The Insolvency and Bankruptcy Code, 2016 (IBC) is a transformative piece of legislation which has completely overhauled the bankruptcy laws in India. The code is enacted with the objectives of resolution of corporate insolvency in a time bound manner, maximisation of the value of assets of Corporate Debtor and balancing the interests of all the stakeholders including Government authorities. IBC is still evolving through periodic reinterpretation of the law and being constantly amended to harmonize with other legislations and balance the interest of all the stakeholders. Numerous legal issues pertaining to legal rights of various stakeholders have been set at rest by the Hon’ble Supreme Court. Although having received wide-spread acclamations at resolving distressed assets, the code requires further fine tuning to rest the controversial issues experienced with growing practical experience. One of such controversial issues is the interplay between government dues and IBC which has increasingly been gaining traction and flashing questions that have a great bearing on the future of India’s insolvency regime. Recently, Hon’ble Supreme Court has shed some light on the interpretation of “secured creditors” with respect to the statutory dues owed to any government authority. The SC observed that the committee of creditors cannot secure their own dues at the cost of statutory dues. This judgment has once again ignited a contentious debate in the realm of Insolvency and Bankruptcy.
Statutory dues and their priority under the IBC, 2016
It is settled law that statutory dues owing to the Central and State Governments, as well as any municipal authorities, are operational debts and such creditors are terms as operational creditors. This is also clear from the definition contained u/s 5(21) of IBC which defines ‘operational debt’ as “a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority”.
Bankruptcy Law Reforms Committee in its final report dated 04.11.2015, extensively deliberated upon the order of propriety of payments to various stakeholders in the event of liquidation of a company. The committee recommended that government dues ought to rank lower then the workmen dues and secured debts. Committee has 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 for promoting the availability of credit and developing a market for unsecured financing.
In line with the above recommendation, Section 53 of IBC has created a waterfall mechanism for priority of dues. Whether it is distribution in liquidation process or resolution plan – both processes would need to honour the priorities under Section 53 of IBC. The order of priority under Section 53 ranks government dues at a lower priority as compared to secured creditors in line with the objectives of the IBC.
The term “secured creditor” essentially means a creditor in whose favour some sort of security interest is created. The entire object and purpose of creation of a security interest is to protect the creditor in case of default by the Borrower to the extent of at least the value of the “security interest”. Operational debts can also be ‘secured’ if a security interest is created on such debts. However, mere assessment of statutory dues by government authorities does not create a security interest automatically in the property of the debtor, unless mandated by operation of law.
Judicial Precedents and interpretation of law
Till September 2022 and before delivery of momentous verdict in the case of Sales Tax Officer v. Rainbow Papers Limited (in short “Rainbow Papers”), all Government dues were ipso facto treated under Section 53(1)(e)(i) of the IBC. There are countless decisions of Hon’ble Supreme Court and other judicial authorities which demonstrate that government dues such as Income tax, value added tax, and other statutory dues are operational debts and hence priority such government are much lower than the secured creditors as provided under Section 53 of the Code. For instance, in the case of PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited, Hon’ble Supreme Court held that the IBC will override anything which is in conflict with other statutes, as well as the Income Tax Act of 1961 and unequivocally ruled 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 the case of Dena Bank v. Bhikhabhai Prabhudas Parekh & Co., Hon’ble Supreme Court ruled that “the common law doctrine of priority of crown debts would not extend to providing preference to crown debts over secured private debts.”
Further, in the case of Moser Baer Karamchari Union thr. President Mahesh Chand Sharma v. Union of India & Ors, the Hon’ble Supreme Court had emphasized upon the priority payments under IBC and held that provisions of the IBC are carefully thought out. The same gives options to secured creditors, and balances their interests with those of other creditors in a liquidation proceeding. Similarly, a three-judge bench of the Hon’ble Supreme Court in the matter of 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’ as defined under Section 5(21) of the IBC. It further elucidates those debts, including statutory dues, would be extinguished if they are not encompassed in the approved resolution plan.
Additionally, in a very judgment of Division Bench of Hon’ble Supreme Court in the case of Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited, emphasized that the dues owed to creditors under the IBC hold a superior position as compared to the electricity dues payable under the Electricity Act.
However, in the Rainbow Papers (supra), Supreme Court has overturned the well-established principles it had previously upheld and has given the Government, a way of preventing their dues from being relegated towards the bottom of the waterfall mechanism. Each Government can now, by creating security interests in its favour in all its tax/economic statutes, contracts, instruments, etc. ensure that its dues are treated as secured debt, instead of as operational debt. The Apex Court seemed to have ignored the Judgement in the matter of Ghanshyam Mishra (supra) wherein a larger bench the Supreme Court had considered the issue of State tax in detail and held the same to be Operational Creditor. The Supreme Court has also clarified that a resolution plan that has been approved by the financial creditor by sidelining the statutory dues and demands that are payable to the State and Union Government or other statutory authorities, such a resolution plan was liable to be rejected.
While secured creditors such as banks and financial institutions were somehow getting used to delayed CIRP and liquidation processes, the above judgement of the Hon’ble Supreme Court came as a surprise and created ripples in already trouble eco-system under the Code, by holding that “the Committee of Creditors, which might include financial institutions and other financial creditors, cannot secure their own dues at the cost of statutory dues owed to any Government or Governmental Authority or for that matter” . This Ruling created chaos in the IBC regime as it prompted the State tax departments to file their claim afresh in the ongoing liquidation proceedings and get treated at par with the first priority secured creditors.
