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Revitalising Revenue: A Critical Analysis of the Treatment of Statutory Dues in the Insolvency and Bankruptcy Code, 2016

Updated: Sep 22

- Natasha Mittal, Second-year Law student at National Law University, Patiala.




Introduction

The Insolvency and Bankruptcy Code, 2016 [“IBC”] is a ground-breaking legislation which aims to create a single and comprehensive framework that would provide a time-bound and cost-effective process for resolving insolvency and bankruptcy. Under the IBC, statutory dues primarily refer to liabilities owed to the Central and State Governments, as well as municipal authorities, in the form of taxes, levies, and other charges. The article seeks to examine on whether the current treatment of statutory dues aligns with principles of fairness, efficiency, and economic stability as envisaged by the IBC. The same is analysed with a particular focus on the legislative amendments that grant statutory dues a greater priority in the hierarchy of claims, akin to financial creditors, to ensure more equitable treatment and enhance recovery rates for the government.

Hierarchy of claims : role of statutory dues

The role of statutory dues and their position in the hierarchy of claims under the IBC underscores the challenges faced in crafting a balanced insolvency resolution framework. Statutory dues are obligatory payments that are mandated by various statutes which are crucial for government’s revenue collection and public expenditure.  They are legally defined within the ambit of “operational debt”.  Therefore, a creditor to whom such a debt is owed either directly or by way of assignment or transfer is classified as operational creditors.

Before the introduction of the IBC, the Supreme Court's decision in Dena Bank vs Bhikhabhai Prabhudas Parekh & Co. established that secured creditors are to be prioritized over government dues. The introduction of the Insolvency and Bankruptcy Code (IBC) further established a structured hierarchy with secured creditors at the top for the distribution of funds during liquidation through the waterfall mechanism as defined under Section 53. This hierarchy ensures that creditors will be paid in a systematic and transparent manner, protecting their rights and preventing disputes.

Conversely, regulatory dues have been denied the safeguard granted to operational debts in cases of default as evident in BSE Limited v. Asahi Infrastructure & Projects Limited, wherein the NCLAT upheld the NCLT's decision to dismiss the appellant's Corporate Insolvency Resolution Process (CIRP) application due to non-payment of listing fees, categorizing these fees as regulatory rather than operational debts. Hence, on one hand, operational debts are given precedence over other types of debts but on the other hand, regulatory fees do not receive the same level of protection as operational debts in cases of default.The statutory dues come after the claims of secured creditors, wages, and employee dues and before unsecured and preference shareholders. The point of contention here is that if a company owes vast amounts in statutory dues, but also has substantial secured and unsecured financial debts, the government might receive a miniscule portion or even nothing by the time its turn comes in the waterfall mechanism. These funds are essential for the functioning of the state and fulfilling its sovereign obligations. Economic stability and growth are further supported by public expenditure that is funded through statutory dues. Public investment, driven by these funds, acts as an economic stimulus, creating jobs and spurring economic activity. Additionally, revenue generated from statutory dues help service national debt, maintaining fiscal health and investor confidence. Hence, recovery of statutory dues is crucial.

Committee of Creditors and Resolution Planning

Historically, the Committee of Creditors (CoC), a group crucial to decision-making during insolvency proceedings, did not allow statutory authorities to vote. The resolution plan lays out a blueprint for the debtor's comeback and specifies how different creditors will be paid back. Such a plan must prioritize costs associated with the insolvency resolution process over all other claims. Given the hierarchy of importance, it would be prudent to make accommodations for statutory dues in order to comply with the IBC.

However, the settlement process in IBC often takes precedence over the statutory dues. A notable example is the ruling in Ghanashyam Mishra and Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Ltd., wherein the Apex court held that the claims formulated in the plan of resolution are valid and binding against the company's debtors and their employees, members, creditors, and the central and state governments once the resolution plan has been duly approved by the judicial authority in accordance with Section 31(1) of IBC. Hence, if relevant departments of the Central or State Governments do not submit a proof of claim form to the Resolution Professional (RP) or the Interim Resolution Professional (IRP) or participate in the settlement procedure, their rights are immediately extinguished. This application is necessary to assert their rights regarding statutory dues, such as taxes, levies, or other charges owed by the corporate debtor.

The Madras High Court used a different logic in M/s. Ruchi Soya Industries Limited v. Union of India and Anr., holding that "a tax once ascertained to be paid in compliance with the law is a sovereign debt" and that "tax and duties levied and collected under law can never be treated as operational debt as defined in Section 5(21) of IBC, 2016." This ruling contradicts the express interpretation in Section 5(21) of IBC, which specifically states that statutory dues are operational debts. The court’s interpretation that statutory dues are sovereign debts implies that these payments, due to their nature as taxes levied under law, should be treated differently from operational debts. This perspective reflects the view that sovereign debts, such as taxes, hold a higher or different priority in insolvency proceedings due to their importance in maintaining government functions and services.

