Whether section 327(7) of the Companies Act, 2013 is arbitrary and violative of Article 21 of the Constitution of India – Adv. Yashowardhan SNV Dixit

on by

Moser Baer Karamchari Union Vs. Union of India

In relation to whether section 327(7) of the Companies Act, 2013 is arbitrary and violative of Article 21 of the Constitution of India

Adv. Yashowardhan SNV Dixit
MZM Legal, Mumbai

Case: Moser Baer Karamchari Union Thr. President Mahesh Chand Sharma Vs. Union of India
Citation: (2023) ibclaw.in 59 SC
Date of Judgement: May 02, 2023

The division bench comprising M.R Shah and Sanjiv Khanna, JJ., of the Hon’ble Supreme Court of India upheld the validity of Section 327(7) of the Companies 2013 Act (“2013 Act”) through the judgement dated 02.05.2023, delivered in Moser Baer Karamchari Union Thr. President Mahesh Chand Sharma Vs. Union of India.

Section 327(7) of the 2013 Act, while dealing with the aspect of preferential payments in the event of winding up of a company, stipulates that Sections 326–Overriding Preferential Payments and 327-preferential payments of the 2013 Act shall not be applicable in the event of liquidation under the Insolvency and Bankruptcy Code, 2016 (“Code”).

The Hon’ble Supreme Court has addressed and duly disposed of writ petitions filed by Moser Baer Karamchari Union (“the Union”) seeking directions of (i) that Clause 19(a) of the Eleventh Schedule of the Code pursuant Section 255 of the Code, be declared as unreasonable and violative of Article 14 of the Constitution of India as Clause 19(a) inserts sub-section (7) in Section 327 of the 2013 Act, which puts statutory bar on the application of Sections 326 and 327 of the 2013 Act to the liquidation proceedings under the Code, (ii) that sub-section (7) of section 327 of the 2013 Act be declared as unreasonable and violative of Article 14 of the Constitution of India as sub-section (7), which was inserted in section 327 of the 2013 Act pursuant to section 255 and the Eleventh Schedule of the Code, creates unreasonable classification for the distribution of legitimate dues of workmen in the event of liquidation of the company under the Code and liquidation of the company under the provisions of the 2013 Act, (iii) distribution of the workmen’s due as envisaged under section 53 (1) (b) (i) of the Code, be declared as unreasonable and violative of Article 14 of the Constitution of India, as section 53 (1) (b) (i) of the Code limits the workmen’s dues payable to workmen to twenty-four months only preceding the date of order of liquidation and then rank the said workmen’s dues equally with the secured creditors in the events such secured creditors has relinquished security in the manner set out in section 52 of the Code, and (iv) settlement of Workmen Dues should be done in accordance with the reasonable principles laid down under section 326 even in the event of liquidation under the Code.

Brief Facts of the Case

The Union began its quest for relief in January, 2019 by way of filing an application with the National Company Law Tribunal, Principal Bench (“NCLT”) thereby seeking directions to the Liquidator to exclude the amount due to them towards ‘Provident Fund’, ‘Pension Fund’ and Gratuity Trust Fund’ from the waterfall mechanism envisaged under section 53 of the Code and pay them the ‘Provident Fund Dues’, ‘Pension Fund Dues’ and ‘Gratuity Fund Dues’ as these will not constitute part of the liquidation estate.

In turn, the Liquidator claimed that the ‘Provident Fund Dues’, ‘Pension Fund Dues’ and ‘Gratuity Fund Dues’ would form part of the liquidation estate of the corporate debtor and be subject to the waterfall mechanism under section 53 of the Code. The NCLT passed an order on 19.03.2019 upholding the prayer of the Union. The financial creditor- State Bank of India, being aggrieved by the order of the NCLT, filed an appeal against the impugned order dated 19.03.2019 with the National Company Law Appellate Tribunal (“NCLAT”). The NCLAT in an order passed on 19.08.2019 upheld the view of the NCLT and placed reliance on section 36(1) r/w section 36(3) of the Code to come to the conclusion that the aforesaid funds do not come within the meaning of ‘liquidation estate’ for the purpose of distribution of assets under section 53 of the Code and that the workmen have first charge interests on the same.

