Problems in sections of the Companies’ Act

Some firms, especially hotels may face a catch 22 situation when enforcing sections of the new Companies’ Act, according to corporate sector analysts.

“Section 219 and 220 are problem areas that company directors will face in implementing them,” Aritha Wickremanayake, Lawyer and Partner, Nithya Partners said.

Section 219 refers to the duty of directors on insolvency where a director who believes that the company is unable to pay its debts as they fall due shall call a meeting of the director board to consider whether the board should apply to court for the winding up of the company and the appointment of a liquidator or an administrator or carry on further the business of the company.

Section 220 deals with the duty of the directors on serious loss of capital where if at any time it appears to a director of a company that the net assets of the company are ‘less than half of its stated capital’, the board shall within 20 working days of that fact becoming known to the director, call an extra ordinary general meeting (EGM) of shareholders of the company, to be held not later than 40 working days from that date of calling such a meeting.

“A lot of the hotels, especially outside Colombo are facing an issue with Section 220. Unlike hotels other firms can say that they are going to improve their businesses in the medium to longer team, because those businesses are not as affected by the country’s ground situation as the hotels,” Wickremanayake said.

He said if they continue to be in business after calling an EGM (and explaining to the shareholders that they can continue to be in business) and subsequently the hotels are liquidated, the directors will be liable to the shareholders and in fact, they can be sued.

A hotel industry analyst pointed out that more than other companies, hotels are hard pressed to meet their loan obligations. “The law is not practical. That is why it is at times referred to as a draconian law,” he said.

However a corporate lawyer noted that with regard to Section 220, the directors of hotels may be able to make a justification to shareholders on an overall basis saying that the asset value of the hotel property is sufficient to ensure that all creditors can be paid. “They can say that the sale of the property will realise a larger value than the amounts owed to creditors and in the medium term they are able to pay debts,” he said.

He also noted that most hotels have short term debts such as supplier debts etc, and no major bank debts. “Unless they have gone for major expansion with bank debts, most hotels have short term loans. None of the Colombo hotels, except maybe Galadari and Hilton has major bank debts,” he added.

Addressing the solvency test introduced in the new Act, he said that it would assure the solvency of a company, where it requires the Board of a company to satisfy the solvency test and to obtain a certificate of solvency from the auditors before any distribution is made.

“Distributions can only be made if the company satisfies the solvency test. A company will qualify in the solvency test if its total assets (Non current assets + current assets) exceed the total liabilities (stated capital + other liabilities). Dividends can only be paid if the company has positive reserves; dividends cannot be declared if the company has accumulated losses. A company shall be deemed to have satisfied the solvency test, if it is able to pay its debts as they become due in the normal course of business and the value of the company's assets is greater than the value of its liabilities and the company's stated capital,” he explained .

Prof. T. Furkhan, Chairman Confifi Hotels, said that according to the new law several firms in the CSE will be insolvent. He also pointed out that the law is not clear in terms of who is enforcing the law. “The solvency test is an internal exercise where a company is declared solvent or not,” he said. He said that if the company is insolvent they cannot pay dividends. “Anyhow the law is not clear as to who the watchdog is,” he added.