Recent Trends in the Closure of Defunct Companies: Legal Procedures and Pitfalls

The rising number of businesses opting for closure reflects the profound shifts in economic and market conditions, particularly in the aftermath of the pandemic. Many enterprises face unprecedented challenges, including supply chain disruptions, changing consumer behaviour, and rising operational costs. It has been witnessed that a huge number of companies were faced with closing their business as they could not generate business which led them to be a defunct company and ultimately forced them to close down their business.

This mandatory closure of the companies for reasons beyond their control requires a proper understanding of the legal procedures involved in the closure process, especially for the defunct companies.

Many businesses are choosing to formally dissolve rather than leaving operations in limbo. This often includes filing for bankruptcy or voluntarily dissolving under the Insolvency and Bankruptcy Code; or filing of an application for the closure of a defunct company as per the provisions of the Companies Act, 2013, to avoid ongoing liabilities.

While applying the closure, it has been seen that the companies encountered common pitfalls such as incomplete knowledge of choosing the correct mode of closure, ignoring tax implications, proper approvals of the creditors and stakeholders, etc.

Therefore, this article will focus on the closure of defunct companies in a rightful manner without encountering any legal hurdles.

Understanding the Closure of Defunct Companies

Defunct Company: A defunct Company means a company that has Nil assets and Nil liability and failed to commence business within one year of incorporation. A defunct company is a company that is not involved in any business activities for a period of two immediately preceding the financial year and has not obtained the status of a dormant company. Reasons for the closure of a defunct company: A defunct company chooses to close itself due to the following reasons:

1. It has failed to commence its business activities within one year of incorporation.
2. A company is not carrying on any business or operation for a period of two immediately preceding the financial year and has not made any application within such period for obtaining the status of a dormant company.
3. The company does not have any assets or liabilities.
4. Continuing operations may not be financially viable, prompting a decision to cease activities to minimize losses.
5. Failing to meet regulatory requirements can result in penalties or forced closure.
6. Companies may choose to close certain divisions or subsidiaries as part of a strategic realignment to focus on core business areas.
7. The closure of the parent company can also be a reason for the closure of its subsidiary company.

The legal framework for the closure of a company is enumerated below:

1. Strike-off application as per the provisions of the Companies Act, 2013- To make an application for strike-off, the company should be non-operational in the immediately preceding 02 (two) financial years or has failed to commence its business activities within one year of incorporation and shall not have any assets and liabilities as on the date of filing the application and all the bank accounts of the company must be closed. In addition to this, the company is also required to provide a few declarations as per the requirement of law. It is to be noted that the company needs to ensure that the liabilities are fully paid off to obtain the order of closure of the company.

Subject to the compliance of procedural requirements and satisfaction of the concerned authorities with respect to the documents submitted, the authorities shall pass the order of strike off.

2. Voluntary winding up as per the provisions of Insolvency and Bankruptcy Code, 2016- To apply for voluntary winding up, the company through its director will be required to declare itself solvent i.e., it should be able to pay off its liabilities completely and thereafter by following the procedures given under the said enactment, an application for winding up will be filed before the Hon’ble National Company Law Tribunal, of the appropriate jurisdiction. It is to be noted that the company needs to ensure that the liabilities are fully paid off to obtain the order of closure of the company.
3. Winding up as per the provisions of Section 10 of Insolvency and Bankruptcy Code, 2016- Under the said option, a company can make an application for winding up in case it has committed default in payment of debt along with the documentary proof of its inability to make the default good. The said application shall be filed before the Hon’ble National Company Law Tribunal, of the appropriate jurisdiction by following the procedural requirement. It is to be noted that the admission of the application shall be the sole discretion of the Hon’ble National Company Law Tribunal, and the corporate insolvency resolution process shall commence from the date of admission of the application.

