Resolution Plans to Subsume Statutory Dues?

By Shikha Bansal & Richa Saraf (resolution@vinodkothari.com)

The Insolvency and Bankruptcy Code, 2016 facilitates drawing up resolution plans for corporate debtors who has defaulted in making payment to its creditors. The resolution plan is approved by a committee of creditors consisting of a class of creditors (called financial creditors) of the corporate debtor. The resolution plan, once approved and sanctioned by the adjudicating authority, becomes binding on all the stakeholders of the company including dissenting financial creditors and operational creditors. As such, it assumes the nature of a contract framed under a statute. However, the question before us is whether a class of creditors can approve a resolution plan which seeks to extinguish statutory liabilities of the corporate debtor.

The article seeks to study the question in the light of various provisions of law, some judicial precedents and principles established over time.

Resolution Plan under the Code

Section 31 (1) of the Code provides that the resolution plan approved by the adjudicating authority shall be binding on the parties:

“(1) If the Adjudicating Authority is satisfied that the resolution plan as approved by the committee of creditors under sub-section (4) of section 30 meets the requirements as referred to in sub-section (2) of section 30, it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.”

In the context of the UK Insolvency Act, 1986, in Johnson v. Davies [1999] Ch 117 it was held that the scheme was a consensual arrangement between the parties. The court stated: “Unlike the earlier legislation, section 260(2) of the Act of 1986 does not purport, directly, to impose the arrangement on a dissenting creditor whether or not he has agreed to its terms; rather he is bound by the arrangement as a result of a statutory hypothesis. The statutory hypothesis requires him to be treated as if he had consented to the arrangement.”

An individual voluntary arrangement which has been approved by the requisite majority operates by analogy with a contract between the debtor and all his or her creditors: see Lloyds Bank v. Ellicott (2002) EWCA Civ 1333[1]. The ruling was followed in Narandas-Girdhar and another v. Bradstock (2016) EWCA Civ 8866, where this effect (binding a whole class to a contractual arrangement by the vote of only part of it), was called the “statutory magic” [para 35][2].

Schemes under SICA & the Companies Act, 1956/2013

The concept of “resolution plan” under the Code may be compared with the schemes framed under the Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”), or the schemes of compromise/arrangements referred to under the provisions of the Companies Act, 1956/2013. However, as we see later, there are differences between resolution plans and schemes framed under SICA and the schemes of arrangements/compromises under the Companies Act, 1956/2013.

Scheme under Sick Industrial Companies (Special Provisions) Act, 1985

Going back to the times of Sick Industrial Companies (Special Provisions) Act, 1985, sub-section (8) of section 18 of SICA provided the following in respect of a sanctioned scheme –

“(8) On and from the date of the coming into operation of the sanctioned scheme or any provision thereof, the scheme or such provision shall be binding on the sick industrial company and the transferee company or, as the case may be, the other company and also on the shareholders, creditors and guarantors and employees of the said companies.”

Section 32 of SICA provided for overriding effect of SICA:

“32. Effect of the Act on other laws.—The provisions of this Act and of any rules or schemes made thereunder shall have effect not-withstanding anything inconsistent therewith contained in any other law except the provisions of the Foreign Exchange Regulation Act, 1973 (46 of 1973) and the Urban Land (Ceiling and Regulation) Act, 1976 (33 of 1976) for the time being in force or in the memorandum or articles of association of an industrial company or in any other instrument having effect by virtue of any law other than this Act.”

The Calcutta High Court examined the legal effect of the scheme sanctioned by BIFR in CIT v. J.K. Corporation Ltd.[3] The SICA is a special Act and the scheme framed thereunder is of tremendous implication. So, it is binding upon everyone, as it has assumed the character of conclusiveness by virtue of section 18 sub-section (4) and also sub-section (8). Once a scheme having been sanctioned under this Act, the provisions of the scheme will have the overriding effect over any other laws except the FERA and the ULCRA.

However, it must be noted that there is difference in the manner in which resolution plans are approved under the Code and the manner in which BIFR schemes were approved – see below.

