Section 53 of IBC: The Heart of Insolvency Law

Vinod Kothari
Vinod Kothari and Company

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Agenda
01 The need for prioritization
How priorities encourage equitable treatment

02 The Waterfall Mechanism

Discussion upon the priorities u/s 53 of the Code

03 Position w.r.t. secured creditors

The General Rule of priority and its exceptions

04 Priorities under Personal Insolvency

Discussion upon the priorities u/s 53 and treatment of inter-se priorities
 The Need for Prioritization

Kinds of Priority & its relevance

Priority ensures “distributive justice”
Global Scenario
Kinds of Priority and its Relevance

 Prioritization based on ranking

Priority
 Losses, that is, shortfall, is allocated in reverse
order of priority
 Cashflows are allocated as per waterfall.
Based on Based on
ranking timing sequence  Prioritization based on time sequence
 Without breaching the seniority ranking, is it
possible that in terms of time sequence, a
Relevant in case of Normally relevant subordinated class may be paid before a senior
deficit in case of ‘no-deficit’ class?
 Normally, the answer should be negative
 However, if the cashflows are certain, what matters
any shortfall shall be Sums must be
borne starting fro distributed as per is the ranking; timing is not crucial
the last category time sequence
Relevance of Distributive Justice under the Code

Different stages under the Code

Insolvency Resolution Process Liquidation Process Voluntary Liquidation

 Resolution Plan must be take into  The crux of the liquidation  Under voluntary liquidation
consideration priority laid down process is distribution on the  Assets > liabilities
u/s 53- basis of priorities.
 Ref. sec. 30 (2)(b)(ii) & Sec. 30 (4)  Hence, all creditors shall be paid
 Amendment introduced on the  Deficit in realisation makes it in full.
basis of order of Hon’ble SC in necessary to have priorities
Essar Steel v. Satish Kumar Gupta
ascertained with clarity  However, by virtue of priority
& ors.
 To ensure distributive justice based on sequence, section 53
 Haircut may be faced by creditors, must be followed
however, priority must be maintained  Ref sec. 59 (6)
by resolution plan.
RELEVANCE OF PRIORITIES IN SPECIFIC SCENARIOS

 Is it relevant in case of liquidation sale as going  Is it relevant in case of winding up under the
concern? Companies Act?
 Different forms of going concern transfer – transfer of  Priorities are there under the Companies Act, though
the corporate debtor the priorities are a shade different
 Transfer of the business of the corporate debtor  Is it relevant in case of compromise u/s 230 without
 Transfer of one of the businesses of the corporate being in insolvency or liquidation?
debtor
 Is it relevant in case of scheme of arrangement u/s
230 as a part of liquidation process?
 If the scheme of arrangement is sanctioned by
shareholders, creditors and the NCLT, the matter
comes out of liquidation, and becomes an debtor-
creditor contract
 Relevance of Priority in Resolution Plans

 Enshrined in sec 30 (2) (b)-OCs must receive min.-  Proviso to sec. 30 (2)
 Liquidation value; or  For removal of doubts, it is hereby clarified that a
 Amount under resolution plan if distributed as per sec. 53, distribution in accordance with the provisions of this
Whichever is higher.
clause shall be fair and equitable to such creditors
 Dissenting Financial Creditors u/s 30 (2) must also be paid min.
 Is this a deeming provision, or overarching requirement?
liquidation value
 Can a resolution plan have a cramdown unless it is fair
 Section 30 (4) provides that-
and equitable?
 CoC may approve a resolution plan, after considering
 Sec. 1129 (b) of US Bankruptcy Code
feasibility and viability
 Which may take into account the order of priority amongst  Regulation 38 (3) (b) requires the resolution plan to
creditors u/s 53 (1) feasible and viable
 Also upheld by Hon’ble SC in Essar Steel vs. Satish Kumar  Sec 30 (4) of Code includes taking into account order
Gupta & Ors (Ref. para 40)
of distribution while determining priority.
 Thus, what is left to the majority decision of the Committee of
Creditors is the “feasibility and viability” of a resolution plan, which
obviously takes into account all aspects of the plan, including the
manner of distribution of funds among the various classes of
creditors.
 Vertical & Horizontal Equity during Resolution
Horizontal equity
Amount proposed under entitles pari-passu
creditors to receive the
Resolution Plan same treatment.
Hence, here since A gets
Receivable on revival – 80% lower than B & C,
60% horizontal equity
70% 70% breached

