Companies Act, 1956 — Sections 529, 529-A & 530 — Winding up — Application of insolvency rules — Right of secured, unsecured creditors and workmen of insolvent company — Overriding preferential payment

June 22nd, 2013

Companies Act, 1956 — Sections 529, 529-A & 530 — Winding up — Application of insolvency rules — Right of secured, unsecured creditors and workmen of insolvent company — Overriding preferential payment — The sick Company possessed assets at different places throughout India — High Court passed orders for winding up of the company and appointed the official liquidator — The liquidator then took over the assets of the company and sold some of the assets of the company and paid to the secured creditors and workmen representing 50% of their verified claims towards wages — When the liquidator sold some more assets, the appellant filed application before the High Court contending that the assets of the company which have been sold are not properties over which the banks/financial institutions have any charge and therefore, they cannot be treated as secured creditors in respect of these properties and the sale proceeds from these properties should be kept separately and be paid to the workmen first before disbursing any amount to the banks/financial institutions — Question of law is as to the ambit, scope and the legislative scheme of Sections 529, 529A and 530 of the Companies Act, 1956 — A.K. Patnaik, J. held, in the winding up of an insolvent company, respective rights of secured and unsecured creditors of an insolvent company, which is being wound up, will be the same as the respective rights of secured and unsecured creditors with respect to the estates of persons adjudged insolvent as are in force under the law of insolvency — Provisions of clause (c) of sub-section (1) of Section 529 of the Companies Act along with the provisions of the Insolvency Act relating to the respective rights of secured and unsecured creditors, a secured creditor of an insolvent company which is being wound up has only a right over the particular property or asset of the company offered to the secured creditor as a security and the unsecured creditors have rights over all other properties or assets of the insolvent company — Workmen will not have priority over the dues of the secured creditor and this is because of the unambiguous language of Section 529A (1) that the workmen’s dues and the dues of the secured creditor to the extent such debts rank under clause (c) of sub-section (1) of Section 529 pari passu with such dues will have to be paid in priority to all other debts — High Court has clearly fallen in error by holding that all debts due to secured creditors will rank pari passu with the workmen’s dues and have to be paid along with the workmen’s dues in priority to all other debts of the company — The impugned order of High Court and the order of the Company Judge are set aside and the matter is remitted to the Company Judge to decide the application in accordance with law as laid down in the judgment — Consequently, appeal is allowed — Swatanter Kumar, J. held — The workmen’s charges as well as that of the secured creditors have to be paid in preference to all others, but with inter se pari passu charge on the amounts realized from the sale of the security or otherwise — Judgment of the High Court, to the extent it takes the view that the charges of the workmen and secured creditors have to rank pari passu, cannot be faulted with — However, where the learned Single Judge as well as the Division Bench of the High Court have fallen in error of law, is the computation and adjustment of the shares between the workmen, on the one hand and the secured creditors, on the other — Direction that the amounts recovered from the secured creditors to be distributed between the workmen and the secured creditors in equal proportion of 50 per cent of their respective admitted claims, is opposed to the very scheme of the provisions, particularly with respect to determination of the workmen’s portion — The High Court erred in not noticing that the Company Court has not made calculation and computation in accordance with law — The Company Court as well as the Appellate Court should have considered the workmen’s portion in terms of proviso to Section 529(1) and Section 529(3)(c) along with the illustration appended thereto and thereafter, its over-riding preferential payment vis-a-vis all other unsecured creditors in terms of Section 529-A and 530 of the Act — Once that is done, the Court could then have settled the payment received by the Official Liquidator from the sale of the unsecured assets of the company — Secured creditor has realized its security but without putting the security or the receipts thereof in the common hotch potch of the winding up proceedings for the general benefit of the creditors — Thus, in terms of Section 47(1) of the Insolvency Act, the secured creditor is entitled to the balance due to it, deducting the net amounts realized — If the secured creditor would have participated in the winding up proceedings in its entirety with the security being realised and/or relinquished for the general benefit of the creditors and not restricted to the compliance of Section 529 of the Act, it would not be entitled to the benefit of Section 529A of the Act — As the amounts, by the consent of the parties, have already been disbursed and utilized by the workmen as well as the secured creditors in terms of Section 529 of the Act which obviously are subject to adjustment as per the orders of the Court — High Court should re-compute the amounts payable pari passu between the secured creditors and the workmen in accordance with the principles — Matter is remanded back to the Company Court to apply the principles and calculate the amount payable to the respective parties afresh and in accordance with law — Insolvency Act, 1920 — Section 2(1)(a) & (e).

Allahabad Bank v. Canara Bank & Anr., (2000) 4 SCC 406, Andhra Bank v. Official Liquidator, (2005) 5 SCC 75; and ICICI Bank Ltd. V. Sidco Leathers Ltd. and Others, (2006) 10 SCC 452, Referred.

