A Critical Analysis of the Complexity Posed and Impact on Liquidation Process

due to the Rainbow Papers Case

The present matter at hand revolves around the interpretation of Section 48 of the Gujarat
Value Added Tax Act, 2003. This section stipulated that any sum owed for taxes or penalties
by an individual would constitute a 'primary claim' on that individual's or dealer's assets. The
corporate debtor had failed to meet its tax obligations, leading to the initiation of recovery
proceedings. Simultaneously, insolvency proceedings had also commenced. During the
resolution process, the state tax authorities asserted that the outstanding dues had to be
considered as pre-existing liabilities, citing both Section 48 and Section 53 of the Insolvency
and Bankruptcy Code (IBC). The state argued that the "non-obstante" clause in the state
legislation and the "non-obstante" clause in the IBC applied in different domains, and
therefore, the state should be treated as a 'secured creditor' by virtue of Section 48 of the state
act. This argument was dismissed by both the National Company Law Tribunal (NCLT) and
the National Company Law Appellate Tribunal (NCLAT). However, the court in question
took into account Sections 30 and 31 of the IBC, along with certain other provisions, and
concluded that the NCLT had made errors in its previous assessments.

There is significant uncertainty surrounding the potential repercussions of the Supreme

Court's ruling in the Rainbow case. Key issues under consideration are:

a. Whether statutory authorities, with their first charge claim, should be classified as
financially secure creditors.
b. Furthermore, how will the Rainbow decision affect ongoing resolution plans and
liquidation proceedings?

Impact on Liquidation Process

Given that the Supreme Court's judgment involves interpreting the provisions of the Code
rather than enacting legislative changes, it will apply retroactively. The principles established
in the Rainbow judgment will impact all ongoing resolution plans and liquidation processes.
However, resolution plans that cannot be legally challenged in appellate authorities due to
time limitations have reached a final decision and cannot be revisited. This is because a
subsequent judgment overturning these principles will not undermine the binding nature of
the initial decision on the parties involved. In the Rainbow case, the Sales Tax department
submitted a Form B (Operational Creditors' Form) as they argued that they qualified as
secured operational creditors by operation of the law, a point upheld by the court. It is
essential to recognize that statutory authorities with a first charge should indeed be treated as
secured operational creditors, as their claim arises from the operation of the Corporate
Debtor's activities. As secured operational creditors, the statutory authorities holding the first
charge will not be included in the Committee of Creditors (CoC). This exclusion is due to the
fact that statutory authorities with a first charge are recognized as secured creditors according
to Section 3(30) of the Code, as a security interest is established in their favour by Section
3(31) of the Code. Section 53(b)(ii) of the Code does not distinguish between secured
financial creditors and secured operational creditors. Given their status as secured operational
creditors, the statutory authorities must release their claim to the first charge on the corporate
debtor's property and remove any existing property attachments. Since operational creditors
in a resolution plan must receive at least the same amount as they would in a liquidation
scenario, the secured operational creditors should be paid an amount equal to or greater than
the liquidation value stipulated in Section 53 of the Code. In practical terms, the financial
creditors have two options: they can either pay the secured operational creditors an amount
equal to or greater than the liquidation value as part of the resolution plan, or the secured
operational creditors will receive this value as per Section 53 of the Code in the event of
liquidation. In essence, the financial creditors are obligated to compensate the secured
operational creditors, with no way to avoid this obligation, whether through the resolution
plan or the liquidation process. Section 52 provides secured creditors with a choice between
two alternatives in the context of the liquidation process. They can either surrender their
security interest, following the procedure outlined in Regulations 21 and 21A of the
Liquidation Regulations1, or opt to enforce it. If they decide on the latter course, the secured
creditor must initially express this choice within the specified timeframe, which is typically
30 days, by using Form C or D of Schedule II as set forth in the Liquidation Regulations.
Once the liquidator approves this option, in accordance with Section 52(3), the secured
creditor can then recover the proven debt associated with the security interest. Following the
liquidator's clearance, the secured creditor is free to initiate the process of enforcing its claim
as stipulated in Section 52(4). If any challenges or disputes arise during this process, the
secured creditor has the option to seek resolution through the National Company Law
Tribunal (NCLT) as defined in Section 52(5) and (6). After successful enforcement, any
surplus amount obtained must be remitted to the liquidator as outlined in Section 52(7).

