In IBC, no automatic secured creditor tag for govt's statutory dues

The government’s statutory dues can be treated in the same way as secured creditors’ dues only in cases where there is a written documentary transaction classifying them as such under the Insolvency and Bankruptcy Code, a senior government official told Business Standard.

The Ministry of Corporate Affairs (MCA) would consider issuing this as a clarification, if needed, following the recent Supreme Court (SC) judgment in the Rainbow Papers case, the senior official said.

On October 31, an SC Bench in the Rainbow Papers case dismissed petitions seeking a review of its earlier order, which held that state-level tax authorities would enjoy parity with secured creditors.

Experts said the SC decision in Rainbow Papers case inadvertently disrupted the established hierarchy of claims, and that could affect insolvency resolution outcomes and unsettle the expectations of financial creditors.

According to the IBC’s waterfall mechanism, secured creditors, such as banks, get priority over unsecured and operational 

creditors when it comes to repayment of dues.

The SC’s interpretation of the term “secured creditor” in the Rainbow Papers case was based on the Gujarat VAT (Value-added Tax) Act, which says the government, to the extent of VAT dues, is a statutory charge holder and has the status of a secured creditor. The official clarified the treatment of statutory dues under the secured category in the Rainbow Papers case was exclusive to that specific matter because the debt was classified as “secured” in the Gujarat VAT Act.
 

This, however, does not mean that issues of other statutory dues, such as income tax, would come up in the waterfall mechanism to be treated on a par with secured financial creditors.

Another Supreme Court Bench has reiterated this. In the matter of Paschimanchal Vidyut Vitran Nigam Ltd vs Raman Ispat, the SC has held that the scope of the Rainbow Papers judgment has to be restricted to that case alone.

“It is held that reliance on Rainbow Papers is of no avail to the appellant. In this court’s view, that judgment has to be confined to the facts of that case alone,” the court order said.

It is in the light of these two judgments that the MCA is considering if there is a need to clarify its position.

Interestingly, in a January 18 notice inviting public comments on proposed changes to the IBC, the MCA said: “It will be clarified that only where the security interest is created pursuant to a transaction of the central government or a state government with the corporate debtor, the government in question will continue to be treated as a secured creditor in the order of priority.”

The decision, the experts said, also opened the door to proactive claims by tax authorities in insolvency proceedings, possibly complicating and prolonging the resolution process.

“The clarification provided in the Paschimanchal verdict has given relief by suggesting a more case-specific application rather than a sweeping change to the insolvency regime, though the full ramifications across the insolvency landscape remain to be seen, potentially necessitating legislative clarification or amendments to reinforce the original intent of the IBC,” said Sonam Chandwani, managing partner at KS Legal and Associates.