Rainbow versus Raman: A Riddle so crucial and so hard to resolve

– Vinod Kothari

The heart of insolvency law is the priority order or the waterfall given in sec. 53, and one of the very crucial issues in the priority of secured creditors is whether statutory claims will rank at par with secured creditors by virtue a provision in the respective laws giving the Government a status of a secured creditor, or will have to rank at the fifth priority as provided by sec. 53 (1) (e), there is a situation of uncertainty.

Essentially, the statute will have to step in, because courts can only interpret the law as seen and read by the courts; courts cannot mend the law to meet what might have been the design of the law. On the contrary, if the lawmakers leave the law as is, liquidators will have to face claims, as they already are facing, from state governments claiming equality of ranking with secured creditors, even though many liquidations might have already closed or distributed their assets.

At the centre of the uncertainty are two rulings of the Supreme Court: the first one, in the matter of State Tax Officer(1) v. Rainbow Papers Limited, rendered on 6th September, 2022, and another one, in the matter of Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited & Ors., rendered on 17th July, 2023.

The Rainbow Papers ruling interpreted the provisions of section 48 of the Gujarat VAT Act to say that to the extent of VAT dues, the Government was a statutory charge holder, and had the status of a secured creditor. The Apex court held that a charge need not be contractual; it may be a statutory charge as well, and in this case, the statute had granted the Gujarat Govt the status of a secured creditor.

In Raman Ispat, dealing with a similar issue of priority of government claims, the Apex court went into the report of the BLRC, the express intent of the IBC to preserve the contractual security interests, and held that-

“The Gujarat Value Added Tax Act, 2003 no doubt creates a charge in respect of amounts due and payable or arrears. It would be possible to hold [in the absence of a specific enumeration of government dues as in the present case, in Section 53(1)(e)] that the State is to be treated as a ‘secured creditor’. However, the separate and distinct treatment of amounts payable to secured creditor on the one hand, and dues payable to the government on the other clearly signifies Parliament’s intention to treat the latter differently – and in the present case, having lower priority. As noticed earlier, this intention is also evident from a reading of the preamble to the Act itself”

On the 31st October, the SC rejected the Review Petition filed for review of the order passed by this Hon’ble Court in the matter of Rainbow Papers. The review application was rejected largely on technical grounds, (a) that the grounds of review of a judicial verdict are set in Order XLVII Rule 1 of the Code of Civil Procedure, and the applicant has to demonstrate that there was an error apparent on the face of record; and (b) that it is not correct to say that the Apex court in Rainbow had not considered the priority. On the other hand, the Apex court used the priority provision and granted the status of equivalence to the State govt.

SC Bench consisting of Justice A.S. Bopanna and Justice Bela M. Trivedi rejected the review application on the ground that the decision of a conjugate bench of equal standing cannot be used to displace the decision of another bench of equal strength.

The rejection of the review petition, in our humble opinion, does not add to the strength of either of the two rulings; as the Justices A.S. Bopanna and Bela M. Trivedi ruled – both the Benches have equal strength.

However, on a practical aspect, all liquidators will be left in a quandary. Without doubt, none of the liquidators would have accorded a status of equality to government claims. Many liquidations would have been closed, or many would have done substantial distribution. Also, we need to understand that the provision of the Gujarat VAT law is not unique – similar provisions exist in the laws of most other taxing statutes. In fact, CGST Act [sec 48] has a similar provision. Also, it needs to be understood that if a statute can grant a status as a secured creditor, nothing stops the Govt from bestowing such status by amending the statute. Such statutes have existed for long and are just a matter of codifying the law to self-equip the state.

There is also a point arising from the very definition of “secured interest” read with the definition of “transaction” under IBC whereby “security interest” means a right or title created by a ‘transaction’ which secures payment or performance of an obligation, and in turn, the expression “transaction” includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor. Therefore, even though a statute may grant the government the status of a secured creditor, the IBC treats a creditor as secured only when it is a transactional secured creditor. The issue was discussed elaborately under two of our articles, “Supreme Court ruling revives the quandary, holds tax authorities to be secured creditors” and “Statutory dues cannot override section 53: Supreme Court clarifies the applicability of Rainbow ruling”.

Subsequently, the Discussion Paper of the Ministry of Corporate Affairs dated 18th January, 2023 also talked about treatment of government dues (other than where the security interest is created pursuant to a transaction of the Central Government or a State Government with CD) at par with unsecured dues; however, it is yet to take shape in the form of law.

Hence, there is an urgent need for the lawmakers to interfere.  Not filling the gap is quite costly, as it will disrupt both ongoing and completed liquidations, and given the situation that over 55% liquidations are already running with over 2 years of vintage, the country cannot afford to have any uncertainty on such a crucial provision of law.