Also while analysing the applicability of the present case, the apex court in
Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited & Ors. The
specific issue of whether Paschimanchal Vidyut Vitran Nigam Ltd. (Appellant) could enforce

1
The said provisions of the Liquidation Regulations read as follows:
“21. Proving security interest. The existence of a security interest may be proved by a secured creditor on the
basis of-
(a) the records available in an information utility, if any;
(b) certificate of registration of charge issued by the Registrar of Companies; or
a security interest created over the assets of Raman Ispat Private Limited (Corporate Debtor)
outside of the liquidation proceedings under the Insolvency and Bankruptcy Code, 2016
(Code) was settled in the negative. The apex court observed that the Rainbow Papers case did
not acknowledge the existence of the 'waterfall mechanism' outlined in Section 53 of the IBC
Act 2016. This provision was neither referred to nor excerpted in the judgment. It's important
to note that the Rainbow Papers (supra) case was situated within the context of a resolution
process, distinct from the scenario of liquidation. As Section 53 of the IBC Act 2016
establishes the waterfall mechanism, dictating the order of priority for various categories of
creditors' claims. This carefully structured section positions the obligations owed to secured
creditors and employees as the second priority, following the expenses associated with the
liquidation process. However, the debts owed to the government are ranked considerably
lower than those of secured creditors and even unsecured and operational creditors. It appears
that either the court in the Rainbow Papers (supra) case was not made aware of this design or
it was overlooked. In any case, the judgment failed to consider the provisions of the
Insolvency and Bankruptcy Code (IBC), which accord a higher preference to debts owed to
secured creditors over those owed to the Central or State Government.

Although the Gujarat Value Added Tax Act, 2003 indeed establishes a charge
concerning outstanding or overdue amounts, one could argue that, in the absence of specific
government dues categorically listed as in Section 53(1)(e) of the Code, the State might be
considered a 'secured creditor.' However, the distinct and separate treatment of amounts owed
to secured creditors versus dues owed to the government unmistakably reflects Parliament's
intention to handle the latter differently, with a lower priority, especially evident in the
present case. As mentioned earlier, this intention is also discernible from an examination of
the preamble to the Act. Also according to the principles of statutory interpretations as
enumerated in Member, Board of Revenue v. Anthony Paul Benthall2 that when in an
enactment two distinct expressions are used, both of the expressions can not be construted as
having the meaning.
“When two words of different import are used in a statute, in two
consecutive provisions, it would be difficult to maintain that they are used in the
same sense…”

The Bankruptcy Law Reforms Committee Report of 2015, which paved the way for the
formulation and subsequent enactment of the Insolvency and Bankruptcy Code (IBC), made a
significant declaration. The Committee has proposed a prioritization in the distribution of
assets during liquidation that places the rights of the Central and State Government below

2
(1955) 2 SCR 842
those of unsecured financial creditors, as well as all categories of secured creditors. This
adjustment aims to foster the availability of credit and foster the growth of unsecured
financing, including the development of bond markets. Over the long term, this shift is
expected to expand access to finance, reduce capital costs, stimulate entrepreneurial activity,
and spur accelerated economic growth. The government, too, stands to gain from this
progression, as it will lead to increased revenue through economic expansion. Furthermore,
the efficiency improvements and the resulting greater value realized through the proposed
insolvency framework will deliver additional benefits to both the economy and the public
treasury. The explanation to this appears in the Report of the Insolvency Law Committee
(2020)3.

“7.3. The Committee noted that the Code aims to promote a collective
liquidation process, and towards this end, it encourages secured
creditors to relinquish their security interest, by providing them second-
highest priority in the recovery of their dues, as under Section 53(1)(b).
Thus, they are not treated as ordinary unsecured creditors under the
Code, as they would have been under the Companies Act, 1956. It was
noted that, to some extent, this provision intends to replicate the benefits
of security even where it has been relinquished, in order to promote
overall value maximisation. However, even if secured creditors realise
their security interest, they would only recover to the extent of their
security interest, and would claim any excess dues remaining unpaid
under Section 53(1)(e) of the liquidation waterfall. Thus, the Committee
was of the view that this provision could not have been intended to
provide secured creditors who relinquish their security interest, priority
of repayment over their entire debt regardless of the extent of their
security interest, as it would tantamount to respecting a right that has
never existed. Further, if the “debts owed to a secured creditor” is not
restricted to the extent of the security, there would be broad scope for
misuse of the priority granted under Section 52(1)(b), as even creditors
who are not secured to the full extent of their debt would rely on the mere
fact of holding any form of security, to recover the entire amount of their
unpaid dues in priority to all other stakeholders.

7.4. On the basis of the above discussion, the Committee agreed that the
priority for recovery to secured creditors under Section 53(1)(b)(ii)
3
Report of the Insolvency Law Committee (2020) – Heading 7.3 – Realisation or Relinquishment of Security
Interest by a Secured Creditor (pg. 76).
 should be applicable only to the extent of the value of the security
interest that is relinquished by the secured creditor. The Committee was
of the opinion that this issue stands clarified in terms of the reasoning
provided above and does not necessitate any further amendment to the
provisions of the Code.”

Conclusion

The Rainbow Paper case has somewhere failed to consider the sole objective of the
Insolvency and Bankruptcy law, it shall also be considered that the while deciding the
case the apex court had a legislative approach with respect to the law so that a new
concept could be introduced rather than limiting the interpretation within the scope of
the objective of the law in derogation. The Supreme Court has reaffirmed the supremacy
of the Insolvency and Bankruptcy Code (IBC) over other legal frameworks during
liquidation proceedings. Of particular significance is the restriction of the applicability
of the Rainbow Papers case to its specific factual context, effectively segregating it from
the body of legal precedents related to the handling of government dues under the Code
and related regulations.