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CASE STUDY-1

INDIAN COURT PROTECTS EMPLOYEES' PAYMENTS DURING


LIQUIDATION PROCEEDINGS
The Supreme Court of India ("SC") has held that in the event of liquidation of a
company, claims of employees have to be considered by the Official Liquidator of
the company and not by the Debt Recovery Tribunal ("DRT"). The SC made this
decision in the case of Bank of Maharashtra v. Pandurang Keshav Gorwardkar &
Ors, and laid down certain rules for deciding employee claims.

FACTS
Paper and Pulp Conversions Limited ('Company') had taken a loan from Bank of
Maharashtra ("Appellant") in the year 1980. Upon facing liquidity problems, the
Company closed its operations in 1992 followed by an order for liquidation by the
Board of Industrial Financial Reconstruction ("BIFR"). The Appellant filed
proceedings against the Company and its directors for recovery of certain
amounts with future interest. The DRT ordered for payment of sums to the
Appellant and held that in the event of the Company failing to repay the due and
outstanding amounts, the Appellant was entitled to sell all the properties to
recover such amounts.
Simultaneously, recovery proceedings were initiated by employees of the
Company ("Respondents") before the DRT praying for registration of their claims
before auctioning of the properties by the Appellant. The Recovery Officer
auctioned the movable properties of the Company and received certain amounts
of which a part was kept aside towards the employees' likely claims.
Almost immediately, the employees filed a writ petition before the Bombay High
Court ("Bombay HC") for appointment of a provisional liquidator and for staying
further proceedings before the DRT. The writ was opposed by the Appellant. The
Bombay HC passed an order for liquidation of the Company and appointment of an
Official Liquidator. The Bombay HC also held that the jurisdiction to determine
the payment and its priorities totally vested with the DRT and directed the DRT to
retain INR 11,755,000 (amount claimed by the employees) until the claim of the
employees was determined leading to an appeal before the SC.

ISSUE
The issue before the SC was whether in case of liquidation of a company, the
claims of the employees which rank pari passu to the creditors' claims, should be
considered by the Official Liquidator or the DRT.

ARGUMENTS
The Appellant had a two-fold argument. The first being that no rights could be
claimed by the employees over the security held by a bank or financial institution
and that the DRT lacked the requisite competence to decide on adjudication of
their claims. The purpose of DRT is adjudication and recovery of dues of banks or
financial institutions and not employee related dues, which should be dealt with by
an appropriate forum such as the Industrial Tribunal.
Secondly, if the debtor company is in liquidation and the security has been sold in
proceedings before the DRT, then the sale proceeds should be distributed by taking
into account the pari passu charge to the limited extent of the "employees
portion".2 It was argued that the Company was in the process of starting their
liquidation process and the employees had no claims on the assets of the Company
or any standing to approach the DRT to participate in a proceeding filed by a bank
or financial institution.
The employees on the other hand contended that the DRT had the right to
anticipate not only a situation when the Company is in liquidation but also when
the Company, though not in liquidation, will be rendered as an empty shell if the
assets of the Company are sold and the proceeds are handed over to financial
institutions and banks. With regard to the claims of the creditor, it was argued that
the official liquidator represented the entire body of creditors and the rights of the
employees rank pari passu with that of the secured creditors.

JUDGMENT AND ANALYSIS


The SC while analyzing the arguments, held that the employees' dues were pari passu
with secured creditors under section 529A of the Companies Act, 1956 (duly
amended from time to time) ("Act") and a combined reading of section 529A and
proviso to section 529(1)(c) of the Act indicates that where a company is in
liquidation, a statutory charge is created in favour of the employees 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 of the secured creditor is
limited to the extent of the employees' portion in relation to the security held by
the secured creditor in the company.
In view of the observations, the SC laid down certain rules for the determination
of the claims of the employees:
1. Statutory charge is created in favor of employees for their dues which is pari passu
with that of the secured creditor when a company is in liquidation or when the
assets of the company have been sold for the recovery of dues but before the
proceeds realized from the sale have been disbursed. However, the same is limited
to the extent of employee's portion in relation to the security held by the secured
creditor of the debtor company and will be decided on the date of the liquidation
order.
2. Prior to full and final disbursement of sale proceeds if the debtor company goes
into liquidation and subsequently Official Liquidator is appointed, disbursement
of undisbursed sale proceeds by DRT can only be done after giving notice to and
hearing the liquidator. In the event of claims by employees, the DRT has two
options:
i. either pay off the bank or the financial institution as per the recovery
certificate after securing an indemnity bond of restitution of the amount of the
employees' dues as may be finally determined by the Official Liquidator, or
ii. set apart tentatively, a portion of the undisbursed amount towards employees' dues in
the ration as per the illustration in Section 529(3)(c) of the Act and disburse the
balance amount to the bank on an undertaking to restitute the amount to the extent of
the employees' dues as may be finally decided by the Official Liquidator.
3. The first option must be exercised only in the situation where no application for
distribution of employees' dues against the company has been made by the
Official Liquidator or the employees before the DRT.
4. Where the sale of security has been affected in lieu of DRT's recovery certificate,
the distribution of proceeds has to be made by the DRT alone according to Section
529A of the Act and by no other authority.
5. The employees acquire the standing of the secured creditors on and from the date of
order of liquidation and become entitled to the distribution of sale proceeds.
CASE STUDY-2

Nationwide carpet and upholstery cleaning franchise (company A) and nationwide


removals company (company B), incorporated in December 2004 and April 2009
respectively.

