Strategy of Voluntary Liquidation (A study triggered by Go First Airlines)

A company is formed through the legal process of incorporation, but its existence is terminated through liquidation. Voluntary liquidation is the process of a corporation being wound up at the request of its members. The primary goal of voluntary liquidation is to avoid the need for court intervention and allow members and creditors to resolve their debts among themselves. Only a solvent corporation can enforce voluntary liquidation. A corporation can choose the FTE (Fast Track Exit) route, which involves striking off the name/de-registration of a company from the Register of Companies u/s 560 of the Companies Act, 1956, as an alternative to voluntary liquidation. While in theory, members of the company are expected to initiate this process, in the first quarter of 2023, operational creditors are leading new case admissions now with as much as 50 per cent cases were initiated by operational creditors and 40 per cent by financial creditors.

In the commercial arena, bankruptcy has become a tool not infrequently used by business people.?Be it an asset sale, a device to negotiate with the taxing authorities or a precursor to a recapitalization, the financial professional should be familiar with the options available under the Bankruptcy Code.?Also, being aware of what may occur in a bankruptcy can prove invaluable in restructuring a business without a business filing.?The purpose of this article is to review certain options made available by the law. In India, this is currently seen in the case of GO FIRST though this is not the first case of voluntary liquidation in India.

Pre-Condition to voluntary liquidation

As per Section 59 of the Code read with the Regulations, any corporate entity may initiate a voluntary liquidation proceeding if it satisfies the following conditions:

• it has not committed any default;
• if majority of the directors or designated partners of the corporate person make a declaration verified by an affidavit to the effect that (i) the corporate person has no debt or it will be able to pay its debts in full out of the sale proceeds of its assets under the proposed liquidation; and (ii) liquidation is not initiated to defraud any person;
• such declaration is accompanied by the audited financial statements and valuation report of the corporate person;
• within 4 (four) weeks of such declaration, a special resolution (an ordinary resolution would suffice in cases of voluntary liquidation by reason of expiry of its duration or occurrence of any dissolution event) is passed by the contributories* requiring the corporate person to be liquidated and appointing an insolvency professional as a liquidator (Contributories' Resolution); and
• creditor(s) representing two-thirds in value of the total debt owed by the corporate person, approve the Contributories' Resolution within 7 (seven) days of its passage (Creditors' Approval).

Go First issues

Go First, earlier known as Go Air, has remained relatively ambitious in terms of expansion of fleet and network compared to its more aggressive competitors. On May 13, 2021, when the corona virus pandemic lock-down conditions were strong, the airline announced rebranding itself as 'Go First' with a focus on an ultra-low-cost business model.The airline has liabilities of nearly Rs 9,000 crores. The cash-starved airline reported a loss in the range of Rs 1,800 crores; including an Rs 800 crores notional loss due to accounting standards in the financial year ended March 2023.

Go First: What's The Issue?

Go First said it has been forced to take the decision due to "serial failure" of Pratt & Whitney engines resulting in the grounding of 50 per cent of the fleet and is no longer in a position to continue to meet its financial obligations. To keep the airline afloat, promoters have infused funds worth Rs 3,200 crores in the last three years and out of the total amount, Rs 2,400 crores was injected in the last 24 months.

An amount of Rs 290 crores was pumped in April this year. "This brings the total investment in the airline since its inception to approximately Rs 6,500 crores," the airline said in a statement. Further, Go First has received around Rs 1,000 crores from the government's Emergency Credit Line Guarantee Scheme (ECLGS).

Strategic Advantage that GOFIRST now has

Restructuring the Balance Sheet

Many times, shareholders and investors really want to turn around their business. However, they are unable to do so with the current financial obligations of the firm. This is because even if they inject new capital into the business, the capital will actually be consumed in paying the interest and principal payments of previous obligations. Hence, there will be no money left over for working capital or for conducting business.

