Explore recent Supreme Court rulings on Section 53 of the Insolvency Bankruptcy Code (IBC) and its implications for the hierarchy of creditor claims. Gain insights into the evolving legal landscape, the clash of judicial perspectives, and the potential need for legislative amendments.
In the recent ruling of Sanjay Kumar Agarwal vs. State Tax Office (‘Sanjay’), the Supreme Court (‘Court’) has upheld the previous judgment of State Tax Officer (1) vs. Rainbow Papers Limited (‘Rainbow’). The Court held in lieu of the previous ruling that as per Section 53 of the Insolvency Bankruptcy Code, 2016 (‘IBC’), the state government of Gujarat would be considered as a secured creditor and exclusion of dues payable to the government in the resolution process means non-conformity with the provisions of the IBC. This judgement has clarified the final position pertaining to this issue distinguishing from another judgment of the coordinate bench in Paschim Anchal Vidyut Vitran Nigam Limited vs. Raman Ispat Private Limited and Others (‘Paschim’) which has mentioned that government dues would have had the least priority under the waterfall mechanism (prioritising the distribution of assets) as per Section 53 of the IBC. This article critically analyses recent judicial rulings, particularly those by the Supreme Court, on the interpretation of Section 53 of the IBC, focusing on the implications for the priority of government dues in the insolvency resolution process.
Section 53 of IBC
Section 53 of IBC deals with the hierarchy of the stakeholders and chronologically concerning the order of repayment. As per the general rule, secured creditors would be given priority over government and other statutory obligations. This process which is termed as “waterfall mechanism” emphasizes on distribution of assets of the company on account of the liquidation. As per this mechanism, payment priority is to be given to the cost incurred for insolvency and insolvency resolution process. Following this, the second priority is to be given to payment of workmen’s due and debts owed to unsecured creditors. This mechanism gives the least priority to the government dues and operational creditors. The priorities specified in Section 53 of the IBC are consistent with worldwide norms and reflect the goals indicated in the 2015 Bankruptcy Law Reforms Committee Report. This analysis emphasises that secured creditors routinely rank first in the distribution of proceeds from the sale of a debtor’s assets across the world. Placing government dues below unsecured creditors’ financial claims is a deliberate approach to increase credit availability, establish a market for unsecured financing, cut capital costs, promote entrepreneurship and permit rapid economic expansion. Furthermore, the 2020 Report of the Insolvency Law Committee emphasises that the IBC’s waterfall mechanism is intended to enable a collaborative liquidation procedure.
The Court’s stance in several decisions established a consistent view on the hierarchy of creditors’ claims, notably in the context of bankruptcy procedures. For instance, in the case of PR Commissioner of Income Tax vs. Monnet Ispat and Energy Limited (Supreme Court) [Petition(s) for Special Leave to Appeal (C) No(s). 6483/2018] it stated that income tax dues, which are classified as crown debt, cannot supersede the rights of secured creditors. who hold a private status. This demonstrates the Court’s acknowledgement of the necessity of defending the rights of private people with secured interests even in the face of government claims. Similarly, the decision in Moser Baer Karamchari Union thr. President Mahesh Chand Sharma vs. Union of India & Ors demonstrates the care taken with the IBC. The Court emphasised the well-thought-out nature of the IBC regulations, emphasising the careful balance created between secured creditors and other stakeholders’ interests in a liquidation process. In a parallel vein, the case of Sundaresh Bhatt, Liquidator of ABG Shipyard vs. Central Board of Indirect Taxes and Customs recognised the IBC’s authority over Customs Act proceedings. The Court stated that authorities cannot pursue the enforcement of taxes and levies under the Customs Act during the moratorium period.
The Court’s Rainbow decision upended the long-standing position on secured debts in bankruptcy proceedings. Unlike prior rulings, the Court emphasised the Gujarat Value Added Tax Act’s non-obstante language, claiming that security interest’ under the IBC might be formed by operation of law, accorded government bodies the status of secured creditors. This ruling created havoc in the IBC system, leading state tax agencies to refile their claims in existing liquidation processes in order to receive equal status as first-priority secured creditors. However, this decision which subsequently uphold in Sanjay’s case got criticised owing to going against the objectives of IBC.
