Lock In Charges are not "Debt" : Delhi High Court Rules

The Division Bench of the Delhi High Court in Tower Vision India Pvt. Ltd. v. Procall Pvt. Ltd. has examined whether unpaid "lock in charges" would amount to "debt" under Section 433 / 434 of the Companies Act. The matter came up before the Division Bench owing to a reference by the Single Judge, expressing doubts over the correctness of an earlier judgment rendered by another Single Judge in Manju Bagai vs. Magpie Retail Ltd. While answering the reference, the Division Bench has opined that the views expressed by the Single Judge in Manju Bagai vs. Magpie Retail Ltd. was the correct view and "lock in charges" were not "debt" within the meaning of the Companies Act. The Division Bench held as under;

1. All these three company petitions are referred by the learned Company Judge to the Division Bench for decision. Initially Company Petition No.458/2010 had come up before the Company Judge and was heard on 31.10.2011 when following order was passed: 

"After hearing the parties at length, this Court is of the view that following question need to be answered by a Division Bench of this Court as the said issue arises in a number of matters and an authoritative pronouncement of the same is required:-

i) Whether in a contract for rendering of service/use of site, a stipulation to pay an amount for the "lock-in‟ period, is an admitted debt within the meaning of Section 433(e) of the Companies Act, 1956 or whether the same is in the nature of damages?

The present reference has been made as this Court has some doubts with regard to the judgment rendered by another learned Single Judge of this Court in Manju Bagai vs. Magpie Retail Ltd., 175 (2010) DLT 212.

Accordingly, the present matter is referred to a Division Bench. Let the papers be placed before appropriate Division Bench on 1st December, 2011, subject to orders of Hon‟ble the Acting Chief Justice."

2. As this issue came up subsequently in other two petitions, they have also been referred to the Division Bench. That is how we have heard these matters. It would be pertinent to point out that at the time of hearing, the counsel for all the parties in all these petitions agreed that it is not only the question which is formulated to be answered, but on the basis of answer given to the aforesaid question and applicability thereof in each case, the company petitions themselves be decided on merits as it would be reflected in our discussion, answer to the question cannot be in vacuum and may vary depending upon the facts of each case. 

What is 'debt' : The legal position

12. We have already extracted the order dated 31.10.2011 vide which reference was made to the Division Bench in Co.Pet. 458/2010. That order takes note of the judgment of another learned Single Judge in Manju Bagai (supra) and reason for referring the matter to Division Bench was that vide reference order, the Company Judge raised some doubts about the legal position formulated therein, though while doing so, no reasons because of which doubts are nurtured have been given in the reference order. In this scenario, it would be appropriate to first look into the raison de‟tre of Manju Bagai (supra). That was a case where petitioner had filed winding up petition under Section 433(e) of the Act on the ground that the respondent company therein had taken on rent certain premises from the petitioner. The rent was fixed at Rs.1,29,580/- excluding water and electricity charges. The company started paying rent with effect from 1.11.2006 and paid rent till February, 2007. It did not pay rent for the months of March, April and May, 2007 and handed over the possession of the premises on 31.5.2007. Thus, rent for March, 2007 to May, 2007 amounting to Rs.3,88,740/- was admittedly due which the company was to pay. However, as per the petitioner, agreement to lease entered into between the parties contained a clause to the effect that this agreement shall not be cancelled before the lock-in period of three years. Since the premises were vacated after seven months, according to the petitioner, the company was also liable to pay rent for the remaining period of 29 months because of the aforesaid clause containing lock-in period of three years. The said rent for unexpired period was claimed as liquidated damages in the sum of Rs.37,57,820/-. The petitioner made a total claim of Rs.41,46,560/- as well as interest and since the respondent company failed to pay the same, company petition for winding up was filed on that basis claiming that the aforesaid amount was debt payable. It was on these facts the question arose as to whether liquidated damages for the remaining lock-in period could be treated as „debt‟ entitling the petitioner to maintain petition for winding up of the respondent company. Though the learned Single Judge noted that agreement to lease in question was an unregistered document and could not be relied upon for making the claim, even on merits, the Court took the view that the claim for "liquidated damages" was not sustainable. In the opinion of the Court:

"10. ....The distinction between 'liquidated' and 'un- liquidated' damages is well settled. Mere use of the term 'liquidated' damages in a document cannot be the criteria to determine and decide whether the amount specified in the agreement is towards 'liquidated' damages or 'un-liquidated' damages. Amount specified in an agreement is liquidated damages; if the sum specified by the parties is a proper estimate of damages to be anticipated in the event of breach. It represents genuine covenanted pre-estimate of damages. On the other hand 'un-liquidated' damages or penalty is the amount stipulated in terrorem. The expression 'penalty' is an elastic term but means a sum of money which is promised to be paid but is manifestly intended to be in excess of the amount which would fully compensate the other party for the loss sustained in consequence of the breach. Whether a clause is a penalty clause or a clause for payment of liquidated damages has to be judged in the facts of the each case and in the background of the relevant factors which are case specific. Looking at the nature of the Clause and even the pleadings made by the petitioner, I am not inclined to accept the contention of the petitioner that Clause 5 imposes liquidated damages and is not a penalty clause. No facts and circumstances have been pleaded to show that Clause 5 relating to lock-in-period was a genuine pre-estimate of damages which by the petitioner would have suffered in case the respondent company had vacated the premises. No such special circumstances have been highlighted and pointed out.

11. The decision in the case of Food Corporation of India and Others (supra) is distinguishable. In the said case a civil suit was filed and there was evidence to show that the plaintiff therein had performed his part of the contract and altered his position, having constructed the plinths according to specifications of the defendant i.e. FCI. The defendant had promised to plaintiff that on completion of the construction, they would hire the premises for a period of three years but later on backed out. The trial court and the finding of the Supreme Court was that the construction was made in accordance with the design and specification prescribed by the defendant. Therefore, it was held that the defendant cannot back out from the promise held out and escape from the liability.

12. It may be also noted that the Doctrine of Unavoidable Consequence or Mitigation of Damages is applicable in cases of un-liquidated damages....

13. A person therefore, must take reasonable steps to minimize the loss and refrain from taking unreasonable steps which would increase the loss. Defence cannot be held liable to pay a loss which the claimant could have avoided or which arises due to the neglect and failure of the claimant to take such reasonable steps. Damages is compensation for the wrong suffered by the claimant and the loss incurred by him but this is subject to the rule that the claimant must take reasonable steps to avoid their avoidable accumulation. It is difficult to accept that the petitioner was unable to rent out the premises for the lock-in-period of three years despite the highly commercially viable location of the premises. Decline in the rate of rent is not pleaded. The onus in this regard is on the petitioner and no evidence and material has been placed on record to show that the premises could not be rented out. Even the date on which the premises was subsequently rented out has not been stated."

