Decoding State Tax Officer v/s Rainbow Papers Limited Case

Table of Contents

1. Facts of the Case
2. Issues Before SC
3. Approval of resolution plan by Adjudicating Authority (AA)
4. Defeat objective of IBC – Resolution of CD
5. Commercial Wisdom of COC
6. Overriding of IBC over section 48 of GVAT Act
7. NCLAT: Volkswagen Finance Pvt Limited vs Shree Balaji [2021] 124 taxmann.com 614 (NCLAT)
8. Section 48 of GVAT Act
9. Section 82 of CGST ACT
10. Section 26E of SARFAESI Act, 2002
11. What if there is unsecured FC and secured operational creditor and secured operational creditor not relinquish its right?

1. Facts of the Case

• One operational creditor of the respondent, filed Company Petition under Section 9 of the IBC before Ahmedabad Bench of the National Company Law Tribunal (NCLT), for initiation of the Corporate Insolvency Resolution Process (CIRP) against  the respondent and the same had been admitted by the NCLT vide order dated 12.09.2017
• A Committee of Creditors was constituted on 10th October 2017 and the State tax filed a claim before the Resolution Professional on 28.02.2018 in the requisite Form B, claiming that Rs.47.36 crores (approximately), was due and payable by the respondent to the appellant, towards its dues under the GVAT Act.
• The claim was filed beyond time. Later State Tax on 22.10.2018 called upon the Resolution Professional to confirm the claim of the State Tax towards outstanding tax dues and the Resolution Professional informed the state tax that the entire claim of the appellant had been waived off. Therefore, State Tax challenged the Resolution Plan by making an application before the Ahmedabad Bench of the NCLT contending that Government dues could not be waived off. State Tax prayed for payment of total dues towards VAT/CST on the ground that the Sales Tax Officer was a secured creditor.

1.1 NCLT Ahmedabad (27.02.2019)

• The Adjudicating authority stated that Section 53 of IBC lists the priorities to the given to the beneficiaries of liquidation value of the asset of the corporate The provision of section 53 makes it amply clear that operational creditors are at the end of the list of beneficiaries as the secured financial creditors have edge over the others and the Operational creditors have no locus standi as far as approval of the Resolution Plan by the Committee of the Creditor is concerned.
• The NCLT further stated that the provisions of the IBC dispelled the misconceptions of the Sales Tax-Intervener that they have edge over the other beneficiaries. The very object of the IBC is resolution of failing corporate debtor companies and not liquidation of Corporate Debtor companies. The NCLT therefore dismissed the State tax plea as nonmaintainable.

1.2 NCLAT (19.12.2019)

• State Tax filed an appeal with the NCLAT against the Adjudicating Authority’s order dated February 27, 2019. The NCLAT dismissed the appeal by the judgement and order Impugned reported at. As a result, the NCLAT determined that the Adjudicating Authority observed that the State Tax filed a claim at a much later stage, not only before the Resolution Professional, but also before the Adjudicating Authority. The Appellant failed to file his claim on time. It approached the ‘Resolution Professional’ after the Adjudicating Authority approved the ‘Resolution Plan’.
• In light of the IBC’s Statement of Objects and Reasons, together with the Section 53 of the IBC, the government cannot claim first charge over the ‘Corporate Debtor’s’ property. Section 48 of the GVAT Act cannot take precedence over Section 53 of the IBC. As a result, the State Tax does not meet the definition of ‘Secured Creditor’ under Section 3(30) read with Section 3(31) of the IBC. Furthermore, since the ‘State Tax Department’ filed its claim after the plan had been approved by the ‘Committee of Creditors,’ the ‘Resolution Professional’ had no jurisdiction to hear it, and it was rightfully denied.

1.3 Supreme Court of India (06.09.2022)

The appeal has been filed against the NCLAT order dated December 19, 2019 dismissing the company appeal filed by the State Tax against the order of Adjudicating Authority rejecting the state tax application and holding that the Government cannot claim first charge over the Corporate Debtor’s property, as Section 48 of the Gujarat Value Added Tax provides for first charge on the property of a dealer in respect of any amount payable by the dealer on account of tax, interest, penalty etc. under the GVAT Act, cannot prevail over Section 53 of the IBC.

