Shubham Sharma
The author is a student at Chanakya National Law University
Introduction
Recently, the Supreme Court of India, in State Tax Officer vs Rainbow Papers Limited ("Rainbow Papers"), ruled that debts owed to a secured creditor, which includes the state under the GVAT Act, are to be ranked equally with other specified debts, including debts on account of workmen’s dues, for a period of 24 months preceding the liquidation’s commencement date. The court went on to hold that the IBC cannot overrule GVAT, and thus, any resolution plan that does not prescribe for payment of the statutory dues owed to any state or tax authority is liable to be rejected by the adjudicating authority. It goes without saying that such an interpretation taken by the Apex Court is likely to hurt the various stakeholders in the insolvency regime, particularly banks and financial institutions, who are now placed in an uncomfortable position as the government authorities will now have an equal charge on the property of the debtor in case of default.
The author in the present article argues that the said ruling of the Apex Court is a significant departure from the well-established judicial jurisprudence on the issue of conflicting payment of tax dues and secured dues, the objectives of the code, and the intent of the legislature, and the author offers his views as to why this judgment demands an immediate review.
GOVERNMENT DEPARTMENT IS NOT A SECURED CREDITOR
The court in Rainbow Papers unhesitatingly accepted the view that a charge created in favour of tax authorities by virtue of Section 48 of the GVAT Act would mean the same as ‘security interest’ as defined in Section 3(31) of the IBC. Thus, any government or governmental authority would fall squarely under the definition of ‘secured creditor’ as defined in Section 3(30) of the IBC. However, it is the author’s view that such an interpretation of the terms ‘security interest’ and "secured creditor" is erroneous and inconsistent with the Code.
Under the code, a secured creditor is "a creditor in favour of whom security interest is created," and security interest means "right, title, or interest or a claim in a property, created in favour of, or provided for, a secured creditor by a transaction which secures payment or performance of an obligation, and includes mortgage, charge, hypothecation, assignment, encumbrance, or any other agreement or arrangement securing payment or performance of any obligation of any person." Further, under Section 3(33), "transaction" includes an agreement or arrangement in writing for the transfer of assets, funds, goods, or services, from or to the corporate debtor. A concordant reading of the above definitions clearly implies that for a creditor to qualify as ‘secured creditor," a consensual agreement or arrangement must be reached by the parties to provide for "security interest" in favour of the creditor. It is clear that it was the legislature’s intent to keep statutory charges created in favour of tax authorities by tax laws outside the ambit of "security interest" under the code. Nevertheless, it is a settled position of law that dues payable to the Central Government, any State Government, or any local authority would be classified as "operational debt" under Section 52(1) of the IBC and not "secured debt." Thus, there is no doubt that tax or revenue authorities cannot qualify as secured creditors under the IBC.
SECURED CREDITOR DUES TAKE PRECEDENCE OVER TAX DUES
In any economy, banks and financial institutions play a key role in ensuring that businesses have easy and cheap access to capital, which is crucial to spur economic growth. The Bankruptcy Law Reforms Committee (BLRC) Report, which served as the basis for the code, was of a similar view and justified its stance of prioritising secured creditors over crown debts. It was recommended that there should be an explicit provision in the Code that would prioritise the rights of the secured creditors based on their security interests, irrespective of any state or central law that creates a first charge on the assets of the assessee in favour of the government due to non-payment of statutory dues. In its final report, it stated that[4] "the committee has recommended to keep the rights of the central and state governments in the distribution waterfall in liquidation at a lower priority than 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 (including the development of bond markets)." In the long run, this would increase the availability of finance, reduce the cost of capital, promote entrepreneurship, and lead to faster economic growth. Accordingly, the draughtsmen of the IBC consciously placed government dues in the fifth position in the priority order as compared to the second position of secured creditors under the waterfall mechanism for payment under Section 53 of the Code to give priority status to secured creditors' debt over crown debts.
Coming to judicial precedents, there have been several instances in the past where the courts, faced with a similar conflict, have upheld the paramountcy of secured creditors over tax and statutory dues. In PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited, the SC unambiguously held 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 SC had observed that "the common law doctrine of priority of crown debts would not extend to providing preference to crown debts over secured private debts." In fact, in the very recent case of Sundaresh Bhatt v. Central Board of Indirect Taxes and Customs, the SC held that the IBC will have an overriding effect on the Customs Act, which too creates a statutory charge in favour of the Customs authorities. It’s shocking that none of these rulings were considered in the Rainbow Paper Judgment. In Bombay Stock Exchange v. V.S. Kandalganonkar & Ors, the SC held that Bombay Stock Exchange, being a secured creditor, would have priority over government dues as the Income Tax Act does not provide for precedence of income tax claims over the dues of secured creditors. A similar view was taken by the Bombay HC in M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer. It should be noted that the GVAT Act, too, doesn’t contemplate any such provision; however, the SC ignored this aspect in the Rainbow Papers judgment.
