NATIONAL LAW INSTITUTE UNIVERSITY

PROJECT WORK
IN
LAWS OF BUSINESS ASSOCIATION II
[COMPANY LAW]
“INTEREST OF CREDITORS AT THE TIME OF WINDING
UP”

CONTENTS OF THE PROJECT

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  INTRODUCTION
 MEANING
 WINDING UP
 CREDITOR
 RIGHTS OF THE CREDITORS
 OVERRIDING PREFERENTIAL PAYMENTS
 POSITION OF WORKMEN
 CASE LAWS
 CONCLUSION
 BIBLIOGRAPHY

INTRODUCTION

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The term ‘company’ has no strictly technical or legal meaning. According to terms of the
Company Act1 a “company means a company formed and registered under the companies
Act.2 In common law a company is a “legal person” or “Legal entity” separate from and
capable of surviving beyond the lives of, its members.3 The very basic meaning company
is a legal entity apart from its members, capable of rights and duties of its own, and
endowed with the potential of perpetual succession. It is a legal device for the attainment
of any social or economic end and to a large extent publically and socially responsible. It
is, therefore, a combined political, social, economic and legal institution. A company is an
undertaking which basically performs its business in combination of the money or the
capital hired by the investors or the creditors. That’s why company remains under the
obligation to pay its debt and when the company is not in a position to pay its debt then
the company law itself asserts the right of the creditor to get the company to be wound up
and to get his money back in the process of liquidation.4

Winding up is a means of dissolving a company. In that event, its assets are realized and
applied in payment of its debts, and after satisfaction of its debts, the balance, if any, is
paid back to the members in proportion to the contribution made by them to the company.
Winding up of a company is basically a right of the creditors. In case of the winding up
basically a liquidator is appointed who take possession and power of whole of the assets
of the company concerned. After disposing these assets and other security of the company
he started to satisfy the claim of the creditors.

This project discusses the rights of the creditors in winding up of the company and the
position of workmen with regard to this.

Winding up: Meaning

1
No. 1 of 1956 or under any of the preceding Acts
2
Section 3(i)
3
Salomon v Salomon & Co.[1895-1899] All ER Rep 33
4
Section 433 of the Companies Act, 1956

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Winding up is a method of putting an end to the life of the company. In the words of
Professor Gower: “winding up of a company is the process whereby the life of the
company ended and its property administered for the benefit of its creditors and
members. An administrator, called the liquidator, is appointed and he takes control of the
company, collects its assets, pays its debts and finally distributes any surplus among the
members in accordance with their rights”5

During winding up process, the management of a company’s affairs is taken out of

directors hands and an administrator called liquidator is appointed. Liquidator is
responsible for collection of debts and payment of liabilities and finally distributes
surplus if any, among members in accordance with their rights. At the end of winding up
process, the company will have no assets and liabilities. But company continues to exist
after winding up and ceases to exist only after a dissolution order is passed by the court.
Thus in between the winding up and dissolution, the legal status of the company
continues.

Winding up of a company differs from the insolvency of an individual in as much as a

company cannot be made insolvent under the insolvency laws. Moreover, a perfectly
solvent company may be wound up. The concept of winding up is thoroughly dealt up
under part VII of the companies’ law form section 425 to section 560 divided into five
chapters. Thus under the scope of the winding up all the sections in chapter VII of the
Companies Act, 1956 unanimously says that in case of winding up of a company every
assets and the security of the company comes under the control and hold of the liquidator
so appointed and then after disposal of those assets he according to the preference order
given under sections 529, 529A and 5306 has distributed that outcome of the assets in the
claimants.

Creditor – Meaning

5
THE PRINCIPLES OF MODERN COMPANY LAW, 647 (3rd Edn, 1969)
6
Companies Act, (1 of 1956)

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In the very literal meaning a creditor is a person, someone to whom money is owed. A
secured creditor is someone holding a security over an assets of the person or company
owing him or her money and usually can realize (sell) the asset to recover the debt
without having to bankrupt the debtor or (in the case of a company) put it into
liquidation. Thus in this way a creditor can be defined as a person to whom company
owes the capital in the form of debentures, securities and so on. That’s why it becomes
the duty of the company to pay back the money or other advantages which are subsidiary
to that money to the creditor. And in case of non payment of money the creditor would
reserve a right to get the company to be wound up. Creditor themselves are of two types
one is secured creditors and other one are unsecured creditors. A creditor is an integral
part of the company as he furnishes capital to the company in the form of credit. The
importance of a secured creditor comes into play especially during winding up
proceedings when the company has to repay the debts owed to the creditors.

