SUPREME COURT REITERATES ‘WATERFALL MECHANISM’ FOR DISTRIBUTION OF ASSETS OF A COMPANY UNDERGOING LIQUIDATION
In a recent case of Paschimanchal Vidyut Vitran Nigam Ltd. vs Raman Ispat Private Limited & Ors. Civil Appeal No. 7976 of 2019, a two Judge Bench of the Supreme Court comprising of Justice S. Ravindra Bhat and Justice Dipankar Datta passed a Judgment dated 17-07-2023 and reiterated the ‘waterfall mechanism’ or order of priority under the Insolvency Bankruptcy Code 2016 (IBC) as per which dues are settled amongst creditors and stakeholders of a corporate debtor undergoing liquidation.
i) In the present case, the Respondent- Raman Ispat Private Limited (Corporate Debtor) and the Appellant, Paschimanchal Vidyut Vitran Nigam Ltd. entered into an Agreement dated 11-02-2010, as per which the Appellant agreed to supply electricity to the Corporate Debtor.
ii) But the Corporate Debtor failed to remit the dues payable to the Appellant amounting to Rs. 4,32,33,883/- for the electricity supplied by the Appellant.
iii) Aggrieved, the Appellant got the properties of the Corporate Debtor attached by the Ld. District Magistrate and Tehsildar, Muzaffarnagar (Trial Court) vide Order dated 12-01-2016.
iv) Further, the Trial Court vide Order dated 23-01-2016, restrained the transfer of Corporate Debtor’s property by sale, donation etc, and also created a charge on such properties.
v) The District Collector issued a Notice of Recovery of dues of Rs. 2,50,14,080/- by way of auction of movable and immovable properties, vide Order dated 05-03-2018.
vi) As a result, the Corporate Debtor’s properties were attached by the Orders of the District Collector, Muzaffarnagar and Tehsildar, Muzaffarnagar.
vii) Meanwhile, the Corporate Debtor underwent Corporate Insolvency Resolution Process (CIRP) under the IBC and eventually, became subject to liquidation process vide Order dated 31-01-2018 passed by the Hon’ble National Company Law Tribunal, Allahabad (NCLT) in CP No. (IB) 23/ALD/2017.
viii) The Liquidator had filed an Application before the NCLT seeking release of the aforementioned attached properties, which was allowed. The Liquidator took the plea that the Appellant’s claim would be considered in order of priority prescribed under Section 53 IBC, and that the Appellant would be entitled to pro rata distribution of proceeds along with the other secured creditors from sale of liquidation assets.
ix) The NCLT, vide Order dated 21-08-2018, directed the Ld. District Magistrate and Tehsildar to release the Corporate Debtor’s property in favour of the Liquidator to enable him to sell the same and distribute its sale proceeds amongst the creditors and other stakeholders of the Corporate Debtor in accordance with Section 53 IBC.
x) Aggrieved by the NCLT Order dated 21-08-2018, the Appellant filed an Appeal before the Hon’ble National Company Law Appellate Tribunal (NCLAT) in Company Appeal (AT) (Insolvency) No. 639 of 2018.
xi) The NCLAT, vide Order dated 15-05-2019, upheld the NCLT Order dated 21-08-2018 that directed the Ld. Magistrate to release the Corporate Debtor’s property in favor of the Liquidator.
Supreme Court Observations
Aggrieved by the NCLAT Order dated 15-05-2019, the Appellant filed Civil Appeal No. 7976 of 2019 before the Hon’ble Supreme Court on 22-08-2019. The Apex Court passed an Order dated 17-07-2023 and made the following observations:
1) That as per Section 5 (7) of IBC, a “financial creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to. Further, as per Section 5 (8) of IBC, a “financial debt” is a debt which is disbursed against consideration for the time value of money.
2) That Section 5 (20) of IBC defines an “operational creditor” as a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Further, as per Section 5 (21) of IBC, an “operational debt” is a claim in respect of provision of goods or services.
3) That as per Section 35 of IBC, the liquidator has the power and duty to verify the claims of creditors, evaluate assets of corporate debtor, carry on the business of the corporate debtor, take into consideration the assets of the corporate debtor. Further, after the admission of claims of creditors, the liquidator has to determine the value of the claims, for the purpose of distribution of assets of the corporate debtor.
4) That Section 53 of IBC provides for the ‘waterfall mechanism’ i.e. the order of priority for distribution of assets of corporate debtor amongst its verified creditors and other stakeholders.
a) Firstly, insolvency resolution process costs and the liquidation costs;
b) Secondly, workmen’s dues for the period of 24 months preceding the liquidation commencement date and debts owed to a secured creditor in the event such secured creditor has relinquished security;
In the event, the secured creditor relinquishes its interest in the secured assets of the corporate debtor as per Section 52 of IBC, its dues will rank high in the waterfall mechanism’. But if the secured creditor chooses not to relinquish its ‘interest and proceeds to enforce the secured asset, subject to intimation and verification by the liquidator, and in the process of enforcing the secured assets, the secured creditor is unable to realize all its dues, then it has to stand lower in priority of debts and thereby, await distribution of assets by the liquidator.
c) Thirdly, wages and any unpaid dues owed to employees other than workmen for the period of 12 months preceding the liquidation commencement date;
d) Fourthly, financial debts owed to unsecured creditors;
e) Fifthly, any amount due to the central government and the state government and debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;
Thus, the Government dues rank lower in the order of priority / hierarchy to the class of creditors described in Clauses (a) to (d) of Section 53(1) IBC hereinabove. Hence, the Government dues have to be treated as separate from those owed to secured creditors.
f) Sixthly, any remaining debts and dues;
g) Seventhly, preference shareholders; and
h) Eighthly, equity shareholders or partners.
5) That in the present case, the Appellant entity has Government participation, however, that does not render it as a ‘Government’ or part of the State Government. Further, the NCLT and the NCLAT both held that the Appellant is a secured creditor and even the Liquidator had taken the plea before the NCLT that the Appellant would be entitled to pro rata distribution of proceeds along with the other secured creditors from sale of liquidation assets. Hence, the Bench directed the Liquidator to decide the claim of the Appellant-Secured Creditor in the manner required by law.
Thus, based on the aforesaid observations, the Supreme Court directed the Liquidator of the Corporate Debtor to complete the process of determining the claim of the Appellant-Secured Creditor under Section 53 IBC, within 10 weeks from the date of pronouncement of its decision. As a result, the Appeal filed by the Appellant was dismissed with the aforesaid directions to the Liquidator.
The Indian Lawyer
 Section 53 IBC. Distribution of assets. –
(1) 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 the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely: –
(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following:
(i) workmen’s dues for the period of twenty-four 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 twelve 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) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(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.
(2) Any contractual arrangements between recipients under sub-section (1) with equal ranking, if disrupting the order of priority under that sub-section shall be disregarded by the liquidator.
(3) The fees payable to the liquidator shall be deducted proportionately from the proceeds payable to each class of recipients under sub-section (1), and the proceeds to the relevant recipient shall be distributed after such deduction.
Explanation. – For the purpose of this section-
(i) it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full; and
(ii) the term “workmen’s dues” shall have the same meaning as assigned to it in section 326 of the Companies Act, 2013 (18 of 2013).