So, what could be the take away from the Stayzilla episode? Does it make it easier now, and will act as a precedent, to initiate a criminal action against promoters in cases which otherwise appear perfect fit for a civil dispute? What could have driven the creditor in Stayzilla’s case to file a criminal complaint alleging cheating by the start-up and its founders for non-payment of the dues? Was it just a befitting reply in response to the agony suffered by the creditor or the lack of alternative remedy to recover dues through a civil suit? The answer won’t be easy, but this case yet again brings into sharp focus the issue of lack of adequate recovery laws in India. This case has outraged the start-up community, and they are up in arms over the action taken against the founders of Stayzilla.
The start-ups have reasons to feel scarred. They may argue that what happened was incorrect and defeats the proper course of law. They believe that for start-ups to flourish in India a completely different, protective regime should apply. The stakeholders dealing with start-ups should very well be prepared for taking risks should the start-up fail to honour its obligations and shut down because the business it ventured into failed. It is worth noting that taking such a risk is always a feature of a shareholder, but never for a creditor. As a principle, a company must honour its obligations towards its creditors. Therefore, it is no surprise that on the issue of default towards creditors, no distinction is made between a start-up and any other kind of company.
Shutting down a company is governed by the Companies Act, 2013, and the recently enacted Insolvency and the Bankruptcy Code (IBC), 2016. These statutes do not provide for any special treatment for start-ups. The Companies Act does provide for a concept of “small companies” based on certain threshold of capital and turnover. But even these companies do not have any favourable provisions or exemptions for winding up or when they fail to pay their creditors. They are all painted with the same brush. Further, the Companies Act has a process for summary procedure for liquidation, but that only covers companies having assets of book value not exceeding `1 crore. The summary procedure was aimed to provide for a faster mechanism to wind up companies and settle claims of creditors. This could well be extended to start-ups. The central government has the power, under the Companies Act, to prescribe additional classes of companies to which the summary procedure could be extended. Perhaps, the government could consider covering start-ups within the ambit of the summary procedure.
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Interestingly, the Companies Act doesn’t deal with cases of winding up when a company fails to pay its creditors. It only deals with cases when a company is solvent and is able to pay its debts. Until December 2016, any failure to pay debt was one of the grounds to apply to the NCLT to wind up the company. Since the IBC has come into force, this provision has been brought within the ambit of the IBC. It is now the IBC that applies when a company defaults to pay its creditors. Unlike the Companies Act, the IBC provides that there will be no direct liquidation of a defaulting company. First, there will be an insolvency resolution process and only when that process fails will winding up be taken up. So, the real question is not whether the laws are adequate or not to deal with recovery of dues, but whether these are so cumbersome and time-consuming to implement that it forces creditors to explore alternative ways. It is no hidden fact that it could take several years of fiercely fought legal battle to win a recovery claim. There is also no denying the fact that the legal process for shutting down operations is an uphill task. These complexities only add to the miseries of the creditors.
While the Companies Act never provided for a time-bound process, thankfully, there is some silver lining now as the IBC provides for timely disposal of cases. It provides that if a resolution plan is not approved or not submitted within 180 days (this period can be extended by NCLT for another 90 days, but only once) the company will go into liquidation. The creditors will then be paid from the proceeds of liquidation as per the distribution waterfall provided in the IBC. But it is still early days to comment if these provisions will be strictly adhered to. The success of the IBC would depend upon how its provisions are enforced. If we truly go down the path laid in the IBC, we could surely avoid Stayzilla like cases. Let’s hope this opportunity is seized.