed during their tenure.

 
29. How common is litigation against directors and officers for violation of their duties after commencement of insolvency/reorganisation proceedings? Is the litigation typically successful?

It is not unusual for directors to be sued for their previous actions as directors in a company, both before and during the process of a company being wound up.

There are no fixed criteria for judging the success of any proceeding against the director or officer. The same depends on the offence committed and the validity of the defence taken by them. In such a case, the claimant needs to satisfy the court that:

  • The director had intentionally committed the alleged misfeasance.

  • The director had not taken reasonable care to avoid the occurrence of the act in question.

Generally, officers and directors are not sued unless there is a clear case of fraud or dereliction of duty. Recent examples of such prosecution stem from the Satyam case and the Sahara case. For offences committed by a company, the officer is said to be liable if the officer had a positive involvement in the commission of the offence. However, the officer will not usually be held liable if it can be shown that he:

  • Exercised all possible due diligence to ensure that the offence would not be committed.

  • Was not aware of such offence being committed.

 
30. What defences against civil and/or criminal sanctions are available to directors and officers?

Good faith

In certain cases the directors can rely on the defence of acting in good faith. For example, the director may not be held liable if he:

  • Has acted in good faith and in the best interests of the company.

  • Can show that he had undertaken due diligence to avoid the occurrence of the act.

Due diligence

Indian courts have shown an inclination to not hold a director liable for an offence committed by the company in which he is a director, if the director can satisfy the court that he had undertaken due diligence (for example, in relation to obtaining a valuation of the assets) to avoid commission of the offence in question.

Reliance on outside consultants or professionals

The courts in India strongly adhere to the doctrine of ignorantia juris non excusat (that is, ignorance of law cannot be given as an excuse to evade liability). The courts have held that legal advice cannot ordinarily constitute a valid defence. However, taking advice from lawyers (as well as advice from accountants and financial advisers) may support an argument of good faith and due diligence taken by the director.

Exercise of reasonable judgment

See above, Good faith and Due diligence.

 
31. If it appears that "going concern values" will result in a higher return to creditors than a liquidation of the assets, can directors and officers be protected if they decide to continue operations to protect the values for the benefit of all creditors?

The Indian courts have held that, until and unless all measures have been taken to revive the company, passing a winding-up order may not result in the best interest of all the creditors. If there is a chance that the company could revive itself after a set-back, and is earnestly endeavouring to do so, the proper order will be to stay the proceedings for a reasonable time and to give the company a chance to recover.

Therefore, if it appears to the satisfaction of the court that "going concern values" will or would have resulted in higher repayment to the creditors, the directors can seek to defend their actions on grounds of good faith.

Generally, if a director can satisfy a court that his actions were a result of good faith, an unfavourable outcome of such actions alone would not make a director liable.

 
32. If a company becomes insolvent, is a director or officer of the insolvent company legally restricted from acting as a director or officer in another company, or from obtaining credit as a promoter of another company?

Insolvency of a company does not restrict a director or officer from acting as a director or officer in another company.

However, under the "guidelines for wilful defaulter" (adopted by banks and notified financial institutions in India), banks and notified financial institutions have been advised to include a covenant in the loan agreements with the companies in which such banks/financial institutions have significant stake, that the borrowing company should not induct on its board a person whose name appears in the list of Wilful Defaulters, and where such a person is found to be on its board, would take expeditious and effective steps for removal of the person from its board. Furthermore, no additional facilities will be granted to the listed wilful defaulters by any banks or financial institutions. Additionally, such companies (including their entrepreneurs and promoters) where banks or financial institutions have identified siphoning or diversion of funds, misrepresentation, falsification of accounts and fraudulent transactions will be debarred from institutional finance from the scheduled commercial banks, financial institutions, and non-banking financial companies, for floating new ventures for a period of five years from the date of removal of their name from the list of wilful defaulters as published/disseminated by the Reserve Bank of India, or the Central Information Commissions.

Under the above guidelines, the lender categorises a borrower as a "wilful defaulter" in any of the following circumstances:

  • The company has defaulted in meeting its payment/repayment obligations to the lender, even when it has the capacity to honour these obligations.

  • The company has defaulted in meeting its payment/repayment obligations to the lender and has not used the finance from the lender for the specific purposes for which finance was provided, but has diverted the funds for other purposes.

  • The company has defaulted in meeting its payment/repayment obligations to the lender and has siphoned off the funds, so that the funds have not been used for the specific purpose for which finance was provided, nor are the funds available with the company in the form of other assets.

  • The company has defaulted in meeting its payment/repayment obligations to the lender and has also disposed of or removed the movable fixed assets or immovable property given by him or it for the purpose of securing a term loan without the knowledge of the lender.

 
33. If a director or officer becomes personally insolvent, is he legally restricted from continuing to act as a director or officer of his current company or another company?

Current company

If a director becomes an undischarged insolvent, his office is deemed to have been vacated (Companies Act 2013).

Another company

A person who becomes an undischarged insolvent cannot be appointed as a director of another company (Companies Act 2013).

 

Online resources

Ministry of Corporate Affairs, India

W www.mca.gov.in

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