Vertical Equity provides Creditor A Creditor B Creditor C

that the Creditor must
atleast receive the
liquidation value
Pari-passu Creditors

Creditor A Creditor B Creditor C

Total value of claims of A, B and C, Rs 500 crores;

Liquidation value– 50%
total asset value Rs 250 crore
HORIZONTAL AND VERTICAL EQUITY IN RESOLUTION PLANS

 Provisions under US Bankruptcy Code – Chapter 11  Horizontal equity

 Reorganisation has a “cramdown” provision – 1129 (b)  All creditors of equal ranking must be placed in the
 However, sec 1129 (a) (7) provides minimum assurance same ranking
 In UK- no explicit provision of vertical equity  Examples of fair and equitable resolution plans:
 Courts have applied in several rulings  A secured creditor cannot become unsecured creditor
 See Re T & N Ltd [2004] EWHC 2361 (Ch). or vice versa
 Mourant & Co. Trustee Ltd. v. Sixty UK Limited (In  A senior creditor cannot become junior creditor or
Administration), [2010] EWHC 1890 (Ch) vice versa
 Prudential Assurance Co Ltd v PRG Powerhouse Ltd  Rights against third parties cannot be obliterated
[2007] EWHC 10002 (Ch)
Treatment of Creditors- Equal vs. Equitable

Q. Whether prioritization disturbs/ distorts equitability?

 Code posits a fair and equitable treatment of  Prioritization encourages equitability-
creditors- Does not mean that all creditors can be
 UNCITRAL Legislative Guide states-
treated equally
“The objective of equitable treatment is based on the notion
 See Swiss Ribbons v. Union of India;
that, in collective proceedings, creditors with similar legal
 Essar Steel India Limited v. Satish Kumar Gupta & ors. rights should be treated fairly, receiving a distribution on
their claim in accordance with their relative ranking
 As per Principles for Effective Insolvency and and interests.”
Creditor/Debtor Regimes by World Bank-
 American Jurisprudence-
 Insolvency law systems should provide for The bankruptcy system is designed to distribute an estate
equitable treatment of similarly situated creditors as equally as possible among similarly situated
creditors. Thus, creditors of equal status must be treated
equally and equitably.
The Waterfall Mechanism
Priorities u/s 53 (1) of IBC
Insolvency Resolution Process Cost (if any) & liquidation costs- in full

workmen’s dues for 24 months prior to LCD; & Secured creditors

Employee dues (other than workmen) for 12 months prior to LCD

Financial debts owed to unsecured creditors

Statutory dues for 24 months prior to LCD & Remaining amount towards secured creditors