The situation ends up being irreconcilable since the company cannot address its fundamental challenges and is only falling into a debt trap whereby it is being forced to throw good money after bad. GO First is reported to have a debt of 9000 crores

The airline has presumably planned to use bankruptcy strategically. If the airline declares bankruptcy, the creditors will only be paid over the long term. This is also known as compounding with the creditors. Instead of immediate, the debts will be paid over a longer period of time. Thus an immediate payment gets converted to a five year period time frame. As negotiator you can also offer them a haircut (reduction in amount to be paid) for a shorter time frame to ensure it’s a ‘win-win’ situation in comparison to total loss of the creditors. In the short term, the company will get the money required to restructure its business by coming out of the debt trap.

Preventing Litigation

In many cases, companies have strategically used bankruptcy to delay or prevent litigation against them. The laws relating to bankruptcy filing prevent more litigation from being imposed on a company that is already under bankruptcy. This is the reason that when a company with a failing cash flow is about to face expensive litigation for a faulty product or for poor service, they often resort to filing bankruptcy.

Lowering the Interest Rate

Bankruptcy laws have specific provisions about repayment of debt to creditors. If the debt in question is secured, then the company is only allowed to repay the debt with market interest rates. It does not matter what the interest rate was agreed between the parties at the time of the contract. Once the matter is in bankruptcy court, the market interest rate is the highest rate, which is legally allowed. This is beneficial to the incumbent company. This is because companies on the verge of bankruptcy often take up debt at rates much higher than the market rate. Once they file for bankruptcy proceedings, the interest rate on this debt is automatically reduced to the market rate which is usually lower than the contracted rate.

On the other hand, if the debt in question is unsecured, then the bankruptcy court does not allow for the payment of any interest. The incumbent company is only allowed to pay back the principal over a period of time without any interest. This could work out to be a profitable strategy in the long run as the interest costs can be reduced immediately.

However, the creditworthiness of the company is likely to take a severe hit if such a policy is indeed implemented.

Only the future will tell whether GoFirst will bounce back and fly again. If it does then it will set a healthy precedent for others in troubled situations.

Some examples of companies bouncing back after bankruptcy.

Abuse of Voluntary Bankruptcy

It is well known that ?any tool can be used and abused. Abuses of law provisions are the most feared during any amendment or passage of a new Bill. In the present topic under study, the case of Johnson and Johnson merits mention. The Johnson and Johnson talc powder for babies has been stirring controversy globally. Most of us have grown up with that comforting ‘baby’ scent. And yet we were completely unaware of just how hazardous it was.?In 1971 to the early 2000s, the talc tested positive for small amounts of asbestos (known to be carcinogenic) — this is recorded in internal company records, according to News agencies. The company has been dealing with thousands of lawsuits from women who have claimed to develop ovarian cancer allegedly through the powder. Till date though, the company continues to stand by their claim that the product is safe, tested via independent scientific analysis. However, in 2020, Johnson and Johnson stated they will stop selling the talc-based powder in the US, and this month, they stated the same for the UK. The product will be replaced by cornstarch-based baby powder that is already being sold in certain parts of the world including India.

The Instrument of Abuse (to stop suits)

J&J created the spinoff company, LTL Management, under a Texas law, while facing some 38,000 lawsuits from people who say its baby powder was contaminated with asbestos, causing cancer and other ailments. A federal judge allowed a company spun off by Johnson & Johnson to proceed with a controversial bankruptcy, despite complaints from thousands of people who say they were harmed by the consumer product giant's baby powder and who could now be denied a chance to sue.

Critics challenged the bankruptcy as a bad-faith effort to shield J&J itself from responsibility for an allegedly harmful product.

"The bankruptcy code was never intended to be abused in this way by massively profitable corporations as a means to delay or prevent cancer victims from having their day in court," said an attorney representing some of the people pursuing J&J.

?The bottom line is that there a wide variety of reasons due to which a company may decide to file for bankruptcy strategically. In all cases, the reputation of the company does take a severe beating. However, sometimes the very survival of the firm gets threatened, and even loss of reputation seems to be a viable option.

There have been notable Individuals who have gone bankrupt and bounced back. If individuals have proved bouncing back, corporate can also bounce back

We have enough corporate and personal examples of bounce back after being declared Bankrupt. Intentions of the interested parties are paramount. A process is never the be and end all to assure success. It is just a tool to be used in a constructive manner.