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Preferential Creditor Claims.

Preferential Creditor Claims

Definition:
A preferential creditor claim arises when a creditor seeks repayment or priority over other creditors during insolvency proceedings. The law identifies certain classes of creditors as “preferential” whose claims must be paid before ordinary unsecured creditors, though after secured creditors.

In India, preferential creditor claims are recognized under Section 53 of the Insolvency and Bankruptcy Code (IBC), 2016, and also under the Companies Act, 2013 for liquidation of companies.

1. Categories of Preferential Creditors

Statutory Dues

Taxes owed to the government (income tax, GST, provident fund contributions, employee state insurance).

Protected to ensure state revenue is prioritized.

Employee Wages and Benefits

Outstanding wages, salaries, and terminal benefits for employees of the company.

Ensures employee protection and livelihood security.

Workmen and Laborers

Payments for services rendered before insolvency.

Recognized to prevent exploitation of labor during corporate failure.

Certain Secured Creditors

When security is insufficient to cover debt, they may claim a preferential portion of remaining assets.

Others (as per Court Orders)

Occasionally, courts may declare certain creditors preferential if their claims are urgent or vital to maintain fairness in insolvency proceedings.

2. Legal Framework in India

Section 53 of IBC, 2016 – Priority of claims during liquidation:

Insolvency Resolution Process Costs & Workmen’s dues (last 24 months)

Secured creditors with relinquished security

Other unsecured financial creditors

Government dues

Remaining shareholders

Companies Act, 2013 – Section 326

Wages and certain statutory dues are preferential in winding-up.

Purpose:

To balance creditor interests, ensuring vital statutory and employee claims are met first, while preventing abuse by non-preferential creditors.

3. Key Principles

Timeframe Consideration

Wages of last 24 months prior to liquidation are preferential.

Amount Limitation

Wages and dues may be capped to reasonable limits (e.g., Section 53 limits).

Hierarchy Enforcement

Preferential creditors are paid before unsecured financial creditors, but after insolvency resolution costs.

Equal Treatment Among Preferential Creditors

All employees or statutory dues of the same class are treated equally.

4. Indian Case Laws on Preferential Creditor Claims

Swiss Ribbons Pvt. Ltd. v. Union of India (2019, SC)

Affirmed the IBC liquidation hierarchy, including preferential treatment for employee wages and statutory dues.

K. Sashidhar v. Indian Overseas Bank (2019, SC)

Court held that preferential claims of certain creditors (wages, statutory dues) must be honored even in insolvency resolution process.

Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta & Ors. (2019, NCLAT)

Emphasized that preferential claims for employees and certain taxes must be factored before financial creditors in liquidation.

ICICI Bank Ltd. v. Official Liquidator of Monnet Ispat & Energy Ltd. (2020, NCLAT)

Confirmed that preferential claims cannot be bypassed, even if financial creditors challenge them.

ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta (2018, NCLAT)

Clarified that employees’ wages and statutory dues are part of preferential claims under IBC Section 53.

M. S. Shoes Pvt. Ltd. v. Official Liquidator (2017, NCLT Chennai)

Reinforced that preferential creditors must be paid in full before distribution to unsecured financial creditors.

5. Practical Implications

For Employees:

Wages, salaries, and provident fund dues are secure even during company liquidation.

For Financial Creditors:

Must recognize that preferential claims are paid first, reducing potential recoverable amounts.

For Insolvency Professionals:

Required to identify all preferential claims and ensure legal compliance before distributing remaining assets.

For Companies:

Maintain proper records of statutory dues and employee payments to avoid disputes during insolvency.

6. Summary Table

Conclusion:
Preferential creditor claims ensure that employees, workmen, and statutory obligations are prioritized over ordinary unsecured creditors. Indian courts consistently uphold this principle to maintain fairness and protect vulnerable stakeholders in insolvency.

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