TMI Blog1968 (11) TMI 63X X X X Extracts X X X X X X X X Extracts X X X X ..... onth after they had restarted the mills as in the beginning at any rate they were genuinely interested in working the mills and implementing the scheme unless of course the allegation that Jhunjhunwalas were their nominees was true. But, as the appeal court has rightly said, no proof was offered in support of that allegation. It was not as if the mills had to be worked even if their working resulted in loss. Assuming that the Jalans were under an obligation to bring in finance including their own monies, they could not be said to be under an obligation to bring in finance even if the working of the mills showed no reasonable prospect of profit. If the mills could not be worked except at a loss the company would be justified in ceasing to work them. The very object of the company being to manufacture cloth, if the mills had to be closed that would mean that the very object for which the company existed and which also was the assumption on which the scheme was framed ceased to exist. The claim urged on behalf of schedule 'B' creditors that they had a charge irrespective of the proposed mortgage and were entitled to be treated as secured creditors cannot therefore be upheld.Ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d execute a second legal mortgage of its fixed and other assets in favour of the J. K. group and certain other unsecured creditors named in schedule 'B' to the agreement in consideration of which those creditors agreed not to claim interest at more than % and not to demand repayment of their debts except in the manner set out in the agreement and schedule 'C' thereto, and that the transactions therein contained should be completed within one month from the date when the said petition would be withdrawn. The agreement recorded that the debts due to schedule 'B' creditors amounted to Rs. 48.28 lakhs. Schedule 'C' to the agreement contained the terms to be included in the second mortgage to be executed by the company. Term 3 provided that the said Rs. 48.28 lakhs were to be repaid two years after the date of the said mortgage by annual instalments of an amount equal to 50 per cent, of the profits made by the company or Rs. 6.50 lakhs, whichever was lower, provided, however, that in any event the whole debt should be paid off by June 30, 1980. Term 4( a ) provided that in the event of the assets secured under the second mortgage being damaged or impaired or the first mortgagees enforc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by Rs. 5 lakhs. To remove the bank's objection the Jalans had, therefore, to make an immediate financial arrangement. On February 14, 1966, an agreement between the company (still under the old management), the Jalans and Sushil Investment (P.) Ltd., a company under the control of the Jalans, was made whereunder Sushil Company agreed to pay off the said cash credit accounts and also to pay Rs. 5 lakhs against the said term loan, in all Rs. 23 lakhs. On so doing the bank was to release the assets hypothecated with it and the company was to hypothecate such assets in favour of Sushil Company. Sushil Company also agreed to finance the company to the extent of Rs. 40 lakhs including the said Rs. 23 lakhs on the company hypothecating cotton cloth, yarn and other movable assets in its favour, and the Jalans giving their personal guarantee. This agreement under which the company agreed to hypothecate all its movable assets together with term 4( d ) and ( e ) of schedule 'C' to the agreement of August 16, 1965, shows that it was understood between the parties that the Jalans were entitled to procure finance on the security of the company's assets, both fixed and movable, and that such se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oration, the Collector of Sales Tax, the Commissioner of Income-tax, the Bombay Port Trust, the Collector of Bombay, the Life Insurance Corporation, the Employees' State Insurance Corporation, the workers, their co-operative society, and, lastly, the Tata Power Company Ltd. These were to be paid off within the time specified against their names. Category 3 creditors were 15 in number and were the suppliers of cotton and to whom Rs. 6.84 lakhs were due. These were to be paid off in certain instalments, the first instalment being 37% of the debt, payable within 90 days from the date of sanctioning of the scheme. Category 4 creditors whose claims were Rs. 1,000 or less were to be paid off within 90 days after the sanction of the scheme. Creditors whose claims were above Rs. 1,000, the total of whose debts amounted to Rs. 33.70 lakhs, were to be paid off by 8 equal annual instalments, the first instalment being 12 % payable within 90 days from the sanctioning of the scheme. Clause (3) of the scheme referred to the said agreement dated October 18, 1965. Lastly, clause (4) provided that the Jalans "will provide the necessary finance required for running the mills". Except for c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ayment in full to category 2 creditors and for payment of the first instalment to categories 3 and 4( a ) and ( b ) creditors. It is undisputed that the company made these payments. What remained, therefore, to