The companies' directors contacted KSA after reading the website. Meetings were
subsequently held between the directors and KSA representatives. KSA was
appointed to assist company A in July 2010 and company B in August 2010.

Turnover for the financial 2009 financial was:


- Company A: 1.84m up 230K compared with the previous year
- Company B: 483K first 9 months trading.

The companies were encountering financial difficulties due to:


Company A
- Inability to repay the vendor loans for the franchise acquisitions.
- Downturn in trade in the market due to the recession
- Undercapitalised.
- Loss of c20% of turnover, being c320k in 2009 due to loss of key contract .
- Historic accrued arrears with HMRC and trade creditors increased
past manageable levels

Company B
- Its relationship with company A, a company owned by the directors of company
B. Company A by far was the main customer of company B, and was itself looking
to arrange a Company Voluntary Arrangement with its creditors. Company A
struggled to pay company B which has therefore placed company B in financial
difficulty outstanding debtor balance of c264K owed by company A.
- Historic accrued arrears with HMRC increased past manageable levels.

Leased Premises
- Both companies operated from various premises around the country, which were
all in the name of company A.
Employees
- Company A had 53 employees including directors. No redundancies were
planned.
- Company B had no employees: these were drawn from company A, company B
was invoiced for services rendered.

Bank & Financial facilities:


Company A
- Bank held debenture fixed and floating charge over
- Overdraft c32K
- 2 loans total c70K
- Invoice Finance Facility held debenture fixed and floating charge over debtor
book and was owed c140.5K

Company B
- The bank had no exposure:
- No loan or overdraft facilities.
- No security

Directors Loan Account


- One director was owed c134K for loans made available to company A
Unsecured Creditor debt:
Company A
- 1.055M of which HMRC was 59%

Company B:
- 174K of which HMRC was 100%

Nominees review took place for both companies on 20th April 2011 therefore
CVA process close to completion

April 2011 bailiff was instructed by a major creditor (not HMRC) to attend the
premises of the company to collect c380K. It is always advisable to prevent entry
to company premises if bailiff action has been threatened by keeping all means of
entry locked; which was the case here. However bailiffs have tricks to gain entry,
once they have, they cant be ejected. In this case, the bailiff rang the door bell
and when questioned simply said delivery! and he was in. He then proceeded to
execute his brief which was collect full payment or remove assets to the value of.
No amount of negotiation from KSAs part would dissuade him. Often a bailiff
may be persuaded to take walking possession which means an inventory of
unencumbered goods is taken and they are labelled so no one else may remove
them. However in this case that was not possible.

Unfortunately, deprived of the assets necessary to trade, company A ceased trading


and was placed into Liquidation. Company B, having found its outstanding debtors
book had completely turned to bad debt and its major client had gone, was also
placed into liquidation.

CASE STUDY-3
LIQUIDATION CASE STUDY: AVIATION SERVICES COMPANY
The director first contacted KSA Group to discuss the companys rapidly
deteriorating position after its European parent operation filed for bankruptcy in
the European courts.

After an initial telephone consultation, a meeting with the UK based director and
KSA Group Regional Manager, George Davis, was arranged. At the meeting, the
financial position of the business was discussed in depth, as were any options that
may have been open to the company. By that time, given the critical position of the
business, the duties and responsibilities of the remaining directors were also
covered.

Up until this point, the company, a wholly owned subsidiary of the European
parent, had operated as a service company. It was set up in the UK to provide UK
based cabin staff for use on the parent companys commercial flight operations out
of the UK.

In discussion, it quickly became obvious that as the company had no other contracts,
and with creditors now pressing in the UK, there was effectively little or no time to
restructure, and to look for new work. The demise of its parent operation
had effectively brought things to a close in the UK.

Following the meeting, KSA reported to the remaining directors, both UK and
European based, again, providing a detailed assessment of the position. After
further consideration, the directors decided that liquidation was the only remaining
option.

Following appointment, the liquidator dealt quickly with the European lawyers
dealing with issues related to the parent company, disclaimed leases on two offices
at different Airports, and dealt with any remaining staff as well as UK creditor
issues.

Although disappointed at the outcome through no fault of his own, the UK based
director had been battling against a variety of complex issues surrounding the
potentially imminent demise of the parent company for many weeks.

As such, the decision to enter a Company Voluntary Liquidation allowed matters to


be dealt with quickly and professionally, leaving the director to get on with his life,
whilst at the same time, maximizing the interests of the creditors.