Remaining debts and dues

Preference shares

Equity shareholders
 Priorities under Companies Act
Companies Act, 1956 Companies Act, 2013
i. Pari-Passu Payments to – i. Pari-Passu Payments to –
Priorities Under IBC vis-à-vis Companies Act
a.
b.
workmen' s dues
debts due to secured creditors
a.
b.
workmen' s dues
debts due to secured creditors, so much of the debts due to such
ii. all revenues, taxes, cesses and rates due from the company to the Central secured creditor as could not be realised by him or the amount of
or a State Government or to a local authorities the workmen's portion in his security, whichever is less
iii. all wages or salary in respect of services rendered to the company and due ii. all revenues, taxes, cesses and rates due from the company to the
for a period not exceeding four months within the 12 prior to Central Government or a State Government or to a local authority upto
commencement of liquidation 12 months prior to relevant date.
iii. all wages or salarydue for a period not exceeding four months within
iv. all accrued holiday remuneration becoming payable to any employee,
the twelve months immediately before the relevant date
v. all amounts due, in respect of contributions payable during the twelve iv. all accrued holiday remuneration becoming payable to any employee,
months next before the relevant date, by the company as the employer of v. all amounts due, in respect of contributions payable during the twelve
any persons, under the Employees' State Insurance Act, 1948 months next before the relevant date, by the company as the employer
a. Except in case of voluntary liquidation/ arrangement of any persons, under the Employees' State Insurance Act, 1948
vi. all amounts due, in respect of contributions payable, by the company as the a. Except in case of voluntary liquidation/ arrangement
employer of any persons, under the Workmen’s Compensation Act, 1923, vi. all amounts due, in respect of contributions payable, by the company as
a. Except in case of voluntary liquidation/ arrangement the employer of any persons, under the Workmen’s Compensation Act,
vii. all sums due to any employee from a provident fund, a pension fund a 1923,
gratuity fund- or any other fund for the welfare of the employees a. Except in case of voluntary liquidation/ arrangement
viii. the expenses of any investigation held in pursuance of section 235 or 237, vii. all sums due to any employee from the provident fund, the pension fund,
in so far as they are payable by the company. the gratuity fund or any other fund for the welfare of the employees,
maintained by the company
viii. the expenses of any investigation held in pursuance of sections 213 and
216,in so far as they are payable by the company
 Priorities under Insolvency laws outside India
Insolvency, Restructuring And
US Bankruptcy Code, Chapter 7 UK Insolvency Act
Dissolution Act of Singapore
i. Cost of administration (including trustee’s fee) i. Cost to realising fixed charge i. the costs and expenses of the winding up incurred
ii. certain expenses incurred in an involuntary bankruptcy assets by the Official Receiver
Priorities Under IBC vis-à-vis Companies Act
case before entry of an order of relief or appointment of ii. Fixed charge holders; ii. any other costs and expenses of the winding up,
a trustee iii. Obligations under any new including the remuneration of the liquidator
iii. Wage, salary or commission claims contract entered iii. the costs of the applicant for the winding up order
iv. Claims for contribution to employee benefit plans iv. Expenses of insolvency iv. all wages or salary including any amount payable by
v. Claims for farmers and fisherman v. Preferential claims way of allowance or reimbursement under any
vi. certain claims for alimony, maintenance, or support. vi. Floating charge claims (subject contract of employment
vii. certain governmental claims for income, property, to “prescribed part” provision) v. the amount due to an employee as a retrenchment
employment, and excise taxes, and customs duties. vii. Unsecured claims benefit or ex gratia payment
viii. certain claims by a federal depository institution viii. Equity shareholders vi. all amounts due in respect of work injury
regulatory agency. compensation under the Work Injury
ix. unsecured claims in which a proof of claim is timely filed “Prescribed part” refers to a certain Compensation Act
by creditor who had no knowledge of the bankruptcy percentage of Net Property that must be vii. all amounts due in respect of contributions payable
x. unsecured claims in which a proof of claim is tardily who set aside for payments to be made to towards superannuation or provident funds for 12
had knowledge of bankruptcy the unsecured creditors months prior to commencement
xi. claims for any fine, penalty, or forfeiture, or for multiple, viii. all remuneration payable to any employee in
exemplary, or punitive damages Calculation of Prescribed part (sec. respect of vacation leave or, in the case of the
xii. interest on the claims paid above from the date of filing 176A) employee’s death
the petition at the legal rate. 50% of the first £10,000 of assets; and ix. the amount of all tax assessed, and all goods and
xiii. to the individual debtor or equity holders of 20% of the balance up services tax due, under any written law before the
the corporate or partnership debtor pursuant to the commencement of the winding up
articles of incorporation or state law.
THE CONTOURS OF LIQUIDATION ESTATE

 What is to be distributed is the liquidation estate  Amount in Provident fund, Pension funds and gratuity
fund
 Hence, it is important to understand what will not
be part of liquidation estate, as these monies are not  Tall question – what if the company did not have a
impressed with the colour of liquidation estate fund?
 Fall outside the domain of the liquidator  What about the shortfall in contributions – is it a claim
against the company or a claim against the fund?
 Sec 36 (4) provides several exclusions
 What about other funds – say superannuation fund?
 Money held in trust
 Liquidation estate may be enhanced by anti avoidance
 For example, security deposit held by the company – if powers of the liquidator
against specific property or obligation, it is typically not a
part of the funds of the company
 Usual rule is – setting aside of a fund for the payment to
creditors creates a trust – Baroda Spinning and Weaving
Mills, 46 Comp Cas (Guj)
 Bailment of assets
 Priorities u/s 53 (1) of IBC
Clause (a)- CIRP & Liquidation Costs

What constitutes CIRP Costs- (Sec 5 (13) and Reg 31 of CIRP Regulations)

 Where expenses incurred towards or by IRP are not ratified

Amount due to by CoC- Applicant must bear the expenses
Fee payable to AR of
suppliers of essential
class of creditors
goods and services  Only expenses ratified by CoC shall form part of CIRP Cost
 Interim financing and cost thereof – sec 5 (13)

Amounts due to  Not forming part of CIRP Cost- (As per IBBI Circular
Out-of-pocket person whose rights dated 12.06.2018)
expenses of RP for are prejudicially  any fee or other expense beyond the amount approved by CoC,
discharge of functions affected due to
moratorium  any expense incurred by a creditor, claimant, resolution applicant,
promoter or member of the Board of Directors of the CD in
relation to the CIRP

Other costs directly  any fee or other expense incurred before the commencement of
Expenses incurred on CIRP or to be incurred after the completion of the CIRP
related to CIRP and
and by the RP
approved by CoC
Critical Supplies vs. Essential Goods- What Forms Part of CIRP Cost?

