The significance of the insolvency code may be put into question if state governments do not observe the order of priority for creditors over a corporate debtor’s assets, write Arvind Varma and Amita Chohan

“The law must clearly lay out the priority of distributions in bankruptcy to all stakeholders. The priority must be designed so as to incentivize all stakeholders to participate in the cycle of building enterprises with confidence” – Report of the Bankruptcy Law Reforms Committee, November 2015, on Principles driving the design [of the Insolvency and Bankruptcy Code 2016].

State governments in India have more regularly than not directly demanded corporate entities to repay statutory dues such as value added tax (VAT) on the incorrect assumption that such debts take precedence over all other creditors in the insolvency process. This article explores the tensions that arise between the powers of the court in policing the implementation and proper interpretation of the Insolvency and Bankruptcy Code 2016 (code), the limits on the rights of the corporate debtor during the insolvency process, and the powers of the insolvency resolution professional (IRP) in these circumstances. We also place the spotlight on what lessons can be learned from the English legal position on insolvency and taxes.

Pressing claims

Arvind Varma

The code recognizes three types of creditors who are each accorded different types of rights and powers: operational creditors, financial creditors, and other creditors. An operational creditor is one to whom an operational debt is owed. Under section 5(21) of the code, an operational debt is confined to goods, services (including employment) and debts due to the central government, any state government or any local authority. With respect to the order in which the proceeds of sale of a corporate debtor’s assets are distributed under section 53 of the code, the central and state government rank fifth, low in the pecking order.

On 20 March 2019, the National Company Law Appellate Tribunal (NCLAT) clarified that the payment of statutory dues such as VAT fall within the scope of an operational debt, and that any government authority demanding repayment is to be treated as an operational creditor (Director General of Income Tax v Synergies Dooray Automotive Ltd and Ors).

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Arvind Varma is a senior advocate in the Supreme Court and Delhi High Court, and Amita Chohan is an English barrister based in the London office of Locke Lord, where she concentrates her practice in dispute resolution and insolvency.