The Dichotomy between the Companies Act and the IBC Resolved

November 2023

1.        Introduction 

Over the years, ever since the Insolvency and Bankruptcy Code, 2016 (“IBC”) came into force, there has been ample litigation addressing different elements of the “waterfall” mechanism prescribed in section 53 therein whereunder the secured creditors have the highest standing. This section conflicts with other statutes. For example, sections 326 and 327 of the Companies Act, 2013 (“2013 Act”) prescribe a different hierarchal order wherein workmen’s dues have been prioritized over the debts to secured creditors, subject to certain conditions specified therein. The differing sequence of preferential payments under the two statutes created confusion for companies undergoing liquidation. On May 2, 2023, the Supreme Court (“SC”) passed an important judgment in Moser Baer Karamchari Union through President Mahesh Chand Sharma v. UOI & Ors. etc.[1] where it held that the IBC procedure would prevail when a company is undergoing liquidation under the IBC. Consequently, workmen’s dues, placed on par with debts owed to secured creditors, would be cleared only after costs of the insolvency resolution process and liquidation are paid completely.

This newsletter analyzes the abovementioned judgement to understand how the court has resolved the dichotomy between the conflicting provisions of the 2013 Act and the IBC.

2.        The Legal Provisions Involved

Before discussing the judgement, it is necessary to understand the relevant legal provisions. The three essential provisions of the 2013 Act are (a) section 326 which provides that in case of the winding-up of a company under the Act, workmen’s dues shall be paid first followed by the debts due to secured creditors, subject to certain conditions; (b) section 327 which provides that, after the amounts under section 326 are paid, certain other sums including revenues and taxes to the government and various specified remunerations must be paid before all other debts; and (c) section 327(7) which provides that sections 326 and 327 and the order of preferential payments specified thereunder will not apply in case a company is undergoing liquidation under the IBC. In contrast, section 53 of the IBC provides how, during liquidation, the proceeds from the sale of assets are to be distributed. It prioritizes costs of the insolvency resolution process and liquidation followed by workmen’s dues, debts owed to secured creditors, wages and unpaid dues owed to employees, other than workmen, for 12 months preceding the liquidation commencement date, debts owed to unsecured creditors and amounts due to the Government, etc. This hierarchy is referred to as the “waterfall mechanism” and ensures equitable treatment for various stakeholders through an organized and fair distribution of assets based on priority.

Sections 326 and 327 were designed to prioritize the interest of workmen and give them preferential payments in respect of their claims during winding-up. The provisions are based on the view that workmen are left vulnerable and devoid of financial security when companies undergo insolvency and, therefore, require safeguarding. In contrast, section 53 of the IBC creates a hierarchy under the waterfall mechanism which attempts to equitably balance the interest of all stakeholders and considers worker’s dues on par with secured creditors, second only to costs of the insolvency resolution process and liquidation. This creates a conflict between the IBC’s objective to provide fair treatment to all dues and debts, and the intent under the 2013 Act of preferential treatment to workmen based on the need to safeguard their livelihood during winding-up.

3.        The Moser Baer Karamchari Union Case

Owing to a financial crisis, inadequate profits, and consequent default on payment of debts by Moser Baer India Ltd. (“MBIL”), the corporate insolvency resolution process of MBIL commenced in 2017. However, no resolution plan fructified. On September 20, 2018, National Company Law Tribunal, New Delhi passed an order approving liquidation of MBIL.[2] While liquidation proceedings were ongoing, writ petitions were filed by MBIL trade union and others (“Petitioners”) seeking that section 327(7) of the 2013 Act be struck down as being arbitrary and violative of Article 21[3] and that workmen’s dues be kept out of the scope of section 53 of the IBC. They also sought direction for MBIL to pay their dues of 24 months.

The Petitioners’ argued (a) intent behind introducing the terms “workmen,” “workmen’s dues,” “workmen’s portion” and “overriding preferential payments” in the 2013 Act was to ensure the assets of the company are distributed to workers since their labour forms an essential part of its capital; (b) status of secured creditors was to be pari passu with its employees and workers regarding claims during liquidation and unpaid salaries, for two years preceding the winding-up order, were to be given absolute priority; (c) section 327(7) and the hierarchy created by section 53 IBC contradict 2013 Act’s objectives and disrupt its system such that workmen and secured creditors are arbitrarily placed in the same pool under the IBC which is disadvantageous for workmen. Therefore, these sections violate Articles 14[4] and 21 of the Constitution. The Respondent contended (a) section 325 was omitted when IBC enacted which is a complete Code in itself; (b) section 327(7) was added to the 2013 Act to explicitly exclude application of sections 326 and 327 to IBC liquidations; (c) section 53 IBC prioritizes distribution of proceeds from sale of liquidation assets, it equates workmen dues up to 24 months and sums due to secured creditors in case of relinquishment of security. So, effectively, the wages of workmen are safeguarded and guaranteed under liquidation costs equitably under section 53.