Recent Trends in the Closure of Defunct Companies

The trend of businesses opting for voluntary liquidation has been rising due to several factors that make it a simpler and more cost-effective method for winding up operations. Some of the key reasons are as follows:

1. Control over process: In a voluntary liquidation, the company’s management followed by the stakeholder's approvals is a pre-requisite. Thus, the management holds control over the process of initiating the voluntary closure of the company.
2. Cost Efficiency: A voluntary closure often involves lower legal and administrative costs, making it a more financially attractive option.
3. Easier process and clearer outcome: Voluntary closure is an easier process, and the outcome is also clear.
4. Regulatory Framework: The government have simplified the voluntary closure of the companies. This has resulted in less paperwork and ease of filing applications for the closure of the company.

Shift Towards Digital Filing:

The government has eased the process of filing applications for the closure of defunct companies using the digital platform without the need for making any physical application. The shift toward digital platforms for filing closure documents accelerates the process and enhances accessibility and user experience. This process has helped the companies in various ways such as its speedy disposal and efficiency, cost-effectiveness, enhanced tracking and transparency, etc.

Legal Procedures for Closing a Defunct Company

A defunct company can be closed by filing an application for strike-off subject to compliance with the applicable laws. The process of closing a defunct company is given below:

• The application for the closure is filed in form STK-2 along with the supporting documents such as affidavit and indemnity bond from each director, board and shareholders resolution, statement of account, no objection certificate from the appropriate authority, if any, etc.
• The Registrar of Companies shall put the name of the applicant(s) on the MCA portal, giving 30 (thirty) days for objections, if any, by the stakeholders to the concerned ROC;
• The authorities shall examine the application and if found in order, shall give order to strike off the name of the company from the register and the company will be dissolved;
• The ROC immediately after completion of the stipulated timeline under the applicable law and on being satisfied that the case is otherwise in order, shall strike its name off the register and shall send a notice for publication in the official gazette and the applicant company shall stand dissolved from the date of publication of the notice in the official gazette.

Common Pitfalls to Avoid When Closing a Defunct Company

• Unsettled Debts and Liabilities:

The companies generally fail to clear the unsettled debts and liabilities which results in failure for successful closure of the company. Therefore, the companies must ensure that there are no debts and/or liabilities in the company before filing the application for closure. Any failure to ensure the same can result in a delay in the closure process, rejection of the application, etc.

• Incomplete documentation:

It is equally important to ensure that the documents submitted for the closure of the company are complete in every aspect. Any incomplete or incorrect documents can result in a delay in the processing of the application, and it may also lead to the rejection of the complete application.

How to Ensure a Smooth Closure Process

• Seek Professional Legal Guidance:

One of the reasons for the failure of the successful closure of the company is incomplete guidance from the professionals. Therefore, it is important to seek proper guidance from a qualified professional on this matter.

• Prepare All Necessary Documents:

For smooth closure, it is important to prepare all the supporting documents such as indemnity, affidavits, board and shareholders resolutions, and no-objection certificates in advance as per the requirement of the applicable laws.

• Ensure Compliance with Local Laws:

For a smooth closure of a company, it is also important to ensure compliance with applicable laws to avoid any issues at later stages.

Implications of Not Closing a Defunct Company Properly

• Legal and Financial Consequences:

The failure to close a defunct company can cause legal consequences such as default in completing annual compliances, reporting, etc., that can in turn also lead to financial consequences such as fees for late submission or non-submission of any statutory return, show cause notice by the authorities, etc.

• Impact on Directors and Shareholders:

Failure to follow the legal procedures can affect the directors and shareholders as various declarations are required to be given to them which can jeopardize their position.

Conclusion

It is of utmost importance to follow the correct legal procedures when closing a defunct company as it does not only fulfill obligations to creditors, and shareholders but also protects the owners from potential liabilities and legal repercussions in the future. Failure to adhere to these procedures such as neglecting to file necessary paperwork, overlooking tax obligations, or failing to formally notify stakeholders can lead to significant pitfalls and complicate the process and create lasting complications.

To navigate this complex process effectively, it is strongly encouraged that business owners and directors seek professional legal assistance. Engaging experienced legal advisors can ensure a smooth and compliant closure process, helping to avoid common mistakes and ensuring that all necessary steps are taken.

“Need help navigating the legal complexities of closing a defunct company? Contact Ahlawat & Associates for expert guidance on ensuring a smooth and compliant company dissolution.”