"Balancing Priorities: Supreme Court's Review of Secured Creditors vs. Government Dues in the IBC"

"Balancing Priorities: Supreme Court's Review of Secured Creditors vs. Government Dues in the IBC"

Author:- Ayushi Mishra, a Student of Jitendra Chauhan College of Law

Introduction

The ongoing review by the Supreme Court of India regarding the hierarchy of creditors under the Insolvency & Bankruptcy Code, 2016 (IBC) has brought to light a critical legal and economic debate. The central question revolves around whether debts owed to secured creditors should take precedence over dues owed to the Central and state governments. This issue gained prominence due to the judgment in Sales Tax Officer v. Rainbow Papers, which is now under reconsideration. This article delves into the intricacies of this legal conundrum, examining the historical context, legislative intent, and economic implications.

Historical Precedents

In addressing the question of creditor hierarchy, it's essential to acknowledge the historical legal framework. English common law traditionally recognized the supremacy of government dues, known as "crown debts," over those of ordinary citizens. This principle prevailed when government dues and citizen debts of equal degree competed for payment. However, it is vital to clarify that this precedence applied only to unsecured creditors, not secured debts.

India followed this legal tradition, first by High Courts and later affirmed by a Constitution Bench of the Supreme Court in Builders Supply Corporation v. Union of India. The legislative history of the Companies Act, 1956, also mirrored this order of priority, ranking government dues below workmen's dues and debts owed to secured creditors.

Legislative Intent and Economic Considerations

The Bankruptcy Law Reforms Committee (BLRC) was tasked with designing India's insolvency resolution regime. The BLRC extensively debated the priority of payments to various stakeholders in case of liquidation. It recommended that government dues be ranked lower than workmen's dues and secured debts. The rationale behind this recommendation was to prioritize maximizing debt recovery for secured creditors, typically banks and financial institutions, to ensure a stable financial system and encourage lending and entrepreneurship.

Elevating government dues to parity with or above secured creditors could limit their debt recovery potential, leading to adverse consequences such as higher interest rates for borrowers. These recommendations were subsequently incorporated into the IBC, specifically in Section 53, which outlines the waterfall mechanism for distributing proceeds upon liquidation.

The IBC's Waterfall Mechanism

Section 53 of the IBC establishes a clear order of priority for distributing proceeds in the event of a corporate debtor's liquidation:

1. Insolvency resolution process costs and liquidation costs

2. Workmen's dues and dues of secured creditors who have relinquished their security interest (ranked equally)

3. Unpaid dues of employees other than workmen

4. Financial debts owed to unsecured creditors

5. Dues owed to Central and state governments and unpaid debts of those secured creditors who have enforced their security interest (ranked equally)

6. Any remaining debts and dues

7. Preference shareholders

8. Equity shareholders

Secured creditors who relinquish their security interest are accorded higher priority than government dues. Furthermore, the IBC prioritizes even financial debts of unsecured creditors over government dues to maximize debt recovery and free up stressed assets.

The Rainbow Papers Judgment and Its Implications

In the case of Rainbow Papers, the Supreme Court faced a VAT demand by the Gujarat government against the corporate debtor, Rainbow Papers Ltd. The Court ruled that the government's dues, by virtue of Section 48 of the Gujarat Value Added Tax Act, were secured debts and thus enjoyed pari passu priority of payment with other secured creditors and workmen. Consequently, the resolution plan and National Company Law Tribunal's approval were set aside for not accommodating the government's dues.

However, this interpretation appears to overlook the essence of a "secured creditor" under the IBC, defined as one with a security interest created through a voluntary transaction. A government's statutory right to a first charge on a defaulter's assets doesn't necessarily make it a secured creditor under the IBC.

Furthermore, Parliament amended other related laws, explicitly stating that secured creditors' debts take priority over government taxes and dues, signaling its intent to prioritize secured creditors over government dues.

Conclusion and Way Forward

The Supreme Court's reconsideration of the creditor hierarchy in the IBC presents a crucial juncture for aligning legal interpretations with legislative intent. The IBC's waterfall mechanism, meticulously crafted to bolster the economy and financial stability, emphasizes the importance of secured creditors' rights.

While the Court's concern for government dues is valid, the IBC represents an economic legislation shaped by experts and endorsed by Parliament. A judicial hands-off approach in this matter is essential to prevent potentially devastating economic consequences.

Notably, the Ministry of Corporate Affairs has proposed amendments to the IBC to clarify that government's statutory rights to first charges do not elevate them to secured creditor status. This move is in line with the legislative intent and the need to maintain a balanced and stable financial ecosystem.

In the ongoing review proceedings, all eyes are on the Supreme Court's decision, as it has the power to harmonize legal interpretations with the broader economic interests of the nation. Ultimately, the resolution of this legal debate will have far-reaching implications for India's insolvency and bankruptcy framework and the overall health of its economy.