In the midst of the ever-evolving Indian insolvency regime and post the catastrophic pandemic, the Honorable Supreme Court ("SC") in the case of State Tax Officer (1) v. Rainbow Papers Limited Civil Appeal No. 2568 ("Rainbow Papers") has shed some light on the interpretation of "secured creditors" with respect to the statutory dues owed to any government or government authority. The SC observed that the committee of creditors ("CoC") cannot secure their own dues at the cost of statutory dues. Further, the SC held that Section 48 of the Gujrat Value Added Tax Act, 2003 ("GVAT Act") is not inconsistent or contrary to Section 53 of the Insolvency and Bankruptcy Code, 2016 ("the Code"). The authors in this article analyze the current status of government dues in light of the interpretation taken by SC in the Rainbow Papers judgement along with previous judicial pronouncements based on similar situations with the tax authorities.
RAINBOW PAPERS CASE: BRIEF
The moot issue to be decided by the SC was whether the National Company Law Appellate Tribunal ("NCLAT") is correct in holding that provisions of the Code (specifically Section 53) overrides Section 48 of the GVAT Act, that reads as follows:
"48. Tax to be first charge on property — Notwithstanding anything to the contrary contained in any law for the time being in force, any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person."
Honorable NCLAT held that the claim of the State Tax Officer qualifies as an operational debt under Section 5(21) of the Code and the said debt does not qualify under the definition of 'Secured Creditor' as per Section 3(30) read with Section 3(31) of the Code. Further, referring to the objectives read with Section 53 of the Code, Justice Mukhopadhaya observed that Section 48 of the GVAT Act does not override Section 53 of the Code and thus government authorities are not eligible to claim first charge with regards to the attached property of the corporate debtor.
Aggrieved by the order of the Hon'ble NCLAT, the appellant(s) filed an appeal under Section 62 of the Code1 before the bench comprising of Justice Indira Banerjee and Justice A.S. Bopanna. Setting aside the orders passed by the NCLAT, Justice Banerjee held that the NCLAT erred in observing that Section 53 of the Code overrides Section 48 of GVAT Act. The SC is of the opinion that:
"Section 48 of GVAT Act is not contrary to or inconsistent with Section 53 or any other provision of the Code. Under Section 53(1)(b)(ii), the debts owed to secured creditor, which would include the State under the GVAT Act, are to be ranked equally with other specified debts."
Therefore, the SC held that State shall fall under the ambit of secured creditor as per the GVAT Act and the definition of secured creditor under the Code does not exclude any Government or Governmental Authority.
LAW OF THE LAND:
Prior to the Rainbow Papers case, the legislature as well as numerous precedents, including those made by the SC, have held that secured creditors' debts have priority over crown debts, however, none of these decisions have ever compared tax debts to secured debts.
Starting with the Bankruptcy Law Reforms Committee ("BLRC"), in its interim2 as well as the final report,3 where it has elaborately discussed the prioritization of the crown debts. One of the BLRC's most important recommendations that is pertinent to our situation was
"there should be a separate declaratory provision that upholds the priority rights of secured creditors on their security interests notwithstanding anything to the contrary contained in any state or central law that imposes a tax or revenue payable to the Government by virtue of a specific statutory provision made as a first charge on the assets of the assessee; provided that such first charge may be allowed for claims that existed on the date when such security interest was created".
The BLRC explicitly envisioned secured creditors having priority over government obligations in its final report as well. It states: "The Committee has recommended to keep the right of the Central and State 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 (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"
Moving forward to the precedents, in PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited, the SC 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". Moreover, the Bombay High Court very recently in the matter of M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, dated July 28, 2021, held that, the secured debt shall take priority over the 'Government' dues/tax dues, the rationale being that the Income Tax Act makes no mention of the Income Tax Department's obligations having any precedence above secured debt. The petitioner's rights as a secured creditor could not be interfered with by the Revenue. The attachment order was invalid.
Moving forward to the precedents, in PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited,4 the SC 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".
Moreover, the Bombay High Court very recently in the matter of M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer,5 dated July 28, 2021, held that, the secured debt shall take priority over the 'Government' dues/tax dues, the rationale being that the Income Tax Act makes no mention of the Income Tax Department's obligations having any precedence above secured debt. The petitioner's rights as a secured creditor could not be interfered with by the Revenue. The attachment order was invalid.
The Madras High Court, in its ruling, noted that "from a plain and conjoint reading of Sections 31-B of the RDB Act and Section 25-E of the SARFAESI Act, it is obvious that by virtue of the non-obstante language included therein, the rights of secured creditors to realize secured debts by the sale of assets over which security interests are created, must have priority over Government dues, including revenues, taxes, cesses, and rates due to the Central/State Government or to the Local Authority."6
Further, the Bombay High Court, in the case of Jalgaon Janta Sahakari v. Joint Commissioner of Sales,7 question that arose was who legally had priority for the liquidation of their individual debts owed to the borrower/dealer upon enforcement of the "security interest"—a secured creditor or the taxing/revenue departments of the Central or State governments, the court found The court held that the dues of a secured creditor (subject, of course, to CERSAI registration) and subject to proceedings under the Insolvency & Bankruptcy Code would rank superior to the dues of the relevant department of the State Government.
