Earlier this month, the Supreme Court of India pronounced judgment (State Tax Officer v Rainbow Papers Ltd) on the status of statutory creditors, such as tax authorities, in corporate insolvency resolution proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC).

In a nutshell, the apex court held that statutory creditors who are granted a charge over the assets of a debtor company by virtue of a statute would be considered secured creditors. The court also held that any resolution plan that waives off such secured statutory dues altogether, would be bound to be rejected by the National Company Law Tribunal as resolution plans must necessarily contemplate the “dissipation of a debtor company’s dues in a phased manner with uniform proportional reduction”.

The court also observed that financial creditors like banks cannot secure their own dues at the cost of statutory dues, or any other dues. With respect, this judgment neither appropriately appreciates the legal design of the IBC nor the policy intent behind its enactment.

Legally, the definition of secured creditors under the IBC is restricted to creditors who are granted security as part of a “transaction”. Disregarding this, the judgment goes on to hold that charges that are deemed to be created by statute and are not created as part of a transaction, are security interests under the IBC.

Moreover, the IBC does not place any requirement that all creditors, regardless of their position, would be paid out under a resolution plan. Instead, it specifically puts in place a test under Section 30(2) to provide the minimum amount that must be paid out to dissenting financial creditors and operational creditors. This amount of payout can be zero.

Any amount that is paid above this minimum, is left to the commercial wisdom of the financial creditors who approve the resolution plan and there is no requirement that this be equal to the amount paid to secured creditors. Despite this, the Supreme Court in this case has gone on to observe that a resolution plan that does not provide for any payment to statutory creditors, or other creditors cannot be accepted.

Key principles disregarded

The Supreme Court’s interpretation in Rainbow Papers also completely disregards two key policy principles encoded in the provisions of the IBC.

The IBC abolishes the preference due to crown debts or government dues and expressly subordinates these dues to financial debts, both secured and unsecured, and dues to employees and workmen. Specifically, the Bankruptcy Law Reform Committee which recommended the enactment of the IBC 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.”

The Committee specifically noted that the Government would benefit even though its dues had been subordinated, as this subordination would lead to greater economic growth and better revenues for the exchequer.

Moreover, the IBC recognises that different types of creditors have different entitlements. Some creditors are not entitled to any pay-outs in the case of a company’s insolvency, because the pool of assets remaining is not enough to pay their dues. Consequently, the court has no jurisdiction to require that all creditors be made payments regardless of their entitlement, and certainly none to require that they be paid in a “uniformly proportional manner”.

Both these policy choices had been respected by the Supreme Court in its previous judgments. In Rainbow Papers, unfortunately, the Supreme Court has not done so.

What is most concerning is that this judgment does not seem to be an outlier. It is yet another in a recent set of Supreme Court judgments that disrupt settled practice under the IBC. The reasons for this change in the Supreme Court’s outlook are up for debate, but what is indubitable is that the judgment in Rainbow Papers will stir up a hornet’s nest.

The writer is a lawyer based in New Delhi

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