Introduction
Recently, the eminent and esteemed adjudicatory bench of the Supreme Court, in the case of Sales Tax Officer v. Rainbow Papers Limited, delivered a momentous verdict that has overturned well-established principles and tenets it had previously upheld. Through this verdict, the Apex Court pronounced that statutory obligations owed by a corporate debtor to the government shall be deemed secured debts. Furthermore, it distressingly pronounced that if the Committee of creditors (COC) accepts a resolution plan, and subsequently, the government asserts its debts, seeking their inclusion in said plan at a considerably later stage, the Adjudicating Authority is duty-bound to reject the Resolution Plan. This judgment has once again ignited a contentious debate in the realm of Insolvency and Bankruptcy. This article undertakes a rigorous critical analysis of thisJ judgment and demonstrates how it violates the fundamental objectives and intents of the I&B Code (Code), established jurisprudence, various sections of the Code, and recommendations of the Law Reform Committee.
Factual Background
The respondent in this matter was Rainbow Papers Limited, a company incorporated under the Companies Act, 2013, conducting business within and beyond Gujarat. A sum of Rs. 53,71,65,489/- was outstanding from the respondent to the Sales Tax authorities (the appellant) as per Section 48 of the Gujarat Value Added Tax, 2003 (GVAT) Act, which explicitly accords priority to taxes owed to the government. Consequently, the appellant initiated recovery proceedings and subsequently attached the respondent’s property on 8th October 2018.
Neeraj Papers Private Limited, an operational creditor of the respondent, filed an application under Section 9 of the Code before the Adjudicating Authority, NCLT Ahmedabad, seeking to commence Corporate Insolvency Resolution Process (CIRP). On 12th September 2017, the NCLT admitted the application, leading to the commencement of CIRP against the respondent on 22nd September 2017. Following this, through public announcements, claims were solicited from affected creditors, and 5th October 2017 was established as the deadline for claim submissions. On 22nd October 2018, the appellant approached the Resolution Professional (RP) intending to include statutory debts owed by the corporate debtor in the CIRP. However, the appellant not only approached the RP after the stipulated claims deadline had elapsed but also did so considerably belatedly, i.e., after the approval of the resolution plan by the NCLT. Subsequently, the RP dismissed the appellant’s grievance.
Dissatisfied with the RP’s decision, the petitioner approached the Adjudicating Authority, NCLT Ahmedabad, seeking the inclusion of its debt in the CIRP, but the NCLT dismissed the application. The petitioner then appealed to the Appellate Authority, NCLAT, which also dismissed the appeal through its judgment and order. Finally, the petitioner approached the Supreme Court, seeking to set aside the judgments of both the NCLT as well as the NCLAT.
Timelines and Tangles: Court’s Interpretation of Code’s Directive Nature
The primary issue before the Apex Court pertained to the classification of “statutory debts,” encompassing tax obligations, custom dues, and other debts payable to the government, under Section 53 of the Code. The Court deliberated on whether statutory debts should be treated as operational debts or secured debts. Additionally, the Court addressed the question of whether the prescribed time limit in the Code is binding or discretionary.
The two-judge bench of the Supreme Court, while overturning the rulings of NCLT and NCLAT in this case, opined that statutory debts must be considered secured debts, and priority should be accorded to statutory debts over operational and financial debts under the waterfall mechanism outlined in Section 53 of the Code. Moreover, the Court stipulated that the Adjudicating Authority must unequivocally decline any resolution plan that waives statutory debts, even if such claims are submitted after the prescribed time limit has lapsed. Furthermore, the Court concluded that the timelines specified in the Code, even those governing the completion of proceedings, are directory and not mandatory in nature.
