IBC - Kanakkupillai

The ‘Waterfall Mechanism’ Under IBC

Gaurav Verma — Tue, 04 Mar 2025 09:45:57 +0000

India introduced the Insolvency and Bankruptcy Code (IBC) in 2016. It has revolutionized how financially distressed companies are treated. One of the most important aspects of IBC is the Waterfall Mechanism, which determines the order in which creditors should be paid when a company is being liquidated.

It promotes equitable and open distribution of resources. In this blog, we will break down each element of the Waterfall Mechanism under IBC, exploring its significance, how the order of payoff works, and what effects this has on resolution operations.

What is the Waterfall Mechanism in IBC?

The Waterfall Mechanism in the Insolvency and Bankruptcy Code, 2016 refers to how assets from a company’s liquidation are divided among its creditors. This mechanism sets an exact order in which payments are to be made, giving priority to those who have a clear legal right and form of indebtedness with the debtor.

This mechanism is designed to bring clarity and fairness to the payment of liabilities in a way that will help solve insolvent situations.

Importance of the Waterfall Mechanism In IBC

The Waterfall Mechanism Matter in IBC.

Fairness: Through the procedure, creditors shall be paid according to a standardized and transparent order that reflects existing legal priorities.
Clarity: Settling payments in a clear order reduces confusion and enables all stakeholders to know exactly what their positions are.
Speed: The mechanism speeds up how assets are distributed, a vital part of expediting the resolution of cases under IBC.
Lawfulness: It ensures that IBC provisions are kept to, which will help preserve the integrity of the insolvency procedure as it serves as an effective deterrent against bankrupt behavior being repeated.

Understanding the Sequence under the Waterfall Mechanism in IBC

Rules of the Waterfall Mechanism priority creditor payment. According to this system, in case of bankruptcy, the most important needs like wages and statutory obligations received to date are taken care of first.

Below is the order of priority for the distribution of proceeds should we wind up.

1. Costs of Insolvency Resolution Process (IRP)

The Waterfall Mechanism gives priority to Insolvency Resolution Process Costs. These include any expenses borne by an Insolvency Professional (IP) in managing the IRP.

Comprising: The cost of liquidators, counsel, and other professional services required for the job.
Importance: It is essential for the smooth progress of a liquidation process to ensure debts relating to that process are paid before any other.

2. Secured Creditors (with legal priority over unsecured creditors)

Next come the secured creditors. In secured creditors, fixed assets like property or plant and equipment serve as collateral for loans from them. In case the company is liquidated, they get proceeds from the sale.

Priority of Payments: Secured creditors have priority in the order as they have a legal right to claim on the specific collateral.
Critical Note: Should sale proceeds not cover their debts to these lenders, then they could be further catered for using the Company’s remaining assets in a sequence of priority.

3. Workmen and Employees Dues

In the Waterfall Mechanism, workmen and employees are the third groups to be paid. This category includes wages owing to employees as well as other benefits prescribed by law.

Importance: Employees and their claims in the insolvency resolution process take precedence over costs after the company’s operation is carried on by an important part of the workers.
Scope: Everything that is owed for employment, such as unpaid wages, bonuses, and pension contributions.

4. Government Dues and Statutory Liabilities

The Government’s claims come next in the order of priority under the Waterfall Mechanism. This category includes all sorts of statutory liabilities, such as taxes owed to the central and state governments, social security payments, and other regulatory fees.

What it includes: Goods and Services Tax (GST), income tax debt, customs duties, other statutory obligations
Significance: Prioritizing the payment of taxes and social security dues promotes stability in the economic and tax structure of the country. Unpaid taxes are usually given one higher priority than other such items in liquidation payouts.

5. Unsecured Creditors

Paid after secured creditors and statutory dues have been settled, unsecured creditors are suppliers, vendors, and bondholders whose claims are not backed by collateral.

What it includes: Loans or credit extended to the Company without any form of collateral.
Order of Payment: These creditors generally receive a smaller share than the secured creditors of liquidation proceeds.

