Rainbow Papers Judgement: The Supreme Court’s Controversial Ruling under IBC

This article is written by Muskaan Prasad (IV Year, B.A.LL.B.(Hons.) Student at National Law Institute University, Bhopal. The article discusses Supreme Court’s Judgement in Sales Tax Officer v. Rainbow Papers Limited.

Introduction

The Supreme Court of India passed an order on 06 September 2022 wherein it held the State to be a secured creditor under Section 53 of the Insolvency and Bankruptcy Code (IBC). The division bench of the Court also held that the timeline prescribed under IBC is merely directly and not mandatory. By its ruling in Sales Tax Officer (1) v. Rainbow Papers Limitedi, the Supreme Court essentially discarded the court’s previous ruling that the government is an operational creditor.

Facts of Sales Tax Officer v. Rainbow Papers Limited

This appeal was filed against the order passed by National Company Law Appellate Tribunal (NCLAT) on 27 February 2021. NCLAT had rejected the appellant’s plea and held that the Government cannot claim first charge over the property of the Corporate Debtor under Section 48 of the Gujarat Value Added Tax, 2003 (GVAT Act).

The respondent owed Rs. 53,71,65,489/- to the Sales Tax authorities towards CST (Central Sales Tax) and VAT (Value Added Tax). Recovery proceedings were initiated by an operational creditor called Neeraj Papers Private Limited against the respondent around 8 July 2016, under Section 9 of the IBC before the Ahmedabad Bench of the National Company Law Tribunal (NCLT).

NCLT admitted the petition and appointed George Samuel as the Interim Resolution Professional (IRP) on 22 September 2017. Committee of Creditors was constituted on 10 October 2017 and Ramachandra D. Choudhary was appointed as Resolution Professional (RP). The appellant claimed before RP that the respondent is liable to pay approximately Rs. 47.36 crores, but this claim was filed beyond time.

Tourism Finance Corporation of India Limited, a financial creditor, filed an interlocutory application, and claimed that it had wrongly been categorised as an unsecured financial creditor. On 20 October 2018, the RP informed the appellant that its entire claim has been rejected. On 20 December 2018, the appellant challenged the Resolution Plan before the NCLT claiming that the Sales Tax Officer was a secured creditor and prayed for payment of its dues worth Rs.47,35,72,314/-

NCLT rejected the application on 27 February 2019, following which the appellant filed an appeal before the NCLAT on 08 April 2019 under Section 61 of IBC. The NCLAT upheld the order of NCLT and stated that the Resolution Plan was approved by the Committee of Creditors with a majority vote of 72.9 percent, and the claim by the appellant was made at a much later stage. The bench held that the Government cannot claim first charge over the property of the corporate debtor as Section 48 of GVAT Act cannot prevail over Section 53 of IBC.

Court’s Reasoning in Sales Tax Officer v. Rainbow Papers Limited

The apex court said that the timelines provided in the IBC are directory and not mandatory. The claims were invited well before the last date for submission of claims i.e., 5 October 2017. A Notification dated 3 July 2018 w.e.f. 4 July 2018 amended Sub-Regulation (2) stating “a creditor shall submit proof of claim on or before the last date mentioned in the public announcement” was amended with effect from 4th July 2018 to read as “a creditor shall submit claim with proof on or before the last date mentioned in the public announcementii Sub-Regulation (2) of Regulation 14 enables the IRP or the RP to revise the amounts of claims admitted.

The court stated that there was no obligation on the State to claim the dues against which recovery proceedings were initiated since they are statutory dues. The appellants were never summoned to produce documents to substantiate their claim towards the statutory dues.

The bench accepted the appellants’ argument that the state had initiated proceedings against the respondent Corporate Debtor for payment of its statutory dues. The error is on the part of the RP who failed to examine the Book of Accounts of the Corporate Debtor since verifying the same would have reflected the Corporate Debtor’s liability towards the State.

