Post Rainbow Papers – The Supreme Court’s Dueling Rulings on Government Dues

[By Shubham Singh]

The author is a student of National Law University, Odisha.

 

Introduction

Section 53 of the Insolvency and Bankruptcy Code, 2016 (IBC) establishes a waterfall mechanism for the distribution of assets in liquidation, with secured creditors having the highest priority and equity shareholders having the lowest priority. The waterfall mechanism is designed to ensure that the most important creditors are paid first and that all creditors are treated fairly. It also helps to protect the interests of workers and other vulnerable stakeholders. Government dues are treated after all other creditors and before the shareholders of a company.

However, the ruling of the Supreme Court in State Tax Officer (1) v. Rainbow Papers Limited, placed government dues on par with secured creditors and mandated their inclusion in the resolution plan. Given the Rainbow Papers ruling’s deviation from the established principles of the IBC, subsequent litigation concerning Government dues was a predictable consequence. There have been different and conflicting rulings by the Supreme Court regarding the government dues to this date. In this article, the author will delve into those different rulings by Supreme Court post rainbow papers and their reasoning, while critically analysing them and their effect on the present Indian IBC scenario

Supreme Court Rulings

The reasoning behind the Rainbow Papers ruling was provided by the two-judge bench of the Supreme Court. They stated that a statutory charge can be considered a form of security, and according to the definition of a “Secured Creditor” under the IBC, the government can be classified as a secured creditor if it holds a statutory charge. This technical perspective adopted by the court, treating statutory charge as security and using that security to treat government dues as secured creditors contradicts Section 53 of IBC which specifically puts government dues below in the waterfall mechanism. The Rainbow Papers judgement goes against the legislation.

However, In July 2023, the Hon’ble Supreme Court of India, in the case of Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Private Limited & Ors, ruled that the Rainbow Papers judgment overlooked Section 53 of the IBC, which grants priority to secured creditors in liquidation proceedings. This ruling is significant because Rainbow Papers primarily dealt with the resolution process rather than liquidation. Nevertheless, it’s important to note that this judgment was delivered by a single-judge bench, and it cannot ultimately overturn the Rainbow Papers decision.

Interestingly, a review petition was filed against the Rainbow Papers judgment in front of a two-judge bench in October 2023, in the case of Sanjay Agarwal v. State Tax Officer. The review petitioner heavily relied on the Paschimanchal Vidyut Vitran case and argued that the court in Rainbow Papers failed to consider all relevant IBC provisions and cases, including the “waterfall mechanism” discussed in the Rainbow Papers decision. However, the court dismissed the petition

However, once again, in October 2023, a two-judge bench in the case of Principal Commissioner of Customs V. Rajendra Prasad Tak & Ors. stated that tax and customs dues must be paid following the “waterfall mechanism” outlined in Section 53 of the IBC. The ongoing disparity in judicial interpretations raises critical questions about the alignment of these rulings with the legislative framework of the IBC.

The Game Show – Analysis of Rulings

While analysing the judgment in the Rainbow Papers case (Supra), the decision in the case of Ghanashyam Mishra & Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Ltd. was cited, but it was considered in the context of a resolution plan. However contrary to Rainbow papers, In the Ghanashyam Mishra case, the Supreme Court ruled that all types of government dues would be classified as operational debt and could be extinguished if they were not included in the approved resolution plan. Rainbow Papers was judged by a two-judge bench, and Ghanashyam Mishra’s case was judged by a three-judge bench.

However, the ruling in the review petition in the Sanjay Agarwal case (Supra) feels like a conundrum in itself. In the Sanjay Agarwal case, the court stated that Rainbow Papers analyzed the cases and provisions cited in Rainbow Papers correctly. The review was denied, citing the practice that a bench of equal authority cannot critique decisions made by another bench citing cases like Beghar Foundation vs. Justice K.S. Puttaswamy (Retired) and Others, which stated the same. The bench in this case was also a two-judge bench

In the Ghanshyam Mishra case, the ruling was provided from the perspective of the legislative effect of the IBC. In contrast, the Rainbow Papers case was approached from a technical standpoint, neglecting the examination of why Government Dues are placed lower in the waterfall mechanism, contrary to its legislative intent. The analysis of the Ghanshyam Mishra case was confined to the resolution plan in Rainbow Papers, and the assertion in the Sanjay Mishra case that everything was correctly analyzed in Rainbow Papers seems questionable. This doubt arises not only from the perspective of the Ghanshyam Mishra case but also considering the provisions of the IBC.

However, the main argument of this article pertains to the treatment of the Ghanshyam Mishra case. Even if one argues that there may be a different perspective in the Ghanashyam Mishra case and the Rainbow Papers case, and the analysis is correct, the reasoning in the Sanjay Agarwal case, emphasizing the importance of the bench in a judgment, raises a question  Why was the ruling in the Ghanashyam Mishra case, asserting that government dues are not a priority with secured creditors, not embraced in Rainbow Papers, considering that the Ghanashyam Mishra case was decided by a larger bench then rainbow Papers and a larger bench always prevails over a shorter bench?

In the Rajendra Prasad Tak (supra) case, an order was passed which stated that the dues of the Central Board of Indirect Taxes & Customs must adhere to the specific hierarchy outlined in Section 53 of the IBC. This judgment emphasizes the importance of following the structured hierarchy for the fair treatment of creditors and stakeholders within insolvency proceedings and favours the legislative intent. After this latest order, once again, the standing of courts aligns with the line of the IBC. However, it is just an order and was passed by a Two-judge bench, placing it on a similar hierarchy to the Rainbow Paper case and the Sanjay Agarwal case.

These case laws can be used as precedents, but still, they do not provide an answer to the question of government dues. This will affect lower courts, and appeals will be inevitable, regardless of which side of the scale the lower courts favour. On the one hand, government dues have priority due to their statutory charge, making them secured creditors. On the other hand, the IBC supersedes all other laws and uses a regular hierarchy of waterfall mechanisms.

Conclusion

IBC was implemented in India to improve the efficiency of corporate insolvency resolution, and that is why the waterfall mechanism was implemented in the IBC to provide a structure for the liquidation process and make it easier for creditors to claim their money. Government dues were kept below or at the same level as operational debts because the government can recover these dues through other means. The IBC is an economic legislation, and policymakers have implemented it after analysing the economic environment and determining that it is in the best interests of India’s economic policy.

A potential solution is evident in the case of Moser Baer Karamchari Union Thr. President Mahesh Chand Sharma and Ors. v. Union of India. In this case, the Supreme Court invoked the Doctrine of Hands Off when scrutinizing the waterfall mechanism, asserting that economic legislation is formulated with a dynamic economic purpose. Within the Moser Baer case, the Court noted that the Insolvency and Bankruptcy Code (IBC) holds a pivotal role as economic legislation and that the judiciary should refrain from unilaterally modifying its intricate provisions without the agreement of the legislative branch.

The Court acknowledged the significant impact of the IBC on secured creditors and financial institutions and underscored their stability as being crucial for the welfare of the public and the economy at large. It emphasized the essential role played by the IBC’s waterfall mechanism in facilitating employment, fostering economic growth, and encouraging investments.

This conundrum must be resolved as soon as possible by referring the issue of government dues to a larger bench of the Supreme Court. Uniformity is very important for an Economic legislation like IBC to work with its full efficiency.

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