The scheme of approval of a resolution plan under the Code is different from the scheme of approval of a BIFR schemes under SICA. Section 19 of SICA provided for rehabilitation by giving financial assistance and required the draft scheme be circulated to those providing “financial assistance” for their consent. The relevant extract is reproduced as below:

“(1). Where the scheme relates to preventive, ameliorative, remedial and other measures with respect to any sick industrial company, the scheme may provide for financial assistance by way of loans, advances or guarantees or reliefs or concessions or sacrifices from the Central Government, a State Government, any scheduled bank or other bank, a public financial institution or State level institution or any institution or other authority (any Government, bank, institution or other authority required by a scheme to provide for such financial assistance being hereafter in this section referred to as the person required by the scheme to provide financial assistance) to the sick industrial company.

(2). Every scheme referred to in sub-section (1) shall be circulated to every person required by the scheme to provide financial assistance for his consent within a period of sixty days from the date of such circulation (or within such further period, not exceeding sixty days, as may be allowed by the Board, and if no consent is received within such period or further period, it shall be deemed that consent has been given).”

Such safeguards are also present in section 230 of the Companies Act, 2013. However, no such provision is present in the Code.

The Delhi High Court, in Govt. of India (Deptt. of Revenue) & Anr. v. AAIFR & Ors. , held as follows:

“………….Evidently, the letter dated 30.12.1993 issued to the AAIFR and BIFR clarified that for according financial assistance or giving financial concessions, under Direct Tax Laws, each individual case would be considered on merits and that consent, if any, would be granted under section 19(2) of SICA only thereafter. The ‘consent or denial of consent’ would be communicated to the AAIFR and/or BIFR by the Central Government. The Nodal Agency for coordination between BIFR and CBDT and between AAIFR and CBDT would be the Director General of Income Tax (Admn.) . . .

… . .19. In our view, this would be fatal insofar as the sick industrial company is concerned as, party cannot be mulcted with the consequence of a deemed consent unless service of the DRS is effected on the designated authority in terms of the circular dated 683 dated 08.06.1994

  1. As to why service on the designated authority indicated in the circular is crucial before one could say that the sanctioned scheme would be binding on the Income Tax Department, is quite apparent on a bare reading of the provisions of section 19 of sica.

20.1 A perusal of the provisions of section 19 of SICA would show that where the Central Government is to provide financial assistance in the form of reliefs and concessions its consent, is mandatory. Where Central Government proposes not to give its consent, it is required to file its objection within sixty (60) days of the date of circulation of the DRS or such further period not exceeding sixty (60) days, which the BIFR may allow, failing which it shall be deemed that Central Government has given its consent. The Central Government is not defined in SICA. The Central Government being an amorphous body has by virtue of the said circular appointed a ‘nodal agency’, in other words, an agent to act for and on its behalf in matters concerning financial assistance and concessions under the Direct Tax Laws. There is no provision under the Income Tax Act for according such consent. Therefore, the two statutes are required to be read harmoniously in order to avoid a conflict. Harmonious construction would have us hold that not only is the consent mandatory, but that, it has to be of an authorized person acting within the ambit of his authority. The limits of such an authority vested in an agent would be defined by the mandate of its principal, which in any event, cannot go beyond the statute of which it is a creature where the statute seeks to define the limit. . .”

Scheme of compromise or arrangements under the Companies Act, 1956/2013

Section 391 of the Companies Act, 1956 facilitated compromises and arrangements with creditors (or a class of creditors) and members (or a class of members). Under sub-section (2), where the scheme approved by the majority of creditors or members (as the case may be) is sanctioned by the court, it shall be binding on all the creditors, all the creditors of the class, all the members, or all the members of the class, as the case may be, and also on the company, or in the case of a company which is being wound up, on the liquidator and contributories of the company. Corresponding provisions are contained in section 230 of the Companies Act, 2013.

