Will Insolvency Drown Under the Crown’s Weight? Addressing Differential Debt Treatment under the IBC

[Deep Dighe is an Advocate practicing in the Bombay High Court]

The question of statutory dues or crown debts (as they were previously known under the colonial regime) and their interplay with the corporate insolvency law in India has been an issue that has drawn the attention of all stakeholders to it. Much ink has been spilled about the contrasting Supreme Court judgments on the treatment of crown debts in the event of initiation of a corporate insolvency resolution process (CIRP). But there has been one aspect in this jarring development that has missed the limelight it deserves; that is the issue of differential treatment of crown debts in the event of the approval of a successful resolution plan and the unsuccessful resolution of the  CIRP resulting into liquidation of the corporate debtor. This post seeks to shed light on the differential treatment as mentioned above.

This debate around the treatment of crown debts, which essentially concerns what class of creditors the State belongs to under the prevailing insolvency law, was reignited with the pronouncement the State Tax Officer v. Rainbow Papers. In a nutshell, the Supreme Court held that the adjudicating authority could reject a resolution plan approved by the committee of creditors (CoC) under section 30 of the Insolvency and Bankruptcy Code, 2016 (IBC) if the said plan did not accord priority to the crown debts at par with secured creditors and salaries to be paid to workmen. It means that any resolution plan will have to take into consideration the amount owed by the corporate debtors as crown debts to the various government authorities and make necessary allocations for them in the order of priority as laid down by Rainbow Papers. This has effectively conferred a veto upon the government authorities in terms of the approval of resolution plan of the corporate debtor as they can (and will likely) challenge the approval of any resolution plan that does not treat their claims at par with the class of secured creditors and unpaid workmen, something which they could not have done prior to this judgment.

On the other hand a decision in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd, which was rendered subsequent to Rainbow Papers, further accentuates the dilemma surrounding the treatment of crown debts. It held that the statutory dues are to be treated below the secured creditors and workmen’s salaries as contemplated under the waterfall mechanism of the IBC and that the said waterfall mechanism was not brought to the notice of the bench in Rainbow Papers. The interesting fact here to note is that the corporate debtor was already in liquidation when this issue came up for consideration before the Supreme Court in Raman Ispat, whereas in Rainbow Papers a resolution plan had been approved by the CoC and the same was challenged for its treatment of crown debts resulting in multiple rounds of litigation going all the way up to the Supreme Court. The decision in Raman Ispat inspired some parties to file a review petition against the Rainbow Papers judgement; however, the same was dismissed by the Supreme Court by way of a reasoned order.

The rejection of the review petition has now created a situation which perhaps is not addressed by the IBC: that is, two different approaches will have to be taken by resolution professionals or liquidators depending upon the outcome of the CIRP of the corporate debtor. In the event of a resolution plan being put to vote before the CoC and likely to be approved by the CoC, the resolution professional would have to advise the CoC to look at the treatment of the crown debts in the resolution plan and vote accordingly. Per contra, if the corporate debtor were to get into liquidation, the liquidator could very conveniently treat crown debts at a lower footing and offer government authorities a piecemeal chunk of the liquidation estate, since such an outcome is sanctioned by Raman Ispat.

This duality in terms of the treatment of crown debts strikes at the heart of the IBC and its legislative intent. One could argue that the approval of a resolution plan or the liquidation of the corporate debtor are events that cannot be pre-empted before hand and that both the scenarios are nothing but a logical conclusion to the CIRP. Therefore, in no way can these two scenarios be treated with two different yardsticks. The objective of the IBC was to facilitate the revival of corporate debtors that end up in a CIRP due to financial distress. This was a departure from the previous insolvency laws in India, which straightaway provided for winding up of companies in the event of a default. Thus, having a condition precedent for approval of a resolution plan not explicitly mentioned in the statute with regard to treatment of crown debts goes against the letter and spirit of the IBC. In fact, one could go to the extent of saying that the fear of crown debts looming over a corporate debtor would likely dissuade prospective resolution applicants from putting up a resolution plan and force the corporate debtor into liquidation, something which defeats the raison d’etre of the IBC. Besides its impact on the law, the potential economic implications it could have on India Inc is worrisome. Since financially distressed entities would mostly end up in liquidation, the business of such entities would come to a dead-end and hurt the economy and take us back to the pre-IBC regime. It would do no good even for the State, as taxes and duties to be collected in the form of crown debts would be minimal in light of Raman Ispat and not add much value to the exchequer, something that again defeats the whole purpose of according the State priority over the other class of creditors.  

The need of the hour is to bring about clarity in terms of treatment of the crown debts under the IBC. Whether it is done by a reference of the said issue to a larger bench by judicial intervention or by way of an amendment to the IBC is something that remains to be seen. There had been a public notice circulated by the Central Government in early 2023 for proposing amendments to the IBC to address the lacunae in the law as pointed in this piece. However, it seems no further action has been taken on it. But the bottom line remains that this differential treatment of crown debts is an anathema to the IBC and one that needs to be done away with. Instead, a uniform approach to them in both the scenarios, i.e., approval of a resolution plan or liquidation needs to become the law in force again. If the spirit of the IBC is to be kept alive, the crown debts should be accorded their rightful place as per the waterfall mechanism as envisaged under the IBC.

Deep Dighe

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