The State as a Party to Insolvency Proceedings: Diluting Rainbow Papers

[By Rohan Srivastava & Priyanshu Mishra]

The authors are students of National Law School of India University, Bengaluru.

 

Introduction

In 2022, the Supreme Court in the case of State Tax Officer v Rainbow Papers, (hereinafter “Rainbow Papers”) held that Security Interests, which are placed at the second highest priority under the Insolvency and Bankruptcy Code (IBC) waterfall mechanism (contained in Section 53) may be created by operation of statutes. The controversial verdict has since then attracted a lot of criticism for undoing the economic and creditor-friendly rationale of the IBC. Recently, in the case of Paschimanchal Vidyut Vitran Nigam Ltd(PVVNL) v Raman Ispat Private Limited and Ors, (hereinafter “Paschimanchal Vidyut”) the Supreme Court has attempted to limit the applicability of the Rainbow Papers verdict by confining it to its own peculiar sets of facts. This has been commented upon as essentially “quarantining” the ratio of Rainbow Papers from future applicability.

This piece shall delve into the reasoning in Paschimanchal Vidyut to highlight how it deviates from Rainbow Papers and can be seen as a part of the judicial trend of diluting the applicability of the Rainbow Papers verdict. In doing so, this post shall also attempt to shed light on the current applicability of Rainbow Papers, in light of various contradictory verdicts given by the courts on the meaning of “statutory dues” etc and also highlight the lack of uniformity in the jurisprudence.

The Verdict in Paschimanchal Vidyut

In Paschimanchal Vidyut, the appellant, PVVNL had entered into an agreement with Raman Ipsat for the supply of electricity. Clause 5 of the said agreement provided that “any outstanding dues shall be a charge on the assets of the company”. Reliance was placed on such wording by PVVNL to attach the property of Raman Ipsat upon non-payment of dues for recovery under regulations framed under the Electricity Act, 2003. The said attachment was challenged by the respondent claiming that it interfered with the liquidation proceedings that were ongoing against Raman Ipsat under the IBC, after failure of the resolution process.

The NCLT set aside the impugned attachment order as it interfered with the Liquidation proceedings and declared that the assets of the company would be distributed according to the waterfall mechanism contained in the IBC. The NCLAT also endorsed the NCLT’s holding and held that PVVNL had to recover its dues under the IBC as a secured operational creditor within the waterfall mechanism.

In the Supreme Court, PVVNL had argued that it was entitled to recover its dues under the Electricity Act and the mechanism provided in regulations framed under it by virtue of it being a special law and having non-obstante clauses. Alternatively, it had also argued, that in light of the Rainbow Papers verdict, the electricity dues were “secured interests” and the same had also been held by the impugned NCLT and NCLAT orders. In opposition, the Liquidator had argued that the IBC, having already provided a different section for government dues, does not view the government as a secured creditor under the waterfall mechanism and the said dues were covered under Section 53(1)(e) as an amount owed to the government.

The Supreme Court firstly affirmed the overriding nature of the IBC over the Electricity Act and clarified that PVVNL cannot seek recovery under the Electricity Act but only under the IBC’s waterfall mechanism. On the second question, the SC clarified that PVVNL will be a secured creditor under the waterfall mechanism. This post shall focus on the reasoning used by the court in arriving at its second conclusion.

Contrasting Rainbow Papers and Paschimanchal Vidyut

In distinguishing the State as a “Secured Creditor” from “amount due to the government” under 53(1)(e), the court alludes to the wording of 53(1)(e) which makes a reference to the consolidated fund. The Court reasons that the liquidator’s argument that the electricity dues were an amount due to the government under 53(1)(e) is unfounded as it is a due owed to a corporation created by statute which has a separate juristic entity. The Court uses a functional test and concludes that PVVNL’s functions were something which could be performed by private entities as well and was not a governmental function.

While the reasoning in Rainbow Papers and the Court’s reasoning, in this case, both arrive at the same conclusion, the Supreme Court explicitly negates the applicability of Rainbow Papers. The approach in the current case is one which defines State very narrowly, with reference to the consolidated fund and Article 165 of the Constitution, having defined the state narrowly and excluded statutory corporations from its ambit, the court then evaluates the nature of the dues as to whether they are secured or not. Contrary to this, the Rainbow Papers’ decision does not allude to 53(1)(e) to exclude “State” but directly jumps to the evaluation of the nature of interest, regardless of whether the dues come under 53(1)(e) or not. Such an approach is more textually fitting to the scheme of the IBC given that the code’s preamble along with its provisions has sought a different treatment of government dues. Having a two-stage enquiry as laid down by the court in this case by first applying the definition of State to the party and only if the question is answered in the negative, then going to the question of secured interest, is thus more appropriate than broadly giving the status of the secured creditor to the statutory first charge.