In accordance with the prior judgements, the State's rights as an operational creditor are constrained by the waterfall mechanism and the resolution plan guidelines.

Examining the role of moratorium

Due to the lacunes of the waterfall mechanism, the moratorium serves as a protective shield for corporate debtors against coercive recovery actions during the insolvency resolution period, ensuring that the process unfolds smoothly. A moratorium during an insolvency or liquidation proceeding temporarily halts certain actions and legal processes against the debtor. The moratorium is automatically triggered once the National Company Law Tribunal (NCLT) admits a case for corporate insolvency resolution. Once liquidation proceedings commence (after the failure of CIRP or the resolution professional's recommendation for liquidation), the moratorium under Section 33(5) takes effect. Unlike during CIRP, the moratorium in liquidation applies to both proceedings initiated against the corporate debtor and those initiated by the corporate debtor. This ensures that no new proceedings, whether brought by or against the debtor, can be initiated during liquidation.

The primary objective here is evident: to provide the struggling entity with a brief reprieve while making sure that no external coercions interfere with the resolution procedure. This provision aims to shield the corporate debtor from financial attacks and optimize asset recovery. However, Section 14(1)(a) of the IBC does not restrict the corporate debtor's right to initiate or maintain litigation, as clarified by recent rulings such as NDMC v. Minosha India Ltd. This is contradictory to the provisions under Section 33(5) of the IBC, which extends the moratorium to include proceedings initiated by or against the corporate debtor during liquidation.

This broad interpretation of Section 14 creates complexities, particularly concerning scenarios where a corporate debtor initiates legal action before commencement of the Corporate Insolvency Resolution Process (CIRP), potentially halting subsequent appeals by the defendant. Section 14 of IBC imposes a moratorium on legal proceedings against a corporate debtor during the CIRP, barring the initiation or continuation of suits, proceedings, or enforcement actions. This issue necessitates defining the scope of "proceedings against the corporate debtor" to exclude defensive actions, consistent with interpretations under earlier company laws. For instance, under Section 171 of the Companies Act, 1913, defensive actions were typically allowed during legal proceedings against a company. These included actions taken to prevent immediate harm or to assert legal rights necessary for the company's survival.

Similarly, in the context of IBC's Section 14, such defensive actions could include filing responses to legal notices, defending against unfounded claims, or securing necessary approvals for ongoing business operations.  The utility of this proposed definition lies in its ability to strike a balance between the rights of creditors seeking repayment and the need to ensure a fair and orderly resolution process for the debtor. By allowing essential defensive actions, the moratorium can function effectively without unduly impeding the debtor's ability to manage its affairs and participate meaningfully in the CIRP.

Impact on Economic Stability and Recommendations

The introduction of IBC marked a colossal shift in India's approach to insolvency and bankruptcy. However, the handling of statutory dues has generated several discussions and differing (and contradictory) legal interpretations that also discourages lenders from making loans or offering services on credit out of concern regarding lesser recoveries in case of insolvency.

Hence, a new category of creditors has been acknowledged through the introduction of Form F,  that allows creditors beyond financial and operational categories to submit claims. This development prompts a re-evaluation of how statutory dues are treated. While it is acknowledged that statutory claims are intentionally placed lower in priority compared to secured and financial debts, recent judicial decisions suggest uncertainty regarding whether certain statutory dues should be classified as operational debts or not.

Another alternative could be granting statutory dues (considering the contribution to nation building) equal rights as financial creditors. Furthermore, a consistent judicial interpretation can also lessen the uncertainty brought on by conflicting opinions given by various tribunals. The insolvency framework can certainly be improved through a collaborative and adaptive approach from the legislators, the judiciary, industry players, and the government.

Conclusion

Government revenue is a cornerstone of economic growth and development, underpinning essential public services, infrastructure, and welfare programs that drive societal progress. Ensuring the recovery of statutory dues, such as taxes and other levies, is imperative for maintaining the government's ability to generate revenue, particularly in cases of corporate insolvency. However, under the current framework of the IBC, the recovery of statutory dues often takes a backseat to other claims, leading to significant challenges in ensuring that the government can recoup a fair share of its dues.

A new approach is necessary to ensure a higher recovery rate of statutory dues while balancing the rights of other stakeholders and maintaining the core objective of the IBC—business rebirth. This can be achieved through amendments that establish a clear legal framework for handling statutory dues, owed either by the corporate debtor or a successful resolution applicant. Amending the IBC to revise the hierarchy of payments in the waterfall mechanism, and giving statutory dues a more prominent priority, would ensure that the government has a better chance of recovering its debts, even in insolvency cases. Such amendments would create greater uniformity in judicial interpretations and address the current gaps in the treatment of statutory dues. Although it is expected that a more nuanced approach will develop as more cases pass through the IBC process, it is crucial that this approach respects both the government's need to safeguard its revenue base and the IBC’s broader goal of reviving struggling businesses.








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