be implemented were the following : ( i ) the execution of the second mortgage or the debenture trust deed, ( ii ) the transfer of the said investment shares and ( iii ) providing finance for working the mills. Regarding the second mortgage, it appears that after the draft was sent for Singhania's approval a dispute arose between the parties regarding interest payable on Rs. 4813 lakhs due to the schedule 'B' creditors, the Singhanias claiming the original interest chargeable on advances made by them until the execution of the second mortgage and the Jalans replying that interest at % only was payable from August 16, 1965, the date of the agreement between them and the J. K. group. Despite the controversy, the company applied on September 27, 1966, to the Controller of Capital Issues for sanctioning the debenture trust deed. It appears that along with the application the company had to send a Treasury chalan for Rs. 50, that though a chalan was despatched, it was under a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... true, the said alleged acts were of certain individuals, that the company's obligation was not affected thereby and that the proper remedy was to take proceedings against those individuals. As regards the said investment shares, the company got those shares released and handed them over to J. K. (Bombay) (P.) Ltd. but failed to hand over the transfer deeds therefor. There can, therefore, be no doubt that the company failed to implement this part of its obligation. As regards the implementation of clause (4) of the scheme, the Jalans, as aforesaid, entered into an arrangement with Sushil Co., to which the J. K. group were parties, under which Sushil Co. gave loans totalling Rs. 43 lakhs including Rs. 23 lakhs paid to the bank. This arrangement was evidently made as monies were immediately required to pay to the bank, without which the bank's objection to the scheme could not be removed and also because it would not presumably have been possible to have further dealings with the bank. After the initial difficulties with the bank were thus got over, fresh negotiations were started with the bank and an arrangement was made whereunder the bank agreed to advance Rs. 50 lakhs provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lakhs, however, remained with the company presumably for meeting immediate payments under the scheme, the expenses needed to restart the mills and for other urgent purposes. The company obtained from the bank an advance of Rs. 25 lakhs on the provisional guarantee of the State Government and subsequently a further advance of Rs. 20 lakhs on a further charge over its fixed assets. It was contended that though the company obtained Rs. 45 lakhs from the bank, none of it except Rs. 2 lakhs remained with it for working the mills as out of Rs. 45 lakhs Rs. 43 lakhs were paid to Sushil Co. against the loans given by that company. That, no doubt, is true, but as a result of these transactions Rs. 20 lakhs out of Rs. 43 lakhs advanced by Sushil Co. still remained with the company, Rs. 23 lakhs only having been used to pay off the said cash credit accounts and in reducing the said term loan by Rs. 5 lakhs. It appears from the record that at this stage the new directors had before them two alternatives : (1) to continue its liability to Sushil Co. in respect of Rs. 43 lakhs or (2) to procure from the bank a loan of Rs. 50 lakhs on the guarantee of the two Governments. They obviously could not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was no binding obligation or duty undertaken by the Jalans to pay anything to the company or to compulsorily provide finance", that the company had become commercially insolvent, that no reasonable or prudent person would invest any of his monies in the company, that its capital and reserves had been wiped out, that its substratum had disappeared inasmuch as its business of manufacturing cotton cloth could no longer be carried on with profit, and, lastly, that therefore the scheme which was on the assumption that the mills could work and the company's debts would be paid from out of the profits could not be implemented. The appeal court was also of the view that the company judge was in error in giving the said directions and in dismissing the petitions for winding up. Accordingly, it allowed the appeals and ordered winding up. In doing so it rejected the contention that schedule 'B' creditors had under the scheme already become secured creditors and had priority over the other unsecured creditors, or that, in the alternative, the court should order winding up only after directing the company to execute a second mortgage in their favour and thus implement the scheme which the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... praesenti under the scheme and the said agreement of August 16, 1965. As regards financing the company, the contention was that under clause (4) of the scheme the Jalans were bound to bring in their own monies required for working the mills and that they could not contend that because they could not procure finance on the credit of or on the security of the assets of the company, their obligation was over. The company judge agreed with this view, but the appeal court, as