Overriding Preferential Payments as per the Insolvency and Bankruptcy Code

Insolvency and Bankruptcy Code, 2016 (IBC) was enacted to consolidate and amend laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals. One of the most important aspects of liquidation under IBC is the priority of payments, commonly known as the “waterfall mechanism.” At the top of this priority structure lie Overriding Preferential Payments, which are paid before all other claims, including secured creditors in certain cases. These payments reflect the social and legal priorities recognized by the legislature.

Meaning of Overriding Preferential Payments

Overriding preferential payments refer to those payments which enjoy absolute priority during liquidation under the IBC. These payments override all other claims, including preferential debts under the Companies Act, 2013. They must be paid first out of the liquidation estate, before making any distribution to secured creditors, unsecured creditors, or shareholders. The term “overriding” signifies their supreme priority in the order of payment.

Legal Basis under the IBC

The concept of overriding preferential payments is governed by Section 53 of the Insolvency and Bankruptcy Code, 2016, which lays down the distribution of assets in liquidation. Section 53 begins with a non-obstante clause (“notwithstanding anything contained in any law”), giving it overriding effect over other laws, including the Companies Act, 2013. This ensures uniformity and certainty in liquidation proceedings.

Objectives of Overriding Preferential Payments

The key objectives of overriding preferential payments under IBC are:

• To ensure smooth conduct of liquidation proceedings

• To protect workmen and employees

• To provide certainty and transparency in distribution of assets

• To balance economic efficiency with social justice

• To prevent disputes among stakeholders regarding priority of claims

By clearly defining priority, IBC minimizes litigation and delays.

Nature and Characteristics

Overriding preferential payments have the following characteristics:

• They have statutory priority

• They are paid before all other claims

• They apply only during liquidation

• They override provisions of the Companies Act

• They are mandatory and non-discretionary

• They are paid from the liquidation estate

These features distinguish them from ordinary preferential payments.

Liquidation Estate under IBC

Before understanding payments, it is important to understand the liquidation estate. The liquidation estate includes all assets of the corporate debtor, such as:

• Tangible and intangible assets

• Proceeds from sale of assets

• Unencumbered assets

• Residual value of secured assets (if relinquished)

Overriding preferential payments are made only out of this estate.

Categories of Overriding Preferential Payments

As per Section 53(1) of the IBC, the following payments are treated as overriding preferential payments:

Insolvency Resolution Process Costs and Liquidation Costs

These costs include all expenses incurred in:

• Corporate Insolvency Resolution Process (CIRP)

• Liquidation process

Examples

• Fees of resolution professional and liquidator

• Legal and professional fees

• Costs of preserving and realizing assets

• Administrative expenses

Treatment of Employee Dues (Other than Workmen)

Employee dues other than workmen (e.g., managerial staff) for the preceding 12 months rank below workmen’s dues but above unsecured creditors.

This distinction emphasizes protection of blue-collar workers.

Government Dues under IBC

Unlike the Companies Act, government dues are not overriding preferential payments under IBC.

They rank below unsecured creditors in priority.

This reflects the policy shift towards:

• Promoting credit availability

• Protecting business confidence

Impact of Overriding Preferential Payments

Overriding preferential payments have significantly impacted liquidation accounting by:

• Reducing ambiguity in priority

• Enhancing speed of liquidation

• Increasing confidence of creditors

• Protecting vulnerable stakeholders

Accounting Treatment of Overriding Preferential Payments

In liquidation accounts:

• These payments are deducted first from realized assets

• Shown separately in the Liquidator’s Statement of Account

• Paid in full before other claims

Role of Liquidator

The liquidator is responsible for:

• Identifying eligible overriding preferential claims

• Verifying amounts and time periods

• Making payments strictly as per Section 53

• Ensuring compliance and transparency