Overview of Judicial Decisions
Section 3(30) of the IBC specifically defines secured creditors as those against whom a security interest is created, without explicit mention of government or government authorities. However, the Rainbow case introduced a noteworthy interpretation, asserting that the security interest in favour of the government of Gujarat qualifies the state as a secured creditor under Section 53 of the IBC’s waterfall mechanism. The Court’s stance implied that, for alignment with the IBC provisions, all resolution plans must treat statutory dues of government authorities as secured creditors. This expanded the scope for government authorities to claim priority alongside financial creditors and workmen due, potentially impacting previously approved recovery plans by the National Company Law Tribunal.
In contrast, the Paschim case took a divergent view, emphasizing that statutory debts owed to the government should be kept lower in priority within the waterfall mechanism. The Court criticized the Rainbow case for not acknowledging this priority system, raising concerns about the consistency of judgments with the IBC provisions. Section 53 establishes a clear differentiation in the treatment of payments owed to secured creditors and those owed to the government. This distinction in the law prominently reflects Parliament’s intention to handle government dues separately from the dues of secured creditors. Consequently, both secured and unsecured government dues fall under the purview of Section 53 of the Code, forming a distinct and separate class within the legislative framework. This viewpoint of the Court underscored the importance of principles like equality and fairness in the insolvency resolution process.
The Court’s dismissal of the review petition in Sanjay’s case reinforced its commitment to the earlier order. The dismissal of the review petition was grounded in two main principles. Firstly, the Court emphasized the established criteria for reviewing a judicial verdict, as outlined in Order XLVII Rule 1 of the Code of Civil Procedure. This rule requires the applicant to demonstrate that there is a clear and evident error on the face of the record, setting a high standard for the reconsideration of judgments. Secondly, it dismissed the notion that the Court had not considered the priority order in its initial judgement. It clarified that passing references by a bench of equal strength did not warrant a review petition. The Court asserted that a comprehensive review of the judgment in question revealed its consideration not only of the waterfall mechanism but also of additional IBC provisions in determining the order of priority for distributing proceeds from the sale of liquidation assets. The Court argued that if there were concerns about the legality of a bench’s decision, the appropriate course would be to refer it to a larger bench for a comprehensive and well-considered approach, as opposed to seeking a review. This emphasized the need for a careful and deliberate overview for legal interpretation, particularly in matters impacting the insolvency resolution framework.
Concluding Remarks
The recent decisions by the Court have introduced a significant shift from the previously settled position, creating a wave of uncertainty among creditors. The interpretation that allows government dues to take precedence over creditor claims appears to challenge the very essence of the waterfall mechanism carefully crafted by lawmakers. This development raises concerns about the judiciary’s alignment with legislative intent and the potential distortion of the insolvency resolution framework. In light of the evolving legal landscape, urgent attention is warranted to address the issue of government dues being accorded priority over creditor claims. The judgments seem to deviate from the core objectives of the IBC and its meticulously designed waterfall mechanism. It becomes imperative for lawmakers to intervene and consider amendments to the IBC that restore the original intent behind the inclusion of specific provisions.
To mitigate the uncertainty and potential adverse consequences for creditors, a comprehensive review of the relevant sections within the IBC is essential. Lawmakers should actively engage in a dialogue with legal experts, stakeholders and industry representatives to understand the practical implications of recent judicial interpretations. This collaborative approach can pave the way for targeted amendments that align with the overarching objectives of the IBC and ensure a fair and balanced distribution of assets during insolvency proceedings. In conclusion, the evolving legal landscape and recent Court decisions underscore the need for a recalibration of the IBC to reaffirm the principles of fairness, equity and the original legislative intent. A proactive and consultative approach by lawmakers can contribute to the clarity and predictability of the insolvency resolution process, fostering a more conducive environment for creditors and stakeholders alike.
This article is written by Mr Aayush Akar & Mr Aditya Gautam, students of NLU Odisha.
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