The clouds of Rainbow Papers roll away

The Supreme Court’s judgment in State Tax Officer v Rainbow Papers Limited was widely criticised for disregarding the waterfall mechanism of the Insolvency and Bankruptcy Code, 2016 (IBC). This prioritises the claims of workmen, secured creditors, employees and unsecured financial creditors over government dues. The ruling was a setback to the new IBC framework, which had lowered the priority of government debt in favour of the revival of stressed businesses. The Supreme Court in Paschimanchal Vidyut Vitran Nigam Limited v Raman Ispat Private Limited has now addressed the issues arising from Rainbow Papers.

Under the Uttar Pradesh Electricity Supply Code, 2005 (supply code), read with the electricity supply agreement between Paschimanchal (PVVNL) and Raman, PVVNL had a first charge over Raman’s assets in the event of outstanding electricity supply debts. On PVVNL’s application in 2016, the revenue officer attached Raman’s immovable property to satisfy debts. The liquidator of Raman successfully applied to the National Company Law Tribunal (NCLT) to vacate PVVNL’s attachment over the property and to include it in Raman’s liquidation estate for the benefit of all creditors. The decision was upheld by the National Company Law Appellate Tribunal (NCLAT). PVVNL appealed to the Supreme Court.

In the appeal, the court found that the NCLT and the NCLAT had recognised that PVVNL was a secured operational creditor by operation of law. This position had also been admitted by the liquidator. Therefore, PVVNL was confirmed as a secured creditor.

It is now settled that the IBC is a complete code and prevails over other statutes by virtue of the notwithstanding provision of section 238. The court, therefore, confirmed that the IBC overrides the Electricity Act, 2003. It further held that the attached property had been correctly included in the liquidation estate. However, the court rejected the liquidator’s bid to classify PVVNL’s claims as government dues and reduce their priority in the waterfall mechanism, which sets out the priority for the distribution of proceeds from the sale of liquidation assets. The court accepted that government dues had a low priority by design to maximise value and bring the liquidation regime in India in line with best global practices.

Although government dues are not defined, section 53(1)(e) of the IBC identifies amounts received to the account of the Consolidated Fund of India and the Consolidated Fund of the States, as amounts due to the central and state governments. The court held that major public utilities and statutory corporations established under statute are not, in the ordinary sense, the central government or state governments. These entities may be operational, financial or secured creditors depending on the nature of their transactions with the corporate debtor. Conversely, amounts accruing to the Treasury within the ambit of article 265 of the constitution such as taxes and tariffs are government dues.

PVVNL’s functions as an electricity distribution company could also be discharged by a private entity holding a licence. Therefore, amounts due to PVVNL were not government dues despite the state government’s shareholding in PVVNL but rather secured operational debt.

The court distinguished the amounts owed to PVVNL and the amounts due under the Gujarat Value Added Tax Act, 2003, in the Rainbow Papers case. The latter were by their nature government dues despite being secured by a statutory charge. The cardinal principles of statutory interpretation dictate that two expressions used in a statute, here “secured debts” and “government dues”, cannot be construed as meaning the same. These debts are assigned different priorities in the waterfall mechanism and should be treated differently.

Amounts due to the tax department, being government dues, have a lower priority under the waterfall mechanism. The court held that the judgment in Rainbow Papers related to a different circumstance, that is the resolution process. As the waterfall mechanism under section 53 of the code was not taken into account, the decision would be confined to the facts of that case alone.

This case settles the controversy and confirms that government dues are not to be given priority over other financial and operational debts. This will achieve the objective of the IBC of maximising value for all stakeholders.

Karthik Somasundram is a partner and Ayush Sachan is an associate at Bharucha & Partners.