This article is written by Madhu Ayachit who is pursuing a Certificate Course in NCLT Litigation from LawSikho.

Introduction 

Liquidation of a corporate debtor refers to the end of its operations or existence. In simple terms, liquidation means closing down the business of the corporate debtor. Under the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC” / “Code”), the process of liquidation can be initiated if the corporate debtor becomes incapable of repaying the debts or amounts owed by it to other entities.

Though the main objective of the Code is to revive the corporate debtor and prevent it from going through the process of liquidation, there are various circumstances wherein the insolvency of the corporate debtor does not get resolved through the Corporate Insolvency Resolution Process (hereinafter referred to as “CIRP”). Therefore, the corporate debtor has to go throughto through the process of liquidation. 

IBC and the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (hereinafter referred to as “Liquidation Regulations”)  both deal with the process of liquidation of the corporate debtor.

In order to carry out the liquidation process, a liquidator is appointed by the Adjudicating Authority. Once the process of liquidation of the corporate debtor has been initiated, its assets will be sold and distributed amongst the creditors, employees, shareholders, partners, etc., as per the order of priority prescribed under the Code. Distribution of the net proceeds of the assets of the corporate debtor as per the priority is the most important aspect of the liquidation process. The order of priority is also known as the “waterfall mechanism”.

What is liquidation?

The IBC does not define the term “liquidation”. However, in the general sense, liquidation is a process wherein the corporate debtor is dissolved or wound up. Dissolution or winding up of the corporate debtor means that will cease to exist or close down completely. Under the IBC,

the process of liquidation is initiated when the corporate debtor becomes incapable of repaying its debts and carrying on its business in the ordinary course. The settlement of its debts is done by selling the assets of the corporate debtor and distributing the proceeds of the sale to its creditors, workmen, shareholders, partners, and in some cases to the Government. 

Once the order of dissolution has been passed by the Adjudicating Authority, the officers, employees, and workmen of the corporate debtor will be discharged from their respective duties and responsibilities. However, the said persons shall not stand discharged if, during the liquidation process, the liquidator continues the business of the corporate debtor. 

Moreover, after the process of liquidation of the corporate debtor has been initiated, a moratorium will be declared against the corporate debtor stating that the corporate debtor cannot sue or be sued before any court of law. However, the liquidator may institute a legal proceeding on behalf of the corporate debtor only with the permission of the Adjudicating Authority. It is pertinent to note that, the aforesaid conditions shall not apply to the proceedings notified by the Central Government. 

Under what circumstances, liquidation takes place under IBC?

Section 33 of the Code provides for the initiation of the liquidation process. Liquidation of the corporate debtor can take place under the following circumstances:

(i) If the Adjudicating Authority does not receive a resolution plan for the corporate debtor before the expiry of the maximum time period permitted by the IBC for the completion of the resolution process. 

In the case of Pariman Enterprises Pvt. Ltd. v. Atlantis Life Sciences Pvt. Ltd., the Hon’ble Adjudicating Authority ordered the liquidation of the corporate debtor as the maximum period prescribed by the Code for completion of CIRP had lapsed. In this case, even after 5 CoC meetings, a resolution plan for the corporate debtor was not finalized and presented before the Adjudicating Authority and the time period for CIRP had already lapsed. 

(ii) If the Adjudicating Authority rejects the resolution plan due to non-compliance with the requirements specified under section 31 of IBC.

Section 31 of IBC deals with the approval of the resolution plan for the corporate debtor. As per the said provision, the Adjudicating Authority shall approve the resolution plan for the corporate debtor only when it is satisfied that such plan has been approved by the committee of creditors (hereinafter referred to as “CoC”) by a majority of at least sixty-six percent of voting share. 

In the case of Rajput Ana Properties Pvt. Ltd. v. Ultra Cement Ltd. & Ors., it was held that the Adjudicating Authority is empowered to reject the resolution plan and it can order the liquidation of the corporate debtor as prescribed by Section 33(1) of the IBC.

(iii) If the resolution professional, before the confirmation of the resolution plan, informs the Adjudicating Authority that the committee of creditors has decided to liquidate the corporate debtor by at least sixty-six percent of the voting share.

In the case of Punjab National Bank v. Sri Guruprabha Power Ltd., the CoC had passed a resolution for initiating the liquidation process of the corporate debtor with a 100% majority. The Hon’ble Tribunal opined that the CoC has exercised its commercial wisdom and thus, it ordered for the liquidation of the corporate debtor.