Being a coordinate bench, however, the Supreme Court could not overrule Rainbow Papers but instead distinguished it on the ground that Rainbow Papers was not in the context of liquidation, hence was not binding in the given case and must be confined to its factual matrix. This distinction however stands on flimsy grounds as the court did not provide any principled arguments as to why Rainbow papers’ verdict shall not apply to liquidation proceedings and be limited to the CIRP.

This can be seen as a part of the broader judicial course-correction trend which has sought to limit the applicability of Rainbow Papers across a set of judicial decisions.

Judicial Course Correction Post-Rainbow Papers

After the Rainbow Paper case, there has been jurisprudential uncertainty regarding statutory dues due to conflicting decisions from different High Courts and tribunals. Although the courts have unanimously given overriding effect to the provisions of the IBC over other statutes, they differ in their application of Rainbow Papers in granting primacy to “government dues” as secured interest.

There are two judicial trends concerning the dilution of Rainbow Papers. In one line of reasoning, the court distinguishes the facts of the Rainbow Papers case and rules that it holds precedential value only when there is no inconsistency in different statutes. However, in these cases, the court acknowledges the overriding effect of IBC over other legislation. For instance, in the case of Haryana through Excise and Taxation v Anoop Sood Resolution Professional, the NCLT court acknowledges the overriding effect of IBC but refuses to give precedential credibility to Rainbow Papers by pointing out distinctions in the facts and holding that it does not apply in cases of inconsistency between legislations. Similarly, in Jet Aircraft Maintenance Engineer Welfare Association v Ashish Chhawachharia, the court holds that IBC will override the Maharashtra GST Act, 2017, but Rainbow Papers will not be applied since there is an inconsistency between the provisions of the GST Act and IBC. On the other hand, there are opposing cases that give precedential credence to Rainbow Papers. For example, in Empee Distilleries Limited v Superintendent Engineer, the court relies on Rainbow Papers to hold that statutory dues, considered secured interest, cannot be ignored by the adjudicating authority when approving the resolution plan. Similarly, in Deputy Commissioner of State Taxes and Excise v Sanjay Gupta, the NCLAT, ruled that the Rainbow paper is the settled position of law on the question of statutory dues in insolvency proceedings.

Another line of court reasoning seeks to course correct and limit the application of Rainbow Papers, reverting to the Ghanshyam Mishra and Sons Pvt Ltd v Edelweiss Asset Reconstruction Company Ltd (hereinafter “Ghanshyam Mishra”) approach, which extinguishes the statutory dues once the resolution plan is approved by the Adjudicating Authority, restricting Rainbow Papers to the facts of that case only. In NRC Limited v State of Maharashtra, the Bombay High Court distinguishes the facts of the case from Rainbow Papers, confining its application solely to those specific facts. Similarly, in Sree Metalik v Additional Director General, the court rejects the application of Rainbow Papers and applies the clean slate principle of Ghanshyam Mishra, stating that claims not part of the resolution plan stand extinguished and cannot be pursued after the approval of the resolution plan. In West Bengal Electricity v Sri Vasavi Industries Ltd, when dealing with electricity dues, the court held that the rights of the electricity-supplying company to recover electricity dues were extinguished upon the approval of the resolution plan by the adjudicating authority (NCLT).

Overall, the conflicting decisions and diverging approaches of the courts have resulted in uncertainty in the application of Rainbow Papers and statutory dues, despite the courts’ consensus on the overriding effect of IBC over other statutes.

Conclusion

The decision in Paschimanchal Vidyut seems to be the latest case in a series of cases that have overall diluted and limited the scope of Rainbow Papers as a part of the Apex Court’s own course correction measures. Given the muddied jurisprudence around the government as a secured creditor due to such conflicting decisions, it has become imperative that the legislature steps in and clarifies the definition and status of statutory dues and their relation with the status of the secured creditor. The approach taken in Paschimanchal is a unique addition which does justice to the text of Section 53 by defining “government” as used in the provision and restricting the government’s place in the waterfall to Section 53(1)(e) as dues owed to the government.

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