Section 326: Overriding Preferential Payments

This article explains the concept of winding up of company and priority of preferential payments under section 320 of the companies act, 2013 and the difference in the conditions of winding up under insolvency and bankruptcy code, 2016.
Estimated Reading Time: 7 minutes

Introduction

Section 326 of Companies Act, 2013, part of chapter XX, Part III lays down the provision for overriding preferential payments during the winding up proceeding by the company. This provision is applicable to both voluntary and non-voluntary winding up of a company. It lays down the debts which must be paid up in priority before other dues in the process of winding up of a company. This section is a very important part of companies act and is of paramount importance for a company undergoing winding up, as it lays down the priority of repayment of debt. This analysis will give an in-depth overview of this section.

Purpose of Section 326

This section is applicable for winding up proceedings under the act, 2013. It lays down briefly the following:

  • Section 326 provides that following debts shall be paid in priority to all other debts, in case of winding up of a company (a) workmen’s dues (b) where a secured creditor has realized a secured asset, so much of the debts due to such secured creditor as could not be realized by him or the amount of the workmen’s portion in his security (if payable under the law), whichever is less, pari passu with the workmen’s dues.
  • Following sums due from a company to its workmen which are payable for a period of 2 years preceding the winding up order or such other period as may be prescribed shall be paid in priority to all other debts (i) all wages or salary of any workman in respect of services rendered to the company (ii) all accrued holiday remuneration becoming payable to any workman, within a period of thirty days of sale of assets and shall be subject to such charge over the security of secured creditors as may be prescribed.
  • The debts payable above shall be paid in full before any payment is made to secured creditors and thereafter debts payable under that subsection shall be paid in full, unless the assets are insufficient to meet them, in which case they shall abate in equal proportions.
  • The explanation to this section defines the following terms:

a) Workmen’, in relation to a company, means the employees of the company, being workmen within the meaning of clause of section 2 of the Industrial Disputes Act, 1947.

b)‘Workmen’s dues’, in relation to a company, means the aggregate of the following sums due from the company to its workmen (i) all wages or salary including wages payable for time or piece work and salary earned wholly or in part by way of commission of any workman in respect of services rendered to the company and any compensation payable to any workman under any of the provisions of the Industrial Disputes Act, 1947 (ii) all accrued holiday remuneration becoming payable to any workman or, in the case of his death, to any other person in his right on the termination of his employment before or by the effect of the winding up order or resolution (iii) unless the company is being wound up voluntarily merely for the purposes of reconstruction or amalgamation with another company or unless the company has, at the commencement of the winding up, under such a contract with insurers as is mentioned in section 14 of the Workmen’s Compensation Act, 1923, rights capable of being transferred to and vested in the workmen, all amount due in respect of any compensation or liability for compensation under the said Act in respect of the death or disablement of any workman of the company (iv) all sums due to any workman from the provident fund, the pension fund, the gratuity fund or any other fund for the welfare of the workmen, maintained by the company.

c)‘Workmen’s portion’, in relation to the security of any secured creditor of a company, means the amount which bears to the value of the security the same proportion as the amount of the workmen’s dues bears to the aggregate of the amount of workmen’s dues and the amount of the debts due to the secured creditors.

  • Section 326 also sets out an illustration to calculate the divisions according to which debt of the company will be cleared.

Situation Before Enactment of Section 326

The section 529A of the old act, 1956 is like the section 326 of the new act, 2013. There are slight changes in the new provision. In addendum to the existing protection of the interest of the workmen, a new provision has been inserted in the Act of 2013, whereby invulnerability has been given to the workmen, whose wages or salaries are not paid for a period of two years or more. Such sum must be paid in priority to all other debts, i.e., even before the debts due to the secured creditors, subject to the charge over the security of the secured creditors. Apart from this, both the sections in the old and the new act are similar.

