Supreme Court Upholds IBC Section 53: Workmen Dues Prioritized in Liquidation (2 May 2023)

Date of the Judgment: 2 May 2023

Citation: (2023) INSC 426

Judges: M.R. Shah, J. and Sanjiv Khanna, J.

Can the Insolvency and Bankruptcy Code (IBC) alter the priority of workmen’s dues established under the Companies Act? The Supreme Court of India recently addressed this critical question in a batch of writ petitions, examining the validity of Section 327(7) of the Companies Act, 2013 and the waterfall mechanism under Section 53 of the IBC. This judgment clarifies the interplay between these two laws concerning the distribution of assets during liquidation, particularly focusing on the rights of workmen.

The bench, comprising Justices M.R. Shah and Sanjiv Khanna, delivered a unanimous judgment, upholding the constitutional validity of the challenged provisions. The court emphasized the distinct objectives of the IBC and the Companies Act, highlighting the need for a balanced approach that considers the interests of all stakeholders, including workmen, secured creditors, and the national economy.

Case Background

The case originated from writ petitions filed by Moser Baer Karamchari Union and other petitioners challenging the constitutional validity of Section 327(7) of the Companies Act, 2013, and certain provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). The petitioners argued that these provisions unfairly altered the priority of workmen’s dues during liquidation, as established under the Companies Act.

The primary contention was that Section 327(7) of the Companies Act, 2013, which excludes the applicability of Sections 326 and 327 of the Companies Act, 2013 in the event of liquidation under the IBC, and Section 53 of the IBC, which provides a waterfall mechanism for distribution of assets during liquidation, were arbitrary and violated Article 14 and 21 of the Constitution of India.

The petitioners sought a direction to exclude workmen’s dues from the purview of the waterfall mechanism under Section 53 of the IBC, and to ensure that their dues are settled in accordance with the principles laid down under Section 326 of the Companies Act, 2013, even in the event of liquidation under the IBC.

Timeline

Course of Proceedings

The judgment does not mention any lower court proceedings. The case was directly filed as a writ petition under Article 32 of the Constitution of India before the Supreme Court.

Legal Framework

The Supreme Court discussed the following legal provisions:

• Section 327(7) of the Companies Act, 2013: This section states that Sections 326 and 327 of the Companies Act, 2013, which deal with preferential payments during winding up, shall not apply in the event of liquidation under the IBC.
• Section 53 of the Insolvency and Bankruptcy Code, 2016: This section provides the waterfall mechanism for the distribution of assets during liquidation under the IBC. It specifies the order of priority for payments to various stakeholders, including workmen, secured creditors, and the government.

  “53. 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).”

• Section 326 of the Companies Act, 2013: This section deals with overriding preferential payments in the winding up of a company, including workmen’s dues and debts owed to secured creditors.

  “326. Overriding preferential payments.— (1) In the winding up of a company under this Act, the following debts shall be paid in priority to all other debts:
  (a) workmen’s dues; and;
  (b) where a secured creditor has realised a secured asset, so much of the debts due to such secured creditor as could not be realised by him or the amount of the workmen’s portion in his security (if payable under the law), whichever is less, pari passu with the workmen’s dues:
  Provided that in case of the winding up of a company, the sums referred to in sub-clauses (i) and (ii) of clause (b) of the Explanation, which are payable for a period of two years preceding the winding up order or such other period as may be prescribed, shall be paid in priority to all other debts (including debts due to secured creditors), within a period of thirty days of sale of assets and shall be subject to such charge over the security of secured creditors as may be prescribed.
  (2) The debts payable under the proviso to sub-section (1) shall be paid in full before any payment is made to secured creditors and thereafter debts payable under that sub-section shall be paid in full, unless the assets are insufficient to meet them, in which case they shall abate in equal proportions.
  Explanation.—For the purposes of this section, and Section 327—
  (a) “workmen”, in relation to a company, means the employees of the company, being workmen within the meaning of clause(s) of Section 2 of the Industrial Disputes Act, 1947;
  (b) “workmen’s dues”, in relation to a company, means the aggregate of the following sums due from the company to its workmen, namely—
  (i) all wages or salary including wages payable for time or piece work and salary earned wholly or in part by way of commission of any workman in respect of services rendered to the company and any compensation payable to any workman under any of the provisions of the Industrial Disputes Act, 1947;
  (ii) all accrued holiday remuneration becoming payable to any workman or, in the case of his death, to any other person in his right on the termination of his employment before or by the effect of the winding up order or resolution;
  (iii) unless the company is being wound up voluntarily merely for the purposes of reconstruction or amalgamation with another company or unless the company has, at the commencement of the winding up, under such a contract with insurers as is mentioned in Section 14 of the Workmen’s Compensation Act, 1923, rights capable of being transferred to and vested in the workmen, all amount due in respect of any compensation or liability for compensation under the said Act in respect of the death or disablement of any workman of the company;
  (iv) all sums due to any workman from the provident fund, the pension fund, the gratuity fund or any other fund for the welfare of the workmen, maintained by the company;
  (c) “workmen’s portion”, in relation to the security of any secured creditor of a company, means the amount which bears to the value of the security the same proportion as the amount of the workmen’s dues bears to the aggregate of the amount of workmen’s dues and the amount of the debts due to the secured creditors.
  Illustration
  The value of the security of a secured creditor of a company is Rs. 1,00,000. The total amount of the workmen’s dues is Rs. 1,00,000. The amount of the debts due from the company to its secured creditors is Rs. 3,00,000. The aggregate of the amount of workmen’s dues and the amount of debts due to secured creditors is Rs. 4,00,000. The workmen’s portion of the security is, therefore, one-fourth of the value of the security, that is Rs. 25,000.”