Essential Supplies Critical Supplies

 Forms part of IRP costs under reg. 31(a) of CIRP  Not an explicit part of IRP Costs
Regs;  Section 14(2A) – inserted by amendment of 2020 (w.e.f.
28.12.2019) on recommendation of ILC report, 2020.
 The essential goods and services shall mean- electricity;
water; telecommunication services; and information  ‘Critical’ to protect and preserve the value of the corporate
technology services, debtor and manage the operations of such corporate debtor as
a going concern
 to the extent these are not a direct input to the output
produced or supplied by the corporate debtor  As the IRP/RP considers to be ‘critical’
 the supply of such goods or services shall not be terminated,
suspended or interrupted during the period of moratorium
 except where such corporate debtor has not paid
dues arising from such supply during the moratorium period or
in such circumstances as may be specified
 no specifications as on date
 past dues till insolvency commencement date? – resolution plan
 Priorities u/s 53 (1) of IBC
Clause (a)- CIRP & Liquidation Costs

Cost incurred  Fee of the liquidator- in terms of Reg. 4

Cost incurred
for protecting for carrying on  Percentage based; or
the assets of the the CD as  As decided by the CoC
Cost incurred CD Going Concern
for verification Interest on
of claim interim finance  Interest on Interim Finance- for the period lower
of-
 12 months; or
Remuneration paid Amount payable  LCD till repayment of interim finance
by the liquidator to
for professional contributories
services to liquidation  Contribution under Reg. 2A of Liquidation
costs Regulations - read with Reg. 39B of CIRP
Regulations
Liquidation Any other cost  Also entitled to interest @bank rate
Fee of the Costs essential for
Liquidator liquidation
Reg 2(e)(a) process  Any cost incurred by the liquidator in relation to a
scheme of compromise or arrangement- does not
form part of Liquidation Costs
 Shall be paid by the applicant
Priorities u/s 53 (1) of IBC
Clause (b)- Secured creditors & Workmen dues

 Workmen as defined under the Industrial Disputes Act-

 Meaning of workmen dues- As per section 326 of the

Parri-passu distribution Companies Act, as per which workmen dues mean aggregate
towards of-
 All salary or wages;
 Accrued holiday remunerations
 all amount due in respect of any compensation or liability
Workmen Dues Secured creditors for compensation in respect of death or disablement of
any workman

Towards dues upto 24 Where the security  Sums due towards PF, Pension & Gratuity outside the scope of
months prior to LCD interest in relinquished Sec 53 read with section 36 (4) (a) (iii)
 See SBI v. Moser Baer Karamchari Union & Ar

 Secured creditor’s claim is covered to the extent of value of

security; and not the total sum due
 Recommendations of the Second ILC Report
WIDE COVERAGE OF THE EXPRESSION “WAGES”

 There have been lots of rulings defining what all is included in “wages”
 Rulings under the winding up regime of the 1956 Act should all remain relevant
 The following have bee included in definition of wages
 Dearness allowance
 Bonus
 Unavailed leave
 Compensation for Termination is clearly covered by Explanation (b) (i) below sec. 326 (2) of the Companies Act
 The following are held not included
 Ex gratia payments
SECURED CREDITORS
 Secured creditors are, evidently, the largest claimants in  The following are not security interests:
resolution/liquidation proceedings  A mere obligation to pay, not being an obligation attached
 Following points important to understand: to property

 Is the person a “creditor”, and a “secured creditor”?  A negative lien or negative pledge
 Definition in sec. 3 (30) and 3 (31) seem generally broad  A covenant requiring maintenance of asset cover etc may
be a financial covenant but not a security interest
 For example, an owner of an asset taken on financial lease is not
a creditor  Also, it is important to note that in sec. 53 (1) (b), it is
 Is the security interest registered? important to define “secured creditor” and not
 Sec. 77 (3) of the Companies Act. Unregistered charges not to
“financial creditor”
be taken cognizance of  There may be secured creditor who is not a financial
 Has the creditor relinquished security interest, or are creditor
deeming provisions applicable?  Partly secured creditor or fully secured creditor
 Determining the “security interest”
 Ascertainable assets or unascertainable assets
 Determining the ranking
 Secured creditors and the value of security interest