Further, the High Court of Telangana and Andhra Pradesh in Leo Edibles and Fats Limited v. the Tax Recovery Officer, observed that "the tax dues, being an input to the Consolidated Fund of India and the States, clearly come within the ambit of Section 53(1)(e) of the Code. If the Legislature, in its wisdom, assigned the fifth position in the order of priority to such dues, it is not for this Court to delve into or belittle the rationale underlying the same." Furthermore, in Jalgaon Janta Sahakari v. Joint Commissioner of Sales, the Bombay High Court held that the mere use of the words "first charge" in the RBD and SARFAESI Act would not automatically accord paramountcy to tax dues and could be made subservient to secured debts. Thus, the Rainbow Papers judgement defeats the intent of the legislature and also actively ignores its own precedents while placing crown debts on the same pedestal as secured debts.
OVERRIDING NATURE OF IBC AND MANDATORY NATURE OF TIMELINE UNDER IBC
Section 238 of the act provides for the overriding effect of the IBC over other legislation, which was first emphasised in Innoventive Industries Ltd. v. ICICI Bank, where it was held that a later non-obstante clause of a parliamentary enactment supersedes a non-obstante clause of a state enactment. Similarly, in Sundaresh Bhatt vs. the Central Board of Indirect Taxes and Customs, the court held that the IBC has precedence over the Customs Act. Further, even under the doctrine of repugnancy, it is ostensible that the IBC should take precedence over the GVAT or any other such state legislation.
Another concerning aspect of Rainbow Papers is that the apex court held that timelines under IBC are directory in nature and should be construed liberally, which is in stark contrast to the view taken by the court in its earlier precedents. In Ghanashyam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited, the apex court held that once a resolution plan is approved by the NCLT, all such claims, including those of the central or state government that did not form a part of the approved resolution plan, would stand extinguished, and no proceedings could be initiated or continued for such claims. Again, in Sundaresh Bhatt vs. Central Board of Indirect Taxes and Customs, the court stressed on strict compliance with timelines and procedures prescribed under the IBC while submitting one’s claims before the adjudicating authority. In its landmark decision, the SC in Ebix Singapore Private Ltd. v. Committee of Creditors of Educomp Solutions Ltd. held that once a resolution plan is approved by the CoC, it cannot be approved or modified at a later stage and will be binding on all the stakeholders. Similarly, in Taguda Pte. Limited vs. Subodh Kumar Agrawal, RP of Ushdev International Limited, NCLT Mumbai, while waiving off the GST and income tax liabilities of the corporate debtor that accrued after initiation of CIRP, held that "all past liabilities arising out of any levies/tax dues to any government authorities, etc., which accrued during the CIRP period and are not part of the Resolution Plan, shall stand extinguished from the date of approval of Resolution Plan."The court also emphasised that the authorities should file their claim before the approval of the resolution plan so that the resolution applicant is not burdened with the liabilities that had arisen before the approval of the resolution plan. It is nothing short of misconceived that the apex court overlooked these precedents and principles while arriving at its conclusions in the Rainbow Paper judgement.
WAY FORWARD
From the above analysis, it is clear that the verdict in Rainbow Papers will certainly have far reaching consequences and will particularly raise apprehension in the lending sector as tax and revenue authorities will now have more teeth in the resolution plan. Such an interpretation of the code is likely to deter potential bidders from participating in the resolution process owing to the additional risks and uncertainty associated with repaying statutory dues to the government, resulting in fewer bidders and lower valuations. This will ultimately lead to a substantial haircut for creditors, particularly banks. Though the conclusions of the court in this judgement should not be interpreted out of context, it will have a direct impact on other tax statutes that provide for "first charge" over the assets of the taxpayer. For instance, in Re, Recorders and Medicare Systems Pvt. Ltd., the Chandigarh Bench of the NCLT, relying on the Rainbow Papers judgment, held that the income tax department is a "secured creditor," having a first charge over the assets of a corporate debtor as per the IBC. Similarly, the Rainbow Papers judgement will have a deleterious impact on several other resolution plans that excluded the payment of statutory dues thereby causing delay and unwanted litigation in the resolution process. Thus, there is a need for an immediate review of the Rainbow Paper judgment, or until then, the legislature should intervene by bringing in suitable amendments to the Code to safeguard the rights of financial creditors and provide some clarity with respect to the treatment of statutory dues under the IBC.
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