Section 327(7) of the Companies Act, 2013 not arbitrary / violative of Article 21 of the Constitution of India – Supreme Court
ABCAUS Case Law Citation:
ABCAUS 3731 (2023) (05) SC
Important Case Laws relied upon:
Manish Kumar Vs. Union of India and Anr. (2021) 5 SCC 1
Swiss Ribbons Private Limited and Anr. Vs. Union of India and Ors. (2019) 4 SCC 17
Ghanashyam Mishra and Sons Private Limited Vs. Edelweiss Asset Reconstruction Company Limited (2021) 9 SCC 657
Allahabad Bank Vs. Canara Bank and Anr., (2000) 4SCC 406
R.K. Garg Vs. Union of India and Ors., (1981) 4 SCC 675
Committee of Creditors of Essar Steel India Limited Vs. Satish Kumar Gupta and Ors., (2020) 8 SCC 531
Small Scale Industrial Manufacturers Association vs. Union of India and Ors. (2021) 8 SCC 511
Sections 326 and 327 of the Companies Act, 2013 (Act 2013) provide for preferential payments in a winding up under the provisions of the Act 2013. However, under the Insolvency and Bankruptcy Code, 2016 (IBC/Code), in case of liquidation under IBC, distribution is to be made as per Section 53 of IBC.
In view of the enactment of IBC and Section 53 of the IBC, the companies act 2013 was amended to provide that Sub-Section (7) of Section 327 and Sections 326 and 327 of the Act 2013 shall not be applicable in the event of liquidation under the IBC.
In the instant case several Petitions had been filed before the Hon’ble Supreme Court praying for declaring certain provisions of the Companies Act 2013 and the Insolvency and Bankruptcy Code, 2016 be declared as violative of the Constitution of India as under:
(i) Prayer was made for striking down Section 327(7) of the Companies Act, 2013 as arbitrary and violative of Article 21 of the Constitution of India.
(ii) It was also prayed to issue an appropriate direction or order so as to leave the statutory claims of the “workmen’s dues” out of the purview of waterfall mechanism under Section 53 of the Insolvency and Bankruptcy Code, 2016 (IBC/Code”).
(iii) It was also prayed to give a purposive interpretation to Section 53 of the IBC.
(iv) It was also prayed that Clause 19(a) of the Eleventh Schedule of the IBC pursuant Section 255 of the IBC, be declared as unreasonable and violative of Article 14 of the Constitution of India as Clause 19(a) of the Eleventh Schedule of the IBC inserts sub-section (7) in Section 327 of the Companies Act, 2013, which puts statutory bar on the application of Sections 326 and 327 of the Companies Act, 2013, to the liquidation proceedings under the IBC.
(v) It is further prayed that sub-section (7) of Section 327 of the Companies Act, 2013, be declared as unreasonable and violative of Article 14 of the Constitution of India as sub-section (7) of Section 327 of the Companies Act, 2013, which was inserted in Section 327 of the Companies Act, 2013 pursuant to Section 255 and the Eleventh Schedule of the Insolvency and Bankruptcy Code, 2016, creates unreasonable classification for the distribution of legitimate dues of workmen in the event of liquidation of the Company under the IBC and liquidation of Company under the provisions of the Companies Act, 2013.
The Hon’ble Supreme Court opined that object and purpose of amending the Act, 2013 and to exclude Sections 326 and 327 in the event of liquidation under the IBC seems to be that there may not be two different provisions with respect to windingup/liquidation of a company. Therefore, in view of the enactment of IBC, it necessitated to exclude the applicability of Sections 326 and 327 of the Act, 2013 which cannot be said to be arbitrary.
The Hon’ble Supreme Court stated that merely because under the earlier regime and in case of winding up of a company under the Companies Act, 1956/2013, the dues of the workmen may have pari passu with that of the secured creditor, the petitioner cannot claim the same benefit in case of winding up/liquidation of the company under IBC. The parties shall be governed by the provisions of the IBC in case of liquidation of a company under the provisions of the IBC.
Further, the Hon’ble Supreme Court observed that under IBC as per Section 53(1)(b) the workmen’s dues for the period of twenty-four months preceding the liquidation commencement date shall rank equally between the workmen and the secured creditor in the event such secured creditor has relinquished security in the manner set out in Section 52. Therefore, workmen’s dues for the period of twenty-four months preceding the liquidation commencement date shall have pari passu with the dues of secured creditor.
The Hon’ble Supreme Court noted that as per Section 36(4) of IBC, all sums due to any workman or employee from the provident fund, pension fund and the gratuity fund are not included in the liquidation estate assets and shall not be used for the recovery in the liquidation.
In view of the above, the Hon’ble Supreme Court opined that a conscious decision has been taken by the Parliament/Legislature in its wisdom to keep out of all sums due to any workman/employee from the provident fund, the pension fund and the gratuity fund from the liquidation estate assets [as per Section 36(4)] and that the workmen’s dues for the period of twenty-four months preceding the liquidation commencement date shall rank equally between the workmen’s dues to the said extent and the dues to the secured creditor. Therefore, the same cannot be said to be arbitrary and violative of Article 21 of the Constitution of India.
The Hon’ble Supreme Court opined 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, 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.
The Hon’ble Supreme Court observed that the IBC is based on the organic evolution of law and is a product of an extensive consultative process to meet the requirements of the Code governing liquidation. It introduced a comprehensive and time-bound frame work to maximise the value of assets of all persons and balance the interest of the stakeholders. The guiding principle for the Code in setting the priority of payments in liquidation was to bring the practices in India in line with global practices. In the waterfall mechanism, after the costs of the insolvency resolution process and liquidation, secured creditors share the highest priority along with a defined period of dues of the workmen. The unpaid dues of the workmen are adequately and significantly protected in line with the objectives sought to be achieved by the Code and in terms of the waterfall mechanism prescribed by Section 53 of the Code.
The ppp opined that in either case of relinquishment or non-relinquishment of the security by the secured creditor, the interests of workmen are protected under the Code. In fact, the secured creditors are taking significant hair-cut and workmen are being compensated on an equitable basis in a just and proper manner as per Section 53 of the Code.
The Hon’ble Supreme Court observed that the IBC balances the rights of the secured creditors, who are financial institutions in which the general public has invested money, and also ensures that the economic activity and revival of a viable company is not hindered because it has suffered or fallen into a financial crisis.
The Hon’ble Supreme Court said that in economic matters, a wider latitude is given to the law-maker and the Court allows for experimentation in such legislations based on practical experiences and other problems seen by the law-makers.
The Hon’ble Supreme Court stated that 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.
It was held that the Section 327(7) of the Companies Act, 2013 cannot be said to be arbitrary and/or violative of Article 21 of the Constitution of India. In case of the liquidation of a company under the IBC, 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.
Accordingly, all the writ Petitions were dismissed.
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