By way of the writ petitions, the Union invoked the powers of the Hon’ble Supreme Court under Article 32 of the Constitution of India and prayed for an appropriate order/writ as mentioned above.

Issues before the Hon’ble Supreme Court

  1. Whether section 327(7) of the 2013 Act is constitutionally valid?
  2. Whether “workmen dues” claims can be excluded from the purview of the waterfall mechanism.
  3. Whether it is constitutionally valid to keep the claims of “workmen dues” at an equal footing to that of secured creditors in an event such a creditor is willing to relinquish its security.

Contentions raised by the parties

The then senior advocate Mr. K.V. Viswanathan (now, K.V Viswanathan, J.) appearing as the amicus curie established a brief legislative history of the companies act, with special emphasis to ‘Preferential Payments’ and also the framing of the Code:

The Union submitted that in comparing section 53 of the Code and the ‘overriding preferential payments’ in the 2013 Act, it places the workmen at a disadvantageous position on the basis of,

  1. Workmen’s portion in security held by secured creditor has been done away with which still exists in the 2013 Act.
  2. Preference/superiority given to 24 months dues of the workmen over any other debt has been done away with in the Code.
  3. Workmen and secured creditors have been placed in the same pool.

It is contended that workmen are the ‘nerve center of any company’ hence their interest is to be protected incase of winding up, and their claims/dues should be fairly ranked under the Code.

The Respondents argued that visualizing the objects and working of the Code, the interests of the workmen have been protected from its enactment.

  1. section 36(4) of the Code specifies that workmen dues forming the part of their social security funds are not to be included within the ambit of ‘liquidation estate’ there by establishing a first charge preference to the workmen.
  2. ‘Liquidation Costs’ which are given priority over ‘workmen dues’ under section 53 of the Code also includes the salary and wages paid to the workmen during the period of liquidation to maintain the company as a ‘going concern’.
  3. Payment of workmen dues for the period of 24 months are to be paid along with secured creditors dues in event of relinquishment of security. This is only in the situation where secured creditors have relinquished their security and the same is the part of the liquidation pool, this is done to promote a collective liquidation process and to encourage secured creditors to relinquish their security interest to promote overall value maximization of the corporate debtor.
  4. In either case of relinquishment or non-relinquishment of security by the secured creditor, the interests of the workmen are protected.

It is important to note that the Code has an overarching objective of unlocking sick and insolvent companies primarily to revive such companies in event of failure for transparent and equitable liquidation process. As per the objectives of the Code every effort should be made to resuscitate the corporate debtor in the larger public interest which includes not only the workmen of the corporate debtors but also its creditors and the goods it produces in the larger interest of the economy of the country.

Observations of the Hon’ble Supreme Court

The Hon’ble Apex Court observed that in view of the enactment of the Code it is necessitated to exclude the applicability of sections 326 and 327 of the 2013 Act and the same cannot be said to be arbitrary. It is not arbitrary to state that parties shall be governed by the provisions of the Code in case of liquidation of a company under the provisions of the Code. The Hon’ble Supreme Court held that the Code enacted is a separate and consolidated enactment specifically relating to and dealing with companies which are insolvent and unable to pay dues and envisages a procedure with a mandate to first explore possibility of rehabilitation and revival of the company and dissolution/winding up as the last resort.

