Can the government have priority over the assets of the debtor company?

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The Supreme Court, in State Tax Officer v Rainbow Papers Ltd, significantly watered down the strict provisions of the Insolvency and Bankruptcy Code. The case concerns an appeal against an order of the National Company Law Appeals Tribunal (NCLAT) which ruled that the Government of Gujarat cannot claim the first charge on the property of a debtor company, under the Section 48 of Gujarat Value Added Tax, 2003.

The Gujarat government’s claim of ₹47.36 crore was overturned by the resolution professional. The state government challenged the resolution plan in the National Company Law Tribunal (NCLT) and asked to be treated as a secured creditor. The request was rejected by NCLT and later also by NCLAT.

The issue before the Supreme Court was whether or not Section 53 of the Code, which explains how each class of debt is to be apportioned among claimants, trumps Section 48 of the GVAT.

The Supreme Court quashed the NCLAT order, along with the creditors’ committee resolution plan, and allowed the Gujarat government’s appeal.

He also reiterated that the three-day time limit to file a claim under Rule 12 was not mandatory and was only a guideline. Accordingly, the resolution professional will be required to include the claim filed even before the creditors’ committee meets to approve the proposed resolution plan.

This mechanism will disrupt the resolution process as no information memoranda can be finalized and therefore no finalized resolution plan can be submitted.

The Supreme Court further held that under section 48 of the GVAT, Gujarat’s claim fell within the definition of “security” under section 3(31) of the code. Thus, the state becomes a “secured creditor” under article 3(30) of the code. The creditors’ committee cannot guarantee its rights to the detriment of the statutory rights owed to the governmental authorities.

However, in our view, the legal charge created under the GVAT Act would not constitute security and does not make government agencies a secured creditor. Indeed, “security”, as defined in Article 3(31) of the IBC, must be created by means of a “transaction in writing” and the word “transaction”, in accordance with Article 3 (33), includes an agreement or arrangement. in writing for the transfer of assets or funds, goods or services to or from the debtor company. Security must be created by a “written transaction” between the parties and does not include encumbrance created by law.

As the Supreme Court has ruled that Section 48 of the GVAT Act is not contrary or inconsistent with Section 53 or any other provision of the code, debt owed to a government agency will have the same rank under the section 53(1)(b)(ii) ) of the code, with other secured creditors and workers for their specified rights.

This judgment has serious consequences and will classify government contributions between those guaranteed by a statutory charge and those which are not. Guaranteed contributions would now fall under Article 53(1)(b)(ii) of the code, instead of Article 53(1)(e)(i), which would significantly reduce the collection of contributions by banks and financial institutions.

A motion for review has been filed.

(The editors are respectively Managing Partner and Partner at SNG & Partners, a law firm)

Published on

September 25, 2022

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