The Solicitor General argued that the term “secured creditor” defined under Section 3(30) of the IBC is wide enough to cover all types of security interests which secures payment or performance of an obligation, which was accepted by the bench. The claim of the Tax Department falls within the ambit of “security interest” provided under Section 3(31) and hence the State becomes a secured creditor under Section 3(30) of the IBC.

The Additional Solicitor General relied on Swiss Ribbons Pvt. Ltd. v. Union of Indiaiii wherein the Supreme Court had held that the RP does not have adjudicatory powers to accept or reject any claim. The duty of a RP is to only receive, verify and collate the claims. NCLT had held in Vishal Saxena & Anr. v. Swami Deen Gupta Resolution Professional[1] and Assistant Commissioner of Customs v. Mathur Sabhapathy Vishwanathan[2] that the time stipulated provided in Regulation 12 for submitting a claim is merely directory and not mandatory.

The Court said that the word “shall” denotes a mandate or binding direction while “may” denotes discretion. Even though Section 31(2) of IBC confers discretionary power on the Adjudicating Authority to reject a Resolution Plan, this discretionary power cannot be exercised arbitrarily. It is a well-settled principle of interpretation that “may” can be construed as “shall” if the circumstance of the case demands such. If the Resolution Plan fails to mention the statutory dues payable to the State, then the Adjudicating Authority must reject it.

The Court held that NLCAT made an error in stating that Section 53 of the IBC overrides Section 48 of the GVAT Act since Section 53 begins with a non-obstante clause. Section 48 of the GVAT Act is not contrary to or inconsistent with any provisions of the IBC. According to Section 53(1)(b)(ii) of IBC, the debts owed to a secured creditor which includes the State under the GVAT Act, are placed on the same level with other specified debts under the IBC.

Analysis of Judgement of of Sales Tax Officer v. Rainbow Papers Limited

In its decision in Ghanashyam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limitediv, a three-judge bench of the Supreme Court held that “harmonious construction of clause (10) of Section 3 of the I&B Code read with clauses (20) and (21) of Section 5 thereof would reveal, that even a claim in respect of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority would come within the ambit of ‘operational debt’. The Central Government, any State Government or any local authority to whom an operational debt is owed would come within the ambit of ‘operational creditor’ as defined under sub­section (20) of Section 5 of the I&B Code.”

The division bench in the Rainbow Papers case comprising of Justices Indira Banerjee and A.S. Bopanna, failed to consider the apex court’s ruling in the Ghanshyam Mishra case wherein the apex court had held that the Central or State Government or any local authority falls under the category of operational creditor under Section 5(20) of the IBC. The bench further held that the Resolution Plan must be rejected since it fails to mention the statutory dues that is payable by the corporate debtor.

This ruling of the Supreme Court can have drastic consequences as it places the burden not on the State to recover its statutory dues from the corporate insolvency resolution process but rather on the IRP or RP to carefully examine the Book of Accounts and include all statutory dues that are to be paid by the corporate debtor. By stating that the State is a financial creditor, the court has placed the State at the same level as financial institutions and enterprises which have invested their money in the corporate debtor and suffered losses for it.

The key objectives of the IBC are “to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders”v, inter alia. By declaring the State to be a financial creditor, the Court has gone against the objectives of the IBC which aim to promote entrepreneurship and balancing stakeholders. Furthermore, ruling that the timelines under IBC are not mandatory but directory. This is directly opposite to the objective of the IBC, i.e., execution of the law in a timely bound manner.

It is the need of the hour that this judgement be immediately reviewed or else it will have disastrous consequences on the insolvency and bankruptcy law regime in India.

[1] Vishal Saxena & Anr. v. Swami Deen Gupta Resolution Professional (2020) SCC Online NCLT 2734.

[2] Assistant Commissioner of Customs v. Mathur Sabhapathy Vishwanathan IBA/578/2019 NCLT, Chennai.