Start-up FAQ: Why closing down can be tougher than starting up

The Stayzilla episode raises questions over the regulations around the closure of a business, says Sudipto Dey.

Illustrations: Uttam Ghosh/Rediff.com
 

Which laws govern closing down a start-up business?
 
The applicable law will depend on the nature of the start-up.

If incorporated as a company, it will be governed by the Companies Act, 2013. If set up as a limited liability partnership, it will be covered by the LLP Act, 2008.

The definition of start-up, as provided by the ministry of commerce, includes only a company and LLP, not a sole proprietorship firm.

There are two primary reasons for shutting down a start-up. Either it has not been able to generate the business it hoped for and is not able to secure funding or it has been running in the red for quite some time and the bootstrap money has been exhausted.

“In the event that there are no debts or liabilities on the shoulders of the start-up, then it may opt for closure of business under Section 304-323 of the Companies Act, 2013, which lists the process relating to the voluntary winding up of a company,” says Kanishq Agarwal, founder, CriTaxCorp.
 
If the company is not debt-free and there are cases filed against the company, then the start-up should opt for the Insolvency and Bankruptcy Code, 2016, says Agarwal.
 
If any entity is not shut down under these provisions, then the company could be held responsible for continued liability, taxes, proper reporting and proper dissolution, criminal prosecution and director identification number.

What are the points an entrepreneur must keep in mind while shutting down a start-up?
 
A start-up will need to ensure that all its debts and dues are paid and the company is solvent, says Lalit Kumar, partner, J Sagar Associates. “Otherwise, it can be a lengthy process to wind up the company,” he adds. 
 
Agarwal says one must seek legal assistance in order to follow the proper process and procedures for closing down a business.
 
To avoid drawn-out legal battles, one must stop hiring more employees, not sign new vendors and issue an advance notice of eviction to the landlord for the termination of the lease.
 
“Try to settle all the unpaid creditors and employees because life is too short, you may require these vendors or employees in the next venture you may start or a bad debt reputation may drag along,” says Agarwal.

Does the law prescribe any rights of creditors and the order in which their commitments have to be honoured in a business that is in the process of shutting down?

Secured creditors get priority in payment of debt over unsecured creditors. “The Insolvency and Bankruptcy Code, 2016, has a specific provision for payment to banks and secured creditors, as they have been accorded priority over trade creditors and then unsecured creditors,” says Agarwal.
 
However, the dues of employees stand in priority over secured and unsecured creditors.

Is there a provision for fast-tracking the closure of a business?
 
There is no separate provision for fast-track closure. However, the process of winding up a company without any debt is much simpler.
 
The Insolvency and Bankruptcy Code, 2016, has set a threshold of 180 days for closure of a business. But this provision is yet to be tested. 

What are the changes required in existing laws to expedite the closure of service-oriented businesses, especially start-ups?
 
There can a specific window for start-ups through a separate body, says Kumar.

However not everyone feels the need for a special provision to expedite closure of start-ups.

According to Sanjay Khan Nagra, senior associate, Khaitan & Co, what will help is an expedited implementation of the Insolvency and Bankruptcy Code, 2016.

“There are suitable provisions and processes in the code for efficient closure of businesses. The framework for a good and supportive regulatory machinery has also been provided,” he says.