[The Viewpoint] Are Government Dues prioritised over Banks? A New Horizon To IBC

The Apex Court in its recent judgment in State Tax Officer vs Rainbow Papers Limited (“Rainbow Papers”) has held that the claim of the tax department of the state, squarely falls within the definition of "security interest" and becomes a “secured creditor” under the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”).

The state tax department preferred an appeal against the order of national company law appellate tribunal ("NCLAT") and national company law tribunal ("NCLT"), wherein the claim of state tax department was rejected on the ground of filing its claim on a belated stage and the status of the claim filed by 'state tax officer' was considered as an 'operational creditor' and 'unsecured creditor'.

In 2016, recovery proceedings were initiated against the corporate debtor, Rainbow Papers in respect of its dues and the Gujarat state tax officer attached the property of the corporate debtor. The state tax department had filed a claim towards its dues under the Gujarat Value Added Tax Act, 2003 ("GVAT Act"). However, the claim of state tax department had been waived off under the resolution plan.

When the state tax officer challenged the resolution plan of Rainbow Papers, contending that the government dues cannot be waived off, the NCLT and NCLAT rejected the same. Thus, an appeal was preferred before the Apex Court holding that the Government could not claim first charge over the property in lieu of Section 48 of GVAT Act which provides first charge on the property.

Section 48 of GVAT Act states that ----------------- “any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person.”

The Apex Court has expounded the definition of secured creditor under the Code, to include any Government, or Governmental Authority. The Apex Court has also held that claims by the statutory authority should be considered in the resolution plan as per books of accounts by the resolution professional and in case the interest of state is not taken care in the resolution plan, the company would have to be necessarily liquidated.

The Apex Court in its ruling has also considered another aspect is that timelines for filing of claim by the creditors and even for completion of proceedings are directory not mandatory. By allowing the claim of the tax department of the state even after the resolution plan has been approved by the committee of creditors ("COC"), the Apex Court has somewhere ignored the consistent views taken by the Supreme Court/ NCLAT in other judgements, where delay in filing of claims were rejected, since the resolution applicant cannot be allowed to face surprise claims after approval of claims by the COC and had recognised the concept of clean slate theory.

In a nutshell, the Apex Court in Rainbow Papers has held that statutory creditors who are granted a charge over the assets of a debtor company by virtue of a statute would fall within a definition of "security interest"(security interest means right, title, interest or claim to property is 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 etc.) under Section 3(31) of the Code and the state becomes a secured creditor under Section 3(30) of the Code (secured creditor is a creditor in whose favour a security interest is created).

By the above definition, the state tax officer argued that by view of the attachment a charge is so created on the assets of the Corporate Debtor which qualifies as a 'security interest' under the Code and the Sales Tax Officer was, therefore a secured creditor for the purpose of Section 53 of the Code (order of priority of creditors for distribution of proceeds of liquidation assets).

The Apex Court also went on to hold that any resolution plan that waives off such secured statutory dues payable to any state, altogether, is bound to be rejected by the NCLT.

Going by the above, if one may interpret the above verdict of Rainbow Papers, it may have a serious impediment from the prospective of lending done by the banks since, statutory dues will now have a charge which will be treated at par with the secured lenders of any corporate debtor.

It is settled position of law that statutory dues are ‘Operational Debts’. This is also clear from the definition contained u/s 5(21) of Code which defines ‘Operational Debt’ as under:

“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";

Such "operational debts" can however be ‘secured,’ if a security interest is created on such debts. Security interest in relation to a debt thus implies creating a “right, title or interest or a claim to property”. 

Generally, assessment of statutory dues by government authorities does not create an automatic interest in the property of the debtor, unless statutorily mandated under the law as was in the case of Rainbow Papers under GVAT Act.

It is also interesting to note that though the judgement of Rainbow Papers has been rendered in context of Section 48 of the GVAT Act, but it will have a direct bearing on government dues under other statutes, which similarly create a charge over assets of the taxpayer. For instance, similar provisions are specified under CGST Act, 2017 and Section 142A of the Customs Act, 1962.

The import of the aforesaid provisions under the GST and Customs laws is the classification of statutory dues as ‘secured debts’, and therefore a priority on distribution of assets as secured debts u/s 53 (order of priority of creditors for distribution of proceeds of liquidation assets) of the Code. However, in our view Rainbow Papers cannot be regarded as laying the general proposition having application to all government and statutory dues. The type of statutory dues will need to be seen on a case-to-case basis in light of specific legislative act.

In our earlier days of Companies Act, 1956 and other laws, tax dues were given priority over debts owed to unsecured creditors. Under the Code, the waterfall distribution as regards the government dues, is subordinate to even unsecured financial debts, workmen dues and wages. In fact, the preamble of the Code specifies the object to include “alteration in the order of priority of payment of Government dues”. However, the categorisation of statutory dues as 'secured creditor' in Rainbow Papers could appear contrary to such object of the Code.

The Apex Court in Rainbow Papers has also seemed to have ignored the Judgement in the matter of Ghanshyam Mishra which was a larger bench Judgement of the Apex Court and had considered the issue of State tax in detail and held the same to be Operational Creditor. For instance, even in Sundaresh Bhatt vs Central Board of Indirect Taxes and Customs the Apex Court had held that the Code has an overriding effect on Customs Act (which too, creates a statutory charge in favour of the customs authorities).

The position clarified by the Apex Court categorising government statutory dues which have a charge over assets of the taxpayer as secured debts has certainly put some dark clouds on the regime under the Code.

In another recent judgment which was under review by the Apex Court in the matter of Vidarbha Industries Power Ltd. vs. Axis Bank Ltd., the Bench while reviewing the Judgment of Vidharba had observed that "judgments and observations in judgments are not read as a provision of statue. Judicial utterances and/or pronouncement are in the setting of the facts of a particular case.

Therefore, going by the above review judgment by the Apex Court in Vidarbha one can assume that the observations made by the Apex Court in Rainbow Papers will have to be read from the facts and circumstances of that case.

The Judgment in Rainbow Papers has only clarified the position, vis-à-vis the statutory creditors who are granted a charge over the assets of any debtor company by virtue of a statute would fall within a definition of "secured creditors"

Going forward the decision of Rainbow Papers, unless reviewed and/or distinguished by Apex Court in other cases it may just open a pandora’s box, owing to the fact that homebuyers (who may also have a statutory charge under laws like RERA, MOFA and Transfer of Property), vis-à-vis banks in that sense may also be able to argue that they can be considered as a secured creditor and have a higher charge than that of the banks under the Code.

Dikshat Mehra is a Principal Associate and Honey Chandnani is an Associate at Rajani Associates.