Objective of the Code

While addressing the constitutional challenge mad by the petitioners it is necessary not to frustrate the objective and purpose of the Code. The Code was introduced to completely replace the then existing framework for insolvency and bankruptcy resolution that was inadequate ineffective and guilty of causing undue delays. The Code was enacted with the objective of reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of the value of assets promote entrepreneurship, enhance availability of credit and balance the interests of all stakeholders. It is aimed towards improving the ease of doing business and facilitate more investments, leading to higher economic growth and development. The Code aims to ensure that jobs are not lost, the use of economic assets is maximized and there is an effective legal framework which enhances the viability of credit in the hands of banks and financial institutions. The Code recognized the financial impact on secured creditors or financial institutions dealing with public money, as their economic health is equally important for the general public as well as the national economy. The code is based on organic evolution of law to bring the practices in India in line with global practices.

Judicial hands off qua economic legislation

The court emphasized on the Code having economic impacts which affords judicial intervention cautiously. It was held that unless there is economic growth and fresh investments in the industry by the financial creditors employment opportunities will not be available which would in turn lead economic woes, insolvencies and bankruptcies. These are all complex economic matters wherein various conflicting interests have to be balanced, and a holistic rather than a one-sided approach has to be taken.

The court was of the opinion that the Code was a well though out and an outcome of a ruminated review on complex fiscal and commercial challenges facing the economy. The Court placed reliance on the case of Swiss Ribbons Private Limited and Another v. Union of India and Others where it was held as follows:

“P.8 …laws relating to economic activities should be viewed with greater latitude than laws touching civil rights… P.19 …That would depend upon diverse fiscal and economic considerations based on practical necessity and administrative expediency and would also involve a certain amount of experimentation on which the court would be least fitted to pronounce. The court would not have the necessary competence and expertise to adjudicate upon such an economic issue.” (Emphasis Supplied)

Based on these observations the Hon’ble Court finally held that in economic matters, a wider latitude is given to the law maker and the court allows for experimentation in such legislations based on practical experiences and other problems seen by law makers.

Objective differences between the 2013 Act and the Code

The 2013 Act does not deal with insolvency and bankruptcy when the companies are unable to pay their debts or the aspects relating to the revival and rehabilitation of the companies and their winding up if revival and revival and rehabilitation is not possible.

In principle it cannot be doubted that the cases of revival or winding up of company on the ground of insolvency and inability to pay debts are different from cases where companies are wound up under section 271 of the 2013 Act. The two situations are not identical. Their grounds for winding up are vastly different. The two enactments deal with two distinct situations and in the opinion of the court they cannot be equated in order to examine discrimination or constitutional validity.

For revival and rehabilitation certain sacrifices are required from all quarters including the workmen, and unless it is found that the sacrifices made are manifestly unjust and arbitrary, they cannot be considered unfair or discriminatory solely on the grounds for some marginal sacrifice made by the workers.

The Waterfall Mechanism

The Hon’ble Supreme Court held upon an in-depth analysis of section 53 of the Code that, the waterfall mechanism is based on a structured mathematical formula, and the hierarchy is created in terms of payment of debts in order of priority with several qualifications, striking down any one of the provisions or rearranging the hierarchy in the waterfall mechanism may lead to several trips and disrupt the working of the equilibrium as a whole and stasis, resulting in instability. Every change in the waterfall mechanism is bound to lead to cascading effects on the balance of rights and interests of the secured creditors, operational creditors and even the Central and State Governments. Depending upon the facts, in some cases, the waterfall mechanism in the Code may be more beneficial than the hierarchy provided under section 326 of the 2013 Act and vice-versa.

The Hon’ble Court held that the workmen were being adequately and sufficiently protected under the waterfall mechanism keeping in mind the objectives sought to be achieved by the Code.

Therefore, in view of the above, the Hon’ble Supreme Court of India held that the Writ Petition lacked merit and consequently, dismissed the same.

Reference:

[1] Writ Petition (C) Nos. 421 of 2019, 777 of 2020 and 712 of 2020; Moser Baer Karamchari Union thr. President Mahesh Chand Sharma vs. Union of India (UOI) and Ors.

 

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