Last updated: May 28th, 2020 3:03 AM

Distribution of liquidated assets under Insolvency & Bankruptcy Code

The fundamental principles that underline the legislative nature of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “The Code”), are in three parts;

1. To reach a resolution on default incurred by the corporate debtor;
2. To maximize the asset reconstruction and operations of the corporate debtor; and
3. To promote credit availability, enterprising in businesses and preserving interests of stakeholders, corporate debtor included.

The Code has been successful, so far, in materializing several unanswered aspects of insolvency and bankruptcy. It has been challenged before the courts and amended three times since its implementation, but it has been going strong. Another aspect of The Code is to provide provisions for liquidation. Liquidation is treated as a last resort for the adjudicating authority.

Liquidation

Before the legislation was passed, creditors could file an application for liquidation against the corporate debtors as sanctioned by the Companies Act, 2013. However, since 2016, the creditors do not have a right to directly apply for liquidation, they first have to apply for Corporate Insolvency Resolution Process (CIRP). If the CIRP unsuccessful, then the adjudicating authority passes an order to initiate liquidation proceeding against the corporate debtor. The adjudicating authority then appoints the liquidator, which in most cases is the person who was appointed as the Resolution Professional in CIRP. The liquidator then executes its functions and role in the liquidation process and creates a report that is submitted before the adjudicating authority. The report contains the list of stakeholders. The list is submitted within forty-five days of the claims from creditors last received by the liquidator. The list of stakeholders is segregated on the following account;

• The admitted claims amounts;
• Secured and unsecured debts or dues;
• Specifics of the stakeholders; and
• Written reasons of the claims admitted and rejected.

Secured Creditor

A secured creditor is holds priority over other stakeholders with reference to repayment of debts. Section 52 of the Code, empowers the secured creditor to choose its mode of repayment. As per Section 52(1), a secured creditor can either;

1. Waive off its security interest that lies in the liquidation estate and agree to receiving proceeds from the waterfall mechanism described u/s 53; or
2. Acquire security interest as per the present provision.

If the secured creditor opts for the first option, then the process continues to move to the next step i.e. the distribution of assets. However, if the secured creditor opts for the second option mentioned above, then the liquidator has other formalities to adhere to. The secured creditor has to intimate the liquidator of its security interest and verify the security interest that has to be realised. Once identified, the liquidator then verifies the security interests that the secured creditor asks to realise. The secured creditor also has to provide proof of his right over the security interest by either;

• Presenting records confirming maintenance by an information utility; or
• Other means as verified and specified by the Insolvency and Bankruptcy Board of India (IBBI).

Secured creditor who realises his security interests has rights to settle, enforce, realise etc. the security interest. It can also apply before an adjudicating authority if it faces any obstacles by the corporate debtor in executing the abovementioned. The secured creditor also has a responsibility to inform the liquidator, after acquiring monies in exchange of its security interests, the following;

• Account of any amount received in excess of its debt; and
• Quote the surplus amount received from the security interests.

Waterfall Mechanism

Section 53 of The Code defines the order of priority of payment of debts in a liquidation proceeding from the proceeds received. The manner and period of the distribution is specified by the Code. The order of priority is as follows;

1. Costs arising out of the liquidation and insolvency proceeding have to be covered in full at priority.
2. Secured creditors, who relinquish their security assets, and workmen are treated equally in this category. The period of workmen considered is twenty-four months preceding the commencement date of liquidation.An explanation to the provision in the Code states that the definition of workmen’s dues will be the same as mentioned u/s 326 of the Companies Act, 2013.
3. Pending employee wages and dues fall next in line. Workmen do not fall under this category. The period of employment considered is twelve months preceding the commencement date of liquidation.
4. Fourth in list of priority is the unsecured creditors to whom the corporate debtor owes a financial debt. Section 8 of the Code defines financial debt.
5. Fifth in list of priority are two stakeholders, treated equally. The stakeholders in this category are as follows;

• • Payments due to the government (Central or State). This includes the amount that is due to both Consolidated funds of India and State. The period of the same is two years preceding the commencement date of liquidation.; and
  • Any unpaid amount to the secured creditors who have enforced their security interest u/s 52.

6. Any other outstanding dues and debts like payments owed to operational creditors or unsecured creditors. 7. Payments owed to preference shareholders; and lastly 8. Partners or equity shareholders Section 53 has an explanation that clarifies the stance of the payments that have to be made equally on the same level. It states that when two stakeholders fall in the same category of priority, they must be treated equally. So, either both the stakeholders will be paid in full or if the proceeds are insufficient, then both stakeholders will be paid in equal proportion. In a number of cases, stakeholders have challenged the Code for keeping the operational creditors on a low priority, unequally from the financial creditors. The Supreme Court clarified the stance if the Code in the case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Ors. The court, in this case, ruled that the Code rightly treats the financial creditors and operational creditors variably. The court stated that equal treatment tendered to creditors falling under the same class or category. Financial creditors and operational creditors do not fall in the same category. Hence, the court dismissed the challenge and upheld the constitutionality of the Code.