Crown Debt Vs Other Debts – The Legislative Intent

Recently the Hon’ble Supreme Court vide the Judgment in the matter of State Tax Officer Vs. Rainbow Papers Limited, 2022 SCC OnLine SC 1162 while interpreting Section 48 of the Gujarat Value Added Tax, 2003 has held that charge created in favour of the authority/State under a Statute, would make the State a Secured Creditor for its dues and ought to be accorded priority in payment under the waterfall mechanism under Section 53 of the Code. In the particular case, the dues arising out of GVAT were treated as Secured Dues, and as such the dues were treated at par with dues of the Secured Financial Creditors, as per the waterfall mechanism as envisaged under the Insolvency and Bankruptcy Code, 2016.

As a result of the interpretation given by the Hon’ble Supreme Court the status of the statutory dues/crown debt, which had to be treated as unsecured under the IBC, till now, have suddenly been altered. The Court has gone to hold that in case a Resolution Plan ignores the statutory demands payable to any State Government or Central Government, the NCLT is bound to reject such Resolution Plan. The Court has further held that if a Company is unable to pay its debts which should include the statutory dues to the Government and/or to any other Authorities, and the Resolution Plan also does not deal with these debts in a phased manner or uniform proportional reduction, then the Company would necessarily have to be liquidated and its assets sold and distributed in the manner stipulated under the IBC.

The said interpretation given by the Hon’ble Supreme Court has cast cloud not only on the Resolution Plans which are pending approval before the various National Company Law Tribunals but also on the resolution of cases in future.

Analysis of the brief history of the Insolvency & Bankruptcy Code, 2016 (‘Code’) would show that the legislature in its wisdom had decided to alter the priority in the distribution mechanism (waterfall provision) by bringing the statutory dues/crown debt belonging to the Government at a lower pedestal than the dues belonging to the Secured Creditors.

The Bankruptcy Law Reform Committee was formed (“BLRC” or the “Committee”) was set up by the Department of Economic Affairs, Ministry of Finance, under the Chairmanship of Mr. T.K. Vishwanathan to study the corporate bankruptcy legal framework in India and submit a report to the Government.

In its Interim Report, the Bankruptcy Law Reform Committee in February 2015, made recommendations to uphold the priority rights of Secured Creditors on the security interest and observed that the preference for crown debt could be traced back to UK where the crown was entitled to an absolute priority for revenue related debts in the event of insolvency of a subject.. The Committee recognised the fact that where the tax or revenue payable to the Government is by virtue of a specific statutory provision made as a first charge on the assets of the assessee, such tax or revenue gets priority over the Secured Creditors as well. In view of the same the committee appreciated the fact that the amendment was required for protecting the interest of secured creditors.

The final report of the Bankruptcy Law Reforms Committee was submitted in November 2015 which made a significantly important recommendation to keep the priority of payment of dues to the Central and State Government below the unsecured financial creditors in the waterfall mechanism. The rationale of the Committee was that such altered priority would increase the availability of finance, reduce the cost of capital, promote entrepreneurship and lead to a faster economic growth. It also recognised that the revival would also eventually mean that the Government will be beneficiary of the economic growth which should also increase the eventual revenue to the exchequer.

Late Finance Minister Sh. Arun Jaitley while addressing a debate on the Insolvency & Bankruptcy Bill before the Lok Sabha on 22.12.2015 stated that the intent of the Government was to change the priority, as to how the money will be distributed. He categorically stated that while distributing the money, the workmen will get their dues first for a period of one year which will be at par with some other secured creditors. After that the unsecured creditors will come and thereafter taxation authorities will come. The rationale for bringing the taxation authorities lower in the priority order was because if the taxation authorities were brought on top they would part with substantial or whole of resolution amount and workmen, banks and financial institutions would not get anything. He admitted that the Government by virtue of this was taking a big hit and admitted that money going into the office of the Government could go down in priority so that the other claimants namely workmen, secured creditors and other creditors go up higher up in priority.

Similar views were echoed by Mr. Jayant Sinha in the Lok Sabha debate held on 5.5.2016 while answering to the query as to why the Government dues would come after the dues of employees and the secured creditors in the waterfall mechanism. Mr. Sinha categorically admitted that the intent of the legislature was that the money should come first to with secured creditors because the money belonging to the secured creditors was after all the depositors money and taxpayers money. That is the reason that the Government has put the most dependent and most vulnerable taxpayers money ahead of the Government, which has other ways of borrowing money and because of that the Government has been put below in waterfall mechanism

Significantly, the above intent of the legislature, to bring down the crown debt lower in priority, also finds mention in the statement of objects and reasons of the Insolvency and Bankruptcy Code, 2016. The statement of objects and reasons duly records the alteration in the priority of payment of Government dues and which forms the basis of Code.

In fact, the notes on clauses appended to the Bill while clarifying Section 53 which envisages distribution of money, also recognise this intent of the Legislature.

However, the Hon’ble Supreme Court of India while passing the judgment, has interpreted the Code in such a way which has suddenly bought the Crown Debt way up in priority. The interpretation given by the judgment has unexpectedly got the Government Departments, who never even claimed themselves to be secured creditors, as suddenly clamouring and filing applications claiming themselves to be secured creditors, apart from mounting challenges to the approved Resolution Plans by the Committee of Creditors and the NCLT’s.

The interpretation given by the Hon’ble Supreme Court does not correctly reflect the intent of the legislature however, till such time the judgement is either reviewed or altered by a larger bench it remains as law of the land.

In this scenario, there remains a huge question mark over not only the approved Resolution Plans but also pending Resolution Plans. With such an interpretation being given by the Hon’ble Supreme Court which has altered the waterfall mechanism, the resolution of Companies is in jeopardy. However, in the meantime it would be prudent for the Government to either amend the Code to clarify the position regarding the statutory dues / crown debts and to restore the original position in the distribution under waterfall mechanism as per Section 53 of the Code.

The author is an Advocate at Delhi. Views are personal