 Second ILC Report, para 7.1 to 7.4 has an important  Subordination Agreements within the Liquidation
discussion on this issue Waterfall
 Repayment to Secured Creditors Covers Value of  First ILC Report clarified that valid inter-
Security Interest Relinquished creditor/subordination agreements would continue to
govern their relationship
 this provision intends to replicate the benefits of
security even where it has been relinquished  Agreements inter-se secured creditors do not disturb
the equal ranking sought to be provided by section
 However, any they will only have priority for the 53(1)(b) and therefore do not fall within the ambit of
amount of security interest; not the entire sum due section 53(2)
 Therefore priority of repayment over their entire debt
regardless of the extent of their security interest is not
the intent.
 Similar provisions in sec. 110 (3) (b) and 123 (2)(b)

Second ILC Report available at-

https://www.ibbi.gov.in/uploads/resources/c6cb71c9f69f66858830630da08e45b4.pdf
Priorities u/s 53 (1) of IBC
Clause (c) and (d)

Clause (c)- Wages and Employee dues Clause (d) Unsecured Financial Creditors
wages and any unpaid dues owed to employees (other Unsecured financial debts have been placed prior to
than workmen) for the period of 12 months preceding Government dues, which have been ranked first in the
the liquidation commencement date; priority list under the Companies Act, 1956
Priorities u/s 53 (1) of IBC
Clause (e)

 Statutory dues include

 due to the Central Government; Parri-passu distribution towards
 Dues to the State Government;
 includes the amount to be received on account
of the Consolidated Fund of India Remaining sums of Secured
Statutory Dues
creditors
 Here, Secured creditors mean those who had
realised outside of liquidation process.
For a period of 2 years prior to Where after realisation or
LCD relinquishment, part of claim is
pending
Priorities u/s 53 (1) of IBC
Clause (f), (g) and (h)

Clause (f)- Residual dues Clause (g)- Preference shareholders Clause (g)- Equity shareholders
 These are debts and dues other  Preference shareholders, by nature,  The residual bite of the assets of
than those mentioned in the receive priority in distribution of the corporate debtor shall go to
foregoing clauses. dividend and assets in the event of the equity shareholders (or
liquidation of companies. partners in case of LLPs).
 For example, operational debts
owed to unsecured creditors
may fall in this category
 Case Study
Claims received in the liquidation process of X Ltd. Amount
1. Insolvency resolution process costs 200
2. Liquidation Costs 400
3. Workmen dues for 24 months prior to LCD 1000
4. Workmen dues for period prior to 24 months before LCD 500
5. Employees (for 12 months preceding LCD) 3000
6. Employees (for periods prior to 12 months preceding LCD) 600
7. Govt. dues (for 2 years preceding LCD) 1500
8. Govt. dues (for periods prior to 2 years preceding LCD) 1000
9. Secured financial creditors who have relinquished security interest 2800
10. Secured financial creditors whose part of the debt remains unpaid after enforcement of security interest* 300
11. Unsecured creditors in respect of financial debts 200
12. Other debts 100
13. Preference Shareholders 900
14. Equity shareholders 1700
*Assumed that the secured creditors had debts amounting to Rs.1000, out of which Rs. 700 has been realised from enforcement of security
 Sorting of claims in line with section 53 Amount

Insolvency resolution process costs 200

1. Liquidation Costs 100

300

Workmen dues for 24 months prior to LCD 1000

2. Secured financial creditors who have relinquished security interest (equal to security interest) 2800

Ratio (5:14) 3800

3. Employees (for 12 months preceding LCD) 3000

4. Unsecured creditors in respect of financial debts 200

Govt. dues (for 2 years preceding LCD) 1500

5. Secured financial creditors whose part of the debt remains unpaid after enforcement of security interest 300

Ratio (5:1) 1800

6. Remaining debts & dues (500+ 600+ 1000+100) 2200

7. Preference Shareholders 900

8. Equity shareholders 1700

 Scenario 1: Amount realised- Rs. 4,500 Scenario 1I: Amount realised- Rs. 2200

Liquidation +
Rs. (200+100)=
CIRP costs (in Liquidation +
Rs. 300 Rs. (200+100)=
full) CIRP costs (in
Rs. 300
full)
Workmen’s
dues = Rs. 1,000 Workmen’s dues=
Amount available Rs. 500
Amount Pari-passu 1900
for distribution= Pari-passu in 5:14
available for Secured FCs=
Rs. 2200 Secured FCs=
distribution= Rs. 2,800
Rs. 4500 Rs. 1400
Employees (for
12 months Rs. 400 Remaining
NIL
preceding LCD) creditors