3.1.      Decision and Reasoning of SC:  The court disagreed with the contention of the Petitioners and held that the amendment to the 2013 Act, through which section 327(7) was inserted, cannot be considered arbitrary since the aim was to exclude application of sections 326 and 327 to IBC liquidations to avoid conflict between different statutes. Since the object of IBC is distinct from 2013 Act, therefore, it is incorrect to compare the two regimes. IBC specifically deals with companies which are unable to pay dues and focusses on the development of a procedure to revive them. If there is no revival, IBC envisages a procedure for dissolution. Thus, the IBC completely replaces the earlier framework for insolvency and bankruptcy resolution, which was inadequate, ineffective, and guilty of causing undue delays. Since the IBC is a complete Code, the defined liquidation process therein will exclusively be governed by its provisions. Section 53 begins with a non-obstante clause and prevails over all other contrasting legal provisions. The section also prescribes a sequential waterfall mechanism, and such hierarchy is based on a structured mathematical formula which acknowledges that secured creditors (usually banks and other financial institutions) are greatly impacted when companies become insolvent. Considering IBC’s object of revival, stakeholders including secured creditors and workmen are required to make certain sacrifices. Revival will benefit them too and unless the court finds the sacrifices of workmen are unjust, arbitrary, and burdensome it cannot set aside the legislation solely because workmen have to make marginal sacrifices in their claims.

SC relied upon its prior judgements[5] to state that certain economic and fiscal decisions of the legislature are based on practical considerations and administrative expediency, courts must avoid interference and rely on legislative judgement, unless it is arbitrary. Where the constitutional validity of an economic legislation is challenged, the court must not adopt a doctrinaire approach. Its decision to strike down an economic provision or rearrange hierarchy may cause instability and “disrupt the working of the equilibrium as a whole”[6] specifically in the balance created between the rights and interests of secured, operational creditors, and government debts. Therefore, the waterfall mechanism of section 53 of IBC adequately safeguards workmen’s rights regarding claims of unpaid dues. The provisions adopt an equitable manner of asset distribution and comprehensively cover every situation when a company can no longer be revived.

3.2.       The judgement: The SC held that

  • Section 327(7) cannot be declared as arbitrary or violative of Articles 14 and 21 of the Constitution.
  • Sections 326 and 327 will not apply to liquidation proceedings under IBC since two simultaneous mechanisms cannot exist to govern asset distribution of a company undergoing liquidation.
  • Section 53 of IBC will be the only legislation governing this aspect, subject to the conditions under section 36(4)(iii)[7] of the IBC.

Thereafter, the court rejected the arguments of the Petitioners and dismissed the writ petitions.

3.3        Analysis: This judgement holds good in law and clears any confusion that companies under liquidation may have regarding the order of preferential payments. The non-interference of the court in changing the established IBC hierarchy is a welcome step. There was no evident reason why workmen were prioritized above secured creditors under the 2013 Act. While it is true that the workmen’s efforts are crucial to the functioning of a company, section 53 simply places them on par with secured creditors and does not adversely affect their claims. The court has rightly found the existing hierarchy under section 53 IBC prioritizes the greater good over the demanded rights of a particular category of stakeholders. The court has safeguarded the interests of financial creditors and removed any apprehensions financial institutions may have as corporate lenders. The court has taken an equitable and balanced stance rather than a socialistic approach, which is ideal to promote business friendly conditions in India’s mixed economy.

4.        Conclusion

An effective legal and regulatory environment plays a crucial role in creating a sustainable business environment that facilitates ease of doing business. This includes the ability and ease of liquidation as much as formation of a company. The IBC facilitated an enabling framework to ensure companies on the brink of bankruptcy could be revived. Where revival does not work out, liquidation is feasible. However, in the last 7 years since the IBC’s enactment, companies have confronted challenges regarding the hierarchal dichotomy in the payments allocation in the two statutes, i.e., the IBC and the 2013 Act. With this judgement, there is clarity and the prevailing contradictions between the statutes are now laid to rest.


Dylan Sharma

[1] Moser Baer Karamchari Union v. Union of India, 2023 SCC Online SC 547

[2] Case No. IB – 378(PB)/2017

[3] Article 21 protects life and personal liberty and states no person shall be deprived of life or personal liberty except according to procedure established by law. Several SC judgements have upheld that right to life under Article 21 includes the right to livelihood and decent standard of living

[4] Article 14 prescribes equality before law within India

[5] Swiss Ribbons Pvt. Ltd. & Anr. v. UOI & Ors. (2019) 4 SCC 17, R.K Garg v. UOI (1981) 4 SCC 675, Bhavesh D. Parish v. UOI [(2000) 5 SCC 471] and Directorate General of Foreign Trade v. Kanak Exports [(2016) 2 SCC 226]

[6] Directorate General of Foreign Trade v. Kanak Exports [(2016) 2 SCC 226], para 71

[7] Section 36 (4)(iii) provides that assets to be liquidated under the IBC shall not include sums due to a workman or employee from the provident, pension and gratuity funds, and shall not be used for recovery

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