13. The aforequoted reasoning demonstrates the following factors which influenced the Court not to treat the amount of unexpired lock-in period as debt or liquidated damages:

(i) Whether a particular clause about pre-determined liquidated damages represents genuine covenanted pre-estimate of damages or it is in the nature of penalty has to be judged in the facts of each case and in the background of relevant factors which are case specific. In that case, no facts and circumstances were pleaded to show that clause relating to lock-in period was a genuine pre-estimate of damages which the petitioner would have suffered in case the respondent company vacated the premises before the expiry of lock- in period.

(ii) In order to prove that amount mentioned as payable for the lock-in period is genuine pre-estimate of damages, proper evidence is required of specific nature, namely, the landlord had altered its position by making the premises available to the tenant keeping in view the tenants‟ requirements and spending thereupon. Certain expenditure was incurred on infrastructure specifically provided to the tenant as per tenant‟s requirements; certain other expenditure incurred on whitewashing, fixtures and fittings and the landlord was forced to incur such expenditure again before giving the premises to new tenant and, therefore, lock-in period was treated as reasonable period to avoid duplication of such expenditure, etc. (iii) The doctrine of mitigation of damages may also apply in such cases and even if the tenant had committed breach by leaving the premises before the expiry of lock-in period, it was for the landlord to prove that he had taken reasonable steps to minimize the loss, but could not award the loss to the extent mentioned in the clause and, therefore, the same is to be treated as genuine pre-estimation of the loss.

On this reasoning, in that case, winding up petition was dismissed.

14. As pointed out above, in the reference order, the learned Company Judge has expressed some reservations about the aforesaid ratio from which we infer that the learned Company Judge has hinted that the amount of unexpired lock-in period can be treated as debt though no specific reasons are given in the reference order.

15. Before we give our final comments, we would like to traverse through the statutory provisions as well as some case law on the subject cited before us during the arguments by counsel for the parties.

16. Consequences for breach of the contract are provided in Chapter VI of the Contract Act which contains three sections, namely, Section 73 to Section 75. As per Section 73 of the Contract Act, the party who suffers by the breach of contract is entitled to receive from the defaulting party, compensation for any loss or damage caused to him by such breach, which naturally arose in usual course of things from such breach, or which the two parties knew when they make the contract to be likely the result of the breach of contract. This provision makes it clear that such compensation is not to be given for any remote or indirect loss or damage sustained by reason of the breach. The underlying principle enshrined in this Section is that a mere breach of contract by a defaulting party would not entitle other side to claim damages unless the said party has in fact suffered damages because of such breach. Loss or damage which is actually suffered as a result of breach has to be proved and the plaintiff is to be compensated to the extent of actual loss or damage suffered. When there is a breach of contract, the party who commits the breach does not eo instant i.e. at the instant incur any pecuniary obligation, nor does the party complaining of the breach becomes entitled to a debt due from the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages. No pecuniary liability thus arises till the Court has determined that the party complaining of the breach is entitled to damages. The Court in the first place must decide that the defendant is liable and then it should proceed to assess what the liability is. But, till that determination, there is no liability at all upon the defendant. Courts will give damages for breach of contract only by way of compensation for loss suffered and not by way of punishment. The rule applicable for determining the amount of damages for the breach of contract to perform a specified work is that the damages are to be „assessed at the pecuniary amount of difference between the state of the plaintiff upon the breach of the contract and what it would have been if the contract had been performed and not the sum which it would cost to perform the contract, though in particular cases the result of either mode of calculation may be the same. The measure of compensation depends upon the circumstances of the case. The complained loss or claimed damage must be fairly attributed to the breach as a natural result or consequence of the same. The loss must be a real loss or actual damage and not merely a probable or a possible one. When it is not possible to calculate accurately or in a reasonable manner, the actual amount of loss incurred or when the plaintiff has not been able to prove the actual loss suffered, he will be, all the same, entitled to recover nominal damages for breach of contract. Where nominal damages only are to be awarded, the extent of the same should be estimated with reference to the facts and circumstances involved. The general principle to be borne in mind is that the injured party may be put in the same position as that he would have been if he had not sustained the wrong.

17. In Murlidhar Chiranjilal v. Harishchandra Dwarkadas and Anr., AIR 1962 SC 366, the Supreme Court highlighted two principles which follow from the reading of Section 73 of the Contract Act. The first principle on which damages in cases of breach of contract are calculated is that, as far as possible, he who has proved a breach of a bargain to supply what he contracted to get is to be placed, as far as money can do it, in as good a situation as if the contract had been performed; but this principle is qualified by a second, which imposes on a plaintiff the duty of taking all reasonable steps to mitigate the loss consequent on the breach and debars him from claiming any part of the damages which is due to his neglect to take such steps.

18. Thus, while on one hand, damages as a result of breach are to be proved to claim the same from the person who has broken the contract and actual loss suffered can be claimed, on the other hand, Section 74 of the Act entitles a party to claim reasonable compensation from the party who has broken the contract which compensation can be pre-determined compensation stipulated at the time of entering into the contract itself. Thus, this section provides for pre-estimate of the damage or loss which a party is likely to suffer if the other party breaks the contract entered into between the two of them. If the sum named in the contract is found to be reasonable compensation, the party is entitled to receive that sum from the party who has broken the contract. Interpreting this provision, the Courts have held that such liquidated damages must be the result of a "genuine pre-estimate of damages". If they are penal in nature, then a penal stipulation cannot be enforced, that is, it should not be a sum fixed in terrarium or interrarium. This action, therefore, merely dispenses with proof of "actual loss or damage". However, it does not justify the award of compensation when in consequence of breach, no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual course of things, or which the parties knew when they made the contract, to be likely to result from the breach.

19. The Supreme Court in the case of Union of India v. Raman Iron Foundry, AIR 1974 SC 1265, expounded this very principle in the following words:

"9. Having discussed the proper interpretation of Clause 18, we may now turn to consider what is the real nature of the claim for recovery of which the appellant is seeking to appropriate the sums due to the respondent under other contracts. The claim is admittedly one for damages for breach of the contract between the parties. Now, it is true that the damages which are claimed are liquidated damages under Clause 14, but so far as the law in India is concerned, there is no qualitative difference in the nature of the claim whether it be for liquidated damages or for unliquidated damages. Section 74 of the Indian Contract Act eliminates the somewhat elaborate refinements made under the English common law in distinguishing between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty. Under the common law a genuine pre-estimate of damages by mutual agreement is regarded as a stipulation naming liquidated damages and binding between the parties : a stipulation in a contract in terrorem is a penalty and the Court refuses to enforce it, awarding to aggrieved party only reasonable compensation. The Indian Legislature has sought to cut across the web of rules and presumptions under the English common law, by enacting a uniform principle applicable to all stipulations naming amounts to be paid in case of breach, and stipulations by way of penalty, and according to this principle, even if there is a stipulation by way of liquidated damages, a party complaining of breach of contract can recover only reasonable compensation for the injury sustained by him, the stipulated amount being merely the outside limit. It, therefore makes no difference in the present case that the claim of the appellant is for liquidated damages. It stands on the same footing as a claim for unliquidated damages. Now the law is well settled that a claim for unliquidated damages does not give rise to a debt until the liability is adjudicated and damages assessed by a decree or order of a Court or other adjudicatory authority. When there is a breach of contract, the party who commits the breach does not eo instanti incur any pecuniary obligation, nor does the party complaining of the breach becomes entitled to a debt due From the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages. That is not an actionable claim and this position is made amply clear by the amendment in Section 6(e) of the Transfer of Property Act, which provides that a mere right to sue for damages cannot be transferred. This has always been the law in England and as far back as 1858 we find it stated by Wightman, J., in Jones v. Thompson [1858] 27 L.J.Q.B. 234 "Exparte Charles and several other cases decide that the amount of a verdict in an action for unliquidated damages is not a debt till judgment has been signed". It was held in this case that a claim for damages does not become a debt even after the jury has returned a verdict in favour of the plaintiff till the judgment is actually delivered. So also in O'Driscoll v. Manchester Insurance Committee [1915] 3 K. B. 499, Swinfen Eady, L.J., said in reference to cases where the claim was for unliquidated damages : "... in such cases there is no debt at all until the verdict of the jury is pronounced assessing the damages and judgment is given". The same view has also been taken consistently by different High Courts in India. We may mention only a few of the decisions, namely, Jabed Sheikh v. Taher Mallik 45 Cal. Weekly Notes, 519, S. Malkha Singh v. N.K. Gopala Krishna Mudaliar 1956 A.I.R. Pun. 174 and Iron & Hardware (India) Co. v. Firm Shamlal & Bros. 1954 A.I.R. Bom. 423. Chagla, C.J. in the last mentioned case, stated the law in these terms:

In my opinion it would not be true to say that a person who commits a breach of the contract incurs any pecuniary liability, nor would it be true to say that the other party to the contract who complains of the breach has any amount due to him from the other party.

As already stated, the only right which he has is the right to go to a Court of law and recover damages. Now, damages are the compensation which a Court of law gives to a party for the injury which he has sustained. But, and this is most important to note, he does not get damages or compensation by reason of any existing obligation on the part of the person who has committed the breach. He gets compensation as a result of the fiat of the Court. Therefore, no pecuniary liability arises till the Court has determined that the party complaining of the breach is entitled to damages. Therefore, when damages are assessed, it would not be true to say that what the Court is doing is ascertaining a pecuniary liability which already existed. The Court in the first place must decide that the defendant is liable and then it proceeds to assess what that liability is. But till that determination there is no liability at all upon the defendant.

This statement in our view represents the correct legal position and has our full concurrence. A claim for damages for breach of contract is, therefore, not a claim for a sum presently due and payable and the purchaser is not entitled, in exercise of the right conferred upon it under Clause 18, to recover the amount of such claim by appropriating other sums due to the contractor. On this view, it is not necessary for us to consider the other contention raised on behalf of the respondent, namely, that on a proper construction of Clause 18, the purchaser is entitled to exercise the right conferred under that clause only where the claim for payment of a sum of money is either admitted by the contractor, or in case of dispute, adjudicated upon by a court or other adjudicatory authority. We must, therefore, hold that the appellant had no right or authority under Clause 18 to appropriate the amount of other pending bills of the respondent in or towards satisfaction of its claim for damages against the respondent and the learned Judge was justified in issuing an interim injunction restraining the appellant from doing so.

20. In that case, Clause 18 of the contract entered into between the parties provide that whenever any claim for the payment of a sum of money arises out of or under the contract against the contractor, the purchaser shall be entitled to recover such sum by appropriating in whole or in part, the security, if any, deposited by the contractor. The purchaser/Union of India, invoking this clause, wanted to recover and adjust liquidated damages in terms of clause 14 of the contract. As is seen from the aforesaid extracted portion, the Court held that a claim for liquidated damages does not give rise to a debt until the liability is adjudicated and damages assessed by a decree or order of a Court or other adjudicatory authority. When there is such a clause, the only right which the plaintiff has is the right to go to Court and recover damages.

21. The Supreme Court also explained that damages are the compensation which a Court of Law gives to a party for the injury which he has sustained and the plaintiff does not get damages or compensation by reason of any existing obligation on the part of the person who has committed the breach. He gets compensation as a result of fiat of the Court. Therefore, it has to be decided by the Court, in the first instance, that the defendant is liable and then it proceeds to assess what liability is. Till that determination, there is no liability at all upon the defendant. The Court further went to the extent of holding that there would not be any debt payable unless the Court determines the liability. In this process, the Court also explained the concept of „debt‟ in the following manner:

"6. The first thing that strikes one on looking at Clause 18 is its heading which reads: "Recovery of Sums Due". It is true that a heading cannot control the interpretation of a clause if its meaning is otherwise plain and unambiguous, but it can certainly be referred to as indicating the general drift of the clauses and affording a key to a better understanding of its meaning. The heading of Clause 18 clearly suggests that this clause is intended to deal with the subject of recovery of sum due. Now a sum would be due to the purchaser when there is an existing obligation to pay it in praesenti. It would be profitable in this connection to refer to the concept of a 'debt', for a sum due is the same thing as a debt due. The classical definition of 'debt' is to be found in Webb v. Stenton [1883] 11 Q.B.D. 518 where Lindley, L.J., said :"... a debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation". There must be debitum in praesenti; solvendum may be in praesenti or in future- that is immaterial. There must be an existing obligation to pay a sum of money now or in future. The following passage from the judgment of the Supreme Court of California in People v. Arguello [1869] 37 Calif. 524 which was approved by this Court in Kesoram Industries v. Commissioner of Wealth Tax : [1966] 59 ITR 767 (SC) clearly brings out the essential characteristics of a debt:

Standing alone, the word 'debt' is as applicable to a sum of money which has been promised at a future day as to a sum now due and payable. If we wish to distinguish between the two, we say of the former that it is a debt owing, and of the latter that it is debt due."

22. The Supreme Court in the matter of ONGC Ltd. v. Saw Pipes Ltd., AIR 2003 SC 2629, in para 65 has discussed provisions of Section 73 and 74 of the Indian Contract Act and held as under:

"Under Section 73, when a contract has been broken, the party who suffers by such breach is entitled to receive compensation for any loss caused to him which the parties knew when they made the contract to be likely to result from the breach of it. This Section is to be read with Section 74, which deals with penalty stipulated in the contract, inter alia [relevant for the present case] provides that when a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, the party complaining of breach is entitled, whether or not actual loss is proved to have been caused, thereby to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named.

Section 74 emphasizes that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach. therefore, the emphasis is on reasonable compensation. If the compensation named in the contract is by way of penalty, consideration would be different and the party is only entitled to reasonable compensation for the loss suffered. But if the compensation named in the contract for such breach is genuine pre-estimate of loss which the parties knew when they made the contract to be likely to result from the breach of it, there is no question of proving such loss or such party is not required to lead evidence to prove actual loss suffered by him. Burden is on the other party to lead evidence for proving that no loss is likely to occur by such breach..."