Remaining
NIL
categories
Scenario III:Amount realised- Rs. 2,200
Assumption:
Out of Secured creditors of Rs. 2,800, Securities creditors of Rs. 2,000 are first-charge holders; and remaining Rs. 800 are second-charge holders

Liquidation +
Rs. (200+100)=
CIRP costs (in
Rs. 300
full)

Workmen’s
In case of intra-
Amount available dues= Rs. 500
1900 First Charge class priority, the
for distribution= Pari-passu in 5:14 Holders- Rs. first charge
Rs. 2200 Secured FCs= 1,400 holders shall be
paid in full, only
Rs. 1400 after which
Second Charge distribution can
holders- NIL be don to
Remaining second charge
NIL holders
creditors
 Secured Creditors & Floating Charges under IBC vis-à-vis Companies Act
Point of comparison Companies Act, 1956 Companies Act, 2013 IBC

Relevant provisions Sec. 529, 529A, 530 Sec. 326, 327 S. 53, read with s. 52
Applicability of priority rules Insolvency rules would apply to winding Replaced vide s. 255 of the IBC Specific priority rules
up of insolvent companies Priority rules only apply to winding up
under the 2013 Act, and not to IBC.
Rights of secured creditors In case of realisation, security of secured Proviso to s. 326(1) read with s. 326(2) S. 52, Reg. 21A, Reg. 37
realising security interest creditor subject to pari passu charge in accords priority to workmen dues (for
favour of workmen – proviso to s. 529. 2 years) for wages, salaries and accrued Have to choose within 30 days in
holiday remuneration. the claim Form;
Secured debt which could not be realised
as above, payable as overriding Realising secured creditors at par with Have to cede proportionate share
preferential payment u/s 529A with workmen dues after the said proviso, at for costs and workmen within 90
workmen dues. par with workmen dues – sec. 326(1). days of LCD;

Have to tender excess realisation

within 180 days of LCD;

Failing which, the asset is presumed

to be a part of the liquidation estate
 Point of comparison Companies Act, 1956 Companies Act, 2013 IBC
Rights of secured creditors On relinquishment, would stand at par Nothing specific. Therefore, treated at Pari passu with workmen dues for

Priorities Under IBC vis-à-vis Companies Act

relinquishing
interest
security with unsecured creditor – inferred from
a conjunctive reading of s. 529(2), 529A
par with general creditors. 24 months – s. 53(1)(b)

& 530.
Provision relating to Sec. 530(5) – Preferential debts, so far Sec. 327(3) – Preferential debts, so far Not specified.
floating charge as the assets of the company available as the assets of the company available
for payment of general creditors are for payment of general creditors are
insufficient to meet them, have insufficient to meet them, have
priority over the claims of holders of priority over the claims of holders of
debentures under any floating charge debentures under any floating charge
created by the company, and be paid created by the company, and be paid
accordingly out of any property accordingly out of any property
comprised in or subject to that charge. comprised in or subject to that
charge.
Position w.r.t. Secured Creditors
Decision of Secured Creditors- Realisation vs. Relinquishment

Realisation by
Secured
Creditor

Outside Under
Liquidation Liquidation
Process- Sec 52 Process- Sec 53

Realisation Security
outside Interest
liquidation relinquished
Realisation outside Liquidation Process

Regulation 21A Regulation 37

• Communication of decision within 30 days of LCD  The secured creditor must intimate the liquidator
• In Form C (Operational creditors) or Form D (Financial
Step 1 Creditors) the realisable price at which he proposes to realise
the asset.
• Proportional contribution towards Liq. Costs &  Within 21 days of such intimation, liquidator shall
workmen dues
Step 2 • Within 90 days of LCD  Of a person willing to buy the asset before the expiry
of 30 days of intimation; and
• Excess of realised amount over submitted claim to be  At a higher price than intimated by the secured
submitted to liquidation estate
Step 3 • Within 180 days of LCD
creditor
 Secured creditor shall sell the asset to such person; and
• Such assets cannot be sold to any person who is bear the cot incurred by the liquidator for identification
disqualified u/s 29A of the Code; of such person
Note • Must be sold within 180 days of LCD
 Relinquishment by Secured Creditors
 Encumbered Assets do not form part of Liquidation
Liquidation Estate unless security interest Commencement Date (X)
relinquished
30 days Sold
 Reg. 21A of Liquidation Regulations requires Not relinquished within
 Secured creditors must inform decision on Decision X+180
Yes
(non) relinquishment within 30 days of regarding
LCD; relinquishment
conveyed
 Failing such communication, it will be a
deemed relinquishment Relinquished
No
 Asset will form part of the Liquidation
No
Estate
 Where not relinquished, asset must be sold
within 180 days of LCD,
 Else, asset falls back into Liquidation Estate
Asset falls into liquidation estate
General Rules of Priority- Fixed v. Floating Charges