It had also raised worries amongst the financial creditors that tax authorities may claim a significant portion of the recovery, potentially compromising financial lenders’ interest. Therefore various review petitions were preferred by the financial creditors and State Tax officer to seek review of the Judgment dated 06.09.2022 passed by the Supreme Court. In the review petitions filed by the lenders, they contested that the impugned judgment disturbs the entire scheme of priority of dues for the distribution of assets. Grave public mischief will result from this since the statutory dues will have to be paid in priority to the dues of banks and financial institutions, which may in certain cases result in nil or negligible payment to the lenders.
During pendency of the review petitions, Supreme Court awarded a welcome relief to the banking industry through its judgement in the matter of Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited This verdict cleared the cloud created due to Rainbow Papers ruling (supra) on the position of secured debts, and Apex Court once again upheld the overriding effect of IBC. It has clarified the legal position under section 53 of the Code by observing that the decision of Rainbow Papers did not notice the ‘waterfall mechanism’. Further it was clarified that Rainbow Papers verdict was in the context of a resolution process and not during liquidation. The Apex Court has emphasized that amounts payable to secured creditors and workmen are kept at the second place, after the costs and expenses of the liquidator payable during the liquidation proceedings. However, the dues payable to the government are placed much below those of secured creditors and even unsecured and operational creditors. This design was either not brought to the notice of the court in Rainbow Papers case or was missed altogether. In any event, the judgment has not taken note of the provisions of the IBC which treat the dues payable to secured creditors at a higher footing than dues payable to the Government.
Re-affirmation of priority of government dues
The Supreme Court on 31.10.2023, has dismissed a bunch of five review petitions that sought a review of the apex court’s judgment in the Rainbow Papers case. While rejecting the review petitions through common order in Sanjay Kumar Agarwal v. State Tax Officer & Anr, Hon’ble Supreme Court observed that a well-considered judgment does not fall under the ambit of Review. That the Review Petitioners have failed to make out any mistake or error apparent on the face of record in the impugned judgment and have failed to bring the case within the parameters laid down by this Court in various decision for reviewing the impugned judgment. This dismissal means that the legal position specified by the apex court in the Rainbow Papers case will remain intact, and tax authorities keen to recover tax dues, will enjoy the same rights as secured creditors under the IBC waterfall mechanism.
Way Forward:
Though the Supreme Court has re-affirmed the decision of Rainbow Papers and confirmed the status of tax authorities as secured creditors, the ruling has stirred up another debate with respect to the commercial wisdom of the CoC. There have been several instances in the past wherein Hon’ble Supreme Court and NCLT has upheld the commercial wisdom of the CoC and disregarded the requirements of Section 30(2) of the IBC to approve resolution plans seeking waiver of past statutory dues of the corporate debtor. In the case of K. Sashidhar vs. Indian Overseas Bank and Ors., Hon’ble Supreme Court has accorded the paramount status to the commercial wisdom of COC. Further, in Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta & Ors., Supreme Court has held that NCLT and NCLAT can under no circumstance trespass upon the commercial decision of the majority of the CoC. NCLT and NCLAT have been endowed with limited jurisdiction of judicial review to the extent specified in Section 30(2) of the IBC and must not exercise plenary powers or act as a court of equity.
In view of the above, there have been various cases, wherein NCLT and NCLAT has approved the resolution plans waiving all outstanding statutory dues and other claims of the corporate debtor as on the date of approval of the resolution plan. Similarly, in the case of Taguda Pte. Limited vs. Subodh Kumar Agrawal, RP of Ushdev International Limited, NCLT has clarified that all the past liabilities arising out of any levies/tax dues to any government authorities, etc. which are not part of the Resolution Plan shall stand extinguished from the date of approval of the Resolution Plan.
However, in the Rainbow papers case, the Supreme Court held that if a resolution plan excludes statutory dues payable to the government or a government authority or a legal authority, altogether, the NCLT is bound to reject such a resolution plan. It means the commercial wisdom of CoC will no longer be paramount and the common practice of the resolution applicants, claiming waiver of the statutory dues will come to an end. Moreover, the priority given to secured and financial creditors, will vanish and the country’s insolvency regime will effectively return to the erstwhile setup of according Government dues priority, directly against the settled principles of insolvency.
Conclusion:
Dismissal of review petitions and re-affirming the verdict of Rainbow Papers case could have a significant impact on the Insolvency spectrum. Granting a higher priority to the government’s tax dues under the IBC may also affect the financial creditors’ incentives to take a corporate debtor to the IBC. This could make the IBC an inferior platform compared to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), where secured creditors have priority over statutory dues.
Therefore, some clarity must be brought through suitable amendment in the IBC to crystallize the legal position with respect to the treatment of statutory dues in the Corporate Insolvency Resolution Process. This would ensure uniformity in the decisions of the courts/ tribunals in India and will promote the doctrine of ‘clean slate’ to ensure that a successful resolution applicant is not burdened with any ‘undecided claims’ in the future.
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