The apex court quashed a plea filed by Moser Baer Karamchari Union and others seeking to strike down Section 327(7) of the Companies Act, 2013.
New Delhi: The Supreme Court on Tuesday, May 2 quashed a petition seeking to strike down a provision of the Companies Act which says that workers’ dues would not get preferential payment in case a company underwent liquidation under the Insolvency and Bankruptcy Code (IBC), 2016.
The petition was filed by Moser Baer Karamchari Union and others to quash Section 327(7) of the Companies Act, 2013 as arbitrary and violative of Article 21 of the Constitution.
Under Sections 326 and 327 of the Companies Act, 2013, certain payments will get priority over other debts in case a company goes through liquidation. These include workers’ dues, revenues, taxes, and cesses due from the company to the Union government, a state government or a local authority.
However, there’s another section of the Act which overrides this provision.
Section 327(7) of the Act excludes the application of Sections 326 and 327 to the liquidation process.
So, in such a case, Section 53 of the Insolvency and Bankruptcy Code, 2016 is applicable which decides an order of priority according to which proceeds will be distributed to creditors based on the liquidation value.
The order of priority is called the ‘waterfall mechanism’.
As per the waterfall mechanism, secured financial creditors rank the highest in the order of priority. They are followed by unsecured financial creditors, government dues and, finally, operational creditors.
Secured financial creditors are financial institutions such as banks; unsecured financial creditors are credit card companies, landlords, etc.; and operational creditors include those who have rendered services to the company such as employees, or those who have supplied goods to the firm.
In this case, workers’ dues come under operational creditors.
Section 53 of the IBC was framed as a non-obstante clause, meaning a provision that gives an overriding effect to a particular section or the statute as a whole.
What did the apex court say
While dismissing the petitions, a bench of Justices M.R. Shah and Sanjiv Khanna said, “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 bench pointed out that 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, Deccan Herald reported.
“These are all complex economic matters wherein various conflicting interests have to be balanced, and a holistic rather than a one-sided, approach is to be taken. Each opinion may have merit, but the court can hardly substitute its own wisdom or view for that of the legislature, especially when the enactment is the outcome of a thought-out and ruminated review on complex fiscal and commercial challenges facing the economy,” it added.
Moser Baer India liquidation
The petitions come against the backdrop of a Supreme Court judgment last month on the liquidation of Moser Baer.
In 2019, the National Company Law Tribunal’s (NCLT) had ruled that the dues of provident fund, pension and gratuity do not form the part of liquidation estate of corporate debtors, MoneyLife reported.
The top court judgment upheld the NCLT order, citing the waterfall mechanism under Section 53 of IBC.
However, Wasim Beg, partner, Luthra and Luthra Law Offices, India, told Business Standard that “saying that workers’ dues will not get priority” might not be entirely correct.
“We need to bear in mind that any distribution of assets to be made in accordance with Section 53 is subject to Section 36(4), which anyhow protects all sums due to any worker or employee from the provident fund, the pension fund, and the gratuity fund. What may remain out of the scope are entitlements like bonus and leave encashment,” he said.
Anindya Mazumdar, partner, Singhania & Co, told the newspaper: “In the case of insolvency proceedings under the IBC, if there is a conflict between the IBC and Companies Act, the former will prevail and the court has held so. As a consequence, distribution of assets will be in accordance with the IBC.”