Constitutionality of Section 327(7) of the Companies Act 2013: Sanctity of the Waterfall Mechanism

[Simran Malhotra is an Associate at Shardul Amarchand Mangaldas, New Delhi]

In Moser Baer Karamchari Union v. Union of India (2 May 2023), workmen unions challenged the constitutionality of section 327(7) of the Companies Act (“Act”) for excluding preferential payment for workmen’s dues over other dues as provided under sections 326 and 327 of the Act in the event of liquidation of a company under the Insolvency and Bankruptcy Code, 2016 (“Code”). Dismissing the batch petitions, the Supreme Court upheld the constitutionality of the statutory provision, thus in turn preserving the sanctity of the waterfall mechanism under section 53 the Code. The waterfall mechanism provides for distribution of proceeds of sale to different classes of creditors of a company going into liquidation in order of priority, wherein workmen dues come second in priority along with debts owed to secured creditors in the event they have relinquished their security under section 52 of the Code.

Section 327(7) of the Act was introduced by way of an amendment in 2016 to bring uniformity in payment to different class of creditors as provided under the Code. Calling such amendment as a necessity in light of the waterfall mechanism under the Code, the Court declared the provision to be neither arbitrary nor violative of the provisions of the Constitution of India. The judgment of the Court is an important precedent for the following reasons

It safeguards the waterfall mechanism thus further the objectives of the Code

The waterfall mechanism under the Code is a critical economic allocation process aimed at the maximising the value of a corporate debtor that has meet with liquidation. The waterfall mechanism ensures that different classes of creditors are compensated fairly and equitably based on their contribution to the company while also considering the interest of other stakeholders such as the employees and shareholders. For instance, the rationale for having secured financial creditors who have relinquished their security higher up in the ladder and only next to cost incurred on insolvency resolution process and liquidation costs is because they have in economic terms provided monetary assistance to the company and have borne risk associated with the same, which in objective terms is much higher when compared to other forms of creditors. The entire scheme of the waterfall mechanism is based on the prioritising creditors who have borne more risk and have higher stake in the company. Thus, the judgment not only upholds the statutory preserving of rights of the stakeholders but, by not altering the waterfall mechanism, it also instils investor confidence in the entire system.

It considers that the Code aims to accord enough protection to the workmen rights

The Code provides an adequate safety mechanism to protect the interest of the workmen of the corporate debtor: for instance, section 36(4)(a) of the Code specifically provides that employment benefits given to the workmen such as provident fund scheme, pension fund and gratuity fund are kept out of the purview of liquidation assets.  Further, to preserve the liquation assets and for ensuring that the interests of the workmen are protected in cases where the secured creditor opts to realise their security interest under section 52 of the Code, regulation 21a of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 provides a safety net. The regulation provides that the secured creditors realising their secured interest have to pay as much towards the costs of the insolvency resolution process as well as liquidation costs and workmen dues for a period of 24 months preceding liquidation commencement date to the liquidator within 90 days from the liquidation commencement date. Pertinently, even in the event the secured creditor relinquishes its secured interest in the asset and is ranked pari passu with workmen dues, the workmen dues are calculated for a period of 24 months preceding liquidation commencement date which, as defined under section 5(17) of the Code, is much earlier in time and does not necessarily coincide with the winding update, thus providing them a larger window.

The judgment of the Supreme Court is also important because it is line with various earlier dictums of the Court preserving the waterfall mechanism. Reliance can be placed on Sunil Kumar Jian v. Sundaresh Bhatt, wherein the Court not only preserves the waterfall mechanism but also notes that under the Code “workmen dues have been duly protected and provident and pension fund have been excluded from the liquidation estate assets”.


In a developing economy like India, the Code plays a critical role in promoting credit market development, providing a time bound resolution to distressed companies, ensuring value maximisation of the assets of the company and, mostly importantly, protecting the interests of all stakeholders. Through this judgment, the Supreme Court has reiterated the principle that the benefit of whole take precedence over the benefit of the sole. Under the predecessor regimes to the Code, the process was not only marred with long delays, but the overall benefit of the company was not considered. What the judgment also ensures is that there is not multiplicity of claims from different classes of stakeholders who, in their merit, feel that their interests should be prioritised over the other. Further as the Court stated, “some sacrifices have to be made for greater good”. For, when the company is going into the process of liquidation, all stakeholders are taking a haircut to make the system just and equitable, therefore one class of stakeholders’ demand to be prioritized over others when there is already adequate safety net in place is not only unreasonable but also untenable in the larger scheme of the Code.

Simran Malhotra

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