The recent tussle between Section 327(7) of the Companies Act,2013 and
Section 53 of the Insolvency and Bankruptcy Code,both of which hold significant
implications for stakeholders in the corporate and insolvency landscapes, came
into light when the Supreme Court pronounced its judgment in the case of
Moser Baer Karamchari Union v Union of India.
While Section 327(7) precludes the scope of application of Sections 326 and
327 to the liquidation process, Section 53 of the IBC, 2016 establishes an order
of priority for the distribution of proceeds to creditors based on the
liquidation value.The conflict develops when the priority created by Section
327(7) seems to be compromised by the implementation of Section 53.
This article delves into the conflict between Section 327(7) of the Companies
Act and Section 53 of the Insolvency and Bankruptcy Code, exploring the
potential challenges it poses for stakeholders. Additionally, it analyzes the
recent ruling by the Supreme Court, which upheld the constitutionality of
Section 327(7) of the Companies Act. Through an examination of the conflicting
provisions and with the help of constitutional perspective, this article aims to
shed light on the implications of this conflict and the Supreme Court's
Understanding Section 327(7) of the Companies Act, 2013
Preferential payments are made in a winding up in accordance with the Act's
provisions enumerated in Sections 326 and 327. These include the worker's dues,
earnings, taxes, and cesses that the business owes to the union, a state, or a
municipal government.However, according to the Insolvency and Bankruptcy Code,
2016, distribution must be done in accordance with Section 53 of the IBC in
cases of liquidation under the IBC.
The Companies Act of 2013 was amended to provide that Sub-Section (7) of Section
327 and Sections 326 and 327 of the Act 2013 will not be applicable in the event
of liquidation under the IBC in light of the ratification of the IBC and Section
53 of the IBC. The said amendment was brought in order to avoid any friction or
inconsistency with the IBC.
Scope of Section 53 of the IBC and the Waterfall Mechanism
The order of priority for receiving the proceeds from the sale of liquidation
assets is laid forth in Section 53 of the IBC, which has the effect of
superseding all other provisions because it is a non-obstante clause. This gives
priority to the costs of the bankruptcy resolution procedure and liquidation.
Workman's wages and obligations owed to a secured creditor are paid after them,
The 'waterfall mechanism' refers to the precedence hierarchy.Secured financial
creditors are given the greatest priority under the waterfall process. Following
them are unsecured financial creditors, governmental obligations, and then
operational creditors.Financial organisations such as banks are examples of
secured creditors, whereas credit card companies, landlords, and others are
examples of unsecured creditors. Operational creditors are people who have
provided services to the company.
The Conflict between Section 53 and Section 327(7)
The conflict arises when we consider the contrasting treatment of worker's dues
under Section 326 and 327 of the Companies Act and Section 53 of the Insolvency
and Bankruptcy Code (IBC). The Companies Act provisions, namely Section 326 and
327, acknowledge the importance of safeguarding worker's interests by providing
preferential treatment to their dues in the event of liquidation. This
recognition is grounded in the understanding that workers often find themselves
in vulnerable positions during insolvency proceedings and need protection.
However, the IBC takes a different approach by categorizing all dues, including
worker's dues, under the umbrella of operational creditors. This means that in
the context of liquidation under the IBC, worker's dues do not receive any
preferential treatment compared to secured financial creditors. This
categorization can create a conflict of interest between the provisions of the
Companies Act and the IBC, potentially compromising the interests of workers.
The conflict of interest arises from the need to strike a balance between the
rights of workers and the overarching objective of the insolvency proceedings,
which is to ensure a fair and equitable distribution of assets among all
stakeholders. While the IBC aims to streamline the insolvency process and
provide a level playing field for all creditors, the preferential treatment
accorded to worker's dues under the Companies Act recognizes their unique
position and the need to protect their livelihoods.
Moser Baer Karamchari Union Case
The Supreme Court denied the plea to declare Section 327(7) of the Companies
Act, 2013 arbitrary and in violation of Article 21 of the Constitution. The
applications come on the heels of a Supreme Court decision last month ordering
Moser Baer's dissolution.The National Company Law Tribunal (NCLT) held in 2019
that provident fund, pension, and gratuity dues do not form part of a corporate
debtor's liquidation estate.
The Petitioners argued that Clause 19(a) of the Eleventh Schedule of the IBC be
declared unreasonable and in violation of Article 14 of the Indian Constitution
because Clause 19(a) of the Eleventh Schedule of the IBC inserts sub-section (7)
in Section 327 of the Companies Act, 2013, which places an obligatory bar on the
application of Sections 326 and 327 of the Companies Act, 2013, to liquidation
proceedings under the IBC. They requested in court that Workers Dues be settled
in accordance with the reasonable criteria outlined in Section 326, even in the
case of liquidation under the IBC.
While upholding the validity of the provision, a bench of Justices M R Shah and
Sanjiv Khanna stated, "We will not set aside the legislation solely on the
ground that some or marginal sacrifice is to be made by the workers."
Certain sacrifices are required from all parties, especially the workers, for
the revival and rehabilitation of the companies. "In the case of insolvent
companies, everyone, including secured creditors and the central and state
governments, must make sacrifices for the sake of survival and regeneration,"
the bench stated.
The bench further stated 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, and striking down any 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 judgment of the Moser Baer Karamchari Union case, upholding the
constitutionality of Section 327(7) of the Companies Act carries significant
implications. It underscores the court's recognition of the organic evolution of
law and the extensive consultative process involved in enacting the Insolvency
and Bankruptcy Code (IBC). The judgment highlights the Code's objective of
maximizing asset value and balancing stakeholder interests, bringing Indian
practices in line with global standards.
In terms of corporate interests, the case emphasizes the importance of a
comprehensive and time-bound framework for insolvency resolution. The court
recognizes the need to protect the rights of both secured creditors and workmen,
maintaining a delicate balance between the two. By upholding Section 327(7), the
judgment reinforces the notion that the Code promotes transparency, efficiency,
and economic growth by ensuring equitable compensation for workmen and enabling
the revival of viable companies.
Additionally, the judgment acknowledges that economic legislations like the IBC
require a practical and pragmatic approach, allowing for experimentation to
address complex issues and serve the greater societal good. It signifies the
court's willingness to consider the economic impact and overall objectives of
such legislation, provided they are not manifestly arbitrary or unfair.
The case highlights the intricate interplay between corporate interests,
stakeholder protection, and the broader objectives of insolvency resolution
frameworks. It offers insights into the court's approach to constitutional
challenges and the significance of balancing the rights of various stakeholders
in promoting a robust and efficient corporate governance regime.