Moving up ‘crown debt’

A century ago, the haunting proclamation, ‘The sun never sets on the British Empire’, resonated with a bitter reality.

Today, despite legislative endeavours to downgrade Crown debts to the fifth tier in the waterfall mechanism, the Rainbow Papers case reveals an unsettling prevalence of Crown debts in the resolution process.

A recent well-reasoned Supreme Court order dismissing the petition for reviewing the earlier stance in the Rainbow Papers case only adds to the complexity.

The earlier Order in the same case by the same court was delivered in September 2022, giving a new meaning to the old government dues by treating them as secured creditors for the security interest created by them. IBC follows the waterfall mechanism under section 53 of IBC, that is the sacrosanct portion of the whole IBC system.

Accordingly, the government dues fall squarely in the fifth priority in the order, well after payment to the cost of insolvency, secured creditors, workmen due, and financial debt to unsecured creditors.

The earlier SC order moved the security interest created by the tax authorities to second position thereby completely reversing the understanding of the market.

In simple words, with any amount of government due and the creation of security interest, the priority automatically moves from fifth to second.

At present, GST, Customs, and other central Acts have been aligned to provide the superiority of distribution methodology provided in IBC over the respective dues.

However, there are other State Acts, and municipal tax dues that are not amended to align themselves to IBC.

The confirmation of Rainbow Papers is susceptible to many departments moving applications to treat them as secured government dues even in decided cases.

The entry of government dues into the resolution process introduces a host of complications beyond the mere reshuffling of priorities.

It arrives with a new subset of problems like, debts having no provision of haircuts, the claims coming late in the process of resolution, upsetting commercial wisdom and time, and claims laden with interest and penalties.

Unlike traditional secured creditors who register their security interests, Rainbow Papers, in its order, acknowledges the creation of security interest by operation of law.

The implications extend to any Indian Act — excluding those aligned with the IBC — that can create a charge over government dues, making them de facto secured creditors.

Unknown unknowns

The lack of a systematic method to verify government dues under the operation of law adds a layer of uncertainty, akin to ‘unknown unknowns’.

Any law takes time to settle and creates its path of jurisprudence. These blind spots are deeper than just interpretational issues; they may hurt business decisions. Severe uncertainty like this sets a discouraging tone to investors trying to work out a solution to keep an unforeseen variable open.

Priority of distribution in IBC with government dues being the fifth in the pecking order was the language of business until the same was visited in the Rainbow Papers.

SC ruling of the Pachimanchal Vidyut Vitran Nigam Ltd case which sets the tone in liquidation in such matters brings little light to the resolution process.

This piece of law means business, soaking them with high variability of uncertainty due to interpretation and intricacies, could reduce the confidence of the stakeholders involved.

To put matters of confusion to rest, the lawmakers have a choice to move an amendment to nullify the order.

Alternatively, the petitioner can visit a larger bench with their prayer to review the order for clarity on the context for which the law was brought in.

The writer is a chartered accountant and insolvency professional

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