• Section 36(4) of the Insolvency and Bankruptcy Code, 2016: This section excludes all sums due to any workman or employee from the provident fund, the pension fund, and the gratuity fund from being included in the liquidation estate assets.
• Section 52 of the Insolvency and Bankruptcy Code, 2016: This section provides the secured creditor two options in a liquidation proceeding. First, the secured creditor may relinquish its security interest and receive the proceeds from the sale of assets by the liquidator in the manner specified in Section 53 of the Code. The second option is to realize the security interest, but in the manner specified in Section 52 of the Code.

Arguments

Petitioners’ Arguments:

• The petitioners argued that Section 327(7) of the Companies Act, 2013, which excludes the applicability of Sections 326 and 327 of the Companies Act, 2013 in the event of liquidation under the IBC, is arbitrary and violates Article 21 of the Constitution of India.
• They contended that the waterfall mechanism under Section 53 of the IBC unfairly alters the priority of workmen’s dues, which were previously protected under the Companies Act.
• The petitioners submitted that the workmen’s dues should be settled in accordance with the principles laid down under Section 326 of the Companies Act, 2013, even in the event of liquidation under the IBC.
• It was argued that the IBC places workmen’s dues on par with secured creditors, which is detrimental to the interests of workmen.
• The petitioners also argued that the definition of “workmen’s dues” under the Companies Act, 2013, includes the Pension Fund, Gratuity Fund, and Provident Fund amounts, and there was no exclusion of the said amounts in the case of liquidation.
• The petitioners contended that the changes introduced through the IBC to the existing scheme under the Companies Act, 2013, are unconstitutional.

Respondents’ (Union of India) Arguments:

• The respondent argued that the IBC is a new insolvency mechanism aligned with international practices, with the objective of reviving sick and insolvent companies and ensuring transparent and equitable liquidation of assets.
• It was submitted that the IBC was introduced as a watershed moment for insolvency law in India, consolidating processes under several disparate statutes into a single code.
• The respondent contended that the objective of the IBC was to introduce a comprehensive and time-bound insolvency framework and to maximize the value of assets of all persons and balance the interest of all stakeholders.
• The respondent highlighted that the IBC was drafted based on the UNCITRAL Legislative Guide on Insolvency Law and the Bankruptcy Law Report.
• It was argued that the waterfall mechanism under Section 53 of the IBC was a result of detailed consultations and deliberations and that the workmen’s dues were duly protected under the IBC.
• The respondent submitted that the Provident Fund, Gratuity Fund, and Pension Fund are excluded from the liquidation estate under Section 36 of the IBC.
• The respondent pointed out that the workmen dues for a period of 24 months are to be paid along with secured creditors dues in the event of relinquishment of security and that the liquidation costs cover the wages and salary of the workmen during the liquidation process.
• The respondent argued that the IBC is an economic legislation and should be viewed with greater latitude than laws touching civil rights.

Amicus Curiae Arguments:

• The Amicus Curiae provided a detailed legislative history of the Companies Act and the IBC, highlighting the evolution of provisions related to preferential payments and workmen’s dues.
• It was submitted that the focus of the committees was on bringing the claims of “employees of a company” pari passu with the secured creditors.
• The Amicus Curiae explained the rationale behind the changes introduced by the IBC and the reasons for capping workmen’s dues at 24 months preceding the liquidation commencement date.
• It was argued that the waterfall mechanism under the IBC is different from the Companies Act, 1956 and the Companies Act, 2013, and that the waterfall mechanism from the Companies Act, 2013 cannot apply under the IBC.
• The Amicus Curiae emphasized the principle of “judicial hands-off” when it comes to economic legislation.
• It was submitted that the IBC has an intelligible differentia for classification of financial creditors and operational creditors and that the object sought to be achieved by the IBC is a reasonable classification.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether Section 327(7) of the Companies Act, 2013 is arbitrary and violative of Article 21 of the Constitution of India.
2. Whether the statutory claims of the “workmen’s dues” should be left out of the purview of the waterfall mechanism under Section 53 of the Insolvency and Bankruptcy Code, 2016.
3. Whether the distribution of the workmen’s due as envisaged under Section 53(1)(b)(i) of the IBC is unreasonable and violative of Article 14 of the Constitution of India.
4. Whether settlement of Workmen Dues should be done in accordance with the reasonable principles laid down under Section 326 even in the event of liquidation under the IBC.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court relied on the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Court relied on Manish Kumar Vs. Union of India and Anr., (2021) 5 SCC 1* to support the principle that courts should give deference to legislative judgment in economic matters.
• The Court relied on Swiss Ribbons Private Limited and Anr. Vs. Union of India and Ors., (2019) 4 SCC 17* to highlight the objects and reasons for enactment of the IBC and to uphold the reasonable classification of creditors under the IBC.
• The Court relied on Small Scale Industrial Manufacturers Association (Registered) Vs. Union of India and Ors., (2021) 8 SCC 511* to support the principle that courts should give deference to legislative judgment in economic matters.
• The Court relied on Committee of Creditors of Essar Steel India Limited Vs. SatishKumar Gupta and Ors., (2020) 8 SCC 531* to emphasize that financial and operational creditors cannot be treated equally as it would defeat the objective of the IBC.
• The Court relied on Ghanashyam Mishra and Sons Private Limited Vs. Edelweiss Asset Reconstruction Company Limited, (2021) 9 SCC 657* to highlight that the approved resolution plan is binding on the government to create a clean slate.
• The Court relied on Allahabad Bank Vs. Canara Bank and Anr., (2000) 4 SCC 406* and Andhra Bank Vs. Official Liquidator and Anr., (2005) 5 SCC 75* to interpret the meaning of “workmen’s portion” under the Companies Act.
• The Court relied on Innoventive Industries Limited Vs. ICICI Bank and Anr., (2018) 1 SCC 407*, Arcelormittal India Private Limited Vs. Satish Kumar Gupta and Ors., (2019) 2 SCC 1*, Arun Kumar Jagatramka Vs. Jindal Steel and Power Limited and Anr., (2021) 7 SCC 474* and Sesh Nath Singh and Anr. Vs. Baidyabati Sheoraphuli Co-operative Bank Limited and Anr., (2021) 7 SCC 313* to highlight the objectives of the IBC in unlocking value for all its stakeholders.
• The Court relied on R.K. Garg Vs. Union of India and Ors., (1981) 4 SCC 675*, Rustom Cavasjee Cooper Vs. Union of India, (1970) 1 SCC 248*, Delhi Science Forum and Ors. Vs. Union of India and Anr., (1996) 2 SCC 405* and BALCO Employees’ Union (Regd.) Vs. Union of India and Ors., (2002) 2 SCC 333* to support the principle that laws relating to economic activities should be viewed with greater latitude.
• The Court relied on Directorate General of Foreign Trade v. Kanak Exports, (2016) 2 SCC 226* to highlight that the government has the right to amend, modify, or rescind a particular scheme.
• The Court relied on Bhavesh D. Parish v. Union of India (2000) 5 SCC 471* to emphasize that courts should not interfere in economic policy matters.

Final Decision

The Supreme Court upheld the constitutional validity of Section 327(7) of the Companies Act, 2013, and the waterfall mechanism under Section 53 of the Insolvency and Bankruptcy Code, 2016. The Court held that the IBC is a complete code in itself and that the waterfall mechanism under Section 53 is not arbitrary or violative of Article 14 of the Constitution. The Court also clarified that workmen’s dues are duly protected under the IBC, with a priority for 24 months dues along with secured creditors in the event of relinquishment of security.

Implications

For Workmen:

• Workmen’s dues for the period of 24 months preceding the liquidation commencement date are prioritized and rank equally with secured creditors who have relinquished their security.
• Provident Fund, Gratuity Fund, and Pension Fund amounts are excluded from the liquidation estate, ensuring their safety.
• Workmen’s dues are not given absolute priority but are placed in a higher category than unsecured creditors.

For Secured Creditors:

• Secured creditors who relinquish their security interest rank equally with workmen for their dues for 24 months preceding the liquidation commencement date.
• Secured creditors who enforce their security interest rank lower in the waterfall mechanism for any unpaid amounts.

For Companies undergoing Liquidation:

• The liquidation process under the IBC is upheld as a valid and complete code.
• The waterfall mechanism under Section 53 of the IBC is the governing rule for the distribution of assets.

Flowchart of Asset Distribution under Section 53 of the IBC