Significance of SC verdict in State Tax officers vs Rainbow Papers

The recent Supreme Court order in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited & Ors has brought back the attention to its earlier judgement in State Tax officer Vs Rainbow Papers Ltd case.

We take a look at the apex court’s judgement in the State Tax officer Vs Rainbow Papers Ltd case, and why it made all the headlines.

The Supreme Court in the Rainbow Papers case ruled that if a proposed resolution plan does not take into account the statutory dues payable to a governmental entity, the Adjudicating Authority is bound to reject the plan. This means that if a company is not in a position to pay its statutory dues, it will be forced to go into liquidation.

“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 IBC,” the court said in its 6 September 2022.

The Supreme Court’s ruling is a departure from the earlier settled position of law, which held that government dues are subordinate to the debts of secured creditors. The court’s decision has been criticized by some commentators, who argue that it goes against the purpose of the Insolvency and Bankruptcy Code (IBC).

The IBC is a law that was enacted in 2016 to help companies that are struggling financially. The law provides a process for companies to restructure their debts and continue operating, or to be liquidated in an orderly manner.

The Supreme Court’s ruling in the Rainbow Papers case has implications for the way that statutory dues are treated under the IBC. It is now possible for government entities to claim statutory dues as secured creditors, even if their claim is not registered with the Insolvency and Bankruptcy Board of India (IBBI).

This could make it more difficult for companies to restructure their debts and avoid liquidation. It could also lead to increased litigation, as companies and government entities dispute the priority of their claims.

SC ‘corrects’ its mistake

However, the ‘mistake’ in the Rainbow Papers case seem to have been corrected by the court in its verdict in the Paschimanchal Vidyut Vitran Nigam Ltd (PVVNL) case, where the court rejected PVVNL’s argument that the rights of electricity suppliers like PVVNL were not subordinate and subject to the ‘priority of claims’ mechanism under the IBC. PVVNL had relied upon the court’s earlier judgement in the State Tax officer Vs Rainbow Papers Ltd case to further its plea.

The Supreme Court said that the verdict in the Rainbow Papers case did not notice the ‘waterfall mechanism’ under Section 53 of IBC. It further said that Rainbow Papers was in the context of a resolution process and not in context of liquidation.

The court argued that Section 53 of IBC enacts the waterfall mechanism providing for the hierarchy or priority of claims of various classes of creditors.

“The careful design of Section 53 locates amounts payable to secured creditors and workmen at the second place, after the costs and expenses of the liquidator payable during the liquidation proceedings. However, the dues payable to the government are placed much below those of secured creditors and even unsecured and operational creditors. This design was either not brought to the notice of the court in Rainbow Papers or was missed altogether. In any event, the judgment has not taken note of the provisions of the IBC which treat the dues payable to secured creditors at a higher footing than dues payable to Central or State Government,” said the apex court.

Also Read: Section 66 of IBC cannot be used to recover dues from 3rd parties: Supreme Court