23. In the matter of Keshoram Industries & Cotton Mills Ltd. v. Commissioner of Wealth Tax (Central), Calcutta, 1966 (2) SCR 688, the Supreme Court considered the meaning of expression "debt owed". What does the word „debt‟ mean was also considered with reference to various English decisions and held as under:

"a debt is a sum of money which is now payable or will become payable in further by reason of a present obligation : debitum in presenti, solvendum in future."

The said decisions also accept the legal position that a liability depending upon a contingency is not a debt in presenti or in future till the contingency happened. But if there is a debt the fact that the amount is to be ascertained does not make it any the less a debt if the liability is certain and what remains is only the quantification of the amount."

24. What follows from the above is that even if there is a clause of liquidated damages, in a given case, it is for the Court to determine as to whether it represents genuine pre-estimate of damages. In that eventuality, this provision only dispenses with the proof of "actual loss or damage". However, the person claiming the liquidated damages is still to prove that the legal injury resulted because of breach and he suffered some loss. In the process, he may also be called upon to show that he took all reasonable steps to mitigate the loss. It is only after proper enquiry into these aspects that the Court in a given case would rule as to whether liquidated damages as prescribed in the contract are to be awarded or not. Even if there is a stipulation by way of liquidated damages, a party complaining of breach of contract can recover only reasonable compensation for the injury sustained by him and what is stipulated in the contract is the outer limit beyond which he cannot claim. Unless this kind of determination is done by the Court, it does not result into "debt".

25. At this juncture, we would like to refer to the judgment of Bombay High Court in the case of E-City Media Private Limited a Private Limited Company v. Sadhrta Retail Limited a Public Limited Company, [2010] 153 Comp.Cas 326 (Bom.) (rendered by Single Judge). In this case also, winding up petition was filed on account of alleged dues stipulated in the contract in case of breach. Facts of the case disclose that the petitioner had appointed the respondent as an exclusive agent for designated branding sites situated within the premises of a shopping mall. The petitioner had permitted the respondent to display advertisements at the Mall, in a theatre and upon ticket jackets. The contract was to commence on 22.5.2008 and was to conclude on 31.7.2009. This term was extended by a formal amendment till September, 2009. The agreement also provided that in the event respondent fail to make payment for a period of one month, during the term of the agreement, the petitioner would be at liberty to terminate the agreement with notice of seven days. In that event, respondent was obliged to make good losses and damages which may be suffered by the petitioner. The respondent was liable to pay entire royalty/minimum guaranteed amount mentioned in the agreement with interest @ 18% per annum on alleged breach committed by the respondent. The petitioner terminated the contract and demanded the entire amount of royalty/minimum guaranteed amount. On the respondents failure to pay, winding up petition was filed. The Court dismissed the said petition holding that it was not maintainable upon a claim for damages which could not be treated as debt. It was held that damages become payable only when they are crystallized upon adjudication. Until and unless an adjudication takes place with a resultant decree for damages, there is no debt due and payable. Damages require adjudication. Until then, the liability of a party in alleged breach of a contract does not become crystallized. In support of this view, the Court referred to a Division Bench judgment of Karnataka High Court in Greenhills Exports (P) Ltd. v. Coffee Board, Bangalore, [2001] 106 Comp.Cas 391 (Kar) in the following words:

" ...Mr. Justice R.V. Raveendran (as the Learned Judge then was) speaking for the Division Bench formulated the propositions of law which emerge from judgments of the Supreme Court and the High Court. The Court held as follows:

(i) A "Debt" is a sum of money which is now payable or will become payable in future by reason of a present obligation. The existing obligation to pay a sum of money is the sine qua non of a debt.

"Damages" is money claimed by, or ordered to be paid to; a person as compensation for loss or injury. It merely remains a claim till adjudication by a court and becomes a "debt" when a court awards it.

(ii) In regard to a claim for damages (whether liquidated or unliquidated), there is no "existing obligation" to pay any amount. No pecuniary liability in regard to a claim for damages, arises till a court adjudicates upon the claim for damages and holds that the defendant has committed breach and has incurred a liability to compensate the plaintiff for the loss and then assesses the quantum of such liability. An alleged default or breach gives rise only to a right to sue for damages and not to claim any "debt". A claim for damages becomes a "debt due", not when the loss is quantified by the party complaining of breach, but when a competent court holds on enquiry, that the person against whom the claim for damages is made, has committed breach and incurred a pecuniary liability towards the party complaining of breach and assesses the quantum of loss and awards damages. Damages are payable on account of a fiat of the court and not on account of quantification by the person alleging breach.

(iii) When the contract does not stipulate the quantum of damages, the court will assess and award compensation in accordance with the principles laid down in Section 73. Where the contract stipulates the quantum of damages or amounts to be recovered as damages, then the party complaining of breach can recover reasonable compensation, the stipulated amount being merely the outside limit.

(iv)...

(v) Even if the loss is ascertainable and the amount claimed as damages has been calculated and ascertained in the manner stipulated in the contract, by the party claiming damages, that will not convert a claim for damages into a claim for an ascertained sum due. Liability to pay damages arises only when a party is found to have committed breach. Ascertainment of the amount awardable as damages is only consequential."

26. Reading of the aforesaid judgments and the ratio laid down therein would amply demonstrate that the legal position propounded by learned Single Judge in Manju Bagai (supra) is the correct legal position of law and we agree with the same. We now proceed to apply this legal principle to each of the cases before us.

Liability of Director in Cheque Bounce Cases : Principles

Justice P. Sathasivam

Supreme Court of India

The Supreme Court in National Small Industries Corp. Ltd. v. Harmeet Singh Paintal, has examined the provisions of the Negotiable Instruments Act vis-a-vis the liability of a Director for the offences committed by a company for cheque bouncing. While examining the authorities on the topic, the Supreme Court has culled out broad principles for determining the liability of directors in such cases. The relevant extracts from the judgment are reproduced hereinbelow;

9) Section 138 of the Act refers about penalty in case of dishonour of cheque for insufficiency of funds in the account. We are more concerned about Section 141 dealing with offences by Companies which reads as under:- 

141. Offences by companies.--(1) If the person committing an offence under Section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly: Provided that nothing contained in this sub-section shall render any person liable to punishment if he proves that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the commission of such offence. 

Provided further that where a person is nominated as a Director of a company by virtue of his holding any office or employment in the Central Government or State Government or a financial corporation owned or controlled by the Central Government or the State Government, as the case may be, he shall not be liable for prosecution under this Chapter. (2) Notwithstanding anything contained in sub-section (1), where any offence under this Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attributable to, any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of that offence and shall be liable to be proceeded against and punished accordingly. Explanation.-- For the purposes of this section,-- 

(a) `company' means any body corporate and includes a firm or other association of individuals; and 

(b) `director', in relation to a firm, means a partner in the firm. 