2. Issues Before SC

2.1 Filing of claims under CIRP Regulations

• The Regulations have to be read as a whole and not in a truncated manner and interpreted in the light of the statutory provisions of the Code. SC has time and again held that the time lines stipulated in the Code even for completion of proceedings are directory and not mandatory.
• Under the unamended provisions of regulation 12(1) of CIRP Regulations, the State Tax Officer (appellant) was not required to file any claim. Read with regulation 10, the appellant would only be required to substantiate the claim by production of such materials as might be called The time stipulations are not mandatory as is obvious from subregulation (2) of regulation 14 which enables the Interim Resolution Professional (IRP) or the RP, as the case may be, to revise the amounts of claims admitted, including the estimates of claims made under the said regulation as soon as might be practicable, when he came across additional information warranting such revision.
• There was no obligation on the part of the State to lodge a claim in respect of dues which are statutory dues for which recovery proceedings have also been initiated. They were never called upon to produce materials in connection with the claim raised towards statutory dues.
• The Books of Accounts of the Corporate Debtor (CD) would have reflected the liability of the CD to the State in respectof its statutory dues. In abdication of its mandatory duty, the RP failed to examine the Books of Accounts of the CD, verify and include the same in the information memorandum and make provision for the same in the resolution plan. The resolution plan does not conform to the statutory requirements of the Code and is, therefore, not binding on the State.
• Regulation 12 of the 2016 Regulations deals with the time period for submission of a claim along with proof, as stipulated in the public announcement under section 15 of the Code. The time period is, however, not mandatory but only directory.

2.2 State Tax Department as secured creditor

• In view of the statutory charge in terms of section 48 of the GVAT Act, the claim of the Tax Department of the State, squarely falls within the definition of “Security Interest” under section 3(31) of the Code and the State becomes a secured creditor under section 3(30) of the Code.
• Such security interest could be created by operation of The definition of secured creditor in the Code does not exclude any Government or Governmental Authority.

3. Approval of resolution plan by Adjudicating Authority (AA)

• When a grievance was made before the AA with regard to a resolution plan, the AA was required to examine if the resolution plan met the requirements of section 30(2) of the Code. The word “satisfied” used in section 31(1) contemplates a duty on the AA to examine the resolution plan. The resolution plan cannot be approved by way of an empty formality.
• Under section 31 of the Code, a resolution plan as approved by the Committee of Creditors (CoC) under section 30(4) might be approved by the AA only if the AA is satisfied that the resolution plan asapproved by the CoC meets the requirements as referred to in section 30(2).
• Section 31(1) of the Code uses the expression “it shall by order approve the resolution plan which shall be binding…” subject to the condition that the resolution plan meets the requirements of section 30(2). If a resolution plan meets the requirements, the AA is mandatorily required to approve the resolution plan. On the other hand, section 31(2), which enables the AA to reject a resolution plan which does not conform to the requirements referred to in of section 31(1), uses  the expression “may”.
• Even if section 31(2) is construed to confer discretionary power on the AA to reject a resolution plan, it has to be kept in mind that discretionary power cannot be exercised arbitrarily, whimsically or without proper application of mind to the facts and circumstances which require discretion to be exercised one way or the other.
• If a resolution plan is ex facie not in conformity with law and/or the provisions of Code and/or the Rules and Regulations framed thereunder, the resolution plan would have to be rejected. It is also a well settled principle of interpretation that the expression “may”, if circumstances so demand can be construed as “Shall”.
• If the resolution plan ignores the statutory demands payable to any State Government or a legal authority, altogether, the AA is bound to reject the resolution plan.

What if plan Proposed 0.1% or 2% whether that means it consider demands or not?

‘If the Resolution Plan ignores the statutory demands payable to any State Government or  a legal authority, altogether, the Adjudicating Authority is bound to reject the Resolution Plan.’

• If a company is unable to pay its debts, which should include its statutory dues to the Government and/or other authorities and there is no plan which contemplates dissipation of those debts in a phased manner, uniform proportional reduction, the company would necessarily have to be liquidated and its assets sold and distributed in the manner stipulated in section 53 of the Code.
• The Committee of Creditors, which might include financial institutions and other financial creditors, cannot secure their own dues at the cost of statutory dues owed to any Government or Governmental Authority or for that matter, any other dues.

4. Defeat objective of IBC – Resolution of CD

• Uniform Proportional Reduction in case there is statutory dues
• If not, plan should be rejected and company should be liquidated.

5. Commercial Wisdom of COC

“any other dues” Whether it means CoC cannot secure its dues at the cost of Operational creditors also?

6. Overriding of IBC over section 48 of GVAT Act

• Section 48 of the GVAT Act is not contrary to or inconsistent with section 53 or any other provisions of the Code. Under section 53(1)(b)(ii), the debts owed to a secured creditor, which would include the State under the GVAT Act, are to rank equally with other specified debts including debts on account of workman’s dues for a period of 24 months preceding the liquidation commencement date.
• The delay in filing cannot be the sole ground for rejecting the claim

The State is a secured creditor under the GVAT Act. Section 3(30) of the IBC defines secured creditor to mean a creditor in favour of whom security interest is credited. Such security interest could be created by operation of law. The definition of secured creditor in the IBC does not exclude any Government or Governmental Authority.