aforesaid, took a different view and held that under clause (4) it was not as if the Jalans were bound to provide finance in all circumstances or were bound to bring in their own monies. In our view both the company judge and the appeal court took extreme views of clause (4). It is clear from the sanctioning order of Mody J. that the company at that stage was, and that fact was well-known to all concerned, commercially insolvent. A winding up petition was at that stage pending before the High Court. There were, therefore, two alternatives before the creditors, either to take the company in liquidation, in which event the creditors knew, as Mody J. has observed, that they could not be paid their dues, or to resta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d other materials knew that there was hardly any chance of their being paid, and, therefore, with few exceptions, were anxious that instead of taking the company into liquidation the mills should be restarted and their dues paid bit by bit. Thus, the assumption on which the scheme was made was that there was a possibility of running the mills successfully and that the creditors would be paid gradually out of the profits which the mills would make. In the events that have happened it is impossible to say that the Jalans had no genuine desire to work the mills or that they did not, in the initial stages at any rate, make arrangements for financing the mills. This can be seen from the arrangement made with Sushil Co., their bringing the mills' machinery in working order after the mills had remained closed for nearly 8 months and their arrangement with the bank and the two Governments for a loan of Rs. 50 lakhs. It is true, as pointed out by Mr. Sen, that out of Rs. 45 lakhs received from the bank, Rs. 43 lakhs were utilised for paying off Sushil Co. leaving only Rs. 2 lakhs therefrom as working capital. But, as already stated, they had to have the assets pledged with Sushil Co. re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wn goods, that after entering into the said agreement the company had in 1966-67 paid Rs. 21.77 lakhs for processing its own goods and in the bargain got only Rs. 50,000 a month. On these figures it was urged that whereas the company earned a profit of Rs. 17 lakhs in 1964-65, it incurred a loss of a like amount in 1966-67 as a result of the aforesaid bargain. On these figures only the company judge directed the company to terminate the said agreement. The figures were, however, misleading because Rs. 17.12 lakhs were the gross receipts and not net profits. Before arriving at net profits, cost of raw materials, labour, depreciation, etc., had to be worked out and then only a true picture of the working of the unit would emerge. Besides, the figure of Rs. 17 lakhs does not take into account the cost of processing of the company's goods and whether that had resulted in profit. This is important when it is remembered that the company paid Rs. 21 lakhs in 1966-67 for processing its goods though Jhunjhunwalas were to charge only cost price for processing the company's goods. It was, therefore, unsafe from a few figures to jump to the conclusion that had the unit not been parted with the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a while. Not only the prices of cotton but all other stores had spiralled up partly due to devaluation of the rupee on June 6, 1966, and partly due to the stock of cotton being less than the demand and the Government's insistence to avoid unemployment that the mills should work at their full quota. As the position worsened after September, 1966, the Federation revoked its earlier policy and permitted its members to buy cotton at prices above the ceiling prices as it was realised that on the one hand the mills were not getting cotton at prices fixed by the Government and on the other they were not permitted to restrict their spindleage. Prices of cotton of almost all varieties had by this time gone up by 50% above the ceiling prices. Realising the difficult supply position the Government on December 3, 1966, directed the mills to observe one extra holiday per week and to pay lay-off compensation for such extra holiday. On December 7 , 1966, the company wrote to the Textile Commissioner that as it was not getting the requisite type of cotton it had reduced its count from 30 to 20, that till that day it had not received a single requisitioned bale, that though the dealers were direc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it their sample survey to ascertain their quality. In March, 1967, the spinning department was partially closed causing labour unrest. The cotton position in April, 1967, as explained by the company in its letter of April 25, 1967, was as follows : 1,282 bales were allotted to the company between February 15, 1967, and April 20, 1967, out of which the company took delivery of 200 bales. No survey by sample was allowed in respect of 732 bales. Survey made by the suppliers of 350 bales was challenged by the company. In respect of the balance of 250 bales, the company disputed the right of the suppliers to demand clearance charges and that dispute was referred to the Textile Commissioner. From this letter alone and without reading it in the