 The priority of several specific charges on the same  Fixed charges prevail over Floating Charges
property is determined by the general rules relating to the  Where a specific charge is created on immoveable property, a
priority of charges. floating charge cannot have priority. Also, the specific charge
which is the first in point of time takes priority over the second.
 See State of Andhra Pradesh v. Rajah Ram Janardhana Krishna, AIR
1966 AP 233, 1966 36 CompCas 950 AP.  State Of Andhra Pradesh v. Rajah Ram Janardhana Krishna, AIR
1966 AP 233, 1966 36 CompCas 950 AP.
 Section 48 of the TP Act, 1882
 A registered floating charge without a restrictive clause ranks
 where a person purports to create by transfer at different after a prior or subsequent specific charge which is duly
times rights in or over the same immoveable property, and such registered.
rights cannot all exist or be exercised to their full extent
together, each later created right shall, in the absence of a  Hamilton’s Windsor Iron Works, Re, (1879) 12 Ch D 707.
special contract or reservation binding the earlier transferees,
 In the absence of a stipulation to qualify the elasticity of the
be subject to the rights previously created.
floating charge, it leaves the company at liberty to create
 Section 70 of the TP Act, 1882 specific mortgages or charges in priority to itself.

 if, after the date of a mortgage, any accession is made to the  Florence Land Co. (1878) 10 Ch. D. 503, and Colonial Trust
mortgaged property, the mortgagee, in the absence of a (1880) 15 Ch. D. 465, as quoted in Imperial Bank Of India v.
contract to the contrary, shall, for the purposes of the security, Bengal National Bank Ltd., AIR 1931 Cal 223
be entitled to such accession.
Exceptions to the Rule of Priority- Fixed vs. Floating Charges

 The characteristic of a floating charge the management  A registered floating charge;

autonomy to deal with the assets covered by the charge
 carrying a restrictive clause to the effect that the same
 If the debtor may deal with the assets in ordinary property shall not be subjected to any charges whether
course of business, the floating chargeholder is bound specific or floating
by a fixed charge or disposal - Biggerstaff v Rowatt’s
Wharf Ltd [1896] 2 Ch 93 will rank before any subsequently created specific charge if
the specific chargee had knowledge or notice of the clause.
 Where a fixed and floating charge was created over land
on the same day; and See English & Scottish Mercantile Investment Trust.Ltd. v.
Brunton, (1892) 2 QB 700.
 the floating charge prohibiting creation of any subsequent
fixed charge,  Constructive notice of floating charge is not a
constructive notice of the restrictive clause Wilson v.
 it was held that the fixed charge became effective only after Kelland, (1910) 2 Ch 306, unless there is proof of wilful
registration with the Registrar of documents which was
naturally subsequent to the floating charge, the floating blindness to the existence of the earlier charge and its
charge had priority over it. restrictive clauses.
 See AIB Finance Ltd. v. Bank of Scotland, (1995) 1 BCLC 185
(CS).
General Rules of Priority- Registration

 Registered charges depend for their validity on  However, the right which the plaintiff has to enforce its mortgage
against the property of the company is dependent
registration but they take priority from the date of
the creation though constructive notice arises from  not only on upon the registration but also on the terms of the
mortgage itself and as per the terms the right which they had, to
the date of registration. enforce against the refinery was a second charge only.
 May be be displaced by an estoppel or some  As such, a second charge does not become a first charge
equitable consideration or when the latter charge merely because of prior registration. Ram Narain & Ors. v. Radha
Kishen Motilal Chamaria,AIR 1930 PC 66.
is a legal charge without actual or constructive
notice or has a better equity.  Charge created by the company in favour of the second creditor
and registered with the Registrar, is valid and an exclusive charge in
respect of immovable properties of the company and gets priority
and prevails over the unregistered charge in favour of the first
creditor.
 Escorts Finance Ltd. v. Fidelity Industries Ltd. and Anr., 2003 117
Comp Cas 282 Mad.
First Charge vs. Second Charge- Treatment of inter-se classifications