Application of Section 326

This section is very important as it comes into application each time a company is going under winding up proceeding. It lays down who gets priority when the company is wound up. Every company must adhere to this section. This section is not applicable when a company is winding up under Insolvency and Bankruptcy Code, 2016.

Cases at a Glance

Following cases are important for this section:

  • Axis Bank Ltd. v. State of Maharashtra [1]: The court held that the secured creditors (banks / financial institutions) will have priority over sales tax dues etc., in respect of the company under liquidation in view of section 529A. There is also statutory recognition of the priority of claim of the secured creditor in view of the amendment brought into force in 2016 introducing section 26E in the Securitization Act providing for priority to secured creditors over all other debts, etc.
  • Textile Labour association v. Official Liquidator [2]: In this case the court held that section 529A of the act, 1956 overrides the claim of secured creditors. Section 529A overrides all the claims of other creditors even where a decree has been passed by a court. In this case supreme court issued mandamus by the power under article 142 of the constitution of India directing certain priority claims in winding up of a company, in which case neither workmen nor official liquidator impeded or raised any plea relating to S. 529A of companies act 1956. Here court held that Supreme Court in its exercise of power under article 142 cannot ignore any substantive statutory provision dealing with the subject and it is only a residuary power, supplementary and complementary to the powers specially conferred on the supreme court by statues, exercisable to do complete justice between the parties wherever it is just and equitable to do so. It is intended to prevent any obstruction to the stream of justice.
  • ICICI Bank Ltd. v. Sidco Leathers Ltd. [3]: It was a case pertaining to interpretation of section 529A of the 1956 act. The issue was related to the concept of inter se priority amongst the secured creditors only because workmen’s due and secured creditors debts are treated pari passu with each other. Here the court held that section 529A of the companies act, 1956 contains a non-obstante clause but in construing the provision, it is necessary to determine the purport and the object for which the same was enacted. Section 529A does not ex facie contain a provision on the aspect of priority amongst the secured creditors and hence it would not be proper to read into things, which parliament did not comprehend. Only because the dues of the workmen and debts due to the secured creditors are treated pari passu with each other, the same by itself would not lead to the conclusion that the concept of inter se priorities amongst the secured creditors had thereby been intended to be given a total go-by.
  • Bank of Mahrahtra v. Pandurang Keshav Gorwardkar[4]: In this case the court held that a cumulative reading of section 529A and 529(1) proviso of the act, 1956 lead to an irresistible conclusion that where a company is in liquidation, a statutory charge in created in favor of the workmen in respect of their dues over the security of every secured creditor and this charge is pari passu with that of the secured creditor.  Such statutory charge is to the extent of the workmen’s portion in relation to the security held by the secured creditor of the company. This position is equally applicable where the assets of the company have been sold in execution of the recovery certificate obtained by the bank or financial institution against the debtor company when it was not in liquidation but before the proceeds realized from such sale could be fully and finally disbursed the company had gone into liquidation. Sated differently, pending the final disbursement of the proceeds realized from the sale of security in execution of the recovery certificate issued by DRT, if the debtor company becomes a company in winding up, section 529A and 529(1) proviso comes into operation immediately and a statutory charge is created in favor of the workmen in respect of their dues over such proceeds.

Concluding Summary

This section forms a very important part of companies act, it was present in the previous companies act as well and was modified and stills forms the part of the act, 2013. It gives workers and their dues overriding priority, in case of winding up of a company. This section mandates that the debt of workers is taken care of by the company and their interest and rights are safeguarded and thus this section is of paramount importance.


[1] Axis Bank Ltd. v. State of Maharashtra (2017) 138 CLA 212 (Bom.).

[2] Textile Labour v, Official Liquidator (2004) 9 SCC 741

[3] ICICI Bank Ltd. v. Sidco Leathers Ltd (2006) 10 SCC 452

[4] Bank of Mahrashtra v. Pandurang Keshav Gorwardkar (2013) 3 SCC (Civ) 650.

Also read, Formation of a Company: requirements lawful formation.

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