6. Shareholders and Equity Holders

Under the Waterfall Mechanism, the final recipients of money are the shareholders or equity holders of the company. Only when there is anything left after all creditors have been paid do shareholders receive anything at all?

Important note: Generally, shareholders receive nothing in liquidation, especially when the asset position of the company does not meet debts laid down by creditors.
Priority: Shareholders are in the last line for payment and bear the most risk if liquidation is carried out.

Impact of the Waterfall Mechanism on Creditors

The Waterfall Mechanism under IBC has a big impact on different types of creditors. It’s arranged in this order: secured creditors first, employees and government dues take second place, another department takes third, an unsecured creditor fourth, and finally stockholders. This kind of priority system means there are fewer conflicts when dealing with liquidation. Conversely, inherent in all its advantages, this type of arrangement can cause problems too, especially for unsecured creditors who never really get a chance to recover much at all.

Conclusion

A major function of the Waterfall Mechanism under the Insolvency and Bankruptcy Code (IBC) is its guarantee that during liquidation, creditors will receive payments in a way that is both open and orderly. By means of establishing a clear priority for payment orders, it reduces the danger of disputes and avoids confusion.

Although the mechanism is designed to accommodate all stakeholders, while at the same time, it retains a priority-serving role in distributing key obligations such as wages and taxes to the government, it ensures fairness in the resolution process. This will enable India’s financial and corporate sectors to continue operating with stability.

An understanding of the Waterfall Mechanism is needed by creditors so that they can adjust their expectations when businesses are in bankruptcy proceedings. Similarly, a knowledge of how this mechanism operates can help businesses work through insolvency proceedings with greater confidence.

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Withdrawal of Insolvency Application

G.Durghasree B.A.B.L (Hons) — Tue, 04 Jul 2023 07:12:49 +0000

The Indian Bankruptcy Code was enacted in 2016 to amend insolvency proceedings. The primary function of the IBC is to facilitate the efficient functioning of corporations. One of the significant steps taken by the IBC was introducing a resolution process for stressed assets, which refers to the loan amounts granted by banks. However, concerns have been raised regarding the potential dissolution of viable companies under the provisions of the IBC. To address this, Section 12A was inserted.

Section 12 A and Regulation 30 A

Section 12 A and Regulation 30 A are essential components of the IBC. Section 12 A emphasizes the withdrawal of liquidation proceedings. However, withdrawal is only granted when specific conditions mentioned in the act are satisfied. These conditions include the satisfaction of Sections 7, 8, and 10, which relate to initiating the insolvency process. Additionally, the withdrawal of liquidation proceedings requires the approval of 90 percent of the creditors. Regulation 30A should be considered along with Section 12A to grant permission to withdraw liquidation proceedings.

The Interesting Situation where Withdrawal is Demanded Suddenly

In certain interesting situations, an application for resolution may be pending before the adjudicating authority, but the parties suddenly reach a settlement plan with the creditors. In such cases, with the permission of the creditors, the party can apply to the NCLT tribunal for the withdrawal of insolvency proceedings. Section 12 A allows for the withdrawal of the application with the approval of 90 percent of the creditors.

In the case of Sathyanarayan Malu vs. CPM Paper Limited, NCLT Mumbai granted the application for the withdrawal of the insolvency application while the resolution was pending before the NCLT. The NCLT considered the creditors’ acceptance of the payment amount by the corporate debtor.

The Intersection Between Section 12 A and Section 29 A

Section 29 A of the Indian Bankruptcy Code prohibits certain individuals from participating in the resolution process. However, in the case of Vishwanath Shirke vs. creditors, the court held that individuals declared ineligible under Section 29 A is not barred from availing of the provisions mentioned in Section 12 A. The court concluded that Section 12 A and Section 29 A are distinct and do not restrict a person from accessing the provisions outlined in Section 29 A.

Conclusion

The withdrawal of insolvency proceedings provided by Section 12A presents a valuable opportunity for companies. However, to derive the benefits of this provision, the approval of the majority of creditors is necessary. This opportunity allows a company to revive and continue its business operations while creditors are given the opportunity to receive the amounts owed to them by the corporate debtors.