RIGHTS OF THE CREDITORS (SECURED CREDITORS AND

UNSECURED CREDITORS)

There are generally two categories of creditor: secured and unsecured.

• A secured creditor is someone who has a ‘charge’, such as a mortgage, over some or all
of the company’s assets, to secure a debt owed by the company. Lenders usually require a
charge over company assets when they provide a loan.
• An unsecured creditor is a creditor who does not have a charge over the company’s
assets.

Prior to the Companies (Amendment) Act, 1985, the secured creditor had the option of
relinquishing his security and to prove the amount due to him as if he were an unsecured
creditor. Under this scheme a secured creditor was able to rule out all other claims
including claims of workmen. The secured creditor was ‘secure’ in the actual sense of the
word and could relinquish his security at any point of time having priority over all other
debts owed by the company.

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This position has however been changed by the provisions of the Companies
(Amendment) Act, 1985, whereby, the workers’ claims have been equated to those of
secured creditors by providing that the security of every secured creditor shall be subject
to the pari passu charge in favour of workmen. In fact the workmen have been elevated
to the status of a secured creditor by virtue of the provisions of new S.529, S.529A and
S.530 of the Companies Act.

Options Available to a Secured Creditor

The options available to a secured creditor can be summarized as thus7

 Sell the property and prove in the winding up for the balance of his debt after
deducting the amount realized. This option is the scheme of S.529 and as per
S.529(1)(c) the remainder of the debt after realizing the money will be paid under
S.529A as overriding preferential payments.

 Surrender his security to the liquidator and prove for the whole of his debt as
an unsecured creditor. This option is different from relinquishing the security
and this is a viable solution when the creditor knows that the assets of the
company is more than the liability of the company but the company is being
wound up as it does not have a steady cash-outflow to pay the creditors.

 Estimate the value of his security and prove for the balance of his debt after
deducting the estimated value. Under this option the creditor estimates the value
of the security, especially when the value of the security has receded from its
initial value and then claims the rest of the debt as a provable debt against the
company.

Rely on his security and not prove in the winding up. This option is viable
when the creditor is contended with the security given by the company and does not

7
Canfin Homes Ltd. v. Lloyds Steel Industries Ltd., (2001) 106 Comp Case 52 (Bom)

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 want to get into winding up., for example, a pledge, where the creditor sells the
pledge. This is an analogous practice commonly carried out. This will not come
within the provable debts in winding up.

Thus a collective reading of the above information in the light of Sections 529, 529A and
530 shows that the creditors have been given prominent rights in case of winding up of
the company and their rights especially of the secured creditors got expanded after the
Companies (Amendment) Act,1985.

RIGHTS OF THE CREDITORS OUTSIDE THE WINDING UP PROCEEDINGS

The phrase “outside the winding up” has been explained by Lord Wrenbury in Food
Controller v.Cork8, as an intelligible phrase used with reference to a secured creditor, say
a mortgagee. The mortgagee of a company in liquidation is in a position to say that the
mortgaged property is to the extent of the mortgage of the property and it is immaterial
whether the mortgage is in winding up or not and that the mortgagee shall remain
‘outside the winding up’ and shall enforce his rights as a mortgagee.

This is to be contrasted with the case in which such a creditor prefers to assert his right,
not as a mortgagee, but as a creditor. Here the creditor proves in respect of his debt. If so,
he comes into the winding up.

However, this position has been considerably altered after the 1985 amendment and the
subsequent insertion of S.529A, by which, workers dues have been given pari passu
status along with dues of secured creditors. After issuing of winding up order, assets of
the company are deemed to be in possession of National Company Law Tribunal.
Hence, it has been held that after winding up order is issued/petition for winding up is
admitted, the sale of property mortgaged/hypothecated to secured creditors has to be
under supervision or with permission of NCLT 9. However, there has been a view that

8
(1923) AC 647
9
Seventh Edition, Taxmann Allied Services, New Delhi, 2004, p.388

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such a provision would apply only in cases where the winding up is ordered by the NCLT
or is carried out under the supervision of the NCLT. If after exhausting the security
anything more remains due to him, he can claim it as an unsecured creditor by taking part
in the winding up process10. But, if there is no winding up or winding up is not under the
direction and supervision of the NCLT then the earlier position which prevailed prior to
the amendment would apply and the secured creditor can stand outside winding up
proceedings and realize his security even without leave of NCLT 11. In such cases where
the secured creditor opts to stand outside the winding up and enforce his security, then the
provisions of S.529 as it stands amended will apply.

