UB‘s Unsecured Creditors: Happy Hours!

Section 536(2) of the Companies Act, 1956 envisages compulsory winding up by the Court and lays down that transfer of shares after the commencement of winding up is void. Case law has understood that to mean – that courts have discretionary power to allow such an asset sale if it’s in the ordinary course of business. The Single Judge had used this discretion to permit the sale of shares by UB. On appeal, the division bench deliberated on whether a court can allow sale of shares even before a winding up petition is admitted. It answered the question in the negative saying if the court allows a company to do so, it can adversely affect creditors who may not even be aware of petitions made for alienation of property.

Shishir MehtaPartner, Khaitan & Co.“I think what the court has done in this case is it has clearly demarcated and deconstructed Sec 536(2). It has made a distinction between the first preliminary stage where the court is approached to admit a petition into winding up as opposed to actually admitting it. The court has held that there is a clear distinction contemplated under the Section whereby if the court has been approached to admit a company into winding up but the court has still not determined whether there is merit in that preliminary petition to actually admit it, then its clear that the court does not have the right to then interfere into the operation of the company or give consent to a transaction proposed by the company.”

In fact the Karnataka High Court division bench went one step further to examine whether a court has any jurisdiction whatsoever, even in offering interim relief, if a winding up petition has been filed but not admitted. Sec 443 of the Companies Act lays down the power of a court on hearing a winding up petition. It allows the court to dismiss the petition, adjourn it, give interim relief etc. The Division Bench interpreted that to mean the powers of the court to do kick in only after a winding up petition is admitted and duly advertised.

Vyapak DesaiPartner, Nishith Desai “As in case of Sec 536(2), the jurisprudence as it stands to always talked about passing of interim orders anytime during the pendency of winding up petition. This order goes ahead and also interprets Sec 443 to say that the power to pass any such interim order only comes to the court after the pass an order on admission of winding up petition. The question now arises is till the time you admit a winding up petition, will a court now have the power to pass any interim order or only in relation to Sec 536(2) – I think the way 443 is interpreted in this judgment, it has much wider implications because somebody can use this to say that you cannot pass any interim order till the time the petition is admitted which would lead to circumstances where you want certain urgent relief pending the admission of the petition, you may not be able to do so.” Case law suggests that a court may permit an asset sale in the ordinary course of business even if a winding up petition has been filed but not admitted. The second key takeaway from this order is that the Division bench has made it clear that a strategic sale of shares is not equal to ordinary course of business.

When examining UB Holding’s request to permit the sale of USL shares - the single judge bench of the Karnataka High Court accepted the company’s argument that this sale was in the ordinary course of business. But the division bench disagreed. H JayeshFounding Partner, Juris Corp “There is a Bombay High Court judgment- way back in 1931- which says what is in the ordinary course of business prior to the winding up petition being filed and what is in the ordinary course of business after a winding up petition has been filed. Once the winding up petition is filed, all the bets are off because the jurisprudence which applies is different. Why I am giving that analogy is therefore what a pledgee should be doing under normal circumstances should be different from what a pledgee should be doing once the winding up petition has been filed. That equally applies to a mortgagee of any property who has self help rights which anyway they can go sell on their own and appropriate.”

The third important key takeaway relates to the valuation adopted by UB for the sale of its stake in USL which was then approved by the Single Judge.

The Division Bench observed that Diageo had bought USL’s shares from 4 group companies of UB Holding and that the transaction was done to acquire control. It held that the Single Judge order was incorrect in concluding that the price on the Stock Exchange was a reasonable price. It also noted that simply because SEBI, RBI and the CCI had approved the price, it didn’t necessarily mean that it was in fact the actual fair value. The Division Bench concluded that the Single Judge should have appointed an approved valuer and heard the creditors affected by the sale before approving the price of the shares. 

Vyapak DesaiPartner, Nishith Desai“While doing a transaction, one would tend to believe that if one authority has accepted a price to be a fair market price – one can have a different view but that doesn’t mean this view is wrong. But here again parties will have to go into the aspects in further detail and look at the circumstances rather than rely upon formulae given in SEBI pricing or RBI pricing to say that if its fair as per SEBI, it is fair as per Companies Act- that may not be true.” H JayeshFounding Partner, Juris Corp “Valuation should be such that it done from each entity’s perspective. So if you are a promoter trying to sell of a stake held in two or three different entities, don’t just do a single valuation of your stake. Here the borrower held 14% - what is the value of that in isolation should also have been considered. That apart, how much transparency can you can you bring in and sale valuation is also a function of that. I think that can make a significant difference.”

The Court had no jurisdiction to allow the sale; the transaction was not bonafide and so the sale of shares stands void! Where does that leave Diageo? Well, experts say since Diageo bought the shares while the winding up petition was pending, some of the equitable reliefs may not be able available to it. Diageo’s peril’s aside, this order by the division bench is right up there on the series of judgments that have upheld the rights of unsecured creditors in the last couple of years! 

In Mumbai, Payaswini Upadhyay