Preferential Payments, Introductions, Meaning, Features and Types

Preferential payments refer to certain debts that are given priority over other unsecured liabilities at the time of liquidation of a company. These payments are made after secured creditors (to the extent of their security) but before unsecured creditors and shareholders. The concept of preferential payments ensures protection to specific classes of creditors whose claims are considered socially or economically important.

Meaning of Preferential Payments

Preferential payments are those payments which, under the provisions of the Companies Act, 2013, must be paid in priority to all other unsecured debts during the liquidation of a company. These include statutory dues, employee-related claims, and certain government obligations. The objective is to safeguard the interests of employees and the government and ensure fairness in the winding-up process.

Features of Preferential Payments

• Statutory in Nature

Preferential payments are created and governed by law, mainly under the Companies Act, 2013 and the Insolvency and Bankruptcy Code, 2016. The liquidator is legally bound to follow these provisions while distributing the assets of the company. These payments are not optional or discretionary; failure to comply may lead to legal consequences.

• Priority Over Unsecured Creditors

One of the most important features of preferential payments is that they are paid before unsecured creditors. After meeting liquidation expenses and secured creditors’ claims (to the extent of their security), preferential creditors are given priority. This ensures that socially and economically important claims are settled first.

• Protection of Employees’ Interests

Preferential payments primarily aim to safeguard the interests of employees and workers. Wages, salaries, holiday pay, gratuity, and provident fund contributions are given preferential status. This feature reflects the social responsibility of company law towards employees who depend on regular income for their livelihood.

• Limited Time Period Applicability

Preferential payments are allowed only for dues that have arisen within a specified period prior to liquidation, usually 12 months. This prevents old and stale claims from enjoying preferential treatment and ensures fairness among creditors. Only recent and relevant obligations qualify for priority payment.

• Subject to Prescribed Monetary Limits

Certain preferential payments, especially wages and salaries, are subject to maximum monetary limits prescribed by law. This feature ensures equitable distribution of assets and prevents disproportionate claims by a few individuals from exhausting the company’s resources.

• Applicable Only in Case of Liquidation

Preferential payments become relevant only when a company goes into liquidation. During normal business operations, all liabilities are treated as ordinary debts. This feature highlights that preferential payments are a special mechanism applicable exclusively during winding up.

• Paid Out of Company’s Assets

Preferential payments are made out of the general assets of the company. They are not charged against specific secured assets unless specified by law. The liquidator ensures that sufficient assets are available to meet these obligations before paying unsecured creditors.

• Ensures Fair and Orderly Distribution

Preferential payments promote fairness, discipline, and order in the liquidation process. By clearly defining the order of priority, they reduce disputes among creditors and ensure transparency. This feature contributes to the smooth completion of liquidation proceedings.

Types of Preferential Payments

Preferential payments are those payments which are given priority over unsecured creditors at the time of liquidation of a company. These payments are specified under the Companies Act, 2013 and relevant provisions of the Insolvency and Bankruptcy Code, 2016. The main types of preferential payments are explained below.

1. Government Dues

Government dues constitute an important category of preferential payments. These include taxes, duties, cess, and other statutory dues payable to the Central Government, State Government, or local authorities. Only those dues which have become payable within twelve months prior to the commencement of liquidation are treated as preferential. This provision ensures timely recovery of public revenue while preventing indefinite priority to old claims.

2. Wages and Salaries of Employees

Wages and salaries payable to employees and workers are treated as preferential payments. These include remuneration for services rendered during a specified period before liquidation, generally up to four months, subject to a prescribed monetary limit. This type of preferential payment protects employees who rely on regular income for their livelihood and ensures social justice during the liquidation process.

3. Accrued Holiday Remuneration

Accrued holiday remuneration refers to the payment due to employees for leave earned but not taken before liquidation. Such unpaid holiday pay is treated as a preferential claim. This ensures that employees receive compensation for benefits accumulated during their service period. It recognizes the contractual and statutory rights of employees even when the company is being wound up.

4. Contributions to Employee Welfare Funds

Amounts due from the company towards employee welfare funds such as Provident Fund, Pension Fund, Gratuity Fund, and other similar funds are treated as preferential payments. In many cases, these contributions are protected in full and may not form part of the company’s general assets. This reflects the importance given to employee welfare and long-term financial security.

5. Compensation Under Labour Laws

Compensation payable to employees under various labour laws is also treated as a preferential payment. This includes compensation for retrenchment, termination, or injury arising out of employment prior to liquidation. Such payments ensure compliance with labour legislation and safeguard the rights of workers during the winding-up process.

6. Other Statutory Preferential Claims

Certain other statutory liabilities may also qualify as preferential payments if specified by law. These may include amounts payable to statutory authorities or regulatory bodies arising within the prescribed time period. The inclusion of such claims ensures adherence to legal obligations during liquidation.