Proof and Priority of Debts

In one line

Every debt and claim, present or future, certain or contingent, ascertained or sounding only in damages, is admissible to proof on a just estimate; workmen's dues, and a secured creditor's shortfall up to the workmen's portion, are paid before all other debts, with two years' workmen's dues ranking even ahead of secured creditors; and after them come seven classes of preferential payments.

In exam wording: under section 326(1), in the winding up of a company under this Act, workmen's dues, and, where a secured creditor has realised a secured asset, so much of the debts due to him as could not be realised, or the amount of the workmen's portion in his security, whichever is less, shall be paid in priority to all other debts, pari passu with the workmen's dues.

Why the law has this at all

Winding up is a collective proceeding in which the assets are almost always less than the claims, so the law has to decide who is paid first. Three principles compete, and the sections are the compromise between them.

Equality. The starting point of insolvency law is that unsecured creditors share rateably. That is why s.324 admits every kind of claim to proof, including contingent and unliquidated ones, on a just estimate: nobody is excluded merely because his claim is hard to value.

Security. A creditor who took a charge bargained for priority, and the whole system of registered charges in Chapter VI, treated in [Charges: Creation and Registration], exists to give it to him.

And protection of those who cannot bargain. Workmen supply their labour on credit, cannot take security, and have no way of assessing the company's solvency. Revenue authorities are in a similar position, and so are employees owed provident fund and gratuity.

The Act resolves the competition in three tiers, and stating them in order is the fastest way to answer any question on this topic.

First, s.326. Workmen's dues rank ahead of everything, and to the extent of the workmen's portion they rank ahead even of secured creditors, with two years' dues payable within thirty days of the sale.

Second, s.327. Preferential payments, seven classes, paid in priority to all other debts but subject to s.326, ranking equally among themselves, abating rateably, and having priority over floating charge holders.

Third, everybody else, rateably.

Section 324: what may be proved

In every winding up, subject, in the case of insolvent companies, to the application in accordance with the provisions of this Act or of the law of insolvency, all debts payable on a contingency, and all claims against the company, present or future, certain or contingent, ascertained or sounding only in damages, shall be admissible to proof against the company, a just estimate being made, so far as possible, of the value of such debts or claims as may be subject to any contingency, or may sound only in damages, or for some other reason may not bear a certain value.