No Priority For Workers' Dues After Liquidation Of Company Under IBC : Supreme Court Upholds Section 327(7) Of Companies Act 2013

The Supreme Court on Tuesday upheld a provision of the Companies Act 2013, which holds that workers' dues will not get preferential payment in the event a company undergoes liquidation as per the provisions of the Insolvency and Bankruptcy Code 2016.

A bench comprising Justices MR Shah and Sanjiv Khanna dismissed a batch of petitions which challenged the constitutionality of Section 327(7) of the Companies Act 2013.

As per Section 326 and 327 of the Companies Act, certain payments will get priority over other debts in the event of winding up of a company. These are workmen's dues and revenues, taxes, cesses and rates due from the company to the Central Government or a State Government or to a local authority. However, sub-section (7) added to Section 327 as per 2016 amendment stated that Sections 326 and 327 shall not be applicable in the event of liquidation under the Insolvency and Bankruptcy Code, 2016. This, in effect, meant that workmen's dues and government dues will not get priority when a company undergoes liquidation as per IBC.

Section 327(7) was challenged in a writ petition filed by Moser Baer Karamchari Union, contending the union members were denied legitimate dues - gratuity, provident fund, pension, and severance compensation - by the liquidator citing this provision. Later, other petitions were also filed challenging this provision as arbitrary and unreasonable. The petitioners also sought for directions to keep the statutory dues of workmen out of the "waterfall mechanism" for distribution of assets as per Section 53 of the IBC after a company's liquidation.

Dismissing the petitions, the bench observed that Section 327(7) was added in view of the introduction of the new IBC regime.

"The enactment of the IBC and Section 53 of IBC necessitated amendment to the Companies Act 2013. The object and purpose of amending the Companies Act 2013 and to exclude Sections 326 and 327 in the event of liquidation of a company under IBC seem to be that there may not be two different provisions in respect to the winding up/ liquidation of a company. Therefore, in view of the enactment of the IBC, it was necessary to exclude the applicability of Section 326 and 327 of the 2013 Act, which cannot be said to be arbitrary, as contended on behalf of the petitioners", Justice MR Shah read out the operative portion of the judgment.

The bench further noted that Section 53 IBC started with a "non-obstante clause", giving it overriding power over provisions of other laws. Hence, the distribution of assets after liquidation under the IBC can be only as per the priority specified under Section 53.

"The consequence of  sub-section (1) to 53 of the IBC is that it will override the rights of the parties, including the secured creditors when the said provision applies. Section 53 of the Code is a complete and comprehensive code, which provides for the manner in which creditors are to be paid. Even the rights of the secured creditors falling under Section 53 of the Code are diluted and compromised", the bench noted.

The bench declared that Section 327(7) cannot be held to be arbitrary and violative of Article 21 of the Constitution. In case of liquidation of a company under the IBC, the distribution of assets have to be made as per Section 53, subject to Section 36(4) of the IBC, the bench stated, while dismissing the writ petitions as lacking in merits.

"In economic matters, a wider latitude is given to the lawmaker and the Court allows for experimentation in such legislation based on practical experiences and other problems seen by the law-makers. In a challenge to such legislation, the Court does not adopt a doctrinaire approach. Some sacrifices have to be always made for the greater good, and unless such sacrifices are prima facie apparent and ex facie harsh and unequitable as to classify as manifestly arbitrary, these would be interfered with by the court," the judgment said.

For the revival and rehabilitation of companies, certain sacrifices are required from even workmen and governments, the Court said.

"The workmen also have a stake and benefit from the revival of the company, and therefore unless it is found that the sacrifices envisaged for the workmen, which certainly form a separate class, are onerous and burdensome so as to be manifestly unjust and arbitrary, we will not set aside the legislation, solely on the ground that some or marginal sacrifice is to be made by the workers."

Case Title : Moser Baer Karamchari Union through its President Mahesh Chand Sharma vs Union of India W.P.(C) No. 421/2019 and connected cases.

Citation : 2023 LiveLaw (SC) 386

Companies Act 2013- Upholds the constitutionality of Section 327(7) of the Companies Act, which excludes workers dues from priority payment in the event of liquidation of a company under the Insolvency and Bankruptcy Code 2016- The object and purpose of amending the Companies Act 2013 and to exclude Sections 326 and 327 in the event of liquidation of a company under IBC seem to be that there may not be two different provisions in respect to the winding up/ liquidation of a company. Therefore, in view of the enactment of the IBC, it was necessary to exclude the applicability of Section 326 and 327 of the 2013 Act, which cannot be said to be arbitrary, as contended on behalf of the petitioners- Para 6

Insolvency and Bankruptcy Code 2016-  Section 53- Waterfall mechanism- Complete code- 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, striking down any one 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. Every change in the waterfall mechanism is bound to lead to cascading effects on the balance of rights and interests of the secured creditors, operational creditors and even the Central and State Government - Para 16

Insolvency and Bankruptcy Code 2016- Section 53- the distribution of the assets shall have to be made as per Section 53 of the IBC subject to Section 36(4) of the IBC, in case of liquidation of company under IBC- Exclusion of Sections 326 and 327 of Companies Act 2013 in the event of liquidation of company as per IBC not arbitrary- Para 18

Click Here To Read/Download Judgment