A judgement of the Supreme Court (SC), dated 6 September 2022, in the case of Rainbow Papers Ltd, opens a new chapter with regard to consideration of the claims of the sovereign with regard to tax dues under the provisions of the Insolvency and Bankruptcy Code (IBC), 2016.
The Court reversed the decision of the National Company Law Appellate Tribunal (NCLAT) which held that the tax dues under the Gujarat value added tax (VAT) proceedings would not constitute a secured debt under the IBC law. Incidentally, NCLAT also held that the claims were not preferred within the due time and were not to be considered.
While the aspect with regard to admission of a belated claim is more a matter of procedure, the focus of this article is on the issue whether the tax dues are in the nature of a secured debt.
Section 5(21) of the Code defines an operational debt as
“operational debt” means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;
Section 3(30) defines a secured creditor as a creditor in whose favour a security interest is created.
Security interest is defined under clause 31 “as a right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person. Provided, that security shall not include a performance guarantee.”
The argument of the Gujarat tax authority was that, under the relevant VAT law, the dues were secured on the assets of the taxpayer and the said Section 58 of the VAT law should be read into the IBC and, hence, its claim as secured creditor was statutorily established.
The Court was persuaded to conclude that the provisions of the tax law treating the dues as secured debt should be upheld.
This may not be the last word on the matter as government dues, including tax dues, are defined to be an operational debt under clause 21 of Section 5 of IBC. The Code also defines a secured creditor as one in whose favour a security interest stands created. While there is no reason to read into the law that an operational debt may not be secured in all cases, yet the construct of IBC would lead one to believe that tax and other dues to the government were not intended to be given the status of a secured creditor.
The reasons are four-fold.
The first is that the nature of the items specified in operational debt where the government dues figure is indicative that these fall in the genus of unsecured debts.
The second is that the creation of a security interest under clause 31 of Section 3 is explicit about a bilateral contract to create such a security. It doesn’t take cognisance of a legal provision in another law creating such a security.
The third point is that Section 53 of IBC, which gives the waterfall mechanism in the event of liquidation, doesn’t place the statutory dues at the top of the pile. It is behind a few other cases. Thus, even the legislature, in its well-conceived plan, has chosen not to give the typical status that a sovereign debt commands.
The fourth aspect is that the fact that all tax statutes ipso facto provide for tax dues to be secured on the asset is well known to the legislature that enacted IBC. If the intent was to give the tax dues the status of a secured creditor, it would have been the easiest matter to so specify in the law.
The sway of the provisions of the concerned VAT law over the judges has been more than to a logical extent and the construct of IBC was largely ignored by the Court in coming to this conclusion.
Recently, the Court in ABG Shipyards Ltd interdicted the customs authority in their efforts to attach an asset on which duty was due. The case is not on all fours with the present dispute but the power of IBC in situations, where the Code has been triggered and resolution plans are made, was recognised and all other statutory rights, however created, were felt to be subordinate.
IBC, as a code, is an island and the jurisdiction of all other laws stand excluded in that island.
How did the Court come to this conclusion in Rainbow Papers case? In para 56 of the order, the court held “Under Section 53(1)(b)(ii), the debts owed to a secured creditor, which would include the State under the GVAT Act, are to rank equally with other specified debts including debts on account of workman’s dues for a period of 24 months preceding the liquidation commencement date.”
The crucial point is that the provisions of Section 53 do not apply to a secured creditor but only to that portion of a debt of a secured creditor who has chosen to be treated as unsecured by giving up the right over the security or in a case where the sale of the security is inadequate to meet the outstanding debt and the unmet portion becomes unsecured.
Certainly, the decision will come to be revisited in future cases and, until then, the resolution round table that so far had only bankers and debenture-holders and the like, who are typically businessmen, would have a bevy of tax collectors in their midst who may argue that no settlement can be made until taxes to the last pie are paid!
Quite likely, IBC, which has even now only enjoyed a very patchy success with very few resolutions where the financial creditors had just a haircut and not a full tonsure, may end up being completely stymied with no meaningful resolution happening.
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.