Status as on- 02/03/2023
The Insolvency and Bankruptcy Code, 2016 (“IBC“) sought to usher in a new era in the Indian insolvency regime by introducing a uniform, transparent, and predictable insolvency resolution procedure. A key element that differentiates the IBC from previous legislation governing corporate insolvency is the distribution waterfall in the event of liquidation.
Pushback from Operational Creditors and Government Authorities
The above distribution waterfall has been resisted by operational creditors and government authorities. In Swiss Ribbons Private Limited v. Union of India (“Swiss Ribbons“), the Supreme Court of India (“Supreme Court“) upheld the constitutional validity of the IBC. The court held that the differential treatment of financial and operational creditors does not violate Article 14 of the Constitution of India due to the existence of an intelligible differentia in the separate classification of creditors.
Unfortunately, this judgment has not prevented further challenges. There has recently been a rising trend of courts and tribunals seeking to deviate from the distribution waterfall under the IBC. This puts the hard-fought gains achieved so far through path-breaking legislation at risk.
In this note, we discuss three examples:
Classification of the Tax Authority as a Secured Creditor
In September 2022, in State Tax Officer v. Rainbow Papers Limited (“Rainbow Papers“), the Supreme Court held that Section 48 of the Gujarat Value Added Tax Act, 2003 creates a first charge on the property of a dealer to the extent of any statutory dues under such legislation, the state tax authority has a security interest against the corporate debtor to the extent of such dues thereby making it a secured creditor.
This has marked a significant departure from both legislation and precedent.
It is noteworthy that pursuant to Section 3(30) read with Section 3(33) of the IBC, a security interest may be created by a ‘transaction‘ which secures payment or performance of an obligation. A ‘transaction‘ is defined under the IBC as including an agreement or arrangement in writing for the transfer of assets, funds, goods, or services, from or to the corporate debtor.
It is evident that a ‘transaction‘ and a ‘security interest‘ created by such a ‘transaction‘ cannot exist without the consent of the corporate debtor. In the absence of a ‘transaction‘, there can be no ‘security interest‘ as defined under the IBC. Therefore, while the tax authorities might be akin to secured creditors in a general sense, they cannot be classified as secured creditors under the IBC.
Special Position of the Department of Telecommunications
The question regarding the transfer of the spectrum assets licensed to Aircel Limited came up before the National Company Law Appellate Tribunal (the “NCLAT“) in Union of India v. Vijaykumar V. Iyer.
Under the Guidelines for Trading of Access Spectrum by Access Service Providers 2015 (“Spectrum Guidelines“), a license to use a spectrum is allocated to a successful bidder upon payment of license fees and such license is transferable by the bidder.
The NCLAT held in Union of India v. Vijaykumar V. Iyer that the license dues were equivalent to contractual dues in the form of operational debt. The Department of Telecommunications (the “DoT“) was therefore classified as an operational creditor under Section 5(20) of the IBC.
In Swiss Ribbons, the Supreme Court held that similarly placed creditors must be treated on an equivalent level. This judgment places the DoT on an unequal footing as compared to other operational creditors.
An appeal against the decision of the NCLAT in Union of India v. Vijaykumar V. Iyer has been filed in the Supreme Court.
Dues of Workmen and Employees
In October 2022, in Jet Aircraft Maintenance Engineers Welfare Association v. Ashish Chhawchharia, Resolution professional of Jet Airways (India) Ltd., (“Jet Engineers“) the NCLAT held that non-payment of the complete provident fund amount to the workmen and employees and the gratuity payment until the insolvency commencement date amounts to non-compliance with provisions of the IBC. The NCLAT directed the successful resolution applicant to make pending payments of provident fund and gratuity dues owed to the workmen and the employees until the date of commencement of insolvency.
It is important to note that ‘workmen’s dues‘ in Section 53(1)(b) of the IBC are limited to dues in respect of a period of 24 months preceding the liquidation commencement date. It is evident that the Section 53 distribution waterfall envisages payment of all workmen’s dues (including provident fund and gratuity) only for the period of 24 months preceding the liquidation commencement date. The NCLAT has not provided any clear rationale for why the payment of provident fund and gratuity under limb (b) of Section 53(1) must be for the entire period until the date of commencement of insolvency.
By mandating full payment of workmen’s dues, the NCLAT ruling has the effect of creating a special category of creditors that is not provided for under the IBC.
The protection of stakeholders cannot be at the cost of a successful insolvency resolution process. Any judicial or legislative interventions should be mindful of not interfering with a delicate balance sought to be achieved under the IBC after careful deliberation. Piecemeal dilution of the Section 53 distribution waterfall threatens to disturb the foundation of the IBC.
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