The provisions as above are often quoted as “single window clearance system”, as stated in PMP Auto Industries Ltd., In re [1994] 80 Comp Cas 289 (Bom):

“Thus the position in law appears to be clear. Section 391 invests the court with powers to approve or sanction a scheme of amalgamation/arrangement which is for the benefit of the company. In doing so, if there are any other things which, for effectuation, require a special procedure to be followed–except reduction of capital–then the court has powers to sanction them while sanctioning the scheme itself. It would not be necessary for the company to resort to other provisions of the Companies Act or to follow other procedures prescribed for bringing about the changes requisite for effectively implementing the scheme which is sanctioned by the court. Not only is Section 391 a complete code as held by the courts, but, in my view, it is intended to be in the nature of a ‘single window clearance’ system to ensure that the parties are not put to avoidable, unnecessary and cumbersome procedure of making repeated applications to the court for various other alterations or changes which might be needed effectively to implement the sanctioned scheme whose overall fairness and feasibility has been judged by the court under Section 394 of the Act.”

While the concept of resolution plan may sound similar to the schemes of arrangements/compromises under the Companies Act, 1956/2013, yet it must be understood that there is a basic difference between the two. The scheme of arrangement/compromise under the Companies Act, 1956/2013 stands on a different footing because in consideration of such arrangement or compromise, every class has arrived together. Super-majority of each class decides on the compromise/arrangement; as such, the “statutory magic” binds an entire class (including all members, whether assenting or dissenting) which has been separately heard. However, the Code envisages “one-of-its-kind” difference between financial creditors and operational creditors. Statutory authorities, being operational creditors, may go completely unheard during consideration of the resolution plan. This goes against the principles of natural justice.

Resolution plan vis-à-vis Statutory dues

There are laws which require certain payments to be made mandatorily, e.g. taxation (direct or indirect) laws, labour laws. These payments, since arise out of statutory provisions are statutory dues, also known as government dues. As the definition of “operational debt” goes under section 5 (21), it includes “a debt in respect of the repayment 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”.  Therefore, statutory dues have been categorised as “operational debt”, and thus the Central Government, State Government or local authority to whom such a debt is owed, become “operational creditors” by virtue of definition of “operational creditor” under section 5 (20). It must be noted here that the operational creditors are not entitled to be members of the committee of creditors and thus do not have powers to approve or disapprove a resolution plan.

The question under debate is – whether a resolution plan can provide for extinguishment of statutory dues?

Statutory Dues vs. Contractual Dues

Statutory dues do not arise out of a mutual agreement or contract. The dues arise pursuant to a provision in the respective statute levying such charges or obligations on the payer. As such, statutory dues are different from contractual dues. A resolution plan shall not contravene any law for the time being in force – see below.

Waiving off statutory dues will constitute breach of the relevant statute under which such dues arose. Therefore, extinguishment of statutory dues without following adequate procedures and merely seeking resort to “liquidation value argument” cannot be said to be in due compliance of law.

The law-abiding resolution plan

Section 30 (1) of the Code provides for submission of resolution plan by the resolution applicant. Sub-section (2) of section 30 provides as follows –

“(2) The resolution professional shall examine each resolution plan received by him to confirm that each resolution plan—

(b) provides for the repayment of the debts of operational creditors in such manner as may be specified by the Board which shall not be less than the amount to be paid to the operational creditors in the event of a liquidation of the corporate debtor under section 53;

(e) does not contravene any of the provisions of the law for the time being in force;

(f) conforms to such other requirements as may be specified by the Board.”

Statutory dues do not arise out of a contract between the corporate debtor and the statutory authority; the dues arise out of a provision contained in a statute. The Code itself requires that the resolution plan shall not contravene any of the provisions of the law for the time being in force. Any such provision in the resolution plan shall be dehors the provision of the Code which requires that the resolution plan shall not contravene any of the provisions of the law for the time being in force.

The intent of clause (e) of section 30 (2) was explained in the Clarification issued by IBBI[4] — the purpose of the said clause is to prevent approval of resolution plans, which are not legally implementable. For example, a resolution plan must not contemplate 100% foreign investment in a corporate debtor if the FDI policy/relevant foreign exchange laws permit foreign investment only up to 75% in the relevant sector of the industry; it should be compliant with requirements such as restrictions on an Indian entity to issue securities to a person resident outside India under FEMA, 1999.

