The order of priority on distribution, the election under Section 52 to relinquish or realise security and the filing of claims with the liquidator.
If no resolution plan is approved within the time allowed, or the committee of creditors resolves to liquidate, the company is liquidated and its assets are sold. The money is then distributed in the order that Section 53 of the Insolvency and Bankruptcy Code, 2016 prescribes. The order is called the waterfall, and a creditor's recovery in liquidation depends on where its claim stands in it. This note explains the order and the creditor's choices. It is general information, not advice on a particular liquidation.
The order of distribution
Section 53(1) applies notwithstanding any other law, and the proceeds from the sale of the liquidation assets are distributed in the following order of priority, with each class paid in full before the next receives anything, and the claims within a class ranking equally:
- the insolvency resolution process costs and the liquidation costs in full;
- the workmen's dues for the twenty-four months preceding the liquidation commencement date, together with the debts owed to secured creditors who have relinquished their security under Section 52, ranking equally between themselves;
- wages and any unpaid dues owed to employees other than workmen for the twelve months preceding the liquidation commencement date;
- financial debts owed to unsecured creditors;
- dues owed to the Central and State Governments in respect of the period of two years preceding the liquidation commencement date, and debts owed to secured creditors for any amount unpaid following the enforcement of security interest;
- any remaining debts and dues;
- preference shareholders; and
- equity shareholders or partners.
The Supreme Court observed in Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta (2019) that the priority of secured creditors over operational creditors in the waterfall is a matter of statute, and that treating different classes of creditor differently is not discriminatory.
The secured creditor's choice
Under Section 52 a secured creditor in a liquidation may elect between two courses:
- Relinquish the security to the liquidation estate, and receive its share of the proceeds in the second class of the waterfall, ranking equally with workmen's dues for the stated period.
- Realise the security itself, outside the liquidation process, by enforcing it in accordance with the law that governs the security. The creditor then keeps the proceeds up to the amount of its debt, and pays to the liquidator any surplus. Any shortfall becomes an unsecured claim, falling within the fifth class (as a debt unpaid after enforcement).
The creditor must tell the liquidator of its choice. A creditor who intends to realise the security must also satisfy the liquidator that the security is valid and enforceable, and the liquidator may verify that. The choice depends on the value of the security, the expected costs and delay of enforcement and the share the creditor expects from the estate.
Claims and the liquidator's role
The liquidator invites claims by public announcement after the liquidation order, and verifies them. A creditor must submit its claim, with evidence, within the time allowed, usually thirty days from the commencement of liquidation. The liquidator admits or rejects each claim in writing, and a creditor aggrieved by the decision can appeal to the Adjudicating Authority under Section 42. The liquidator is entitled to recover assets through avoidance applications, which add to the estate.
What the waterfall means in practice
- Unsecured operational creditors rank below nearly everyone and often recover little or nothing.
- Secured creditors who stay outside the process can recover from their security first and are exposed only for the balance.
- The recovery depends on the price the assets fetch, which is why the manner of sale matters.
A creditor who is considering how to vote on liquidation, or how to elect under Section 52, should estimate the likely distribution under the waterfall. The estimate is an important part of deciding whether to support a plan that pays less than the claim but more than liquidation would.
This note is general information on the law at the date of publication. It is not legal advice, and it should not be relied on without advice on the facts of a particular matter.
