Conundrum on Priority of Government Dues

The Insolvency and Bankruptcy Code envisions a mechanism aimed towards maximising the value of assets of corporate debtors and balancing the interests of all stakeholders. At the first instance, these objectives are met through the corporate insolvency resolution process, failing which the liquidation of assets takes place. The code provides for a waterfall mechanism for distribution of proceeds from the sale of the assets of the CD during Liquidation under Section 53 and also ensures minimum payment to operational creditors, including government dues, during CIRP, addressing the aforementioned objectives.

The order of priority under Section 53 ranks government dues at a lower priority as compared to secured creditors in line with the objectives of the IBC. However, an interesting question arose on the treatment and priority of the government dues in the event a ‘charge’ is created over the asset(s) of the corporate debtor. The question was initially sought to be addressed by the Apex Court in State Tax Officer v. Rainbow Papers Ltd. However, the Apex Court, recently, in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd, restricting the scope of Rainbow Papers (supra), has observed that the judgment in Rainbow Paper (supra) is limited to the facts of the said case, thereby, creating uncertainty regarding the priority of government dues under IBC where a charge is created under a statute.

Statutory Provision

Section 53 stipulates the order of priority for distribution of the proceeds from sale of assets of the liquidation estate of a corporate debtor. The priority of the amount due to the government (Central and State) is ranked much lower than the dues of the secured creditors.

Application during CIRP and Liquidation

Even though, Section 53 deals with the priority of distribution of proceed from the sale of liquidation assets in Liquidation process, however, the provisions find equal relevance during the CIRP, more particularly while dealing with creditors in the Resolution Plan.

During the Liquidation Process, a secured creditor has an option to either relinquish or realise its security interest under Section 52(1).  The decision to realise the security interest would determine the ranking, for the unpaid dues, of the said secured creditor under ‘waterfall mechanism’ enumerated under Section 53. Interestingly, Section 53(1)(e) ranks the government dues at par with the dues owed to a secured creditors for any amount unpaid following the enforcement of security interest under Section 52(1)(b).

Rationale

The order of priority under Section 53 is in-line with the global practice and corresponds to the objectives of the Insolvency and Bankruptcy Code as recommended by the Bankruptcy Law Reforms Committee Report, 2015. The said report observes that across different jurisdictions, the secured creditors, invariably, are ranked highest in the order of priority for distribution of the proceeds from the sale of the assets of the debtor. The rationale behind the government dues being ranked below the financial dues of the unsecured creditors is to promote the availability of credit, developing a market for unsecured financing, reducing the cost of capital, promoting entrepreneurship and ensuring faster economic growth.

The Report of the Insolvency Law Committee, 2020 notes that the ‘waterfall mechanism’ is aimed at promoting a collective liquidation process to encourage the secured creditors to relinquish their security interest(s), for the benefit of all the stakeholder and value maximisation of the assets of the debtor.

Background

The Apex Court was confronted with a peculiar question as to whether the government dues, secured by a ‘charge’, under a statute, over the assets of the corporate debtor, would rank at par with the priority accorded to the dues of other secured creditors. The Apex Court had the occasion to deliberate on the interplay between Section 53 of the IBC and Section 48 of the Gujarat Value Added Tax Act, 2003. Section 48 of GVAT Act declares that the tax payable to government shall be a first charge on the property of such debtor, therefore, the question that arose for consideration was whether the charge/security created under the GVAT Act would have the effect to alter the rank of government dues under Section 53.

Judgement

The Apex Court was of the opinion that the main issue is not whether the provisions of Section 48 of the GVAT Act override the provisions of Section 53, but, on the contrary, whether the government dues could be treated as ‘secured debt’ and the government a secured creditor.