However, this question has been settled by the Supreme Court in State Bank Of Patiala
and State Bank Of India V. Northland Sugar Complex Ltd. and Others 12 where the Court
held that with the amendment in sections 529, 530 and insertion of section 529A by virtue
of the Companies (Amendment) Act, 1985, the dues of the workmen have a pari passu
charge over the security of the secured creditors. In view of these provisions, though the
secured creditor is outside the winding up, still the property is required to be apportioned
with the permission of the company court as the company court is custodian of the
interest of all the secured creditors and the workmen.

OVERRIDING PREFERENTIAL PAYMENTS

10
Canara Bank v. Official Liquidator, (1991) 70 Comp Cas 295 (Mad)
11
Central Bank of India v. Elmot Engineering, AIR 1994 SC 2358
12
(2004) 121 Comp Case 847 (P&H)

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S.529A deals with ‘overriding preferential payments’. This is a new section brought into
force by the Companies (Amendment) Act, 1985. The importance of this section is that it
enhances the position of the workmen to that of secured creditors. This section also
provides that the payments to be made to the workmen and the secured creditors shall
have overriding preference to that of any other payments.

The Object and Reasons of the Companies (Amendment) Act, 1985 provide that S.529A
was inserted as it was felt that since resources of a company constitute a major segment
of the material resources of the community, the common good demands that the
ownership and control of the resources of every company be so distributed in the
unfortunate event of its liquidation that workers, whose labour and effort constitute an
indivisible part of the activities of the company are not deprived of their legitimate right
to participate in the product of their labour and effort. Thus it clearly tells about the
strong standing of secured creditors and the workers of the company to be given a place
pari passu to the secured creditors.

POSITION OF WORKMEN

The position of the workmen after the Companies (Amendment) Act, 1985 has been a
point of dispute and in Textile Labour Association and Another v. Official Liquidator and
Another13, it has been explained that the effect of S.529 and 529A is that the workmen of
the company become secured creditors by operation of law to the extent of the workmen's
dues provided there exists secured creditor by contract. If there is no secured creditor
then the workmen of the company become unsecured preferential creditors under S.529A
to the extent of the workmen dues. The purpose of S.529A is to ensure that the workmen
should not be deprived of their legitimate claims in the event of the liquidation of the
company and the assets of the company would remain charged for the payment of the
workers' dues and such charge will be pari passu with the charge of the secured creditors.
There is no other statutory provision overriding the claim of the secured creditors except
S.529A. This section overrides preferential claims under S.530 also. Under S.529A the
13
AIR 2004 SCC 2336

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dues of the workers and debts due to the secured creditors are to be treated pari passu and
have to be treated as prior to all other dues. After realization of the claims of the secured
creditors and the workmen under S.529, the unrealized portions of the claims of the
secured creditor as also of the workmen would also rank pari-passu and would be
determined and paid in accordance with the provisions of section 529A out of realization
of other assets in priority to all other debts.

A general concern for the interests of workers without any reference to statutory
provisions was guaranteed by the Supreme Court saying that ‘the subsistence and living
of the workers is of paramount importance and has to rank with highest priority. Their
wages and emoluments upto the date of closure of the company will rank in priority over
the secured creditors.’14 In a subsequent note the Supreme Court added that the order in
the above cited case was due to peculiar circumstances and is not to be taken as a
precedent.15 However, on the other hand in Textile LabourAssociation v. Official
Liquidator16, the Court held that by virtue of S.529A, the workmen of the company in
liquidation have been made secured creditors in respect of their claims against the
company and the assets of the company in liquidation would remain charged for the
payment of workmen's dues and such charge will be pari passu with the charge of the
secured creditors. Thus, the position of the workmen and the secured creditors is sought
to be made equal, under S.529A.

