Why startups rarely wind up legal entity even when they shut operations
The year gone by has been tough for startups. As investors became more driven by profit and unit economics, many emerging companies had to figure out ways to ace up their game, deliver and survive, or to shut down.
An analysis by Techcircle.in revealed that at least 32 well-funded technology startups shut down their operations in the first 11 months of 2016. These shutdowns happened in sectors such as logistics, hyperlocal, food technology, e-commerce, Internet of Things and education technology, for reasons like lack of funding, market saturation and lack of customers.
When founders shut down the operations of a company, they do not necessarily close down the legal entity they were operating through. So how can a company wind up for good?
What is winding up?
In a winding up process, also called 'liquidation', all assets of a business are disposed, creditors are paid, and any remaining assets or proceeds are distributed to shareholders. The last stage is termed 'dissolution', where the juristic identity of the company ceases to exist.
According to Indian law, to completely dissolve itself, a company must submit an application to the Registrar of Companies (RoC) to remove its name from the register of companies.
In a recent development, the Ministry of Corporate Affairs issued a notification dated 26 December 2016 notifying Section 248 to 252 of the Companies Act, 2013 with regard to the removal of names from the register of companies.
Any company that wants to remove its name from the register of companies can apply in Form STK-2 pursuant to Section 248(2) of the Companies Act, 2013 and Rule 4(1) of the Companies (Removal of Names of Companies from the Register of Companies) Rules, 2016 along with filing fees of Rs 5,000, if: the company has extinguished all its liabilities and passed a special resolution to this effect; the company has failed to commence its business within one year of its incorporation; or the company is not carrying on any business or operation for a period of two immediately preceding financial years and has not made any application within such period for obtaining the status of a dormant company.
Such an application shall be accompanied with documents, including an indemnity bond from the director in Form STK-3; a statement of accounts certified by a chartered accountant; an affidavit from the director in Form STK-4; a special resolution duly signed by every director of the company; and a statement regarding pending litigations, if any, involving the company.
If the RoC is satisfied with the application, it will remove the company's name and shall publish a notice in the Official Gazette, following which the company shall stand dissolved.
The process is easy, less cumbersome, inexpensive and time-efficient. But the company can still be restored on certain grounds even after the name has been removed from the ROC, thus reviving liabilities.
Voluntary winding up
In voluntary winding up, the intervention of the courts is limited, and comes essentially at the time of obtaining the final order for dissolution. A company may be wound up voluntarily, if shareholders pass a resolution in a general meeting giving effect to the same. The provisions of voluntary winding up are governed by Sections 484-520 of the Companies Act, 1956 (Sections 304-323 of the Companies Act 2013, which are yet to be notified).
A company has to follow the following process when winding up its operations:
- A declaration of solvency, which is an affirmation that the company has enough assets to pay its debts in full in a specified period not exceeding three years from the commencement of winding up must be made by a majority of directors and filed with the RoC. This must be submitted along with a copy of profit and loss and balance sheet reports, and also a statement of assets and liabilities.
- An advertisement needs to be placed in the Official Gazette and also in some newspapers circulated in the district where the registered office of the company is situated.
- Appointment of liquidator and fixing his remuneration.
- Cessation of the Board's power on appointment of liquidator.
- Sending the notice of appointment of liquidator to the RoC.
- The liquidator has to make an account of the winding up proceedings and lay the same before the final meeting and send the same to Official Liquidator and RoC.
- The Official Liquidator, on being satisfied, has to file a report stating that the affairs of the company have not been conducted in a manner prejudicial to the interest of the members or to public interest with the concerned court (under the Companies Act, 1956)/Tribunal (under the Companies Act, 2013) and then from the date of the submission of such report, the company shall be deemed to be dissolved.
However, the process is time consuming, taking an estimated one to two years. It is expensive as compared to the fast-track exit mode. It is difficult to carry out the process smoothly as there are many parties involved such as the liquidator, official liquidator and court/tribunal. Further, there is a temporary loss of control over the company's assets as there is cessation of the Board's power on appointment of the liquidator.
So, why do startup founders who have shuttered operations choose to keep the legal entity of their enterprises?
The long process, paper work and costs involved in the closure are the main reasons why several companies remain dormant. In some instances, many entrepreneurs continue to run companies on paper, filing tax returns and preparing annual reports every year, even if it is no longer operational.
Roma Priya is a legal adviser and founder of Burgeon BizSupport LLP, which offers legal advisory services to startups.