(Para 5, 7, 15, 26, 27, 28, 40, 46 & 48)

HELD: A plain reading of clause (c) of sub-section (1) of Section 529 makes it clear that in the winding up of an insolvent company, the same rules shall prevail and be observed with regard to the respective rights of secured and unsecured creditors as are in force for the time being under the law of insolvency with respect to the estates of persons adjudged insolvent. This would mean that the respective rights of secured and unsecured creditors of an insolvent company, which is being wound up, will be the same as the respective rights of secured and unsecured creditors with respect to the estates of persons adjudged insolvent as are in force under the law of insolvency. In the State of Jharkhand, the Provincial Insolvency Act, 1920 (for short `the Insolvency Act’) is in force and accordingly the respective rights of secured and unsecured creditors with respect to the assets of the insolvent company being wound up will be the same as in the Insolvency Act. The Companies Act does not define a “creditor” and a “secured creditor” and hence, we have to refer to the Insolvency Act for the definitions of these two words. Section 2(1)(a) and Section 2(1)(e) of the Insolvency Act define the words `creditor’ and `unsecured creditor’ and are extracted hereinbelow:

“2(1)(a) “creditor” includes a decree-holder, “debt” includes a judgment-debt, and “debtor” includes a judgment-debtor.”

“2(1)(e) “secured creditor” means a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor.”

It will be clear from the definition of `creditor’ in Section 2(1)(a) of the Insolvency Act that it is an inclusive and not an exhaustive definition, whereas it will be clear from the definition of `secured creditor’ in Section 2(1)(e) of the Insolvency Act that it is an exhaustive definition and that a secured creditor means a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor. The result is that the expression `secured creditor’ in Section 529(1)(c) would mean a person who holds a mortgage, charge or lien on the property of the company or any part thereof as a security for a debt due to him from the company. Where, therefore, a creditor, such as the bank or the financial institution in this case, does not hold a mortgage, charge or lien on the property of the company or any part thereof as a security for a debt due to it from the company, it is not a secured creditor for the purposes of Sections 529 and 529A of the Companies Act.

(Para 5)

In our considered opinion, therefore, on a reading of the provisions of clause (c) of sub-section (1) of Section 529 of the Companies Act along with the provisions of the Insolvency Act relating to the respective rights of secured and unsecured creditors, a secured creditor of an insolvent company which is being wound up has only a right over the particular property or asset of the company offered to the secured creditor as a security and the unsecured creditors have rights over all other properties or assets of the insolvent company. We may now examine whether the proviso to sub-section (1) of Section 529 of the Companies Act makes any difference to these rights of secured creditors and unsecured creditors of an insolvent company.

(Para 7)

Chapter V of the Act deals with provisions that are applicable to every mode of winding up and in particular, the above provisions deal with the proof and ranking of claims. Section 529 is concerned with the application of insolvency rules to winding up of an insolvent company. The opening language of Section 529 contemplates that in winding up of an insolvent company, the Rules prevalent under the law of insolvency shall be applicable. Thus, the Provincial Insolvency Act, 1920 (for short the “Insolvency Act”), to the extent permissible, would be applicable in regard to the winding up of a company.

(Para 15)

Chapter V of the Act deals with provisions that are applicable to every mode of winding up and in particular, the above provisions deal with the proof and ranking of claims. Section 529 is concerned with the application of insolvency rules to winding up of an insolvent company. The opening language of Section 529 contemplates that in winding up of an insolvent company, the Rules prevalent under the law of insolvency shall be applicable. Thus, the Provincial Insolvency Act, 1920 (for short the “Insolvency Act”), to the extent permissible, would be applicable in regard to the winding up of a company.

(Para 26)

The above provision gives different options that are available and can be exercised by a secured creditor. It, however, has to be kept in mind that in terms of section 529 the rules of insolvency shall prevail and be observed but only with regard to debts provable, the valuation of annuities and future and contingent liabilities and the respective rights of secured and unsecured creditors. Where a secured creditor realizes his security, he may prove the balance due to him after deducting the net amount realized; or where a secured creditor relinquishes his security for the general benefit of the creditors, he may prove for whole of his debt. Still, where a secured creditor does not exercise either of these options, he is entitled to have his debt entered in the schedule and would be entitled to receive the dividend in terms of Section 47(3).

