Electrosteel Steels Ltd. v State of Jharkhand: The Unsettling Doctrine of Clean Slate

[By Akshita Totla and Nikunj Maheshwari]

The authors are students at Institute of Law, Nirma University.

Introduction

The Insolvency and Bankruptcy Code (IB Code) was enacted for the resolution of the corporate debtor so that it continues as a ‘going concern’[i]. The doctrine of clean slate is one of the means to achieve this objective of the revival of the corporate debtor. This doctrine states that post the approval of the resolution plan by the adjudicating authority, the resolution will be binding on all the stakeholders. Thereby, the acquirer will be protected from any undischarged claim against the corporate debtor prior to the completion of the resolution process and would begin the operation with a clean slate. The intent behind this doctrine is to incentivize the acquirer of the stressed company, and to provide scope for the revival of the corporate debtor. This doctrine in Indian laws finds its place under section 31and 32A of the IBC and has been further expanded and interpreted by the Supreme Court in the case of Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta[ii] (2019) (Essar Steel).

Recently, in Ultra Tech Nathwada Cement v. Union of India[iii](2020) (Ultra Tech) the Rajasthan HC held that tax authorities cannot raise demands of pending tax dues from the resolution applicant subsequent to the approval of the resolution plan. However, the Jharkhand HC in the case of Electrosteel Steels Ltd. v. The State of Jharkhand[iv](2020) (Electrosteel) has overturned the decision of Rajasthan HC with respect to the application of the doctrine of fresh slate in the case of pending tax dues. The juxtaposition of contrasting opinions of adjudicating authorities has created an anomaly as to the scope of the doctrine of clean-slate theory. This article seeks to analyze the decision of the Jharkhand HC vis-a-vis the treatment of disputed amounts post the culmination of CIRP in the light of settled precedents and legislation.

Background

In the case of Electrosteel, M/s Vedanta Ltd. emerged as a successful resolution applicant, and its application to take over the petitioner company was approved by the adjudicating authority. Albeit, the sums of money owed by the company to its creditors were paid in the required proportions, the dues outstanding with the VAT authorities (tax department) were not considered. As a sequitur, the tax department started sending garnishee orders to the banker of the petitioner company, to transfer a sum of money to the department, in lieu of the outstanding dues of the petitioner. The petitioner thus filed the writ petition to challenge these garnishee orders. The issue raised before the court was whether the approved resolution plan will be binding on the tax authorities.

The Court noted that the petitioner tried to frivolously enrich itself, by not paying indirect tax amount to the department which it collected from its customers. The petitioner as required under section 13 of the Code didn’t make a public announcement for inviting the claims of creditors at the location of its registered office i.e. in the state of Jharkhand. For this reason, the Tax authority was unable to submit its claims and thus, it never became the party to the resolution plan. The Court further observed that since the 2019 amendment[v]was promulgated after the resolution plan was finalized, it will not have retrospective effect and thus the tax department will have a claim to get its dues recovered. [Note: The 2019 amendment Act amended section 31 to clarify that position that the approved resolution plan would be binding on all stakeholders including government and local authorities]

Analysis of the Judgment

  1. Whether resolution plan will be binding on a party who was not involved in the resolution plan?

The court interpreted Section 31(1) of the IB Code which states that approved resolution will be binding on “all stakeholders involved in the resolution process[vi]and concluded that the resolution plan would be only binding on parties that participated in the resolution process.[vii] On the other hand, the Rajasthan High Court in Ultratech while deciding on the same question held that irrespective of the fact that the creditor or the government participated in the resolution process, once approved the plan would be binding on all stakeholders.[viii] The Supreme Court in the case of Swiss Ribbons v Union of India[ix](2019) was also of the same view that insolvency proceedings are proceedings in rem i.e. would be binding on the public at large.[x]The court in this case misinterpreted section 31 while imposing liability to pay on the petitioner as the resolution plan would have been binding on the tax authority irrespective of its involvement in the resolution process.

Furthermore, the SC in the case of Essar Steel observed that “A successful resolution applicant cannot suddenly be faced with “undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping.[xi]This observation was made in the light of the fact that the acquirer would intend to have a fresh slate without any liabilities of the erstwhile management.[xii]Thus, the ratio of Electrosteel runs counter to the very objective of clean slate doctrine which is to prevent government or any other creditor to intrude in the resolution process. If this position of law is not settled by the SC in appeal, this judgment will have an adverse impact on the prospective applicant who would no longer be willing to acquire any financially distressed company.

  1. Whether indirect tax is operational debt?

The Jharkhand HC while holding the state government as an operational creditor made a distinction between indirect and direct taxes. The court stated that indirect tax may not be considered as operational debt as the VAT in dispute has already been realized from the customers. Hence, it is not a direct debt of the petitioner company towards the state government so as to make it operational debt under section 5(21). The relevant part of Section 5(21) states that “debt in respect of the payment of dues arising under any law for the time being in force and payable to the Government, or any local authority”.[xiii] The section clearly doesn’t distinguish between indirect and direct debts and any debt which is payable to the government will fall under the category of operation debt.

This observation made by the court contradicted with the judgment of NCLAT in the case of Director General of Income Tax v M/s Synergies Dooray Automotive Ltd.[xiv] (2019), wherein it was held that ‘Income Tax’, ‘Value Added Tax’, ‘Sales Tax’, and other statutory dues are to be considered as operational debt.[xv] The rationale for this decision was that operational debts are debts that have a direct relation with the operation of the company as a going concern and liability of statutory dues including taxes would only arise if the company is operational, thus establishing a direct relation with the operation of the company. Therefore, tax collected but not paid to the government is also payment of dues to the central government and thereby, would qualify as operation debt.

Conclusion

The doctrine of a clean slate is necessitated to protect the successful resolution applicant from any undecided claims after the approval of the resolution plan. The interpretation of section 31 adopted by the court, in this case, runs counter to the very intent of this doctrine which is to provide a fresh slate to the corporate debtor. The rationale adopted by this court has made the binding value of the approved resolution plan ineffective as the same can be challenged after the completion of the resolution process. The Court also made this observation that indirect taxes may not amount to operational debt. This observation serves no purpose as the position regarding the inclusion of indirect tax as operational debt has already been settled by the NCLAT.

The objective of the IB Code is revival and the same cannot be achieved if the binding effect of the resolution plan is nullified. If the government and local authorities are permitted to raise claims even after the approval of the resolution plan, then the potential acquirers would be disincentivized from taking over any distressed company.

Endnotes:

[i]Swiss Ribbons Pvt. Ltd. v Union of India, (2019) 4 SCC 17, ¶27.

[ii] 2019 SCC OnLine SC 1478.

[iii] D.B. Civil Writ Petition No. 9480/ 2019.

[iv] 2020 SCC OnLine Jhar 454.

[v] The Insolvency and Bankruptcy Code (Amendment) Act, 2019, Act No. 26 of 2019.

[vi] The Insolvency and Bankruptcy Code, 2016, Act No. 31 of 2016.

[vii]Supra 4, ¶30.

[viii]Supra3.

[ix]Supra1.

[x]Supra 1, ¶43.

[xi]Supra 2, ¶88.

[xii]JSW Steel Limited v Ashok Kumar Gulla,2019 SCC OnLine NCLAT 854.

[xiii] The Insolvency and Bankruptcy Code, 2016, Act No. 31 of 2016.

[xiv] 2019 SCC OnLine NCLAT 691.

[xv]Ibid,¶29.

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