An analysis of State Tax Officer vs Rainbow Papers Limited verdict

In the case of State Tax Officer (1) v. Rainbow Papers Limited (Rainbow Papers), the Supreme Court has provided its ruling on the crucial issue of priority of government dues secured by a statutory charge.

Key facts

In this case, the appellant (State Tax Officer (1)) had contended that it is a ‘secured creditor’ within the meaning of the Code, as it had a first charge on the property of the CD on account of section 48 of the Gujarat Value Added Tax, 2003 (GVAT Act). The said section 48 of the GVAT Act provides that any amount payable by a person under the GVAT Act shall be first charge on the property of such person. The Supreme Court, thus, dealt with the fundamental question of whether a government authority should be treated as ‘secured creditor’ under the Code on account of a statutory charge. The Supreme Court further considered if section 53 of the Code would override section 48 of the GVAT Act.

The ruling

The Supreme Court, in this case, held that the definition of the term ‘secured creditor’ under the Code is broad and expansive to include all forms of security interests, including a statutory charge as provided under section 48 of the GVAT Act. The Supreme Court held that ‘security interest’ includes a security created by the operation of law and that a government authority with a statutory charge would be treated as a ‘secured creditor’ under the Code. The Supreme Court further noted that the definition of ‘secured creditor’ under the Code does not provide for any exclusion of government authorities. Accordingly, the claims of government authorities with a statutory charge would be accorded priority as ‘secured creditors’ in terms of section 53(1)(b)(ii) of the Code. The Supreme Court also did not find any inconsistency between section 48 of the GVAT Act and any provision of the Code, including section 53. The Supreme Court held that if a resolution plan excludes statutory dues payable to the government or a government authority or a legal authority, altogether, the NCLT is bound to reject such a resolution plan.

Examination

Under the Code, ‘secured creditor’ has been defined as ‘a creditor in favour of whom security interest is created.’ Whereas ‘security interest’ has been defined as the ‘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.’ As the definition of the term ‘security interest’ only refers to creation of security interest by way of a ‘transaction’, which has been defined to include an ‘agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor’, it has been argued that a government authority having a security pursuant to a statutory charge, cannot be deemed to be included under the definition of a ‘secured creditor’. On the other hand, it may be argued that the definition of ‘transaction’ is inclusive in nature and does not negate the possibility of including an arrangement creating a statutory charge. Further, the definition of the term ‘secured creditor’, as provided under the Code, is broad and expansive, and thus, should include a government authority holding a security pursuant to a statutory charge. While there are two plausible interpretations applicable in respect of the scope of the term ‘secured creditor’, Rainbow Papers did not consider the definition of ‘transaction’ under the Code while providing a broad and expansive definition to the term ‘secured creditor’, to include government authority holding security interest created by the operation of law. Notably, this case also failed to consider and appreciate the specific inclusion of ‘government dues’ under section 53(1)(e)(i) of the Code, providing for a lower priority to payment of government dues, i.e., after payment of, inter alia, workmen’s dues, debts owed to secured creditors, wages, and unsecured financial debts, adding further complexity on arriving at a correct textual construction on what the intended priority for such secured government dues is under the Code. In our view, the intended effect of the provisions of the Code on the issue of priority to such secured government dues is best discernible keeping in view certain key principles of the Code, namely according a lower priority to the payment of government dues and increasing the availability of credit in the economy. The Code itself under section 53(1)(e)(i) specifically provides for priority to be accorded to government dues. The expression ‘any amount due to the Central Government and the State Government’ used in section 53(1)(e)(i) will include any amounts owed to the government regardless of whether they are secured or not. Further, the said provision makes no distinction between secured or unsecured government dues, and therefore, in our view, it must necessarily include ‘secured government dues’ pursuant to a statutory charge. Such an interpretation finds justification and support in the preamble of the Code and its legislative history.

The Preamble to Code provides:

An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.

The BLRC Report also provides the rationale behind altering the order of priority of payment of government dues in the following terms:

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.

Further, the then Minister of State in the Ministry of Finance, Mr. Jayant Sinha, while introducing the bill for the Code on the floor of Lok Sabha, had provided the justification for according a lower priority to government dues in the following terms:

There was another question that was asked is this. Why is it that the Government comes after employees in secured creditors in this waterfall? The answer to that is because we want the people to come first with secured creditors because after all it is depositors’ money; it is tax payers’ money as Satpathy was pointing out. Obviously, employees are most dependent and most vulnerable. So, we put the most dependent and the most vulnerable tax payers’ money ahead of the Government which has other ways of borrowing money and we put the Government next after these two creditors in the waterfall.

The report of the Insolvency Law Committee dated March, 2018 also notes the following, in response to the subject of according a lower priority to government dues: The present priority given to debts owed to Central and State Governments in section 53 is in line with the recommendation provided in the BLRC Report and has been stated to be in line with the global best practices. Further, the UNCITRAL Legislative Guide on Insolvency Law also provides that many jurisdictions give low priority to state dues. The intention behind this is to give benefit of payment to other creditors who have taken risks while giving loans or providing debts.

Also See: Landmark Judgements

From the above, the intention of the legislature is clear. Government dues were intended to be accorded a lower priority in the distribution waterfall mechanism, especially in order to stimulate the availability of credit and promote entrepreneurship. In fact, one of the fundamental purposes for the introduction of the Code was to enhance the credit availability in view of our economy having one of the lowest levels of credit availability in comparison to its size. The specific inclusion of government dues in section 53(1)(e)(i) clearly reflects this intention in the statutory provisions of the Code.80 Once due recognition is given to this object, it is clear that section 53(1)(e)(i) puts the ranking of any government dues including secured government dues pursuant to statutory charge, firmly below that of secured creditors who have extended credit in any form to the CD.

Further, section 53(1)(e)(i) is a special provision governing statutory creditors, including secured statutory creditors, whereas section 53(1)(b)(ii) is intended to be the general provision governing secured creditors. It is a settled principle of law that in case of a conflict between a special provision and a general provision within the same statute, the special provision must prevail.

In addition, any statute that seeks to disturb this ranking must necessarily be in conflict with the Code, and the Code would override such provision of the statute in light of section 238 of the Code.The construction provided in Rainbow Papers appears to have limited itself to the literal examination of the definition clause of ‘secured creditor’ and appears to have failed to appreciate the legislative history and the stated objects of the Code. However, if a principle-based approach, taking into account the object and purpose of the Code as well as the reflection of this intent in section 53(1)(e)(i), is adopted, then the term ‘secured creditors’ cannot be provided with an expansive meaning to include statutory creditors holding security pursuant to a statutory charge, as such an interpretation is directly incompatible with the principles and the scheme of the Code. In this regard, it is pertinent to note that as on March 15, 2023, a review petition has been filed against the judgment of the Supreme Court in Rainbow Papers.

Further, on January 18, 2023, the Ministry of Corporate Affairs invited public comments on ‘changes being considered to the Insolvency and Bankruptcy Code, 2016’ (MCA discussion paper), wherein, inter alia, it has been proposed that a clarification can be included in the Code that statutory dues secured by a statutory charge, should be treated equally with other unsecured creditors in order to nullify the effect of Rainbow Papers.

This analysis has been done by L Viswanathan, Animesh Bisht and Karan Sangani, and it first appeared in IBBI’s publication Navdrishti: Emerging Ideas of IBC