Banks have a compelling case for an overriding claim on the resources of a defaulting firm after workmen's dues are settled.

Bankers are justified in seeking priority over claims of revenue authorities when a defaulting borrower’s assets are sold in settlement of various dues. Although there are special legislations such as the SARFAESI law — which empowers banks to recover overdue loans by taking possession and selling the securities pledged by the borrowers without going to the courts — their effectiveness, questionable at the best of times, has been further diluted by recent amendments to the Central Excise and Customs Acts. The new provisions, effective since 2011-12, give the taxman the “first charge” over the assets of any firm at the time of recovery or winding up. While the said amendments do recognise the rights of secured creditors, the precedence accorded to recovery of tax dues has, however, given revenues officials leeway to seize and auction the assets of the defaulter, even when these have been offered as collateral against bank loans.

One reason why banks are right in staking claim in the recovery process ahead of the taxman is that it is they who lent the money, which helped create the assets of the firm in the first place. Had it not been for the project and working-capital support from the banks, not to speak of the labour of its employees, the firm would not have even produced the goods or incomes yielding taxable revenues to the Government. In fact, the Companies Act has a clear order of priority in discharge of liabilities at the time of winding-up: Workmen’s dues come first (very rightly), followed by debts to secured creditors, and arrears on account of taxes to Central or State authorities only later. What the Government has been seeking to do through recent legislative amendments is to virtually reverse this order, thereby upsetting well-settled principles of law. These confer importance to enforcement of contracts between parties (in this case, firms vis-à-vis workers or creditors), as opposed to tax demands that are hardly in the nature of pre-existing contracts. It’s high time the Government puts a stop to this business of creating artificial priority of claims. Why should banks lend at all, if they cannot effectively enforce their security interests created by agreements with borrowers?

Enforcement of creditors’ rights is all the more relevant today, when Indian banks are starting to assert themselves even against companies with influential promoters — to the extent of invoking personal guarantees or selling shares pledged by the latter. This process needs encouragement, as part of a necessary transition to a modern, rule-based capitalism where the interest of the ‘system' matters more than that of individual, larger-than-life promoters. Given the catalytic role that banks can play in bringing about this transition, they should be enabled to expeditiously take over the assets of firms and either sell or assign these for others to manage. The SARFAESI Act must clearly provide for no one other than banks to have “first charge” on the collateral held by them.

(This article was published on April 7, 2013)
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