Scope of section 253(1) of Companies Act, 2013

Section 424 of the 1956 Act was vested only with the Board of Directors of the company. The 2013 Act extends the powers to secured creditors too. This Scheme is in line with the provisions of the title 11 of the US code where under not only the debtor, but also the creditors can file a plan for reorganization. However, under the UK Insolvency Act, 1986 directors can propose voluntary arrangements to the company and the creditors. One may, however, note some similarity that the provisions of section 253(1) of the 2013 Act bear with the provisions of the Part 9. Chapter 1 of the UK Insolvency Act, 1986, the bankruptcy petition may be filed either by the creditor or by the individual (debtor) himself.

secured

Further, the application may be made by the any secured creditor once the cause of making such application arises, that is, failure to pay the secured creditors an amount representing 50% or more of the total outstanding debt of the company. An important question that may arise is whether the application shall be a collective action from those demanding payment amongst those may proceed to make a reference to the Tribunal. The use of the word “any creditor” clearly signifies that it may be any creditor and not necessarily all the creditors who demanded, who can make references. Such creditor making reference does not necessarily have to have authorization of the remaining creditors. As mentioned earlier, draft rules for this chapter were circulated by the Ministry for feedback (Draft Rules). These rules were not finalized. Draft rules circulated for this chapter explicitly state that an application under section 253(1) of the 2013 Act, and one of them makes an application on their behalf then, as the Draft rules specify, the single secured creditor making the application on their behalf shall have the authorization of other creditors who have decided to take collective action under section 253(1) of the 2013 Act.

Conditions for reference by secured creditors

Sub-section (1) of Section 253 of the 2013 Act allows any of the secured creditors to prefer an application tribunal for declaration of the company as a sick company, provided the following conditions are satisfied:

  • The secured creditors representing at least 50% of the company’s outstanding amount of debt make a demand on the company for repayment of debt b serving a notice in this behalf; and
  • The company fails to pay the debt within 30 days of the service of notice, or to secure the debt, or to compound the debt to the reasonable satisfaction of the creditor.

Scope of expression “Sick Company”

The 2013 Act, unlike the 1956 Act and SICA, does not provide the definition of the term ‘Sick Company”. Since there is no definition in the 2013 Act, the Tribunal has to determine whether the company is sick or not. Obviously the Tribunal has to be guided by generic principles of sickness and precedents under SICA. The Tribunal cannot determine a healthy company to be a sick company. Also, if the company is close to morality and is beyond any scope for being nursed back to health then also it is not a sick company. Therefore, sickness is a stage between being persuasive value for the Tribunal to come its determination, it is important to take note of the relevant provisions of both SICA and the 1956 Act. SICA was applicable to industrial companies registered under the 1956 Act for at least 5 years, and the company was a sick company. If it had, at the end of any financial year, accumulated losses equal to or exceeding its entire net worth. As can be inferred, there were several loopholes in the initial years of its operations, it could not approach BIFR since minimum existence of 5 years is what SICA stipulated. Further, the initiative could be taken only after the company had eroded a substantial part of its net worth. So, it was likely that most of the companies that took recourse to SICA had bleak or no chances of revival since incurable damage had already been done.

“Debt” meaning of

“Debt” has  not been defined under the 2013 Ac. The expression has been used in the Recovery of debts due to Banks and Financial Institution Act, 1993 (RDDBDI Act) and the SARFAESI Act. It may be argued whether these definitions are relevant for interpreting the meaning and scope of debt under the 2013 Act. The RDDBFI Act and SARFAESI Act pertain to debt arising in course of any business activity undertaken by a bank or a financial institution or by a consortium thereof; not every debt payable by a company is covered by the RDDBFI Act and SARFAESI Act. However, the 2013 act pertains to payment of any debt due to a secured creditor, irrespective of how the debt arises. If the debt is secured, it is covered by the 2013 Act. Also, the precedents in context of section 271(2) of the 2013 Act (corresponding to section 434 of the 1956 act) pertaining to insolvency are also relevant.

Outstanding amount

The relevant question here pertains to the components of debt. The 2013 Act definitely talks about the debt as is outstanding to only secured creditors and not unsecured creditors. However, if there is a secured debt, the entire amount outstanding and payable by the company, covered by the security agreement, will form part of the “outstanding amount of debt” for the purpose of section 253 of the 2013 Act. The amount shall cover interest, principal or such other amounts as may be covered by the security agreement. Needless to say, an unsecured amount payable to a secured creditor will not be covered by section 253 of the 2013 Act. It may be noted that the expression “outstanding amount of debt” may be interpreted to mean the total outstanding debt, including debt payable to unsecured creditors. However, that does not seem to be the intent of law, since the test for making references is the so-called liquidity test which implies failure of the company to pay. Since only secured creditors have the right to make a reference under sub-section (1) of section 253 of the 2013 Act, by analogy the total outstanding amount should only refer to the outstanding amount to secured creditors. There will be a mismatch between the numerator and denominator of the fraction, if the expression “outstanding amount of debt” was interpreted to include both secured and unsecured debts.

Cut-off date for determination of outstanding amount

The 2013 Act has not specified any record date or cut-off date as on which the outstanding amount is to be determined. Neither does the 2013 Act clarify whether the outstanding amount is as per the books of the company or the books of the creditor. However, draft rules require that the application shall be accompanied by an up-to-date statement of the ledger account of the respective secured creditors showing the amount receivable and the amount shown in the demand notice. Usually, there may be significant differences between the books of the company and those of the creditor. Since the reference is to 50% or more of the total outstanding debt of the company due to secured creditors, only the books of the company can be a neutral reference for such debt. Hence, the outstanding amount should be reckoned as per the books of the company.

Notice of demand

The company shall be served a notice of demand by the creditors making the demand. This implies that the demand shall be made in a formal manner by way of serving notice. Draft rules require that the notice shall be dated at least 90 days prior to the date of making the application in the event of non-payment of debt. This, in turn puts a bar on making a reference until 90 days elapse from the date of the notice. Therefore, where the 2013 Act, the Draft Rules indicate that the reference may be made only after 90 days from the date of the demand notice served. The Draft rules require the copy of the initial demand notice issued by the applicant upon the company and the proof of service of the demand notice upon the company shall also accompany the reference made under section 253(1) of the 2013 Act.

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