It is very clear from the above provision that what is required is that the persons who are sought to be made vicariously liable for a criminal offence under Section 141 should be, at the time the offence was committed, was in-charge of, and was responsible to the company for the conduct of the business of the company. Every person connected with the company shall not fall within the ambit of the provision. Only those persons who were in-charge of and responsible for the conduct of the business of the company at the time of commission of an offence will be liable for criminal action. It follows from the fact that if a Director of a Company who was not in- charge of and was not responsible for the conduct of the business of the company at the relevant time, will not be liable for a criminal offence under the provisions. The liability arises from being in-charge of and responsible for the conduct of the business of the company at the relevant time when the offence was committed and not on the basis of merely holding a designation or office in a company. 

10) Section 141 is a penal provision creating vicarious liability, and which, as per settled law, must be strictly construed. It is therefore, not sufficient to make a bald cursory statement in a complaint that the Director (arrayed as an accused) is in charge of and responsible to the company for the conduct of the business of the company without anything more as to the role of the Director. But the complaint should spell out as to how and in what manner Respondent No.1 was in-charge of or was responsible to the accused company for the conduct of its business. This is in consonance with strict interpretation of penal statutes, especially, where such statutes create vicarious liability. A company may have a number of Directors and to make any or all the Directors as accused in a complaint merely on the basis of a statement that they are in-charge of and responsible for the conduct of the business of the company without anything more is not a sufficient or adequate fulfillment of the requirements under Section 141. 

11) In a catena of decisions, this Court has held that for making Directors liable for the offences committed by the company under Section 141 of the Act, there must be specific averments against the Directors, showing as to how and in what manner the Directors were responsible for the conduct of the business of the company. 

12) In the light of the above provision and the language used therein, let us, at the foremost, examine the complainta filed by National Small Industries Corporation Limited and the DCM Financial Services Ltd. In the case of National Small Industries Corpn. Ltd., the High Court has reproduced the entire complaint in the impugned order and among other clauses, clause 8 is relevant for our consideration which reads as under: 

8. That the accused No. 2 is the Managing Director and accused No. 3 is the Director of the accused company. The accused No. 2 and 3 are the in-charge and responsible for the conduct of the business of the company accused No. 1 and hence are liable for the offences. 

13) In the case of DCM Financial Services Ltd., in complaint- Annexure-P2 the relevant clause is 13 which reads as under: 

13. That the accused No. 1 is a Company/Firm and the accused Nos. 2 to 9 were in charge and were responsible to the accused No. 1 for the conduct of the business to the accused No. 1 at the time when offence was committed. Hence, the accused Nos. 2 to 9 in addition to the accused No. 1, are liable to be prosecuted and punished in accordance with law by this Hon'ble Court as provided by section 141 of the N.I. Act, 1881. Further the offence has been committed by the accused No. 1 with the consent and connivance of the accused Nos. 2 to 9. 

14) Now, let us consider whether the abovementioned complaint in both cases has satisfied the necessary ingredients to attract Section 141 insofar as the respondents, namely, Directors of the company are concerned. Section 141 of the Act has been interpreted by this Court in various decisions. As to the scope of Section 141 of the Act, a three-Judge Bench of this Court considered the following questions which had been referred to it by a two-Judge Bench of this Court in SMS Pharmaceuticals vs. Neeta Bhalla and Anr. (2005) 8 SCC 89: 

(a) Whether for purposes of Section 141 of the Negotiable Instruments Act, 1881, it is sufficient if the substance of the allegation read as a whole fulfil the requirements of the said section and it is not necessary to specifically state in the complaint that the person accused was in charge of, or responsible for, the conduct of the business of the company. 

(b) Whether a director of a company would be deemed to be in charge of, and responsible to, the company for conduct of the business of the company and, therefore, deemed to be guilty of the offence unless he proves to the contrary. 

(c) Even if it is held that specific averments are necessary, whether in the absence of such averments the signatory of the cheque and or the managing directors or joint managing director who admittedly would be in charge of the company and responsible to the company for conduct of its business could be proceeded against. 

While considering the above questions, this Court held as under: 

18. To sum up, there is almost unanimous judicial opinion that necessary averments ought to be contained in a complaint before a person can be subjected to criminal process. A liability under Section 141 of the Act is sought to be fastened vicariously on a person connected with a company, the principal accused being the company itself. It is a departure from the rule in criminal law against vicarious liability. A clear case should be spelled out in the complaint against the person sought to be made liable. Section 141 of the Act contains the requirements for making a person liable under the said provision. That the respondent falls within the parameters of Section 141 has to be spelled out. A complaint has to be examined by the Magistrate in the first instance on the basis of averments contained therein. If the Magistrate is satisfied that there are averments which bring the case within Section 141, he would issue the process. We have seen that merely being described as a director in a company is not sufficient to satisfy the requirement of Section 141. Even a non-director can be liable under Section 141 of the Act. The averments in the complaint would also serve the purpose that the person sought to be made liable would know what is the case which is alleged against him. This will enable him to meet the case at the trial. 

19. In view of the above discussion, our answers to the questions posed in the reference are as under: 

(a) It is necessary to specifically aver in a complaint under Section 141 that at the time the offence was committed, the person accused was in charge of, and responsible for the conduct of business of the company. This averment is an essential requirement of Section 141 and has to be made in a complaint. Without this averment being made in a complaint, the requirements of Section 141 cannot be said to be satisfied. 

(b) The answer to the question posed in sub-para (b) has to be in the negative. Merely being a director of a company is not sufficient to make the person liable under Section 141 of the Act. A director in a company cannot be deemed to be in charge of and responsible to the company for the conduct of its business. The requirement of Section 141 is that the person sought to be made liable should be in charge of and responsible for the conduct of the business of the company at the relevant time. This has to be averred as a fact as there is no deemed liability of a director in such cases. 

(c) The answer to Question (c) has to be in the affirmative. The question notes that the managing director or joint managing director would be admittedly in charge of the company and responsible to the company for the conduct of its business. When that is so, holders of such positions in a company become liable under Section 141 of the Act. By virtue of the office they hold as managing director or joint managing director, these persons are in charge of and responsible for the conduct of business of the company. Therefore, they get covered under Section 141. So far as the signatory of a cheque which is dishonoured is concerned, he is clearly responsible for the incriminating act and will be covered under sub-section (2) of Section 141. 

Therefore, this Court has distinguished the case of persons who are in-charge of and responsible for the conduct of the business of the company at the time of the offence and the persons who are merely holding the post in a company and are not in-charge of and responsible for the conduct of the business of the company. Further, in order to fasten the vicarious liability in accordance with Section 141, the averment as to the role of the concerned Directors should be specific. The description should be clear and there should be some unambiguous allegations as to how the concerned Directors were alleged to be in- charge of and was responsible for the conduct and affairs of the company. 