CASE LAWS

14
Workmen of Rohtas Industries Ltd. v. Rohtas Industries Ltd., (1987) 62 Comp Cas 872, 874 (SC)
15
Workmen of Rohtas Industries Ltd. v. Rohtas Industries Ltd., (1989) 65 Comp Cas 350 (SC)
16
AIR 2004 SCC 2336

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In Vaishnodevi Enterprises v. Tai Changbang Textiles Industries Ltd.17 the petitioner filed a
petition under section 433 and 434 of the Companies Act, 1956 for the winding up of the
respondent company for its inability to discharge its liabilities towards its creditors. The
secured creditors had enforced their security under the provisions of Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act, 2002. The petition was admitted and the advertisement for the winding up of the
company got ordered. Though the respondent company plead for not ordering the
winding up petition but the Gujarat High Court held that the assets of the company had
already been sold and remained which would enable the company to carry on any
business or to continue its existence. The company has lost its financial substratum and
held failed to discharge its liabilities towards creditors. The company was to be wound
up. In this way the company finally decided to uplift the claim of the secured creditors
with the claim of the workers of the company pari passu.

In Re Crips Laboratory Ltd. (In Liquidation) 18, the controversy in the petition itself
include the question whether the interest of the secured creditors from the date of the
winding up till the date of the sale of assets should be given preference over the claim of
the unsecured creditors. In this case The Andhra Pradesh High Court in the purview of
section 529, 529A of the Companies Act, 1956 held that:-
 In the winding up of the company the surplus of the security is more than
sufficient to meet debts in entirety.
 Overriding preferential payment is to be made to the secured creditors and they
are not required to prove for their debts
 A conjoint reading of section 529(1)(c) of the Companies Act, 1956 and section
47(3) and 48 of the Provincial Insolvency Act,1920 justified the fact that
whenever the sum realized on the sale of the security(of which SBI is the sole
charge holder in this case) was more than sufficient to meet its debt in entirety
inclusive of the interest from the date due till the date of sale of assets. It was not
required under law to prove its debt before the official liquidator and the fact that
it has submitted proof was of no consequence. Its entitlement to be paid interest at
17
[2008] 145 Comp Cas (Guj)
18
[2008] 145 Comp. Cas 357(AP)

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 the contracted rate from the sale proceeds of the security could not be denied on
the doctrine of estoppel or waiver.
 The official liquidator was to set aside the amount claimed by the workmen along
with the interest of 15% per annum from the date on which it fell due till date,
before any amount was paid to SBI (a secured creditor) towards the interest at the
contracted rate from the date of winding up till the date of the sale of assets.
 The official liquidator could arrive at the amount payable towards other dues only
after setting aside the amount required to be paid as interest to SBI, a secured
creditor and the workmen.
Thus it clearly shows that preference to be given to the secured creditors and their
interests and to the workers of the company pari passu.

Thus we can say that under the provisions of the companies Act, 1956 priority has to be
given to the secured creditors and to the workmen of the company at the time of the
winding up of the company and whatever be left that has to be distributed among the
unsecured creditors.

CONCLUSION

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Thus, it can be seen that the position of the secured creditors is no more the same as it
stood before the enactment of the Companies (Amendment) Act, 1985. As already stated,
the secured creditors have been strengthened and they are in a much better position in
regard to the recovery of the defaulted loans. After taking consideration of all the
important points and the recent cases discussed earlier we briefly analyzed that the
position of the creditors be the secured creditors and the unsecured creditors was not
strong before 1985 but after the companies (amendment) Act 1985 a strong standing is
given to the secured creditors as well as the workers of the company at the time of the
winding up of the company, thus elevating the status of the workmen to that of secured
creditors.

Section 529 relates to the application of insolvency rules in winding up of insolvent

companies. It declares as to how the company would be put under winding up, how the
money would be realized and how the money would be distributed. However, section
529A controls the rights of the parties and issues a mandate to the court.
It is indisputable that the right to recover the money is conferred upon the workmen so
also on the secured creditors. After the claims of the secured creditors and workmen are
satisfied and money is left then the money shall be paid in accordance with section 530.

BIBILIOGRAPHY

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 Ramaiya A., Guide to the Companies Act, Sixteenth Edition, Vol. 2, (2006)
Wadhwa; Nagpur,
 Singh, Avtaar Company Law. 14th Edition.2004, Allahbad, Eastern Book
Company
 Sebi and Corporate Laws Reports, vol 87 October 12,2008
 http/www.taxmann.com/.
 http/www.manupatra.com/
 http/www.banking.indlaw.in/

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