The Notes on Clauses in respect of Section 31 explains: “Therefore, if a plan requires stakeholders to do or not do certain actions for the successful implementation of a plan, it shall be binding on all the affected parties who shall be bound to undertake the actions set out in the plan.” As such, the approval of shareholders/members of the corporate debtor for a particular action required in the resolution plan for its implementation, which would have been required under the Companies Act, 2013 or any other law if the resolution plan of the company was not being considered under the Code, is deemed to have been given on its approval by the adjudicating authority.

Resolution Plan not to be A Device To Evade Taxes

In the case of Hindustan Lever Employees’ Union v. Hindustan Lever Ltd. and Others 1995 Supp. (1) SCC 499, it was observed,

“Section 394 casts an obligation on the court to be satisfied that the scheme for amalgamation or merger was not contrary to public interest. The basic principle of such satisfaction is none other than the broad and general principles inherent in any compromise or settlement entered between parties that it should not be unfair or contrary to public policy or unconscionable. In amalgamation of companies, the courts have evolved, the principle “prudent business management test” or that the scheme should not be a device to evade law.”

In Miheer H. Mafatlal v. Mafatlal Industries Ltd AIR 1997 SCC 506, the Supreme Court discussed broad contours of the jurisdiction of the courts on sanctioning schemes under section 391; relevant extracts are produced as under  –

“ . . . That the majority decision of the concerned class of voters is just fair to the class as whole so as to legitimately bind even the dissenting members of that class.

. . .

  1. That the proposed scheme of compromise and arrangement is not found to be violative of any provision of law and is not contrary to public policy. For ascertaining the real purpose underlying the Scheme with a view of to [be] satisfied on this aspect, the Court, if necessary, can pierce the veil of apparent corporate purpose underlying the scheme and can judiciously X-ray the same.
  2. That the Company Court has also to satisfy itself that members or class of members or creditors or class of creditors as the case may be, were acting bona fide and in good faith and were not coercing the minority in order to promote any interest adverse to that of the latter comprising of the same class whom they purported to represent.”

See also Hindustan Lever & Anr v. State of Maharashtra & Anr (2004) 9 SCC 438.

In the matter of M/s Vodafone Essar Limited [Delhi High Court, CP No. 334/2009][5], it was stated,

“No action which may be violative of a statute is being legitimized by approval of the Scheme, and the income tax authorities are free to move against any of the parties concerned, in case they are of the belief that there has been any impermissible evasion of payment of tax by the petitioners. . . In my view, if the Court is indeed to sanction the Scheme, the powers of the Income Tax Department must remain intact. The authorities relied on by the petitioners also support this proposition, with the only exception being a situation where the Scheme itself has only one purpose, which is to create a vehicle to evade the payment of tax, rather than mere avoidance of tax.”

It may also be noted that there is no provision of restoration of dues under the Code; hence, even if the corporate debtor is relieved of insolvency post implementation of resolution plan, the statutory dues will not be restored. The Code does not even stipulate incorporation of “right to recompense” clause in the resolution plans.

Doctrine of Unjust Enrichment

The resolution plan cannot provide for extinguishment of the liability of the corporate debtor in respect of amounts deducted or collected as fiduciary of the statutory authorities. One example is tax deducted at source, other common example is indirect tax.

Such an amount cannot be said to be forming a part of the estate of the corporate debtor. The resolution applicant who submits resolution plan intends to acquire the corporate debtor at the best (read, lowest) possible price. However, extinguishment of amounts as aforesaid will lead to what is commonly referred to as “unjust enrichment” of the shareholders of the acquirer that too, at the cost of the persons who suffered taxes.