15) In Sabitha Ramamurthy vs. R.B.S. Channabasavaradhya, (2006) 10 SCC 581, this Court while dealing with the same issue observed as under: ......It may be true that it is not necessary for the complainant to specifically reproduce the wordings of the section but what is required is a clear statement of fact so as to enable the court to arrive at a prima facie opinion that the accused are vicariously liable. Section 141 raises a legal fiction. By reason of the said provision, a person although is not personally liable for commission of such an offence would be vicariously liable therefor. Such vicarious liability can be inferred so far as a company registered or incorporated under the Companies Act, 1956 is concerned only if the requisite statements, which are required to be averred in the complaint petition, are made so as to make the accused therein vicariously liable for the offence committed by the company. Before a person can be made vicariously liable, strict compliance with the statutory requirements would be insisted. Not only the averments made in para 7 of the complaint petitions do not meet the said statutory requirements, the sworn statement of the witness made by the son of the respondent herein, does not contain any statement that the appellants were in charge of the business of the Company. In a case where the court is required to issue summons which would put the accused to some sort of harassment, the court should insist strict compliance with the statutory requirements. In terms of Section 200 of the Code of Criminal Procedure, the complainant is bound to make statements on oath as to how the offence has been committed and how the accused persons are responsible therefor. In the event, ultimately, the prosecution is found to be frivolous or otherwise mala fide, the court may direct registration of case against the complainant for mala fide prosecution of the accused. The accused would also be entitled to file a suit for damages. The relevant provisions of the Code of Criminal Procedure are required to be construed from the aforementioned point of view. 

16) In Saroj Kumar Poddar vs. State (NCT of Delhi) (2007) 3 SCC 693, while following SMS Pharmaceuticals case (supra) and Sabhita Ramamurthy case (supra), this Court held that with a view to make the Director of a company vicariously liable for the acts of the company, it was obligatory on the part of the complainant to make specific allegations as are required under the law and under Section 141 of the Act and further held that in the absence of such specific averments in the complaint showing as to how and in what manner the Director is liable, the complaint should not be entertained. The relevant portion of the judgment is reproduced hereinbelow:- 

12. A person would be vicariously liable for commission of an offence on the part of a company only in the event the conditions precedent laid down therefor in Section 141 of the Act stand satisfied. For the aforementioned purpose, a strict construction would be necessary. 

13. The purported averments which have been made in the complaint petitions so as to make the appellant vicariously liable for the offence committed by the Company read as under: That Accused 1 is a public limited company incorporated and registered under the Companies Act, 1956, and Accused 2 to 8 are/were its Directors at the relevant time and the said Company is managed by the Board of Directors and they are responsible for and in charge of the conduct and business of the Company, Accused 1. However, cheques referred to in the complaint have been signed by Accused 3 and 8 i.e. Shri K.K. Pilania and Shri N.K. Munjal for and on behalf of Accused 1 Company. 

14. Apart from the Company and the appellant, as noticed hereinbefore, the Managing Director and all other Directors were also made accused. The appellant did not issue any cheque. He, as noticed hereinbefore, had resigned from the directorship of the Company. It may be true that as to exactly on what date the said resignation was accepted by the Company is not known, but, even otherwise, there is no averment in the complaint petitions as to how and in what manner the appellant was responsible for the conduct of the business of the Company or otherwise responsible to it in regard to its functioning. He had not issued any cheque. How he is responsible for dishonour of the cheque has not been stated. The allegations made in para 3, thus, in our opinion do not satisfy the requirements of Section 141 of the Act. 

17) In a subsequent decision in N.K. Wahi vs. Shekhar Singh & Ors., (2007) 9 SCC 481 while following the precedents of SMS Pharmaceuticals's case (supra), Sabhita Ramamurthy's case (supra) and Saroj Kumar Poddar's case (supra), this Court reiterated that for launching a prosecution against the alleged Directors, there must be a specific allegation in the complaint as to the part played by them in the transaction. The relevant portion of the judgment is as under: 

7. This provision clearly shows that so far as the companies are concerned if any offence is committed by it then every person who is a Director or employee of the company is not liable. Only such person would be held liable if at the time when offence is committed he was in charge and was responsible to the company for the conduct of the business of the company as well as the company. Merely being a Director of the company in the absence of above factors will not make him liable. 

8. To launch a prosecution, therefore, against the alleged Directors there must be a specific allegation in the complaint as to the part played by them in the transaction. There should be clear and unambiguous allegation as to how the Directors are in-charge and responsible for the conduct of the business of the company. The description should be clear. It is true that precise words from the provisions of the Act need not be reproduced and the court can always come to a conclusion in facts of each case. But still, in the absence of any averment or specific evidence the net result would be that complaint would not be entertainable. 

18) The said issue again came up for consideration before a three-Judge Bench of this Court recently in Ramraj Singh vs. State of M.P. & Anr. (2009) 6 SCC 729. In this case, the earlier decisions were also considered in detail. Following the decisions of SMS Pharmaceuticals' case (supra), Sabhita Ramamurthy's case (supra), Saroj Kumar Poddar's case (supra) and N.K. Wahi's case (supra) this Court held that it is necessary to specifically aver in a complaint under Section 141 that at the time when the offence was committed, the person accused was in-charge of, and responsible for the conduct of the business of the company. Furthermore, it held that vicarious liability can be attributed only if the requisite statements, which are required to be averred in the complaint petition, are made so as to make the accused/Director therein vicariously liable for the offence committed by the company. It was further held that before a person can be made vicariously liable, strict compliance of the statutory requirements would be insisted. Thus, the issue in the present case is no more res integra and has been squarely covered by the decisions of this Court referred above. It is submitted that the aforesaid decisions of this Court have become binding precedents. 

19) In the case of second SMS Pharmaceuticals vs. Neeta Bhalla, (2007) 4 SCC 70, this Court has categorically held that there may be a large number of Directors but some of them may not assign themselves in the management of the day-to-day affairs of the company and thus are not responsible for the conduct of the business of the company. 

Para 20 of the said judgment is relevant which is reproduced hereunder:- 

20. The liability of a Director must be determined on the date on `which the offence is committed. Only because Respondent 1 herein was a party to a purported resolution dated 15-2-1995 by itself does not lead to an inference that she was actively associated with the management of the affairs of the Company. This Court in this case has categorically held that there may be a large number of Directors but some of them may not associate themselves in the management of the day-to-day affairs of the Company and, thus, are not responsible for the conduct of the business of the Company. The averments must state that the person who is vicariously liable for commission of the offence of the Company both was in charge of and was responsible for the conduct of the business of the Company. Requirements laid down therein must be read conjointly and not disjunctively. When a legal fiction is raised, the ingredients therefor must be satisfied. 

20) Relying on the judgment of this Court in Everest Advertising Pvt. Ltd. vs. State Govt. of NCT of Delhi & Ors., (2007) 5 SCC 54, learned counsel for the appellants argued that this Court has not allowed the recalling of summons in a criminal complaint filed under sections 138 and 141. However, a perusal of the judgment would reveal that this case was of recalling of summons by the Magistrate for which the Magistrate had no jurisdiction. Further, para 22 of the judgment would reveal that in the complaint allegations have not only been made in terms of the wordings of section but also at more than one place, it has categorically been averred that the payments were made after the meetings held by and between the representative of the Company and accused nos. 1 to 5 which would include Respondent Nos. 2 and 3. In para 23, this Court concluded that it is therefore, not a case where having regard to the position held by the said respondents in the Company, they could plead ignorance of the entire transaction. Furthermore, this Court has relied upon S.M.S. Pharamaceutical's case (three-Judge Bench) (supra), Saroj Kumar Poddar's case (supra) and N.K. Wahi's case (supra). 

