The Conundrum of Prioritising and Defining the Statutory Debt under the Insolvency and Bankruptcy Code, 2016

The Hon’ble Supreme Court in a recent judgment of Rainbow Paper Limited1 (‘Company’) has finally settled (or unsettled) a dispute relating to a claim of statutory liabilities by the Sales Tax Office, ‘Department’, under the Gujarat Value Added Tax Act, 2003, (‘GVAT Act’) wherein, the Hon’ble Apex Court held, that the Department is held to be a secured creditor under Section 3(30) of the Insolvency & Bankruptcy Code, 2016 and the GVAT Act. This article seeks to understand the implications of the abovementioned judgment in terms of the broader objective of the Code.

To understand the complexity of the present dispute the brief facts of the case are, that the Department on account of its assessment, of value added tax and central sales tax on the year 2011-2012, claimed an amount of Rs 53 crore as due from the Company. That in pursuance of the due a recovery proceeding was started on July 8, 2016 and a land parcel owned by the Company was attached on October 10, 2018.

Meanwhile an application under section 9 of the Code was filed for initiating the insolvency proceedings by Neeraj Papers Private Limited, being an operational creditor. The National Company Law Tribunal, Ahmedabad (‘NCLT’) verified the debt and default and allowed the application for initiating the insolvency as per the Code.

As per the scheme of the code the interim resolution professional (‘IRP’) was appointed, claims were invited and committee of creditors (‘COC’) was formed. During the stage of presentation of resolution plan by the Resolution Professional (‘RP’) the Department called upon the RP to confirm the claim of the Department to which the RP stated that the entire claim of the Department has been waived off. The Department filed an application before the NCLT challenging the entire resolution plan and stated that the claim of the Department cannot be waived off as it falls within the definition of the secured creditor.

The NCLT and the Appellate Tribunal dismissed the application and appeal broadly on two grounds, Firstly, the Department delayed in presenting its claim before the RP, Secondly, the Department falls within the definition of Operational Creditor. Further the Appellate Tribunal also, held that the first charge as created under Section 48 of the GVAT Act, cannot prevail over Section 53 of the Code. That as per the Section 31 of the code if the resolution plain is approved by the NCLT’s order, the same is binding upon all the statutory authorities of state and central government.

The Department further went into appeal before the Apex Court for setting aside the NCLAT’s Order. The Apex Court held that as per the Regulation brought by IBBI2, there was no duty cast upon the secured creditor to submit any claim, which finds its basis in the unamended Rule 12 read with Rule 10 of the Regulation brought by IBBI, which lays that if the substantiation is required by RP, he may call for the proof. Second, the timeline given in the Code is only directory in nature and not mandatory.

Further, the Court also held the statutory dues must have been part of the Books of Accounts, therefore the obligation is on the RP to include it in the information memorandum. As per the requirement of Section 29 of the Code, the duty is cast on the RP to prepare the Information Memorandum after following the procedure. The duty is further enhanced by the Rule 36(2) of the IBBI Regulation, which states the content of the information memorandum, supposes inclusion of any material litigation and/or investigation or proceeding initiated by government authorities and statutory authorities. That in the present case the due of the Department and its proceeding did not find any place in the Information Memorandum. Thus, the RP failed to comply with the above said provision.

Further, it was argued as also held in Ebix Singapore3 that the duty was also casted on NCLT to satisfy itself and see if the plan complies with the requirement of Section 30(2) of the Code:

The adjudicating authority shall approve the resolution plan if it is satisfied that it complies with the requirements set out under Section 30(2) IBC. Essentially, the adjudicating authority functions as a check on the role of the RP to ensure compliance with Section 30(2) IBC and satisfies itself that the plan approved by the CoC can be effectively implemented as provided under the proviso to Section 31(1) IBC.

It was argued and accepted that the creditor in the present case belongs to a special class of creditors which is the secured operational creditor and the same is construed from the first charge created over the property under the GVAT Act. That the department falls under the definition of secured creditor as defined under Section 3(30) & 3(31) of the Code, therefore, the dues of the department should be accounted for in terms of Section 52 of the Code. The Apex Court concluded that the claim of Department shall prevail and the order of Appellate authority was set aside.

That the present approach taken by Apex Court will have far reaching consequence. That as the order of precedence is considered under section 53 of the code, it declares that the claim of secured creditor shall be accepted before all other and to be shared equally with the categories mentioned under Section 53 1(b) of the Code, except the cost of the resolution or liquidation process. Thus, it is settled that the dues of statutory authority with a charge in their favour will have precedence over unsecured financial creditor and even the unpaid dues of the employees.

That it is technically well understood and addressed that the claim of statutory authority for the purposes of this Code is categorized as operational debt, even though the claim does not arise out of provision of any goods or services. However, the said portion is not well defined under the Code. It is only through the judicial pronouncements that the definition of the operational debt has been deemed to include dues owed to government authorities.

The judgment emphasises the need for lawmakers to course out a proper interpretation of the portion of debts due to government. Clarity in this portion will go long way in furthering the objective of the Code. Tax forms a significant part of any entities financial position and therefore it is imperative that the same is appropriately addressed under the Code. That in case these issues are not addressed, it might impact revival of the companies and the broad objective of the Insolvency and Bankruptcy Code, 2016 in longer run.

By - Devesh Bhatia

  1. State Tax Officer Vs Rainbow Papers Limited (SC, Civil Appeal 1661/2020)
  2. Insolvency and Bankruptcy Board of India Regulations, 2016
  3. Ebix Singapore Private Limited v. Committee of Creditors of Educomp Solutions Limited and Another, (2022) 2 SCC 401.