New liquidation waterfall: A sea change for creditors

By Satish Anand Sharma and Aditya Dua, SNG & Partners
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Implementation of the Insolvency and Bankruptcy Code, 2016, has led to several challenges and questions to be settled by policy makers, the judiciary and the regulator. The code has brought a sea change in the liquidation regime and the order of distribution of the proceeds among stakeholders.

Satish Anand SharmaSenior associateSNG & Partners
Satish Anand Sharma
Senior associate
SNG & Partners

Section 53 of the code provides a waterfall mechanism for the order of distribution of proceeds from the sale of liquidation assets among the stakeholders in liquidation proceedings of a corporate person. By virtue of the notwithstanding provision of section 53, the waterfall mechanism under the code is to have overriding effect over any other central or state statutes that are in force.

Under section 53 of the code, the proceeds from sale of the liquidation assets shall be distributed in the following order of priority:

(a) The insolvency resolution process costs and the liquidation costs paid in full;

(b) The following debts which shall rank equally: (i) workmen’s dues for the period of 24 months preceding the liquidation commencement date; and (ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) Wages and any unpaid dues owed to employees other than workmen for the period of 12 months preceding the liquidation commencement date;

(d) Financial debts owed to unsecured creditors;

(e) The following dues shall rank equally between and among the following: (i) government dues; and (ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) Any remaining debts and dues;

(g) Preference shareholders, if any; and

(h) Equity shareholders or partners, as the case may be.

Aditya DuaSenior associateSNG & Partners
Aditya Dua
Senior associate
SNG & Partners

Under the earlier liquidation regime, government dues were given a high priority among all the outstanding dues whereas under the code priority for the payment of government dues is shifted to the bottom.

It is notable that all secured financial creditors (whether having superior right or subservient right over secured assets) are treated equally in the liquidation waterfall under the code. In the event they relinquish their right to enforce their security in accordance with section 52 of the code, they will rank pari passu with workmen’s dues for the period of 24 months preceding the liquidation commencement date and are placed second in the order of priority for the payment of all their dues after costs of the corporate insolvency resolution process.

In the earlier liquidation regime, as regards the status of secured creditors who relinquish their security, the Supreme Court in Jitendra Nath Singh v Official Liquidator & Ors (2012) held that: “If the secured creditor relinquishes his security, like any other unsecured creditor, he is entitled to prove the debt due to him and receive dividends out of the assets of the company in the winding up proceedings.”

In the liquidation regime under the code, if secured financial creditors enforce their security, they are placed much lower in the order of priority for their unrealized portion of dues – at par with government dues but below the unsecured creditors. In the earlier liquidation regime, secured creditors who opted to realize their security were placed at par with workmen to the extent of workmen’s portion of dues, and at par with unsecured creditors with respect to the unrealized portion of their dues. Also, the unrealized portion of dues of secured creditors to the extent of shortfall due to payment of workmen dues from the sale proceeds of the secured assets was to be paid in priority over all other dues of the company.

The code does not provide for respective rights of priority among the secured creditors over the assets of the corporate debtor in the liquidation proceedings. This leaves room for a conflict between the secured creditors with superior charge over the assets and those with subservient charge. Going by the view of the Supreme Court in the case of ICICI Bank Ltd v Sidco Leathers Ltd & Ors (2006), creditors having superior charge and who have not relinquished their right to enforce the security will continue to possess rights of priority in accordance with section 48 of the Transfer of Property Act.

To conclude, it is clear that with the implementation of the code, secured creditors will have a tough choice to make as to whether they should relinquish their security and enjoy higher priority or realize their security and chose lower priority in the liquidation waterfall under the code.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Satish Anand Sharma and Aditya Dua are senior associates.

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