In K. Logachandran v. The District Collector[6], it was held by the Hon’ble Madras High Court-

“10. In Deputy Commercial Tax Officer and others v. Corromandal Pharmaceuticals and Others (1997 (Vol 105) Sales Tax Cases 327), in the concurring judgment of Hon’ble Mr. Justice B.P. Jeevan Reddy, His Lordship has observed as follows:-

“It is also a well-known fact that the proceedings before the Board of Industrial and Financial Reconstruction take a long time to conclude and all the while the protective umbrella of section 22 by certain industrial companies-and the wide language employed in the section is providing them a cover We are sure section 22 was not meant to breed dishonesty nor can it be so operated as to encourage unfair practices. The ultimate prejudice to public monies should not be overlooked in the process of promoting industrial progress . . .

. . . 13.Yet another principle laid down by the Hon’ble Supreme Court in the same judgment is that the money collected by the company from the consumers towards tax belongs to the Government and the same cannot be withheld by the company, either sick or non sick . . .

. . . 16.When a question arose as to whether enforcement of notice under section 226(3) of the income tax act would be barred by section 22 of sica, the Gujarat High Court in EZY Slide Fastners Ltd., v. Joint Commissioner of Income Tax (2004 (122) Com. Cases 242 (Gujarat); after having elaborately dealt with the above said cases of the Hon’ble Supreme Court, has distinguished sales tax and the income tax by stating that sales tax amount collected from the consumers is the money belonging to the Government whereas the income tax is a tax on income of the company and unless income tax is paid, it does not belong to the State . . .

. . . (v)Taxes such as sales tax, Central Excise etc., which are collected from the customers and others by the company belong to the State and the sick industrial company cannot withhold said payment by taking re-course to section 22(1) of sica.”

Concluding Remarks

As is evident from the discussion so far, plans or schemes approved under statutes have been given overriding effect, so as to be called “a statutory magic”; however, a pre-condition is that the same shall “legitimately” bind those who dissented to the scheme/plan. A statutory creditor who was not even provided an opportunity to be there in the meeting of creditors for approval and rejection of the resolution plan cannot be excluded in entirety and denied the right to be repaid. A plan framed under one statute cannot prevail over another statute. It may also be noted here that the conflict here is between two classes of creditors. A class of creditors cannot extinguish the rights of other class of creditors.

Therefore, the following may be concluded as regards statutory dues –

  • (i) Statutory dues cannot be reduced or extinguishment without seeking consent of the concerned authority. The authority shall be given a right to object against the provisions of the resolution plan affecting its right to receive statutory dues. It is opined that a public notice shall be issued by the resolution applicant asking for objections against the resolution plan.
  • (ii) The above holds true even if statutory dues are deferred or scheduled to paid in tranches.
  • (iii) The resolution plan shall, at bare minimum, provide for payment of liquidation value due towards statutory dues. The plan cannot go beyond such minimum level. See “Guide to Liquidation Value under the Insolvency Code”[7], by Sikha Bansal.
  • (iv) In case of statutory arrears, the retention of which leads to unjust enrichment of the corporate debtor, waiver/extinguishment is not possible.

In view of the points raised above, it is argued that a resolution plan consented upon by a class of creditors of a company cannot rise above any statute and waive dues and obligations arising under the statue. “Resolution” seeks to address insolvency of the company, which may take a good deal of time – it is entirely different from “liquidation” where there is no probability of the company regaining its life.

[1] http://www.bailii.org/ew/cases/EWCA/Civ/2002/1333.html

[2] http://www.bailii.org/ew/cases/EWCA/Civ/2016/88.html

[3] http://taxcaselaw.com/section-72a/calcutta-h-c-amalgamation-scheme-sanctioned-bifr-sica-will-overriding-effect/

[4] http://ibbi.gov.in/webadmin/pdf/legalframwork/2017/Oct/Clarification%20regarding%20resolution%20plan_2017-10-26%2004:08:34.pdf

[5] https://indiankanoon.org/doc/1447658/

[6] https://indiankanoon.org/doc/1379951/

[7] http://vinodkothari.com/wp-content/uploads/2017/02/Guide_to_Liquidation_Valuation_for_Insolvency_Resolution_under_the_Code.pdf

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