Treatment of: Preferential Creditors, Secured Creditors, Calls on Contributories

Liquidation is the winding up of a company’s operations, where its assets are sold to pay off debts, and remaining funds (if any) are distributed to shareholders. It occurs due to insolvency (involuntary liquidation) or a shareholder decision (voluntary liquidation). A liquidator is appointed to oversee asset sales, settle creditors in priority order (secured → unsecured), and close legal obligations. Once completed, the company is dissolved and ceases to exist. Liquidation ensures an orderly exit, maximizes creditor recovery, and legally terminates liabilities, providing a clean closure for stakeholders.

Preferential Creditors:

Preferential creditors are those who have a statutory right to receive payment before other unsecured creditors during a company’s liquidation. The priority is given under the Companies Act or Insolvency laws. Common examples include employee wages and salaries (for a specified period), contributions to employee welfare funds (like provident fund), taxes due to the government, and certain compensation claims. These debts are paid after the costs of liquidation and secured creditors with fixed charges but before unsecured creditors. The aim is to protect vulnerable groups, such as employees and the government, ensuring they are not disadvantaged during the liquidation process.

The treatment follows the priority order specified under the Companies Act, 2013 and the Insolvency and Bankruptcy Code (IBC).

1. Identify Preferential Debts: Includes employee wages/salaries (up to 4 months), provident fund contributions, gratuity, compensation under labor laws, and certain government dues.

2. Realization of Assets: The liquidator sells company assets to generate funds.

3. Payment: From available funds, the liquidator first clears costs of liquidation, then pays preferential creditors in full, proportionately if funds are insufficient.

4. Balance: Remaining funds go to other creditors as per priority.

Secured Creditors:

Secured creditors are individuals or entities that have lent money to a company and hold a legal charge over the company’s specific assets as security for the debt. In liquidation, they have the right to recover their dues by selling the secured asset before any other creditors are paid. There are two types—fixed charge (on specific assets like buildings) and floating charge (on general assets like inventory). If the sale proceeds exceed the debt, the surplus goes to the company; if less, the remaining amount becomes unsecured debt. This priority safeguards the lender’s interest by reducing the risk of non-repayment.

Treatment of Secured Creditors:

• Right to Realize Security

A secured creditor may choose to sell the asset over which they hold a legal charge without involving the liquidator. The sale proceeds are used to recover the debt owed to them. If the amount realized from the sale is less than the outstanding debt, the remaining unpaid balance is treated as an unsecured claim. The creditor can then participate in the distribution of the company’s general assets for that shortfall, alongside other unsecured creditors, based on the liquidation priority order.

• Option to Surrender Security

Instead of selling the secured asset themselves, a secured creditor may surrender the asset to the liquidator. In return, they can claim the full amount of their outstanding debt from the general pool of assets during liquidation. This option is typically chosen when the asset’s realizable value is uncertain or likely lower than expected. By doing so, the creditor avoids the hassle of sale, but their payment is then subject to the priority rules applicable in liquidation proceedings.

• Fixed Charge Priority

A fixed charge is a security interest over a specific, identifiable asset, such as land, buildings, or machinery. In liquidation, creditors holding a fixed charge are entitled to be paid first from the proceeds of the sale of that specific asset. This payment occurs before any funds are made available to preferential or unsecured creditors. The fixed charge holder’s priority ensures their investment risk is minimized, as their repayment is tied directly to a tangible and often high-value company property.

• Floating Charge Priority

A floating charge is a security interest over a category of assets that can change over time, such as stock-in-trade or receivables. During liquidation, the floating charge crystallizes into a fixed charge over the assets currently held. However, creditors with floating charges are ranked below preferential creditors in payment priority. This means wages, employee benefits, and certain government dues are paid before them. After satisfying preferential creditors, floating charge holders are paid before unsecured creditors from the proceeds of the charged assets.

• Surplus or Deficit

When a secured asset is sold, if the proceeds exceed the debt owed to the secured creditor, the surplus amount must be returned to the liquidator for distribution among other creditors according to the priority list. If the proceeds are less than the debt, the remaining unpaid portion becomes unsecured debt. The creditor can then submit a claim for this deficit and participate in the distribution of the company’s remaining assets, receiving payment alongside other unsecured creditors, usually on a pro-rata basis.

Calls on Contributories:

Calls on contributories refer to the demands made by the liquidator on the company’s shareholders (contributories) to contribute additional funds towards the company’s debts during liquidation. This typically occurs if the company’s assets are insufficient to pay off liabilities, even after selling all property. Shareholders are liable only up to the unpaid amount on their shares. Fully paid shareholders generally have no further liability. The liquidator calculates the required amount, makes the call, and collects it to meet creditors’ claims. This ensures equitable distribution of the liquidation burden among those who benefited from the company’s capital during its operations.

Treatment of Calls on Contributories:

• Identify Liability

The liquidator first identifies which shareholders are liable to contribute during liquidation. Only those who have partly paid shares are liable for the unpaid portion. Fully paid shareholders have no further obligation. Past shareholders who left the company within one year before winding-up may also be liable under certain conditions. The Companies Act defines the extent of liability, ensuring fairness. This step is crucial because it determines the potential sources of additional funds before calculating the exact amounts to be demanded from contributories.

• Determine Call Amount

Once liabilities and available assets are known, the liquidator calculates the shortfall between assets and debts. This deficit determines the total amount to be raised from contributories. The call amount for each contributory depends on their unpaid share capital proportion. The calculation also considers the priority of payments—liquidation costs, preferential creditors, secured creditors, and finally unsecured creditors. By fixing the call amount precisely, the liquidator ensures that no contributory is overcharged and that the funds collected are sufficient to settle the company’s obligations.

• Issue Call Notice

The liquidator sends a formal written notice to contributories, stating the amount payable, due date, and payment method. This notice is legally binding and must comply with statutory requirements under the Companies Act. It ensures transparency and provides shareholders with adequate time to arrange payment. The notice may also include details of the company’s financial position, the reason for the call, and the consequences of non-payment. If a contributory fails to pay, the liquidator can take legal action to recover the amount due.

• Collect and Apply Funds

The liquidator collects the amounts paid by contributories and adds them to the liquidation fund. These funds are then distributed in accordance with the statutory order of priority—first paying liquidation expenses, then preferential creditors, followed by secured and unsecured creditors. If there is any surplus after paying all liabilities, it is returned to shareholders in proportion to their shareholding. This step ensures that the additional contributions raised are used strictly for debt settlement and equitable distribution, safeguarding the rights of both creditors and shareholders.