The Apex Court, after considering the contentions, held that the Section 48 of the GVAT Act is not contrary to or inconsistent with Section 53 or any other provisions of IBC. Thus, the government dues would rank at par with the debts owed to secured creditors. In support of the treatment of the government as a secured creditor, the Apex Court also noted that firstly, a security interest could be created by operation of law and secondly, the definition of secured creditor does not exclude any Government or Governmental Authority. That the judgment in Rainbow Paper (supra) endeavoured to clear the uncertainty around the priority of government dues where a security had been created by operation of law. However, the Apex Court in PVVNL (supra) has observed that the judgment in Rainbow Paper (supra) is confined to the facts of that case alone. 

Background

In PVVNL (supra), the Apex Court was dealing with the question of priority of dues of an operational creditor having a first charge, created by a statue, on the assets of the corporate debtor. Clause 4.3(f)(iv) of the Uttar Pradesh Electricity Supply Code, 2005, stipulates that any outstanding dues will be first charge on the assets of the company.

Judgement

The Apex Court reiterated that Section 238 of the IBC overrides the provisions of the Electricity Act, 2003 in view of the judgements in Sundaresh Bhatt, Liquidator of ABG Shipyard v. Central Board of Indirect Taxes and Customs and Duncans Industries Ltd. v. AJ Agrochem.

The Apex Court observed that a ‘charge’ could be created by either statutory provisions or regulations. Accordingly, the Apex Court held that in the present case, a charge was created on the assets of the corporate debtor by virtue of Clause 4.3(f)(iv), as well as under the agreement between the parties, and therefore PVVNL qualified as a ‘secured creditor’. At the same time, the Apex Court in view of the functions and private participation in PVVNL observed that dues or amounts payable to PVVNL do not qualify as ‘government dues’ under Section 53(1)(e) of the IBC. The Apex Court proceeded to hold that dues payable or required to be credited to the Treasury, such as tax, tariffs, etc., which broadly fall within the ambit of Article 265 of the Constitution are ‘government dues’.

The Apex Court went a step further and examined the question of the order of priority of secured ‘government dues’ vis-à-vis the order of priority under Section 53. The Apex Court while analysing the judgment passed in Rainbow Papers (supra), observed that the GVAT Act, no doubt creates a charge in respect of amount due and payable, however, Section 53 creates a separate and distinct treatment of amounts payable to secured creditor on the one hand, and dues payable to the government on the other, thereby clearly signifying the Parliament’s intention to treat the government dues differently from the dues of secured creditors. Thus, the ‘government dues’, whether secured or unsecured, would be covered under Section 53(1)(e) of the Code, being a distinct and separate class.

PVVNL (supra), has, once again, created doubt around the treatment and priority of government dues by observing that the judgment in Rainbow Papers (supra) is confined to the facts of that case alone, therefore, holding that charge created by a function of a statute in the case of ‘government dues’ will have no bearing on the status of priority of such dues.

Although, the judgment in PVVNL (supra) seems to be well-reasoned, it has been passed by a coordinate bench of the Apex Court which had passed the judgment in Rainbow Papers (supra), therefore, it remains to be seen whether it would have an effect of superseding the observations regarding the treatment of ‘government dues’ in Rainbow Papers (supra).

The Ministry of Corporate Affairs by its Notice dated January 18, 2023 has invited public comments with respect to certain changes being considered to the IBC. The Notice attempts to clarify that the concept of security interest was intended to cover a consensual transaction between the parties and not any similar interest created through mere operation of a statute. The Notice conveys the intention of MCA to consider all unsecured creditors (FCs, OCs, and any government or authority) other than the workmen and employees shall be treated equally for distribution under Section 53. It was further conveyed that it is also under consideration 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. The Paper suggested another class of government dues where the security interest is created pursuant to a transaction of the Central Government or a State Government with corporate debtor, thus entitling the Government to be treated as a secured creditor in the order of priority.

It seems that the said notice was not brought to the notice of the Apex Court in PVVNL (supra), however it would be interesting to see how the Legislature aims to strike a balance between the suggestions made in Notice and the judgments passed in PVVNL (supra) and Rainbow Papers (supra).

Sandeep Bajaj is an Advocate practicing before the Supreme Court of India.

Vipul Jai is a Partner at PSL Advocates & Solicitors.