Subsequently, in the case of K.Sashishar v. Indian Overseas Bank and Ors., the Hon’ble Apex Court observed that the Adjudicating Authority is not empowered to enquire into the commercial decision of CoC to initiate the liquidation process of the corporate debtor if the decision is passed by a majority of sixty-six percent as prescribed by Section 33(2) of the Code.

The Hon’ble Apex Court in the case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors., held that the Adjudicating Authority has only a limited judicial review power in respect of the decisions made by the COC. The Hon’ble NCLT and Hon’ble NCLAT are not empowered to exercise their respective jurisdiction to interfere in the decisions of the CoC taken by the majority of the members.

(iv) If the corporate debtor or any other person whose interests are prejudicially affected contravene the resolution plan approved by the Adjudicating Authority.

The Hon’ble NCLAT in the case of Yavar Dhala Vs JM Financial Asset Reconstruction Company Ltd. & Ors., wherein the resolution applicant failed to make some financial contribution as per the resolution plan, observed that if the terms of the resolution plan are not complied with, the corporate debtor shall go through the process of liquidation as laid down in Section 33(3) of the IBC.

Once the order of liquidation has been passed by the Adjudicating Authority, it shall issue a public notice saying that the liquidation process of the corporate debtor has been initiated. 

Process of liquidation 

a) Appointment of liquidator

Once the liquidation has been initiated, a liquidator will be appointed to carry out the liquidation process and manage the other affairs of the corporate debtor. Usually, the Resolution Professional (RP) appointed for conducting the insolvency resolution process is also appointed for the purpose of liquidation. Regulation 3 of the Liquidation Regulations mentions the eligibility criteria for an insolvency professional to be appointed as a liquidator. 

The powers and duties of the liquidator have been prescribed by Section 35 of the IBC. It includes verification of claims by the creditors, evaluation of the assets of the corporate debtor, carrying on the business of the corporate debtor, taking into his or her custody the assets of the corporate debtor, etc. 

b) Public announcement by the liquidator

After the appointment, the liquidator has to issue a public announcement within 5 days from the appointment in Form B of Schedule II of the Liquidation Regulations. Form B of Schedule II prescribes the format in which a public announcement is to be issued. The purpose of the public announcement is to call upon the creditors and other such persons to submit their claims in relation to the corporate debtor.

c) Consolidation and verification of claims

The creditors of the corporate debtor have to send their claims within thirty days from the initiation of the liquidation process. After the receipt of the claims, the liquidator shall verify those claims submitted by the creditors. The Liquidators may also ask the creditors to submit any evidence in relation to their claims for the purpose of verification.

d) Admission, rejection, and determination of the valuation of claims

A liquidator is empowered to either admit or reject the claims on the basis of his or her verification. If the liquidator rejects or admits a claim of a creditor, he or she has to communicate the same to the creditor as well as the corporate debtor within seven days from such decision. 

After all the required claims have been admitted by the liquidator, he or she has to determine the value of the claims for the purpose of distribution of the assets of the corporate debtor.

e) Time limit for liquidation proceedings

As per Regulation 47 of the Liquidation Regulations, the liquidation proceedings should be completed within 1 year from the date of initiation of liquidation, as opposed to the extendable time limit of 330 days for the resolution process. Regulation 47 of the Liquidation Regulations prescribes the model timeline for the liquidation process.

f) Dissolution of the corporate debtor

The Adjudicating Authority on the application of the liquidator, after the distribution of assets of the corporate debtor as per the priority of claims, shall dissolve the corporate debtor.

g) Appeal against the liquidator

As per Section 42 of the IBC, a creditor who is aggrieved by the decision of the liquidator may file an appeal to the Adjudicating Authority within fourteen days of the communication of such decision to the creditor. 

What is the priority of claims?

After the corporate debtor goes into liquidation, not all the creditors are treated equally in respect of their claims. There are a few claims which are given priority while distributing the assets. Therefore, a priority claim is a claim in respect of a debt owed by the corporate debtor to a creditor which will get repaid before the non-priority claims. This priority will be determined by the liquidator after verification of such a claim.