context of the previous correspondence, the company judge concluded that though cotton was requisitioned for it the company had declined to lift it. The conclusion was neither fair nor just. It stands to reason that no purchaser would take delivery of goods unless he is satisfied from their survey that they were of the quality for which he had paid. If the suppliers declined to permit survey the company could not be accused of refusing delivery. Mr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sons beyond their control, viz., the price; rise due to devaluation which overtook them only two months after they restarted the mills, the impossibility of getting cotton at reasonable prices, and the imposition of the extra holiday which meant both loss of production and the burden of lay-off compensation. It is, therefore, not fair to say that the Jalans were responsible for the closure of the mills either on the ground of failure to lift the cotton or by their having given away the processing unit as alleged. As regards clause (4) of the scheme, we do not agree with the learned Attorney-General that the Jalans had to finance the mills from their own monies only nor with Mr. Nariman that their obligation was confined only to arranging finance on security of the company's assets. Both of them took up extreme positions with which it is not possible to agree. On the one hand sub-clauses ( d ) and ( e ) of term (4) of the said schedule 'C' clearly contemplate the right of the Jalans to arrange finance on the security of the company's assets. On the other hand, it must have been clear to them that, as the company's assets were already mortgaged and pledged, further finance would ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any judge was right in holding that the scheme could have been worked but for the defaults of Jalans, that the company judge was right in giving directions under section 392(1) compelling the Jalans and the company to implement their obligations and that no winding up order in exercise of power under section 392(2) should have been passed. We have examined the circumstances in which and the reasons why the company closed the mills and held that their closure was for reasons beyond the control of the company. As Mody J. had, while sanctioning the scheme, observed, he sanctioned it only because most of the creditors, except a few, were anxious that instead of the company being wound up, it should be given an opportunity under a new management to work so that it may pay off gradually the debts due to them by working its mills. The assumption, therefore, on which the scheme was framed was that the company could work the mills profitably and pay off its creditors from out of the profits. Therefore, it was not as if the mills had to be worked even if their working resulted in loss. Assuming that the Jalans were under an obligation to bring in finance including their own monies, they coul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... order under section 392(2) had become inevitable. By the time the appeal court passed its order, the mills having been closed since June, 1967, a huge amount had become payable as retrenchment compensation. But it was urged that assuming that a winding up order in these circum stances could be passed it had to be subject to the rights and obligations of the parties. The contention was that irrespective of the second mortgage which the company had to execute, schedule 'B' creditors had already become entitled to a charge on the company's assets. It was argued that where an agreement specifies a property out of which a debt is to be payable and is coupled with an intention to subject such property to a charge, the property becomes subject to a charge in praesenti even though a regular mortgage is to be executed at some future date. Such an intention, the learned Attorney-General argued, was demonstrated by the agreement that (1) the debts were to be paid out of profits and (2) the engagement by the company not to deal with its assets. The distinction between a charge and a mortgage is clear. While in the case of a charge there is no transfer of property or any interest therein, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which a debt is to be paid and an intention to subject it to a charge in praesenti, the court must find the charge. Certain other decisions were also brought to our notice but it is not necessary to burden this judgment with them because in each case the question which the court would have to decide would be whether the agreement in question creates a charge in praesenti. Clause (2)( ii ) of the scheme first sets out Rs. 48.13 lakhs as being due to schedule 'B' creditors and then provides that the said amount would be repaid by annual instalments of an amount equal to 50% of the profits which the company would make, such instalments commencing after two years from the date of the execution of the second mortgage. Clause (3) of the agreement of August 16, 1965, provides for the execution of the second mortgage in consideration of the said creditors agreeing to accept repayment in accordance with the terms in schedule 'C' thereto. Term 3 in schedule 'C' provides the said mode of repayment and term 4 provides