FAQs

1. What is the purpose of the Indian Bankruptcy Code (IBC)?

The Indian Bankruptcy Code, enacted in 2016, aims to amend insolvency proceedings and facilitate the efficient functioning of corporations. It addresses the resolution of stressed assets, which refers to loan amounts granted by banks. However, concerns have been raised about the potential dissolution of viable companies under the provisions of the IBC.

2. What is the significance of Section 12A and Regulation 30A in the IBC?

Section 12 A and Regulation 30 A are crucial in the IBC. Section 12 A emphasizes the withdrawal of liquidation proceedings only under certain conditions. These conditions include satisfying Sections 7, 8, and 10 of the IBC. Additionally, the withdrawal of liquidation proceedings requires the approval of 90 percent of creditors. Regulation 30 A complements Section 12 A and should be considered when granting permission to withdraw liquidation proceedings.

3. Can a party withdraw an insolvency application while it is pending before the adjudicating authority?

Yes, in certain situations, if parties come to a settlement plan with the creditors while the application for resolution is pending, they can apply to the NCLT tribunal to withdraw insolvency proceedings. The withdrawal can also be requested by obtaining the approval of 90 percent of the creditors, as outlined in Section 12A of the IBC.

4. Are there any restrictions on availing the benefits of Section 12A due to Section 29A?

According to the Indian Bankruptcy Code’s Section 29 A, certain individuals are barred from participating in the resolution process. However, the court, in the case of Vishwanath Shirke vs. creditors, held that individuals declared ineligible under Section 29 A are not restricted from availing of the provisions mentioned in Section 12 A. The court concluded that both sections are distinct and independent of each other.

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NCLAT and Its Power to Recall Its Order

G.Durghasree B.A.B.L (Hons) — Tue, 04 Jul 2023 06:00:12 +0000

NCLAT, also known as the National Company Law Appellate Tribunal, is a judicial body in India where companies or their related bodies can appeal against orders passed by NCLT. Although it lacks the powers of judicial review of an order that affects itself, it can remit an order under certain conditions. This article aims to delve into the exact process of recalling an order by the NCLAT and clarify its powers and limitations.

Does NCLAT Have the Power to Recall Its Judgment?

In this case, the NCLAT, as an adjudicating body, has reviewed numerous rulings of the Supreme Court to assess whether it triggered its own judgment reversal. Although in it does not hold the power to review a given decision, it can recall its verdicts for particular reasons. Order 11 empowers the NCLAT to recall its judgments.

Recently, a 5-member bench overruled the notion that the NCLT and NCLAT lack the power to recall their judgments. In the case of Union of India vs. Dinkar T Subramaniam, the bench clarified that while there is no jurisdiction available for the NCLT and NCLAT to review their orders and find errors, Order 11 of the NCLAT grants the power to recall an order under certain grounds and conditions. Recalling an order means providing the affected party with an equal opportunity if they were previously denied due to any fraudulent actions committed by the opposing party in the case.

The bench further emphasized that the provision for recalling orders helps reduce the number of appeals, particularly for less significant cases.

Cases Referred

The bench considered the decision in the Aggarwal Coal House Private Limited case vs. K J L Private Limited. Although the rulings, in this case, did not allow the adjudicating authority to review or recall a specific order, the NCLAT overruled the previous judgments on the recall aspect. It stated that the NCLT and NCLAT can recall orders based on Order 11 of the NCLAT.

Additionally, the honourable NCLT decided in the case of Green Arch Private Limited vs. Ireo Limited. The appeal was accepted in this instance, and the NCLAT reconsidered the case. This case clearly shows that the tribunal can recall an order based on certain conditions.

Conclusion

The power of the NCLAT to recall its orders reduces the burden of appeals, benefiting not only society but also India’s legal system. This power streamlines the legal process and contributes to a more efficient system by minimising the number of appeals reaching the high court.

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