The interplay between the liquidation process and priority of claims 

Section 53 of IBC read with Regulation 33 and 35 of the Liquidation Regulations deals with the distribution of assets of the corporate debtor after the verification and valuation of claims have been done by the liquidator. Accordingly, the liquidator has to distribute the net sale proceeds of the assets of the corporate debtor in the order of priority enlisted in Section 53 of IBC. Order of priority under Section 53 of the Code is also referred to as the “Waterfall mechanism”. 

Order of priority:

(i) Costs of CIRP and liquidation process to be paid in full;

Equal priority – (ii) and (iii)

(ii) Dues of the workmen of the corporate debtor of twenty-four months prior to the initiation of liquidation; 

(iii) Debts owed by the corporate debtor to a secured creditor;

(iv) Wages and unpaid dues of the employees of the corporate debtor other than the workmen covered earlier;

(v) Financial debts owed by the corporate debtor to unsecured creditors;

Equal priority – (vi) and (vii) 

(vi) Dues of the Central of State Government, of two years prior to the initiation of liquidation, including the amount in respect to the Consolidated Fund of India and the Consolidated Fund of a State;

(vii) Debts owed by the corporate debtor to a secured creditor;

(viii) Remaining debts and dues not covered above;

(ix) Amount payable to preference shareholders; and

(x) Amount payable to Equity shareholders or partners.

The fees payable to the liquidator shall also be payable from the proceeds of the sale and shall be deducted proportionately to each class of recipients. Moreover, the class of recipients ranked equally, under Section 53 of IBC, shall receive the amount in equal proportion if the proceeds are not sufficient to meet the debts of all the recipients in full. 

As per Section 52 of IBC, a secured creditor may either receive the proceeds from the sale of assets of the corporate debtor by relinquishing its security interest to the liquidation estate or realize its security interest. However, if the secured creditor realizes its security interest against the corporate debtor as per Regulation 37 of the Liquidation Regulations, it shall be treated as an unsecured creditor. Thereafter, while deciding the priority, it shall fall into the category of an unsecured creditor.  

The Hon’ble NCLAT, New Delhi in the case of  State Bank of India v Moser Baer Karamchari Union, expanded the scope of “workmen’s dues” under Section 53 of the IBC and held that it shall also include the dues of an employer towards provident fund, pension fund, and gratuity. 

The priority of claims of financial creditors v. operational creditors

It is evident from the bare reading of Section 53 and the waterfall mechanism laid down therein that the financial creditors are given priority over operational creditors in respect of the satisfaction of their outstanding amounts. While the financial creditors have been expressly enlisted under Section 53, the operational creditors fall under the head of “remaining debts and dues”. 

The same was challenged before the Hon’ble National Company Law Appellate Tribunal, New Delhi in the case of Binani Industries v. Bank of Baroda & Anr., the Hon’ble Tribunal held that Section 53 is discriminative towards operational creditors and the priority should be given to the operational creditors over financial creditors in terms of the distribution of assets. The Hon’ble Apex court also upheld the Binani judgment. 

Thereafter the constitutional validity of Section 53 of IBC was challenged before the Hon’ble Apex Court in the case of Swiss Ribbons Pvt. Ltd. v. Union of India. The Hon’ble court held that the order of priority enlisted under Section 53 is to be followed only during the liquidation of the corporate debtor and not during the approval of CIRP. Moreover, the Hon’ble Court observed that financial creditors are given priority over the operational creditors as both of them do not share the same relationship with the corporate debtor. The debt owed to a financial creditor is larger as compared to an operational creditor. Therefore, Section 53 of the Code is not violative of Article 14 of the Constitution and is based on intelligible differentia.  

Conclusion 

The Legislative intent behind enacting the IBC was to rehabilitate and revive the corporate debtor in such a manner that it becomes capable of carrying on its affairs on its own. The Liquidation process is not an alternative to the resolution process but only the last measure if somehow the resolution process fails. Moreover, the Hon’ble NCLAT and Apex Court have repeatedly upheld that even if the corporate debtor goes through the process of liquidation, the liquidator should try to revive and continue the business of the corporate debtor.   

References 

1. https://www.latestlaws.com/articles/the-battle-of-priority-between-financial-creditors-operational-creditors-under-the-ibc-2016-a-revisit-to-binani-industries-and-swiss-ribbons-rulings/
2. https://www.lexology.com/library/detail.aspx?g=8a81e90f-6535-481b-9cc8-1528950e9dd1
3. http://vinodkothari.com/wp-content/uploads/2020/04/Section-53-of-IBC.pdf

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