Ensuring fair distribution under waterfall mechanism

By Aditya Vikram Dua and Satish Anand Sharma, SNG & Partners

The Insolvency and Bankruptcy Code, 2016 (IBC), has been severely tested on many fronts since its enactment. One concept that remains to be tested is the waterfall mechanism, or priority of payments, in the event of a liquidation. The waterfall mechanism provided under section 53 of the IBC is not a unique concept. The differential treatment prescribed for secured, unsecured and operational creditors, government dues and workmen’s dues in case of distribution of assets during liquidation under the Companies Act, 1956, and the IBC needs an overhaul.

The differential treatment has to be analysed in light of the Companies Act, 1956, because the winding-up provisions under the Companies Act, 2013, came into effect much after the enactment of IBC.

waterfall mechanism
Aditya Vikram Dua
Senior associate
SNG & Partners

Secured creditors: Under the act, if secured creditors do not relinquish their security to the liquidator and chose to enforce it, the amount realized has to be applied rateably for the discharge of workmen’s dues as per section 529(1). For the unrealized portion, the secured creditor is ranked pari passu (on an equal footing) with the workmen’s dues as per section 529A and gets priority over all other creditors. If the secured creditor relinquishes its security, it will still be ranked pari passu with workmen dues.

There has been a drastic change in sections 52 and 53 of the IBC with respect to the position of such secured creditors who choose to enforce their security outside liquidation. Under the IBC, the unrealized portion in such cases falls under clause (e) of section 53, where they are ranked pari passu with government dues, which falls much lower in priority, below unsecured financial creditors.

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SNG & Partners has offices in New Delhi, Mumbai and Singapore. Aditya Vikram Dua is a senior associate. Satish Anand Sharma is a senior associate and a qualified insolvency professional.

waterfall mechanism

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