21) Relying on the judgment of this Court in N. Rangachari vs. Bharat Sanchar Nigam Ltd., (2007) 5 SCC 108, learned counsel for the appellants further contended that a payee of cheque that is dishonoured can be expected to allege is that the persons named in the complaint are in-charge of its affairs and the Directors are prima facie in that position. However, it is pertinent to note that in this case it was specifically mentioned in the complaint that (i) accused no. 2 was a director and in charge of and responsible to the accused Company for the conduct of its business; and (ii) the response of accused no. 2 to the notice issued by BSNL that the said accused is no longer the Chairman or Director of the accused Company was false and by not keeping sufficient funds in their account and failing to pay the cheque amount on service of the notice, all the accused committed an offence. Therefore, this decision is clearly distinguishable on facts as in the said case necessary averments were made out in the complaint itself. Furthermore, this decision does not and could not have overruled the decisions in S.M.S. Pharmaceutical's case (three-Judge Bench)(supra), Ramraj Singh's case (three-Judge Bench)(supra), Saroj Kumar Poddar's case (supra) and N.K. Wahi's case (supra) wherein it is clearly held that specific averments have to be made against the accused Director. 

22) Learned counsel for the appellants after elaborately arguing the matter, by inviting our attention to Paresh P. Rajda vs. State of Maharashtra & Anr., (2008) 7 SCC 442 contended that a departure/digression has been made by the Court in the case of N. Rangachari vs. BSNL (supra). However, in this case also the Court has observed in para 4 that the High Court had noted that an overall reading of the complaint showed that specific allegations had been leveled against the accused as being a responsible officer of the accused Company and therefore, equally liable. In fact, the Court recorded the allegations in the complaint that the Complainant knew all the accused and that accused no. 1 was the Chairman of the accused Company and was responsible for day to day affairs of the Company. This Court though has only noted the decision in N. Rangachari's case (supra) and observed that an observation therein showed a slight departure vis-`-vis the other judgments (i.e. S.M.S. Pharmaceuticals first case and S.M.S. Pharmaceutical's second case), but then Court went on to record that in N.K. Wahi's case (supra) this Court had reiterated the view in S.M.S. Pharmaceutical's case (supra). The Court then concluded in para 11 that it was clear from the aforequoted judgments that the entire matter would boiled down to an examination of the nature of averments made in the complaint. On facts, the Court found necessary averments had been made in the complaint. 

23) Though, the learned counsel for the appellants relying on a recent decision in K.K. Ahuja vs. V.K. Vora & Anr., (2009) 10 SCC 48, it is clearly recorded that in the complaint it was alleged that the accused were in-charge of and was responsible for the conduct of the day-to-day business of the accused Company and further all the accused were directly and actively involved in the financial dealings of the Company and the same was also reiterated in the pre-summoning evidence. Furthermore, this decision also notes that it is necessary to specifically aver in a complaint that the person accused was in-charge of and responsible for the conduct of the business of the Company. After noting Saroj Kumar Poddar's case (supra) and N.K. Wahi's case (supra), this Court further noted in para 9 that ......the prevailing trend appear to require the Complainant to state how a Director who is sought to be made an accused, was in-charge of the business of the Company, as every Director need not be and is not in-charge of the business of the Company...... In Para 11, this Court has further recorded that .....When conditions are prescribed for extending such constructive criminal liability to others, courts will insist upon strict literal compliance. There is no question of inferential or implied compliance. Therefore, a specific averment complying with the requirements of Section 141 is imperative... Though the Court then said that an averment in the complaint that the accused is a Director and in-charge of and responsible for the conduct of the business may be sufficient but this would not take away from the requirement that an overall reading of the complaint has to be made to see whether the requirements of Section 141 have been made out against the accused Director or not. Furthermore, this decision cannot be said to have overruled the various decisions of this Court. 

24) Section 291 of the Companies Act provides that subject to the provisions of that Act, the Board of Directors of a company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorized to exercise and do. A company, though a legal entity, can act only through its Board of Directors. The settled position is that a Managing Director is prima facie in-charge of and responsible for the company's business and affairs and can be prosecuted for offences by the company. But insofar as other Directors are concerned, they can be prosecuted only if they were in-charge of and responsible for the conduct of the business of the company. A combined reading of Sections 5 and 291 of Companies Act, 1956 with the definitions in clauses 24, 26, 30, 31 and 45 of Section 2 of that Act would show that the following persons are considered to be the persons who are responsible to the company for the conduct of the business of the company: 

(a) the Managing Director/s; 

(b) the whole-time Director/s; 

(c) the Manager; 

(d) the Secretary; 

(e) any person in accordance with whose directions or instructions the Board of Directors of the company is accustomed to act; 

(f) any person charged by the Board of Directors with the responsibility of complying with that provision; Provided that the person so charged has given his consent in this behalf to the Board; 

(g) where any company does not have any of the officers specified in clauses (a) to (c), any director or directors who may be specified by the Board in this behalf or where no director is so specified, all the directors: Provided that where the Board exercises any power under clause (f) or clause (g), it shall, within thirty days of the exercise of such powers, file with the Registrar a return in the prescribed form. 

But if the accused is not one of the persons who falls under the category of persons who are responsible to the company for the conduct of the business of the company then merely by stating that he was in-charge of the business of the company or by stating that he was in- charge of the day-to-day management of the company or by stating that he was in-charge of, and was responsible to the company for the conduct of the business of the company, he cannot be made vicariously liable under Section 141(1) of the Act. To put it clear that for making a person liable under Section 141(2), the mechanical repetition of the requirements under Section 141(1) will be of no assistance, but there should be necessary averments in the complaint as to how and in what manner the accused was guilty of consent and connivance or negligence and therefore, responsible under sub-section (2) of Section 141 of the Act. 

25) From the above discussion, the following principles emerge : 

(i) The primary responsibility is on the complainant to make specific averments as are required under the law in the complaint so as to make the accused vicariously liable. For fastening the criminal liability, there is no presumption that every Director knows about the transaction. 

(ii) Section 141 does not make all the Directors liable for the offence. The criminal liability can be fastened only on those who, at the time of the commission of the offence, were in charge of and were responsible for the conduct of the business of the company. 

(iii) Vicarious liability can be inferred against a company registered or incorporated under the Companies Act, 1956 only if the requisite statements, which are required to be averred in the complaint/petition, are made so as to make accused therein vicariously liable for offence committed by company along with averments in the petition containing that accused were in-charge of and responsible for the business of the company and by virtue of their position they are liable to be proceeded with. 

(iv) Vicarious liability on the part of a person must be pleaded and proved and not inferred. 

(v) If accused is Managing Director or Joint Managing Director then it is not necessary to make specific averment in the complaint and by virtue of their position they are liable to be proceeded with. 

