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Proceeds from the sale of liquidation assets shall be distributed in the waterfall mechanism: SC


The Supreme Court bench comprising Justices M. R. Shah and Sanjiv Khanna was on Tuesday hearing petitions in liquidation matter and held that proceeds from the sale of liquidation assets shall be distributed in the order of priority, which is stipulated, and within such period and such manner as may be specified. The waterfall mechanism is based on a structured mathematical formula, and the hierarchy is created in terms of payment of debts in order of priority with several qualifications, striking down any one of the provisions or rearranging the hierarchy in the waterfall mechanism may lead to several trips and disrupt the working of the equilibrium as a whole and stasis, resulting in instability.


The Supreme Court bench observed that Section 53 of the Code which begins with a non-obstante clause and states that notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of liquidation assets shall be distributed in the order of priority, which is stipulated, and within such period and such manner as may be specified. The consequence of sub-section (1) to Section 53 of the Code is that it will override the rights of parties, including the secured creditor when the said provision applies. Section 53 of the Code is the complete and comprehensive code which ensures the collection of assets and then provides the manner in which the creditors are to be paid. Even the rights of the secured creditor falling under Section 53 of the Code to enforce, realise, settle, compromise or deal with the secured assets as applicable to the security interest are diluted and compromised. Clause (a) to sub-section (1) to Section 53 deals with insolvency resolution process costs and the liquidation costs which are to be paid in full. No grievance or issue can be raised in respect of the said clause. Clause (b) to sub-section (1) to Section 53 states that the debts due in the form of workmen’s dues for a period of twenty-four months preceding the liquidation commencement date and the debts owed to the secured creditor in the event the such secured creditor has relinquished security in the manner set out in Section 52 of the Code shall rank equally between and amongst the workmen and the secured creditors. The Explanation to Section 53 of the Code states that ‘workmen’s dues’ shall have the same meaning as assigned to it in Section 326 of the Companies Act, 2013. In other words, Explanation to Section 326 of the Companies Act, 2013 has been incorporated and applies to the waterfall mechanism as prescribed in clause (b) to sub-section (1) to Section 53 of the Code. What is significant here is that under clause (b) to sub-section (1) to Section 53 of the Code, the workmen’s dues are for the period of twenty-four months preceding the liquidation commencement date. The liquidation commencement date, as defined in terms of sub-section (17) to Section 5 of the Code, is much earlier in point of time and need not coincide with the date of winding up. This is in the interest of the workmen. Clause (i) of Explanation to Section 53 of the Code states that where the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts would be paid either in full or would be paid in equal proportion within the same class of recipients if the proceeds are insufficient to meet the debts in full. Ex facie, the clause is very just and fair. It is to be noted that the wages and unpaid dues owed to employees other than the workmen fall in clause (c), which is below clause (b) to sub-section (1) to Section 53 of the Code. They are to be paid wages and unpaid dues only for a period of twelve months preceding the liquidation commencement date, and that too only if surplus funds are available after making payment in terms of clause (a) and (b) of sub-section (1) to Section 53 of the Code. Clause (d) of sub-section (1) to Section 53 of the Code relates to financial debts owed to unsecured creditors. The amounts due to the Central Government and the State Government, etc., and the debts owed to a secured creditor for any amount that remains unpaid following the enforcement of security interest, have been clubbed together in clause (e) of subsection (1) to Section 53 of the Code, and have to be ranked equally between and among both of them. The remaining debts and dues fall in clause (f) of sub-section (1) to Section 53 of the Code. Preference shareholders fall under clause (g) of sub-section (1) to Section 53 of the Code, and equity shareholders or partners fall under clause (h) of sub-section (1) to Section 53 of the Code. Sub-section (2) to Section 53 of the Code states that any contractual arrangements between recipients under subsection (1) with equal ranking if disrupting the order of priority under the said sub-section will be disregarded by the liquidator.


The Bench noted that the waterfall mechanism is based on a structured mathematical formula, and the hierarchy is created in terms of payment of debts in order of priority with several qualifications, striking down any one of the provisions or rearranging the hierarchy in the waterfall mechanism may lead to several trips and disrupt the working of the equilibrium as a whole and stasis, resulting in instability. Every change in the waterfall mechanism is bound to lead to cascading effects on the balance of rights and interests of the secured creditors, operational creditors and even the Central and State Governments. Depending upon the facts, in some cases, the waterfall mechanism in the Code may be more beneficial than the hierarchy provided under Section 326 of the Companies Act, 2013 and vice-versa. Therefore, the Supreme Court bench did not accept the arguments of the petitioners.


The Insolvency and Bankruptcy Code is based on the organic evolution of law and is a product of an extensive consultative process to meet the requirements of the Code governing liquidation. It introduced a comprehensive and time-bound framework to maximise the value of assets of all persons and balance the interest of the stakeholders. The guiding principle for the Code in setting the priority of payments in liquidation was to bring the practices in India in line with global practices. In the waterfall mechanism, after the costs of the insolvency resolution process and liquidation, secured creditors share the highest priority along with a defined period of dues of the workmen. The unpaid dues of the workmen are adequately and significantly protected in line with the objectives sought to be achieved by the Code and in terms of the waterfall mechanism prescribed by Section 53 of the Code. In either case of relinquishment or non-relinquishment of the security by the secured creditor, the interests of workmen are protected under the Code. In fact, the secured creditors are taking significant hair-cut and workmen are being compensated on an equitable basis in a just and proper manner as per Section 53 of the Code. The Code balances the rights of the secured creditors, who are financial institutions in which the general public has invested money, and also ensures that the economic activity and revival of a viable company are not hindered because it has suffered or fallen into a financial crisis. The Code focuses on bringing additional gains to both the economy and the exchequer through efficiency enhancement and consequent greater value capture. In economic matters, a wider latitude is given to the lawmaker and the Court allows for experimentation in such legislation based on practical experiences and other problems seen by the law-makers. In a challenge to such legislation, the Court does not adopt a doctrinaire approach. Some sacrifices have to be always made for the greater good, and unless such sacrifices are prima facie apparent and ex facie harsh and inequitable as to classify as manifestly arbitrary, these would be interfered with by the court.


The Supreme Court noted that sub-section (7) of Section 327 of the Act, 2013 provides that Sections 326 and 327 of the Act, 2013 shall not be applicable in the event of liquidation under the IBC, which has been necessitated in view of the enactment of IBC and it applies with respect to the liquidation of a company under the IBC, Section 327(7) of the Act, 2013 cannot be said to be arbitrary and/or violative of Article 21 of the Constitution of India. In case of the liquidation of a company under the IBC, the distribution of the assets shall have to be made as per Section 53 of the IBC subject to Section 36(4) of the IBC, in case of liquidation of a company under IBC.


The writ petitions were dismissed.


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