The September 2022 ‘Rainbow papers’ judgment (State Tax Officer vs Rainbow Papers Limited) of the Supreme Court is back in the news because a petition seeking a review of the order has recently been dismissed. The Rainbow Papers ruling has raised doubts over the priority to be accorded to dues owed to government entities — in other words, on where they should lie in the pecking order or ‘waterfall mechanism’ spelt out under Section 53 of the IBC — in the event of resolution or liquidation. The Rainbow Papers ruling creates scope for pushing government dues up the ‘waterfall’ from the fifth place to second place, on a par with secured creditors; this is because the apex court ruled that VAT payable by the entity provided the government with a charge on its assets. The question is whether the government (Centre and States) can be assigned the status of a secured creditor in all cases.

This is an important issue, and the stakes are high for all claimants. With even secured creditors (in second place) taking steep haircuts in most cases, it is apparent that the waterfall system will have much less left for those in fifth place or below when the government works its way up the order. The Centre, going by a paper put by the Ministry of Corporate Affairs this January on proposed changes in the IBC, is wary of government dues going up the ladder. It would ramp up the cost of resolution and act as a deterrent to investors.

The IBC has arguably been conceived with a view to promoting smooth resolution of debt through private initiative. The Paschimanchal Vidyut Vitran Nigam Ltd (PVVNL) v/s Raman Ispat ruling of the SC in July 2023 does refer to the downplaying of crown debts as a feature of the IBC law. Its view on the status of government dues would seem to differ from the Rainbow Papers ruling. While noting that electricity dues cannot qualify as a secure charge on the company’s assets (unlike taxes in the Rainbow Papers), it has also observed that the IBC waterfall mechanism should ideally prevail over any statute that governs dues to State agencies. In its view, Section 53 of the IBC quite deliberately places Central and State government dues in fifth place, after meeting resolution costs, dues to workmen and “secured creditors”, dues to other employees and financial unsecured creditors. The petition seeking a review of Rainbow Papers referred to the PVVNL ruling to make out a case. But the apex court dismissed the petition, saying that the PVVNL ruling cannot be construed as going against Rainbow Papers.

The MCA suggests a way out of this mire by amending the IBC law. It suggests that all unsecured creditors other than employees — financial creditors, operational creditors and government — should be treated equally under Section 53. ‘Secured’ claims by government can be restricted to ‘transactions’ involving specific agreements, without a statute coming into play. These changes brook no delay.