7. NCLAT: Volkswagen Finance Pvt Limited vs Shree Balaji [2021] 124 taxmann.com 614 (NCLAT)

To reiterate, in the instant case, as the ‘Security Interest’ was neither registered with the ‘Information Utility’; nor under Section 125 of the Companies Act, 1956/Section 77 of the Companies Act, 2013; no Application was preferred under Section 87 of the Companies Act, 2013; ‘Charge’ was not registered in the Securitisation Asset Reconstruction and Security Interest of India, we are of the opinion that Section 52(3)(b) of the Code and Regulation 21(b) of the (Liquidation Process), Regulation, 2016 are not complied with and the ratio laid down by the Hon’ble  Apex  Court in  Kerala State Financial Enterprises Ltd. (Supra)  and this Tribunal India Bulls Finance Ltd. (Supra) is squarely applicable to the acts of this case. Hence, we hold that when in present matter ‘Charge’ was not registered as per the provisions of Section 77 (1) of the Companies Act 2013 and as envisaged under the Code, the Creditor cannot be treated as a ‘Secured Creditor’.

8. Section 48 of GVAT Act

• Section 48 – Tax to be first charge on property

Notwithstanding anything to the contrary contained in any lawfor the time being in force, any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case may be, such person.

Security Interest

“Security Interest” is defined under Section 3(31) of the IB Code which states following;

“security interest” means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:

Provided that security interest shall not include a performance guarantee;

9. Section 82 of CGST ACT

Section 82 of CGST Act 2017: Tax to be First Charge on Property (CHAPTER XV – Demands and Recovery)

• Notwithstanding anything to the contrary contained in any law for the time being in force, save as otherwise provided in the Insolvency and Bankruptcy Code, 2016, any amount payable by a taxable person or any other person on account of tax, interest or penalty which he is liable to pay to the Government shall be a first charge on the property of such taxable person or such person.

10. Section 26E of SARFAESI Act, 2002

• Secured creditors under SARFAESI Act, 2002 has been given priority as per Section 26E which states that;
• Priority to secured creditors.—Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.
• Explanation —For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.]

11. What if there is unsecured FC and secured operational creditor and secured operational creditor not relinquish its right?

11.1 Bankruptcy Law Reforms Committee (‘BLRC’)

The Committee has recommended to keep the right of the Central and State Government in the distribution waterfall in liquidation at a priority below the unsecured financial creditors in addition to all kinds of secured creditors for promoting the availability of credit and developing a market for unsecured financing (including the development of bond markets). In the long run, this would increase the availability of finance, reduce the cost of capital, promote entrepreneurship and lead to faster economic growth. The government also will be the beneficiary of this process as economic growth will increase revenues. Further, efficiency enhancement and consequent greater value capture through the proposed insolvency regime will bring in additional gains to both the economy and the exchequer.

11.2 IBBI Circular – Reporting to pending HC/SC matters [13.09.2022]

Insolvency Professionals are advised to inform IBBI without any delay about any important issues relating to

• vires,
• interpretation and
• applicability of the provisions of the Code, Rules and Regulations made thereunder

are being contested before the High Courts and the Supreme Court of India, in respect of any assignment handled by them as on date.

Further, the information as above shall be submitted by Insolvency Professionals as and when any such case is filed before Supreme Court and High Courts.

11.3 NCLT Ahmedabad – Parag Sheth , Liquidator of Sai Infosystem vs Collector & Ors IA 157 of 2022 [14.11.2022]

• Attachment on the property cannot be done beyond one year and shall be removed as per Section 45 of GVAT Act, 2003
• State tax be considered as secured creditor in light of Rainbow Papers

11.4 NCLAT Department of State tax vs Ziocom Saas Pvt Limited Appeal 246 of 2022

• Provisions of MVAT act are different than GVAT Act and it gives preference to Central tax law [Section37]
• Notwithstanding anything contained in any contract to the contrary but subject to any provision regarding creation of first charge in any Central Act for the time being in force, any amount of tax, penalty, interest, sum forfeited, fine or any other sum, payable by a dealer or any other person under this Act, shall be the first charge on the property of the dealer or, as the case may be, person.

11.5 MCA – Invitation for comments dated 18.01.2023 changes in IBC

Thus, it is being considered that all debts owed to Central Government and the State Government, irrespective of whether they are secured creditors pursuant to a security interest created by a mere operation of statute, shall be treated equally with other unsecured creditors. Further, 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 CD, the Government in question will continue to be treated as a secured creditor in the order of priority.