that in the events there set out the debt or the balance thereof remaining unpaid would become immediately payable. In our view, neither the scheme nor the said agreement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed which was sanctioned by the court. Later on the scheme was amended and that also was sanctioned by the court. The scheme so amended provided that further calls on A and B shares should not exceed 25% which included 20% already called by the directors between the passing of the original and the amended scheme and provided further that the balance of 5% call should be payable in 5 instalments payable each half year. The directors, however, resolved that the said 5% should be paid on February 26, 1933, ignoring the amended scheme and later passed another resolution forfeiting the shares of those who failed to pay by the aforesaid date. The bank thereafter went into liquidation and the liquidator contended that the forfeitures were ultra vires the bank, being contrary to the scheme and that the names of those shareholders should be included in the list of contributories. The Privy Council held ( i ) that the amended scheme once sanctioned by the court became binding on the company, the creditors and the shareholders and its terms could be varied only by an order of the court after such variation was approved at meetings of the creditors and the shareholders ; (2) that, therefore, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he procedure thereby prescribed the absence of that individual agreement by every member of the class to be bound by the scheme which would otherwise be necessary to give it validity" (Palmer's Company Law, 20th Ed., page 664). Sub-section (2) of section 391 of the Act allows the decision of the majority prescribed therein to bind the minority of creditors and shareholders and it is for that reason that a scheme is said to have statutory operation and cannot be varied by the shareholders or the creditors unless such variation is sanctioned by the court. The effect, therefore, of a scheme between a company and its creditors is that so long as it is carried out by the company by regular payment in terms of the scheme a creditor who is bound by it cannot maintain a winding-up petition. But if the company commits a default, there is a debt presently due by the company and a petition for winding-up can be sustained at the instance of a creditor. The scheme, however, does not have the effect of creating a new debt; it simply makes the original debt payable in the manner and to the extent provided in the scheme. The proposition that a winding-up order can only be passed after compelling ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the Registrar, that is, after the operation of the scheme commences. A scheme, therefore, is not to be considered, for instance, as modifying existing special rights attached to shares unless such modification is provided for in the scheme (cf. In re Downing (T. H.) Co. [1940] 1 All ER 333; also Buckley on the Companies Acts (13th Ed.), page 411) . The contention, therefore, that the scheme becomes part of the company's constitution or of its memorandum, and, therefore, a winding-up order cannot be passed except in conformity with the altered constitution of the company, is not tenable. So long as the scheme is in operation and is binding on the company and its creditors, the rights and obligations of those on whom it is binding are undoubtedly governed by its provisions. But once the scheme is cancelled under section 392(2) on the ground that it cannot be satisfactorily worked and a winding-up order passed, such an order is deemed to be for all purposes to be one made under section 433. It is not as if because the scheme has been sanctioned under section 391 that a winding-up order under section 392(2) cannot be made. If the appellants' contention, that a winding-up or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts of the company pass under the control of the liquidator whose statutory duty is to realise them and to pay from out of the sale-proceeds its creditors. Such creditors acquire on such order being passed the right to have the assets realised and distributed among them pari passu. No new rights can thereafter be created and no uncompleted rights can be completed, for doing so would be contrary to the creditors' right to have the proceeds of the assets distributed among them pari passu. But Mr. Sen's argument was that the appellants had acquired under the scheme a vested right to have a second mortgage which could not be nullified by the court passing the winding-up order. We cannot accede to this contention for the scheme vested no such right. What it did provide was that in consideration of the company agreeing to execute a second mortgage the appellants and the other schedule "B" creditors agreed to receive repayment of debts due to them in the manner provided in the scheme and the agreement of August 16, 1965. On failure of the company to execute the mortgage the consideration for postponement of repayment failed and the monies due to those creditors became immediately payab ..... X X X X Extracts X X X X X X X X Extracts X X X X
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