Departure from Precedent: Deciphering the True Nature of Statutory Debts
The entire judgment of the Apex Court rests on the flawed assumption that statutory debts are indistinguishable from secured debts. It is crucial to construe the sections of the Code harmoniously rather than in isolation. A comprehensive examination of Section 3(30) , Section 3(31), Section 3(33), Section 5(20), and Section 5(21) unequivocally demonstrates that statutory debts fall under the category of operational debts and not secured debts. The definition of security interest in Section 3(31) solely encompasses interests arising from transactions, as defined in Section 3(33), which denotes “an agreement or arrangement in writing for the transfer of assets, funds, goods, or services to or from the corporate debtor.” Thus, security interest solely pertains to agreements or arrangements mutually agreed upon by the parties, rendering the attachment of property by Tax authorities inapplicable under Section 3(33). Numerous precedents established by the Apex Court categorize statutory debts as operational debts rather than secured debts. For instance, in PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited, the Supreme Court categorically asserted that “income-tax dues, being in the nature of Crown debts, do not take precedence even over secured creditors, who are private persons.” Similarly, in Dena Bank v. Bhikhabhai Prabhudas Parekh & Co., the Supreme Court declared that “the common law doctrine of priority of crown debts would not extend to providing preference to crown debts over secured private debts.”
Additionally, as recently as 2021, a three-judge bench of the Supreme Court in Ghanshyam Mishra & Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Ltd. has firmly established that “a claim in respect of dues arising under any law for the time being in force and payable to the Central Government, any state, or any local authority would come within the ambit of ‘operational debt.‘” This verdict explicitly dictates that the Central Government, State Government, or any local authority to whom operational debt is owed would fall under the ambit of an ‘operational creditor’ as defined under subsection (20) of section (5) of the Code. It further elucidates those debts, including statutory dues, would be extinguished if they are not encompassed in the approved resolution plan.
All these previous pronouncements unmistakably demonstrate that the Supreme Court has deviated from its well-established and firmly settled judgments in the Rainbow Papers case by erroneously equating statutory debts with secured debts.
A Misstep in Judgment: Supreme Court’s Deviation from BLRC
In both its interim and final reports, the Bankruptcy Law Review Committee (BLRC) has advocated for prioritizing secured debts over statutory debts. The BLRC recognizes that secured debts and statutory debts are fundamentally distinct and contends that including statutory debts within secured debts would be impractical. The BLRC recommended “to keep the right of the Central and State Government in the distribution waterfall in liquidation at a priority below the unsecured financial creditors in addition to all kinds of secured creditors.” The Supreme Court, in the Rainbow Papers judgment, has disregarded all the conclusions of the BLRC and wrongly allowed the appellant’s claim by elevating statutory debts above operational and financial debts.
Section 53 of the Code delineates the hierarchy for the allocation of proceeds from the sale of liquidation assets in the event of liquidation proceedings against a corporate debtor. This Section expressly places secured debts and statutory debts on an unequal footing, granting second place to dues owed to secured creditors and fifth place to statutory dues. Since the Section itself allocates different subsections for statutory debts and secured debts, the Apex Court in the present case erroneously arrived at a conclusion equating the two.
The Code’s Jigsaw: Piecing Together the Puzzle of Statutory Debts
Clause f of para-3 of the Statement of Objects and Reasons (SOR) of the I&B Amendment Bill, 2019 stipulates “to amend Sub-Section (1) of Section 31 of the Code to clarify that the resolution plan approved by the Adjudicating Authority shall also be binding on the Central Government, any State Government, or any local authority to whom a debt in respect of payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed, including tax authorities.” The Apex Court, in the Ghanshyam Mishra case, held that the amended part of Section 31 would have a retrospective effect owing to its clarificatory and explanatory nature. However, in the Rainbow Papers judgment, the Supreme Court failed to consider the legislative intent and objective of the Code by elevating statutory debts to the same level as secured debts. Mandating the Adjudicating Authority to dismiss a plan if statutory dues are excluded contravenes Section 31 of the code as well as the Court’s prior rulings.
Conclusion
By treating statutory debts at par with secured debts, the Apex Court has inadvertently created impediments for workmen, employees, and operational creditors to secure their dues, which is in opposition to the objectives of Section 53 of the Code. Moreover, since this decision emanates from the Apex Court, its obiter dicta would be binding on lower courts, particularly specialized adjudicating bodies like NCLT and NCLAT, who would be compelled to abide by this erroneous judgment. The ruling has once again ignited a contentious debate.
Nevertheless, there exists a possibility of rectifying the defects in this judgment either through immediate review or when a larger bench of the Supreme Court, in the near future, rules in favor of distinguishing statutory debts from secured debts. Until then, the hardships faced by workmen, employees, and operational creditors during the initiation of CIRP proceedings against a corporate debtor are bound to persist.
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