It stated that under the RDDB Act and SARFAESI Act, tax obligations were subordinate to the obligations of secured creditors, and stated that the phrase "first charge" had no special meaning. Even a "first charge" can be declared inferior or submissive to a paramount duty by clear statutory intention.
Moreover, under the waterfall concept under Section 53, the Code's structure is pretty obvious. Workmen's compensation and secured creditors are given equal precedence, with government obligations coming in fifth. And it defies logic to claim that tax obligations will not be included in government fees. This can be established by the decision of the High Court of Telangana and Andhra Pradesh on a discussion upon the nature of security interest of Government dues, the court made it clear that the Government dues like income-tax dues are unsecured creditors and do not enjoy the status of a secured creditor. "The tax dues, being an input to the Consolidated Fund of India and of 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."8
With regards to the issue of whether the Code prevails over other laws, in Sundaresh Bhatt v. Central Board of Indirect Taxes and Customs9 the Court had held that the Code has an overriding effect on Customs Act (which too, creates statutory charge in favour of customs authorities).
Along with the ratio abovementioned, it has also been clarified by the SC that with respect to any statutory dues owed/claims raised in relation to the period prior to the 2019 Amendment, the resolution plan shall still be binding on the statutory creditors concerned, and the statutory dues owed to them, which were not included in the resolution plan, and such claims shall stand extinguished.10 Hence, it is clear from the above discussion that prior to the judgement of the SC, the tax obligations cannot be compared to the obligations of secured creditors.
The observations made in the cited cases simply suggest that the payment of statutory dues and obligations owed to the government and public agencies must be mandated in the resolution plan. A resolution plan must account for such debts and offer "dissipation of those obligations in a gradual way". These conclusions clearly go counter to the ruling in Ghanshyam Mishra case and undermine the "clean slate" doctrine, which has been the foundation of Indian insolvency regime.
Moreover, the distribution of the proceeds of the estate's liquidation among stakeholders is outlined in Section 53 in terms of priority order or waterfall distribution. The Code significantly altered the game's rules by favoring financial creditors over the government and statutory obligations. The non-obstante provision of Section 53(1) states that, notwithstanding anything to the contrary contained in any other law enacted by the parliament or any state legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the order of priority listed.
The Code is a central act and a general body of law that addresses the particular subject of insolvency and bankruptcy. Any other legislation that has a non-obstante provision that establishes a different priority for any sort of debt shall be deemed to be in conflict with the Code, and its provisions shall not apply.
The SC in the case in question determined that the State is a secured creditor under the GVAT Act and gave the Government's statutory obligations priority. By operation of law, a security interest could be created. The court ruled that a firm must be liquidated if it is unable to pay its debts, including statutory obligations to the government and/or other authorities, and there is no plan in place that calls for their disbursement.
As the debts owed to a secured creditor include the State under the GVAT Act, the statutory dues that would otherwise fall under clause (e) of Section 53(1) are now on the same level as other specified debts, including debts on account of workman's dues for a period of 24 months prior to the liquidation commencement date. If not reviewed, the ruling in the Rainbow Papers might have a subtle downside to the Indian insolvency regime. The same is anticipated to discourage potential bidders and affect the bid valuation in respective matters. Therefore, the same will result in substantial haircuts and impact the spirit of business efficacy.
1. Civil Appeal No. 1661 of 2020; Civil Appeal No. 2568 of 2020
2. Interim Report of The Bankruptcy Law Reform Committee (Page 96) https://ibbi.gov.in/uploads/resources/57420f272e1515f0c9c137f1a6423d78.pdf; Refer section 5(52)(B)(b).
3. The report of the Bankruptcy Law Reforms Committee Volume I: R a t i o n a l e a n d D e s i g n ( P a r a 5 . 5 . 8 a n d P a r a 6 . 5 . 9 ) https://ibbi.gov.in/uploads/resources/BLRCReportVol1_04112015.pdf
4. PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited 2000 (5) SCC 694.
5. M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, Income-Tax Department and Others [Writ Petition (L) No. 7964 OF 2021]
6. State Bank of India v. The State of Maharashtra and Ors. [WP No. 92816 of 2020].
7. Jalgaon Janta Sahakari v. Joint Commissioner of Sales Writ Petition No. 2935 of 2018.
8. Leo Edibles & Fats Limited v. Tax Recovery Officer, Writ Petition No. 8560 of 2018.
9. Sundaresh Bhatt v. Central Board of Indirect Taxes and Customs Civil Appeal No. 7667 of 2021.
10. Ghanashyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruc_on Co. Ltd., (2021) 9 SCC 657
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.