Context: Recently, the National Company Law Appellate Tribunal has ruled that liquidation process of a company under the Insolvency and Bankruptcy Code holds precedence over outcome of an arbitration proceeding.
Issue

• Tamil Nadu-based Surana Power was admitted into insolvency under the Insolvency and Bankruptcy Code (IBC) in January 2019, It did not receive any valid resolution plans.
• So, it was ordered to be liquidated by the Chennai Bench of National Company Law Tribunal (NCLT).
• During the liquidation proceedings, state-run BHEL (Bharat Heavy Electricals Limited) won an ex-parte arbitration award against Surana Power.
• This gave BHEL complete and undisputed rights over all the assets, equipment, goods lying at the site of the Surana power plant.
• It also gave BHEL title rights over the finished and unfinished buildings.
• BHEL is also one of the secured creditors to Surana Power.
• On liquidation, BHEL would have got the money over other unsecured creditors.
• But its share would have come down by a lot going by IBC’s waterfall mechanism (discussed below).
• So, following the award, BHEL, as a creditor, refused to give its consent for liquidation.
• BHEL’s refusal was challenged by the liquidator at the Chennai bench of NCLT.
• The NCLT ruled in favour of BHEL.
• It said that BHEL had full rights to realise the security interests it had won as part of the arbitration.

What is the NCLAT ruling now?

• The NCLAT set aside the Chennai NCLT’s ruling.
• NCLAT held that the liquidation process of a company under the IBC holds precedence over outcome of an arbitration proceeding.
• So just because BHEL won the arbitration award, the liquidation process would not be stopped to favour it.
• BHEL had claimed that it had the first right over the assets and properties of Surana Power.
• But the NCLAT held this claim as invalid.
• BHEL did not have the minimum 60% value in secured interest; it had 26.24% share.
• So, BHEL could not be allowed to stall the IBC proceedings.
• Moreover, all other creditors had given the assent to liquidate Surana Power ('corporate debtor').
• It would be prejudicial to stall the liquidation process at the instance of a single creditor having 26.24% share (in value), in the secured assets.
• NCLAT ruled that BHEL’s charge over Surana Power assets were equal to the other 10 financial creditors.
• So, BHEL could not be given precedence.

What does the NCLAT order mean?

• Essentially, if a corporate debtor is being liquidated, a creditor cannot claim superiority over other secured creditors in the same band.
• Also, everyone must receive a fair share by following the waterfall mechanism of liquidation.

What is the waterfall mechanism for liquidation?

• Section 53 of the IBC deals with the waterfall mechanism for liquidation.
• The waterfall mechanism gives priority to secured financial creditors over unsecured financial creditors.
• Under this, if a company is being liquidated, the secured financial creditors must be first paid the full extent of their admitted claim.
• This should be done before any sale proceedings are distributed to any other unsecured creditor.
• The top most priority, however, is given to costs related to the liquidation process and dues of workmen of the corporate debtor.
• The dues of the workmen include all their salaries, provident, pension, retirement and gratuity funds.
• It also includes any other funds maintained for the welfare of the workmen.