LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link

By recognising the state government as a secured creditor, the Rainbow Papers judgment exposes the Insolvency and Bankruptcy Code to incongruous uncertainty

Promulgation of the Insolvency and Bankruptcy Code, 2016 (IBC) brought much cheer to the entire Indian credit ecosystem, lending long-evasive certainty to the insolvency regime and instilling credit discipline, each indispensable for attracting investment.

The legislature and judiciary also took agile steps to continually improve the insolvency process. Overall, the experiment and experience does hold promise. Even though some problems persist in the process, none are irreconcilable. Even the most ardent IBC critics cannot deny its efficacy compared to the earlier regime.

All stakeholders, including the Supreme Court, were aligned in their vision that judicial scrutiny in respect of the IBC should be limited to only procedural checks. Resolution terms would be left to the commercial wisdom of the creditors.

One of the IBC’s key features has also been primacy given to financial creditors and dues owed to them, in comparison to statutory dues and taxes, which is enshrined in the preamble to the IBC.

Soumitra Majumdar
Soumitra Majumdar
Partner
JSA in Mumbai
Email: soumitra.majumdar@jsalaw.com

However, this suffered a jolt with the recent Supreme Court judgment in State Tax Officer v Rainbow Papers Limited (Rainbow judgment).

Section 48 of the Gujarat Value Added Tax, 2003 (GVAT Act) provides for a first charge in favour of the state government on the property of any person or agent owing payment for unpaid tax, interest or penalty. The court observed that the state government therefore qualifies as a secured creditor to the corporate debtor.

The committee of creditors cannot secure their own dues at the cost of statutory dues owed to any governmental authority. Government dues have to be dealt with in the same manner as secured debt. It is the prerogative of the resolution professional to collate these liabilities, even in the absence of a claim submission by the relevant authorities.

The principles laid down by the Rainbow judgment expose the IBC to significant uncertainties, legal and procedural.

Requirements for creation, perfection, registration and enforcement of charge are dealt with under various statutes like the Transfer of Property Act 1882, Indian Contract Act, 1872, Registration Act, 1908 and Companies Act, 2013. Section 48 of the GVAT Act (or any other similar law) should not be read in denial of all these other statutory and contractual arrangements.

Registration and filing requirements in respect of security interest serve as public notices of the encumbrances to prospective creditors. Allowing government authorities to have first charge on all assets of a corporate debtor without complying with any of these requirements under other statutes is detrimental to the development of an orderly credit market.

Terms such as “security interest”, “secured creditor” and “transaction”, as defined in the IBC, point to the legislative intent of covering charges created in commercial arrangements between contracting parties.

Utkarsh Bandhu
Utkarsh Bandhu
Partner
JSA in Mumbai
Email: utkarsh.bandhu@jsalaw.com

The IBC specifically deals with governmental and statutory dues in section 53 as a separate and distinct class. Any amount due to central and state governments appears lower in priority – paired along with debts owed to a secured creditor for any amount remaining unpaid following the enforcement of security interest – in comparison to debts owed to secured creditors.

The wide sweep of the language used in section 53(1)(e)(i) needs to be given its due interpretation. Additionally, this priority as stipulated is also intended to override any law enacted by parliament or any state legislature. Thus, it is not unreasonable to infer that the IBC consciously downgraded the liability to pay unpaid taxes, whether secured or otherwise, in the liquidation waterfall, true to its preamble.

Therefore, in our view, the Rainbow judgment appears to be incongruent with the IBC. Introduction of section 26E to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) should alleviate this uncertainty, at least in future cases.

Notwithstanding any other law in force for the time being, following the Central Registry of Securitisation Asset Reconstruction and Security Interest of India registration of security interest, the SARFAESI Act prioritises debts due to any ‘secured creditor’ – as defined under SARFAESI Act, which certainly cannot include governmental authorities – over all other debts, revenues, taxes, cesses and rates payable to governments.

It therefore stands to reason that section 53 of the IBC, read together with the SARFAESI Act, should restore primacy to financial creditors while resolving corporate insolvencies.

JSA
Vakils House, 18 Sprott Road
Ballard Estate, Mumbai 400 001, India
Tel: +91 22 4341 8600

www.jsalaw.com

LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link