[Opinion] Implications of Supreme Court judgment in the case of Rainbow Papers Ltd.

[2022] 143 taxmann.com 155 (Article)

The enactment of the Insolvency and Bankruptcy Code, 2016 (“Code“) was aimed at uniformization and consolidation of the insolvency and bankruptcy regime in India, by providing an adequate framework for resolution or liquidation in a time bound manner.

In contrast with the earlier legislations, the Code exhaustively provides for the manner of distribution of assets to stakeholders in case of liquidation of the Corporate Debtor. The order of priority specified in Section 53 of the Code is commonly termed as the ‘waterfall mechanism’, which determines the sequence in which the dues of various stakeholders, such as workmen, secured and unsecured creditors, employees other than workmen, Central Government and State Governments etc. would be prioritized in case of liquidation of the Corporate Debtor.

A perusal of the objectives and provisions of the Code, particularly Section 53 thereof signifies the intention of the legislature to place dues of the Central and State Government below the financial creditors. This is consistent with the view of Bankruptcy Law Reforms Committee (“BLRC“), in its Report given in November 2015. The rationale behind this was perhaps to promote entrepreneurship and faster economic growth, which will in turn increase the revenues for the Government.

The scope and applicability of the Code has, and is continuing to, evolve via several judgments of the Hon’ble Supreme Court, such as judgments upholding the constitutional validity of several provisions of the Code, discussing the applicability of Limitation Act, 1963 to the Code, and interpreting the provisions while aligning them with the objectives of the Code, and thus settling the otherwise unsettled legal position. However, in some cases, the judgments have created a dilemma by unsettling the prevailing legal position and understanding.

In a recent judgment of the Hon’ble Supreme Court, in the case of StateTaxOfficer v. Rainbow Papers Ltd., the findings of the Court appear to be in contradiction with the view which was holding the field by virtue of its judgment in the case of Ghanshyam Mishra & Sons (P.) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd. The observations disturb the prevailing understanding of the order of priority of debts among different classes of creditors in the event of liquidation and appear to be contrary to the scheme and provisions of the Code.

In the case of Rainbow Papers Ltd. (Supra), the Court considered a crucial aspect pertaining to the Code as to whether the tax authorities qualify to be a secured creditor under the provisions of the Code. While doing so, the Court set aside the orders of the National Company Law Appellate Tribunal (“NCLAT“) and National Company Law Tribunal (“NCLT“), Ahmedabad Bench passed in relation to Rainbow Papers Limited, being the corporate debtor in question (“CorporateDebtor“).

The NCLT and NCLAT had observed in their orders that the Government cannot claim the first charge over the property/assets of the Corporate Debtor on account of demands arising under the tax statutes, as the State is not a ‘secured creditor’ under the Code. It was observed that Section 48 of the Gujarat Value Added Tax Act, 2003 (“GVAT Act“), which provides for tax to be the first charge on the property of the dealer, cannot override Section 53 of the Code, which provides the mode and manner for distribution of proceeds of the sale of assets in cases of liquidation.

For the purpose of the present article, the authors have restricted the discussion to the issue of tax authorities being considered as a ‘secured creditor’ under the provisions of the Code, as the other issue dealt with in the matter concerning the admission of a belated claim by the Resolution Professional is procedural in nature and has been settled through a catena of judgments.

In the appeal before the Supreme Court, it was contended by the State that, by virtue of Section 48 of the GVAT Act, it shall have first charge on the property of the dealer which is liable to pay tax, interest and/or penalty, and will thus, be a secured creditor under the Code. Accordingly, the outstanding dues, for which recovery proceedings had already been initiated by the State prior to the date of initiation of the Corporate Insolvency Resolution Process (‘CIRP’), and immovable property attached by the State ought to have been considered by the Resolution Professional. It was argued that it was the correct approach especially when the State had made its claim before approval of the Resolution Plan by the Committee of Creditors (‘CoC’). This was based on the premise that the Resolution Plan must conform to the parameters/requirements laid down in the Code, particularly Sections 30 and 31 of the Code and Regulation 36 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“Regulations“). Further, it was argued that the mere fact that a creditor might be an operational creditor would not result in loss of status of that operational creditor as a secured creditor.

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