In most pre-funded private companies in India, especially startups and early-stage ventures, the shareholders are often the same individuals who serve as Directors. These founder-directors not only manage strategic decisions but also work full-time in various operational roles \u2014 from product development to finance and business growth.<\/span><\/span><\/p>\n<\/div>\n To formalise this working relationship, they typically draw a salary under an Employment Agreement, making them both Directors and Employees\u00a0of the company.<\/span><\/span><\/p>\n<\/div>\n But what happens when such a company unfortunately faces liquidation\u00a0\u2014 whether voluntary\u00a0or involuntary? <\/span><\/span><\/p>\n<\/div>\n Under the Insolvency and Bankruptcy Code, 2016 (IBC), Section 53\u00a0provides a clear waterfall mechanism\u00a0that determines the order in which the proceeds from the sale of company assets are distributed.<\/span><\/span><\/p>\n<\/div>\n Let\u2019s explore where such <\/span>director-employees<\/span><\/u>\u00a0fall in this hierarchy.<\/span><\/span><\/p>\n<\/div>\n When a company goes into liquidation, the liquidator distributes the proceeds from asset realisation in a fixed order of priority known as the waterfall mechanism:<\/span><\/span><\/p>\n<\/div>\n Insolvency resolution process and liquidation costs (includes fees of insolvency professionals, legal costs, and other administrative expenses)<\/span><\/span><\/p>\n<\/li>\n Workmen\u2019s dues\u00a0for the 24 months preceding the liquidation commencement date and\u00a0debts owed to secured creditors\u00a0who have relinquished their security interest.<\/span><\/span><\/p>\n<\/li>\n Wages and unpaid dues owed to employees (other than workmen)\u00a0for the 12 months preceding the liquidation commencement date.<\/span><\/span><\/p>\n<\/li>\n Financial debts owed to unsecured creditors<\/span><\/span><\/p>\n<\/li>\n Amounts due to the Central and State Governments\u00a0(for the 2 years preceding liquidation) and\u00a0remaining secured creditors (if any)<\/span><\/span><\/p>\n<\/li>\n Remaining debts and dues<\/span><\/span><\/p>\n<\/li>\n Preference shareholder<\/span><\/span><\/p>\n<\/li>\n Equity shareholders or partners<\/span><\/span><\/p>\n<\/li>\n<\/ol>\n<\/div>\n The key question here is: <\/span>If a Director\u00a0is also an Employee\u00a0\u2014 with a valid employment contract and monthly salary \u2014 where do their dues fit in the waterfall under Section 53?<\/span><\/strong><\/span><\/p>\n<\/div>\n The answer depends on the nature of their role and remuneration:<\/span><\/span><\/p>\n<\/div>\n If the director holds a full-time executive position\u00a0and has an employment agreement\u00a0defining their salary, benefits, and working conditions, their unpaid salary for the 12 months preceding liquidation\u00a0will fall under:<\/span><\/span><\/p>\n<\/div>\n <\/p>\n Section 53(1)(c)<\/span><\/strong>\u00a0\u2014 \u201cWages and unpaid dues owed to employees other than workmen.\u201d<\/span><\/span><\/p>\n <\/span><\/p><\/blockquote>\n<\/div>\n<\/div>\n They are treated at par with other employees\u00a0(except workmen, who have slightly higher priority).<\/span><\/span><\/p>\n<\/li>\n Their salary dues are paid before unsecured creditors and government dues.<\/span><\/span><\/p>\n<\/li>\n<\/ul>\n<\/div>\n However, only the <\/span>last 12 months of unpaid salary<\/span><\/strong>\u00a0are covered under this category. Any dues beyond that period may fall lower in the order of payment.<\/span><\/span><\/p>\n<\/div>\n It\u2019s important to understand why\u00a0an MD\u00a0or WTD\u00a0is categorised under <\/span>employees other than workmen<\/span><\/em>\u00a0and not under <\/span>workmen\u2019s dues<\/span><\/em>.<\/span><\/span><\/p>\n<\/div>\n The term <\/span>\u201cworkman\u201d<\/span><\/strong>\u00a0is defined under Section 2(s) of the Industrial Disputes Act, 1947, which includes persons employed to do manual, unskilled, skilled, technical, operational, clerical, or supervisory work, but explicitly excludes individuals employed in managerial or administrative capacities<\/span>.<\/span><\/strong><\/span><\/p>\n<\/div>\n Since Managing Directors and Whole-Time Directors\u00a0perform managerial and decision-making functions, they do not fall within the definition of \u2018workman\u2019. <\/span><\/span><\/p>\n<\/div>\n Therefore, their dues are not covered by Section 53(1)(b)\u00a0(which gives priority to <\/span>workmen\u2019s dues for 24 months<\/span><\/em>), but instead fall under Section 53(1)(c)\u00a0(which covers <\/span>employees other than workmen<\/span><\/em>\u00a0and limits dues to <\/span>12 months<\/span><\/em>\u00a0preceding liquidation).<\/span><\/span><\/p>\n<\/div>\n This distinction adds legal precision\u00a0to the classification and directly explains why WTDs and MDs\u00a0enjoy only 12 months\u2019 protection, not 24 months\u00a0like <\/span>workmen<\/span><\/em>.<\/span><\/span><\/p>\n<\/div>\nThe Waterfall Mechanism under Section 53 of the IBC<\/span><\/strong><\/span><\/h3>\n<\/p>\n
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Where Do Directors Who Are Also Employees Fall?<\/span><\/strong><\/span><\/h3>\n<\/p>\n
1. Director as a Bona Fide Employee (Executive Director\/Managing Director)<\/span><\/strong><\/span><\/h4>\n<\/p>\n
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Why Managing Directors and Whole-Time Directors Fall Under Section 53(1)(c) \u2014 Not 53(1)(b)<\/span><\/strong><\/span><\/h3>\n<\/p>\n
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