(Para 27)

It is worthwhile to note that the proviso to Section 529 of the Act creates a deeming fiction in law and makes it clear that the security of every secured creditor shall be deemed to be subject to a pari passu charge in favour of the workmen, to the extent of the workman’s portion thereunder. This fiction is intended to give the workmen a preferential right to recover their dues. The expression `workmen’s portion’ appearing in the proviso to Section 529(1) is explained under clause (c) of Section 529(3) of the Act. The workmen’s portion in relation to the security of any secured creditor of a company means the amount which bears to the value of the security the same proportion as the amount of the workmen’s dues bears to the aggregate of the amount of the workmen’s dues and the amount of the debts due to the secured creditors. The workmen’s portion is to be computed in terms thereof with the aid of the illustration given in that provision. Thus, the security of every secured creditor, by fiction of law, is subject to a pari passu charge in favour of the workmen to the extent of the workmen’s portion and where the secured creditor, instead of relinquishing his security and proving his debt, opts to realize his security, in that event, so much of the debt due to such secured creditor as could not be realized by him by virtue of the pari passu charge in favour of the workmen or the amount of the workmen’s portion in his security, whichever is less, shall rank pari passu with the workmen’s dues for the purposes of Section 529A.

(Para 28)

The relinquishment of security by a secured creditor certainly requires some conscious act on his part more than the mere filing of a claim in response to a public notice issued by the official liquidator. Once the secured creditor takes such further actions like sale of the secured assets through the liquidator and subject to the control of the Company Court in that event, he would be part of the scheme of payment as rationalized under Section 529 and 529A of the Act.

(Para 40)

From the respective contentions raised by the parties, one fact is clear that respondent No.8 has realized its security without prejudice to the proceedings taken by it before the Debts Recovery Tribunal. Furthermore, the security was realized strictly within the scope of Section 529(1) and its proviso. That has to be protected in terms of Section 529A(1)(b) because the secured creditor has not relinquished its security for the general benefit of the creditors but realized the same in terms of Section 47(1) of the Insolvency Act. The argument raised on behalf of the appellant in this regard is not well-founded. If this contention is accepted in the facts of the present case, then it would run contra to the principles stated by this Court in the case of Andhra Bank (supra) and ICICI Bank (supra). It has already been noticed that the provisions of Section 529A are not controlled and/or subservient to any other provision of the Act or any other law. Once the twin requirements stated in the proviso to Section 529(1) are satisfied, the scheme contemplated under clause (c) of the proviso to Section 529 read with Section 529A of the Act would come into play. The Court cannot overlook the reality that intention of the framers of law could not have been that the public funds, for instance, the money of secured creditor (like banks), should be completely ignored for the benefit of the creditors in general, despite there being a definite protection in law, more so, when the security may be sufficient for recovery of dues of such secured creditors to a limited extent, if not in entirety. The scheme of these provisions, thus, has to be understood to make it practicable and in consonance with the accepted commercial principles. It is precisely for these reasons that I am taking the view that the workmen’s charges as well as that of the secured creditors have to be paid in preference to all others, but with inter se pari passu charge on the amounts realized from the sale of the security or otherwise.

(Para 46)

Reverting to the facts of the present case, the judgment of the High Court, to the extent it takes the view that the charges of the workmen and secured creditors have to rank pari passu, cannot be faulted with. However, where the learned Single Judge as well as the Division Bench of the High Court have fallen in error of law, is the computation and adjustment of the shares between the workmen, on the one hand and the secured creditors, on the other. Particularly, the learned Single Judge directed the amounts recovered from the secured creditors to be distributed between the workmen and the secured creditors in equal proportion of 50 per cent of their respective admitted claims. This order and calculation is opposed to the very scheme of the above provisions, particularly with respect to determination of the workmen’s portion. Another error in the calculation that appears from the record is that though the total sale proceeds from the secured assets were Rs.108.90 crore, the Court directed the payment of only Rs.101 crore which is the aggregate of the amount directed to be paid to the workmen and to the secured creditors. Thus, there has been an error of law in applying the statutory provisions in this regard. The High Court erred in not noticing that the Company Court has not made calculation and computation in accordance with law. The Company Court as well as the Appellate Court should have considered the workmen’s portion in terms of proviso to Section 529(1) and Section 529(3)(c) along with the illustration appended thereto and thereafter, its over-riding preferential payment vis-a-vis all other unsecured creditors in terms of Section 529A and 530 of the Act. Once that is done, the Court could then have settled the payment received by the Official Liquidator from the sale of the unsecured assets of UMI. The amounts, thus, are required to be recalculated in terms of the above provisions and the law stated herein.

(Para 48)

Jitendra Nath Singh v. Official Liquidator[Bench Strength 3], C.A. No. 6755/2012 (Arising out of SLP (C) No. 4104/2011(21/09/2012), 2012(9) JT 221: 2012(9) SCALE 186: 2012(7) SLT 395: 2013(1) SCC 462 [S.H. Kapadia, C.J.: A.K. Patnaik, J.: Swatanter Kumar, J.]

Entry Filed under: Commercial Laws