Order of Payments in the event of Liquidation

In the event of a company’s liquidation, the Distribution of proceeds from the sale of assets is governed by a specific hierarchy called the “Waterfall mechanism”. This order ensures that various stakeholders are paid in a legally prescribed sequence. The objective is to maintain fairness, transparency, and legal compliance during the settlement process.

The Insolvency and Bankruptcy Code (IBC), 2016 – Section 53 governs the order of priority in distributing assets. The Companies Act, 2013, also has related provisions under Section 327 (preferential payments) and Section 326 (overriding provisions for workmen’s dues).

1. Insolvency Resolution Process Costs and Liquidation Costs

The first payment priority is to cover the Insolvency Resolution Process (IRP) costs and liquidation costs. These include:

• Fees of insolvency professionals.

• Costs incurred for managing company operations during the resolution.

• Legal and administrative expenses.

• Any interim finance availed during the process.

These costs are non-negotiable and must be paid in full before any distribution to creditors or stakeholders.

2. Workmen’s Dues and Secured Creditors (Unenforced Security)

This class includes:

• Workmen’s dues for the 24 months preceding the liquidation commencement date.

• Secured creditors who choose to relinquish their security interest to the liquidation estate.

They share the proceeds equally under this class. This provision protects employees’ rights and recognizes the importance of workers in business operations.

3. Wages and Unpaid Dues to Employees (Other Than Workmen)

This category consists of:

• Salaries, wages, and other dues to employees, other than workmen, for up to 12 months preceding the liquidation commencement.

This ensures that non-workmen employees such as clerks, assistants, and administrative staff are compensated fairly for their dues.

4. Financial Debts Owed to Unsecured Creditors

After paying employees, unsecured financial creditors are entitled to recover their dues. These include:

• Debentures and bonds without collateral.

• Bank loans that are unsecured.

They form a major class of creditors and bear higher risk, which is why they are positioned lower in the priority list.

5. Government Dues and Remaining Secured Creditors

This class includes:

• Government dues like income tax, GST, VAT, and other statutory dues for the two years preceding liquidation.

• Secured creditors who choose to enforce their security interest outside the liquidation process but have remaining unpaid amounts.

Government dues are placed below unsecured creditors, marking a major shift introduced by the IBC, which prioritizes market creditors over sovereign claims.

6. Any Remaining Debts and Dues

This includes:

• Creditors not fitting in any previous categories.

• Miscellaneous claims without specific legal protection.

These claimants are paid only if surplus remains after fulfilling higher-order liabilities.

7. Preference Shareholders

Preference shareholders are entitled to repayment of capital after all debts and statutory dues are settled. Their preferential right is only with respect to equity shareholders, not above any creditor.

8. Equity Shareholders or Partners

At the bottom of the waterfall are the equity shareholders or partners (in the case of LLPs). They are residual claimants and receive payment only if surplus remains after all prior obligations have been satisfied. Often, in practice, they may receive nothing.

Summary of the Waterfall Mechanism (Section 53 of IBC):