Companies Act Section 332

Companies Act, Section 332: Legal Effect of Floating Charges Created Prior to Winding Up

Section 332 of the Companies Act, 2013 deals with the validity and enforceability of floating charges created by a company shortly before it enters into liquidation. Specifically, it provides that if a company creates a floating charge on its assets or undertaking within the twelve-month period immediately preceding the commencement of its winding-up, such a charge will generally be deemed invalid, unless certain conditions are met.

This provision is designed to protect the interests of unsecured creditors and to prevent companies on the verge of insolvency from unfairly prioritizing specific creditors, especially through last-minute security arrangements over company assets.

Understanding Floating Charges:

A floating charge is a security interest over a pool of changing assets (like stock, receivables, inventory, etc.) of a company. Unlike a fixed charge, a floating charge does not attach to specific assets until an event causes it to crystallize such as default or the commencement of winding up.

Floating charges are common in corporate finance, but they become highly scrutinized in insolvency situations, particularly if created close to the company’s collapse.

Key Provisions of Section 332:

1. Scope and Applicability

This section applies when a company is being wound up under the provisions of the Companies Act, 2013. It specifically addresses floating charges created by the company on its Undertaking, Property, or Assets.
The focus is on charges created within the twelve-month period immediately preceding the commencement of winding-up proceedings.
2. Presumption of Invalidity

Any floating charge created during this 12-month window is presumed to be invalid in the context of the winding-up process.
The rationale is that such charges could be used to provide undue advantage to certain creditors when the company is already nearing insolvency.
3. Exception- Proof of Solvency

The floating charge will not be treated as invalid if the company is able to prove that it was solvent immediately after the creation of the charge.
If such proof is furnished to the satisfaction of the Tribunal, the floating charge will remain valid and enforceable.
4. Partial Validity- Cash Advances with Interest

Even if the floating charge is not validated on grounds of solvency, it may still be recognized to the limited extent of any cash amount actually advanced to the company:
At the time of the creation of the charge, or Subsequent to the creation, but in consideration of the charge.
In such cases, the charge will be valid to secure only that amount of cash, along with interest calculated:
At a rate of five percent per annum, or such other rate as may be notified by the Central Government from time to time.
Illustration:

Let’s say a company creates a floating charge on its inventory in favor of a lender on 1st January 2025, and the company is ordered to be wound up on 1st May 2025. This falls within the 12-month period mentioned in Section 332.

If the company cannot demonstrate that it was solvent on 1st January 2025, the charge is invalid.
However, if the lender had advanced Rs. 10 lakhs in cash to the company at the time of creating the charge, then that portion of the charge would still be valid to the extent of Rs. 10 lakhs plus 5% interest per annum, even though the rest of the charge is void.
Purpose and Legal Significance:

The purpose of Section 332 is to prevent fraudulent or preferential transactions and to maintain equity among creditors during the liquidation of a company.
It deters companies in financial trouble from creating last-minute securities in favor of select creditors, which might otherwise undermine the pari passu principle (equal treatment) in insolvency.
The provision balances this deterrence with practical fairness, by safeguarding amounts genuinely loaned in cash in consideration of the charge.