 Meaning  Can first and second charge arrangements, and other

 First charge holder has the primary security interest over
inter-se classifications be ignored?
an asset;  liquidation proceedings must ensure parity and
 Second charge holder over the remaining asset (after proportionality;
settling claim of the First charge holder)  idea of proportionality is only as far as claims of similar
ranking are concerned-
 Rights are sequential; not proportional
 First charge holders and second charge holders are not similarly
 Section 53 (2) of the Code states that ranked

Any contractual arrangements between recipients with equal  Hence, contractual arrangements based on first and second
ranking, if disrupting the order of priority shall be disregarded charge interest must remain and distribution be dine
by the liquidator accordingly

Where, first charge holder does not relinquish interest, will first/ second
ranking remain? –
YES. See ICICI Bank v. Sidco Leathers Ltd., (2006) 10 SCC 452
Registered vs. Unregistered Claim

Whether registered
Whether registered Whether registered
with Information
with RoC under with CERSAI under the Outcome
Utility under the
Companies Act, 2013 SARFAESI Act, 2002
Insolvency Code
Yes Yes Yes All rights protected under the Companies Act,
Insolvency Code, SARFAESI Act
Yes Yes No All rights protected under the Companies Act,
Insolvency Code, SARFAESI Act, though mandatory to
furnish financial information to IU
Yes No No Rights protected under Companies Act and Insolvency
Act, not under SARFAESI.
No Yes Yes Cannot claim secured status under the Companies Act,
Insolvency Code. Can enforce security under SARFAESI.

No No Yes Cannot claim secured status. Cannot enforce security.

No No No Same as above. Loses on secured status
Fixed vs. Floating Charges- Illustration

[Assumption: There is no stipulation restricting flexibility of floating charges] Example 2:

Example 1:  Creditor A
 Creditor A  Debt Rs. 300 Crores
 Debt Rs. 300 Crores  Fixed charge on assets, which realised Rs. 200 crores
 Fixed charge on assets, which realised Rs. 100 crores  Second charge by way of floating charge on assets, which could
realise Rs. 100 crores
 Pari passu floating charge on assets, which could realise only Rs.
10 crores  Creditor B
 Creditor B  Debt Rs. 20 crore
 Debt Rs. 20 crore  First charge by way of floating charge on the same assets as
above
 Pari passu floating charge on the same assets as above
 Second charge on fixed assets as above
 Second charge on fixed assets as above
Outcome: Creditor B will get Rs. 20 Crores, and Creditor A will get Rs.
Outcome: Creditor A will be repaid Rs. 100 crores from assets subject
200 crores from assets subject to fixed charge, and Rs. 80 crores from
to fixed charge. Out of realisations of Rs. 10 crores from assets subject
assets subject to floating charge.
to floating charge, Rs. 5 crores each will be paid to A and B.
Priorities in Personal Insolvency
Waterfall Mechanism u/s 178

Costs • Costs and expenses incurred by the bankruptcy trustee for

the bankruptcy process- in full.

Workmen & • Workmen dues for a period of 24 months prior to BCD;

Secured creditors • Debts to secured creditors

Employee dues • Wages and any unpaid dues to employees, other than
workmen, for a period of 12 months prior to BCD

Government Dues • Any amount due to CG or SG, for 2 years preceding the
BCD

Other debts • All other debts and dues including unsecured debts
Position of Guarantee Creditors under Personal Insolvency

• Sec. 135 (3) – a creditor shall not be entitled to vote • Hence, the voting shares will be based on claims
for an un-liquidated amount filed by the guarantee creditors
• Un-liquidated amount normally refers to un- liquidated
damages for breach of a contract which requires • Claim amount:
adjudication;
• The right of creditor to demand money from guarantor, if • Where resolution plan for CD has been approved –
clear under the guarantee deed, is an ascertainable the amount of haircut
claim;
• Where the resolution plan for CD is not yet approved
• Several rulings of the SC on this point, - the whole of the amount payable by the CD
 Biswanath Jhunjhunwala, Ganga Kishun, etc • Where the CD is in liquidation, and the creditor has
relinquished security interest – the amount claimed,
• The Code has several provisions for secured creditor’s less any distribution
voting rights – only in respect of surrendered security
interest, or unsecured part of his claim • Where the CD is neither in resolution, nor liquidation
• Sec. 110, 123 (3) • the amount due from CD, as demanded from
guarantor
• However, is a secured creditor of the CD a secured
creditor of the guarantor?
• Answer will be no, unless there assets of guarantor
given as security