Making states secured creditors weakens IBC

By Saroj Pandey and Rachit Munjal, SNG & Partners
0
100

The recent Supreme Court (SC) case of State Tax Officer (1) v Rainbow Papers Limited held that section 48 of the Gujarat Value Added Tax Act, 2003 (GVAT), a notwithstanding provision imposing a statutory first charge on a dealer’s property for outstanding taxes, interest, or penalties, is not contrary to or inconsistent with section 53 or any other provision of the Insolvency and Bankruptcy Code, 2016 (IBC). The IBC did not override the GVAT. It further held that the IBC does not override the GVAT.

The SC held a resolution plan (RP) does not comply with the IBC if it excludes statutory amounts due to the government or a government authority. The RP was not held binding on the state. The SC prioritised the government’s statutory obligations and held that the state was a secured creditor under the GVAT and that it had a security interest. A company must be liquidated if it is unable to pay its debts, including statutory obligations to the government or other authorities. The SC accepted the state’s arguments that the term secured creditor, as defined in section 3(30) of the IBC, is comprehensive and wide enough to include all security interests. The state’s claim constituted a security interest as defined in section 3(31) of the IBC, creating a statutory charge in accordance with the GVAT. The SC further held that no government or governmental entity is excluded from the IBC’s definition of a secured creditor.

Saroj Pandey
Partner
SNG & Partners

Sub-sections 3(30), (31) and (33), read together, indicates that a security interest is required to be a secured creditor. Security interest means the right, title or interest or claim to property created by a transaction, including an agreement in writing. This definition clearly implies that a security interest is an agreed arrangement or transaction between the parties. The concept should not be extended to include forced and non-consensual acts such as the attachment of property by tax authorities.

Under the waterfall mechanism in section 53 of the IBC, proceeds from the sale of assets in the liquidation of the corporate debtor shall be distributed in order of priority. Dues to workmen and secured creditors have a higher priority than the government dues. It is unclear why dues to the government were specially ranked if lawmakers intended to make tax authorities equal to secured creditors. It also defies sense to argue that tax obligations are not included in amounts due to the government.

Rachit Munjal
Associate
SNG & Partners

Section 238 of the IBC, a notwithstanding provision, provides that the IBC overrides any other conflicting law. This has been upheld in cases such as Innovative Industries Limited v ICICI Bank Limited and Leo Edibles & Fats Limited v The Income Tax Department. The notwithstanding provision of a parliamentary statute takes precedence over that of a state law. Even in the absence of such a conflict, the IBC takes precedence over the GVAT under the doctrine of repugnancy.

The SC has decided on such issues before, always upholding the precedence of secured creditors over tax authorities. It held that income tax, being government debt, did not take precedence over secured creditors. In an August 2022 judgement, Sundaresh Bhatt, Liquidator of ABG Shipyard v Central Board of Indirect Taxes, the SC held that the IBC prevails over the Customs Act, 1962. It is to be noted that Customs Act creates a statutory charge for the customs authority. The judgement in Rainbow Papers conflicts with SC precedents, the drafting of the IBC, its legislative intent and the Bankruptcy Law Reform Committee.

The SC held the RP invalid and thus not binding on the state. The National Company Law Tribunal must reject the RP if it disregards statutory demands by any state government or legal authority. It makes no sense to declare an RP unlawful because it does not call for the payment of tax obligations, and to state that outstanding tax must be settled under the RP without taking into account section 53 and liquidation values.

Giving tax authorities the status of secured creditors weakens the IBC’s priority ranking and waterfall mechanism and undermines its core principles. Giving tax officials, workers, and secured creditors the same priority will cause conflict over the payment of dues for liquidation. An increase in claims for government debt is anticipated, impacting credit delivery. Sales tax departments may make claims in practically all corporate insolvency resolution processes where they did not receive proportionate amounts.

Saroj Pandey is a partner and Rachit Munjal is an associate at SNG & Partners

SNG & Partners
One Bazaar Lane, Bengali Market
New Delhi – 110001
India

www.sngpartners.in

Contact details
Tel: +91 11 4358 2000
Email: info@sngpartners.in