(vi) If accused is a Director or an Officer of a company who signed the cheques on behalf of the company then also it is not necessary to make specific averment in complaint. 

(vii) The person sought to be made liable should be in- charge of and responsible for the conduct of the business of the company at the relevant time. This has to be averred as a fact as there is no deemed liability of a Director in such cases.

Scope of Winding Up Proceedings : The Law

Justice Kapadia

The Bench comprising Chief Justice S.H. Kapadia and K.S. Radhakrishnan, in M/s IBA Health (I) Pvt. Ltd. v. M/s Info-Drive Systems SDN. BHD. has examined the scope of jurisdiction of courts in winding up proceedings. While examining various precedents on the subject, the court held as under;

SUBSTANTIAL DISPUTE - AS TO LIABILITY 

17. The question that arises for consideration is that when there is a substantial dispute as to liability, can a creditor prefer an application for winding up for discharge of that liability? In such a situation, is there not a duty on the Company Court to examine whether the company has a genuine dispute to the claimed debt? A dispute would be substantial and genuine if it is bona fide and not spurious, speculative, illusory or misconceived. The Company Court, at that stage, is not expected to hold a full trial of the matter. It must decide whether the grounds appear to be substantial. The grounds of dispute, of course, must not consist of some ingenious mask invented to deprive a creditor of a just and honest entitlement and must not be a mere wrangle. It is settled law that if the creditor's debt is bona fide disputed on substantial grounds, the court should dismiss the petition and leave the creditor first to establish his claim in an action, lest there is danger of abuse of winding up procedure. The Company Court always retains the discretion, but a party to a dispute should not be allowed to use the threat of winding up petition as a means of forcing the company to pay a bona fide disputed debt. 

18. In this connection, reference may be made to the judgment of this Court in Amalgamated Commercial Traders (P) Ltd. v. A.C.K. Krishnaswami and another (1965) 35 Company Cases 456 (SC), in which this Court held that "It is well-settled that a winding up petition is not a legitimate means of seeking to enforce payment of the debt which is bona fide disputed by the company. A petition presented ostensibly for a winding up order but really to exercise pressure will be dismissed, and under circumstances may be stigmatized as a scandalous abuse of the process of the court." 

19. The above mentioned decision was later followed by this Court in Madhusudan Gordhandas and Co. v. Madhu Woollen Industries Pvt. Ltd. 1971) 3 SCC 632. The principles laid down in the above mentioned judgment have again been reiterated by this Court in Mediquip Systems (P) Ltd. v. Proxima Medical Systems (GMBH) (2005) 7 SCC 42, wherein this Court held that the defence raised by the appellant-company was a substantial one and not mere moonshine and had to be finally adjudicated upon on the merits before the appropriate forum. The above mentioned judgments were later followed by this Court in Vijay Industries v. NATL Technologies Ltd. (2009) 3 SCC 527. 

20. The principles laid down in the above mentioned cases indicate that if the debt is bona fide disputed, there cannot be "neglect to pay" within the meaning of Section 433(1)(a) of the Companies Act, 1956. If there is no neglect, the deeming provision does not come into play and the winding up on the ground that the company is unable to pay its debts is not substantiated and non-payment of the amount of such a bona fide disputed debt cannot be termed as "neglect to pay" so as to incur the liability under Section 433(e) read with Section 434(1)(a) of the Companies Act, 1956. 

COMMERCIALLY SOLVENT 

21. Appellant company raised a contention that it is commercially solvent and, in such a situation, the question may arise that the factum of commercial solvency, as such, would be sufficient to reject the petition for winding up, unless substantial grounds for its rejection are made out. A determination of examination of the company's insolvency may be a useful aid in deciding whether the refusal to pay is a result of the bona fide dispute as to liability or whether it reflects an inability to pay, in such a situation, solvency is relevant not as a separate ground. If there is no dispute as to the company's liability, the solvency of the company might not constitute a stand alone ground for setting aside a notice under Section 434 (1)(a), meaning thereby, if a debt is undisputedly owing, then it has to be paid. If the company refuses to pay on no genuine and substantial grounds, it should not be able to avoid the statutory demand. The law should be allowed to proceed and if demand is not met and an application for liquidation is filed under Section 439 in reliance of the presumption under Section 434(1)(a) that the company is unable to pay it debts, the law should take its own course and the company of course will have an opportunity on the liquidation application to rebut that presumption. 

22. An examination of the company's solvency may be a useful aid in determining whether the refusal to pay debt is a result of a bona fide dispute as to the liability or whether it reflects an inability to pay. Of course, if there is no dispute as to the company's liability, it is difficult to hold that the company should be able to pay the debt merely by proving that it is able to pay the debts. If the debt is an undisputedly owing, then it should be paid. If the company refuses to pay, without good reason, it should not be able to avoid the statutory demand by proving, at the statutory demand stage, that it is solvent. In other words, commercial solvency can be seen as relevant as to whether there was a dispute as to the debt, not as a ground in itself, that means it cannot be characterized as a stand alone ground. 

MALICIOUS PROCEEDINGS FOR WINDING UP 

25. We may notice, so far as this case is concerned, there has been an attempt by the respondent company to force the payment of a debt which the respondent company knows to be in substantial dispute. A party to the dispute should not be allowed to use the threat of winding up petition as a means of enforcing the company to pay a bona fide disputed debt. A Company Court cannot be reduced as a debt collecting agency or as a means of bringing improper pressure on the company to pay a bona fide disputed debt. Of late, we have seen several instances, where the jurisdiction of the Company Court is being abused by filing winding up petitions to pressurize the companies to pay the debts which are substantially disputed and the Courts are very casual in issuing notices and ordering publication in the newspapers which may attract adverse publicity. 

Remember, an action may lie in appropriate Court in respect of the injury to reputation caused by maliciously and unreasonably commencing liquidation proceedings against a company and later dismissed when a proper defence is made out on substantial grounds. A creditor's winding up petition implies insolvency and is likely to damage the company's creditworthiness or its financial standing with its creditors or customers and even among the public. 

PUBLIC POLICY CONSIDERATIONS 

26. A creditor's winding up petition, in certain situations, implies insolvency or financial position with other creditors, banking institutions, customers and so on. Publication in the Newspaper of the filing of winding up petition may damage the creditworthiness or 20 financial standing of the company and which may also have other economic and social ramifications. Competitors will be all the more happy and the sale of its products may go down in the market and it may also trigger a series of cross-defaults, and may further push the company into a state of acute insolvency much more than what it was when the petition was filed. The Company Court, at times, has not only to look into the interest of the creditors, but also the interests of public at large. 

27. We have referred to the above aspects at some length to impress upon the Company Courts to be more vigilant so that its medium would not be misused. A Company Court, therefore, should act with circumspection, care and caution and examine as to whether an attempt is made to pressurize the company to pay a debt which is substantially disputed. A Company Court, therefore, should be guarded from such vexatious abuse of the process and cannot function as a Debt Collecting Agency and should not permit a party to unreasonably set the law in motion, especially when the aggrieved party has a remedy elsewhere.