Declaration of Solvency in Voluntary Liquidation

Size: px

Start display at page:

Download "Declaration of Solvency in Voluntary Liquidation"

Chrystal Welch
5 years ago
Views:

1 Declaration of Solvency in Voluntary Liquidation Basis of determining solvency of a company opting for voluntary liquidation Vallari Dubey resolution@vinodkothari.com Declaration of Solvency: The Essence of Voluntary Liquidation Members voluntary liquidation proceedings word-wide demands the declaration of solvency, before the proceedings of liquidation are commenced. It is an established principle that only those companies, which are in a position to pay off all their debts out of their assets, should be allowed to be liquidated as per the terms of the members (since it is a members voluntary liquidation). Since management of a company is in the hands of the directors, it is they, who have to state and declare that the company is solvent and able to pay off all its debts. Given the extensive duties and powers of directors, it is essential that they only take the hardship to validate the solvency status of the company, based on the accounts of the company. Under Indian Law The recently introduced Insolvency and Bankruptcy Code, 2016 ( the Code ), deals with the provisions of Voluntary Liquidation in Chapter V and separate set of regulations viz. IBBI (Voluntary Liquidation Process) Regulations, 2017 ( VL Regulations ). Regulation 3 of the VL Regulations read with section 59 of the Code, provides for declaration of solvency. Accordingly, in case of corporate persons other than an LLP, declaration is required from majority of directors (all the directors in case the company has 2 directors), verified by an affidavit, stating that: 1. they have made full enquiry into the affairs of the company, and 2. they have formed an opinion based on such enquiry that, a. That there are no debts, or b. The company will be able to pay its debts out of the liquidation proceeds. Clause (b) to sub-section (1) provides that such declaration shall be accompanied by:

2 1. Audited financial statements & record of business operations for the past 2 years, and 2. Valuation report. The requirement under the Code is more or less similar to the one provided under the erstwhile provisions of Companies Act, 2013 ( Act, 2013 ) and Companies Act, 1956 ( Act, 1956 ). A comparison of the requirement under each law is drawn below (differences are highlighted in grey): The Code (section 59 and regulation 3) Declaration by individuals constituting the governing body, accompanied by: 1. Audited Financial Statements along with record of business operations of past 2 years, and 2. Valuation report will be able to pay its debts from the proceeds of liquidation. It declares that the company is not being wound up to defraud any person. Act, 2013 (section 305) Act, 1956 (section 488) Declaration by directors, accompanied by: 1) Auditor s report a) on the P&L account, for the period commencing from the date up to which the last such account was prepared upto the latest practicable date, immediately before the making of declaration, and b) on the balance sheet as on that date, containing a statement of assets and liabilities as on that date. 2) Valuation Report will be able to pay its debts from the proceeds of Declaration by directors accompanied by: 1) Auditor s report a) on the P&L account, for the period commencing from the date up to which the last such account was prepared upto the latest practicable date, immediately before the making of declaration, and b) on the balance sheet as on that date, containing a statement of assets and liabilities as on that date. will be able to pay its debts in full within such period not exceeding 3 years, as

3 4 weeks. liquidation. It declares that the company is not being wound up to defraud any person. 5 weeks. specified in the declaration. No declaration that the company is not being wound up to defraud any person was required. 5 weeks. Interpretation of latest practicable date The expression has not been defined under the Act, It may be decoded by breaking into the following parts: 1. Latest something which is most recent or current or last available. In Magnaquest Solutions (P.) Ltd., In re[ SCL 496/[2008] 141 Comp. Cas. 728 (AP), the words, latest auditor s report were interpreted to mean latest report available or which should normally be available at the time of filing petition in relation to section 391 (2) of Act, There will always be a time gap, however, the statutory requirement is that the report should be for the period for which the accounts are audited or ought to have been audited. 2. Practicable something capable of being into practice feasibly or possibly; 3. Date self-explanatory. In one such matter of GIP Investment Adviser (India) Private Limited, which proceeded for voluntary liquidation under the provisions of Act, 1956, the declaration of solvency was executed and approved by the Board on , based on the company s statement of assets and liabilities dated , being the latest practicable date. There is a difference of 6 months between the latest practicable date and the date of declaration. The law simply prescribed the maximum time period allowed passing of shareholders resolution, however, nothing has been provided for with respect to maximum time period between the financial statements and the date of the declaration It therefore can be construed by the aforementioned discussion, that, the latest practicable date shall mean to be such date on which the financials of the company are available in

4 accordance with the respective requirement of making financial statements as per the provisions of law and to the extent practicable. What should directors consider for affirming solvency? Apart from the available audited accounts with the directors, it is pertinent to note the following diagrammed pointers, while making a declaration of solvency: Contingent assets Contingent liabilities Prospective penalties Penalties already known but to be due in future The Insolvency Guidance Note of Malaysian Institute of Certified Public Accountancy 1, for members voluntary winding up, states that the directors should not take into account any contingent assets of the company and rather should take into account full extent of actual or contingent claims, including any claims that may arise from any director or employee as a result of proposed winding up. Contingent liabilities, may also comprise of claims arising out of pending litigations, arbitration awards, etc. Additionally, there might be some penalties that accrue on a periodical basis. Such penalties have been already imposed however due at either end of the month or a similar interval. Directors should give due regards to such continuing liabilities, which may not be provided for in the balance sheet of a company. There may also be a probability of imposition of penalty on account of a breach committed by the company or the director(s). In case the likelihood of such an event is high, the directors 1

5 must also consider an estimated figure of such penalty while making the declaration of solvency. Conclusion There is usually a substantial gap between the available financials of a company and the preparation of declaration of solvency in case the voluntary liquidation is commenced later in a financial year. Clearly, the directors would rely on such latest available accounts for determining the solvency status of the company. However, to enhance the credibility of such accounts, it is always prudent to consider foreseen and unforeseen liabilities that may be incurred by the company which may have a substantial bearing on the solvency status. Extensive penalties may be imposed on directors who fail to disclose that they took reasonable care in preparation of declaration of solvency, in cases where the solvency of the company fails, post commencement of voluntary liquidation of the company.

Article. Winding up of a Company - An Overview. Barsha Dikshit

Article. Winding up of a Company - An Overview. Barsha Dikshit Winding up of a Company - An Overview Barsha Dikshit barsha@vinodkothari.com Vinod Kothari & Company Corporate Law Services Group corplaw@vinodkothari.com 21 st April, 2016 Check at: http://india-financing.com/staff-publications.html