Summary of Important Supreme Court Judgements on IBC

Team Resolution | resolution@vinodkothari.com

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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.

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Clog on redemption of mortgage after publication of sale notice – SC reiterates word of law u/s 13(8)

– Team Resolution | resolution@vinodkothari.com

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( ‘SARFAESI Act’) provides methods that can be undertaken by a secured creditor to recover its dues in case of a default.

Section 13 of the SARFAESI Act being an important section contains provisions relating to ‘Enforcement of Security Interest’. Sub-section (2) and (4) of section 13 describes the manner and timeline within which the creditor can enforce its rights to recover the dues against a Non-Performing Asset (‘NPA’). While, on one hand, the creditor has a right to sell the secured asset; in juxtaposition is the right of the borrower to have the property released on repayment of dues. These rights are in conflict with each other and therefore, there is a need to have clarity around the point of time at which the borrower would lose the right of redemption and the lender’s right of sale becomes absolute.

At this stage, section 13(8) of the SARFAESI Act comes into picture. The present provision of section 13(8) states that where any default has been made by the borrower in terms of repayment of the dues, the amount outstanding if repaid by the borrower at any time before the date of publication of auction notice by the creditor, such a creditor shall not have any further right to transfer or to take any other step in relation to transfer of such secured asset. On a contrary, the earlier provision stated that the right of the borrower to redeem the mortgaged property shall be available till the date fixed for sale or transfer.

The provision of section 13(8) has often been debated upon wherein, several High Courts have held different views. However, a recent ruling of the Hon’ble Supreme Court in the matter of Celir Llp v Bafna Motors (Mumbai) Pvt. Ltd.[1] , has clarified the position and scope of section 13(8) before and after the amendment.

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Statutory dues cannot override section 53: Supreme Court clarifies the applicability of Rainbow ruling

– Barsha Dikshit | resolution@vinodkothari.com

Introduction 

Section 53 of Insolvency and Bankruptcy Code, 2016 (‘IBC’) has created a waterfall citing priority of dues. Whether it is distribution in liquidation process or resolution plan – both processes would need to honour the priorities under Section 53 of IBC. However, in September, 2022, in State Tax Officer v. Rainbow Papers Ltd., the Hon’ble Supreme Court (SC) held that by virtue of the ‘security interest’ created in favour of the Government under GVAT, the State is a ‘secured creditor’ as per the definition in IBC. Hence, as workmen’s dues are treated pari passu with secured creditors’ dues, so should the debts owed to the State be put at the same pedestal  as the debts owed to workmen under the scheme of section 53(1)(b)(ii). [Read our detailed analysis on Rainbow Papers ruling here]. As such, this ruling led to anomalies in interpretation, as it shuffled the already well-settled view on priorities of tax dues vis-a-vis secured creditors. 

Interestingly, the recent ruling of SC in Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Private Limited & Ors. [Civil Appeal Nos. 7976 of 2019] has confined the applicability of Rainbow Papers to its own factual circumstances, thereby, providing relief to all stakeholders, especially IPs undertaking liquidation/resolution processes, who started receiving demands from tax authorities on the strength of Rainbow Papers.

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Classification of fraud and reporting

Should borrower be given an opportunity of being heard?

-Rhea Shah, Executive | rhea@vinodkothari.com

Background

A recent ruling of the Supreme Court placed emphasis on the classification of an account as fraudulent and the consequences thereof. The ruling is in favour of incorporating the principles of natural justice during the process of declaring an account as fraudulent.

Fraud classification by banks and NBFCs is essentially guided by Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs[1] and the Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016[2], respectively (‘Fraud Directions’). However, there has been a certain extent of ambiguity as to the procedural aspects of the classification. While the basic purpose of such classification remains to ensure the early detection and reporting of a fraudulent transaction, it also entails significance in implementing a procedure that is fast and robust for the RBI to disseminate information regarding fraudulent borrowers and related parties.

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Regulatory developments in   Insolvency and bankruptcy law in 2022 – a quick round-up

– Sikha Bansal, Partner & Barsha Dikshit, Partner | resolution@vinodkothari.com

IBC, in a very short span of its life, has undergone multifarious amendments. In 2022, there were no amendments in the Code, but almost all regulations were amended.   Majority of the amendments aimed at compressing the timelines. Few other amendments filled the gaps in law and provided clarity.

A quick snapshot of the key changes introduced in the CIRP regulations, Liquidation regulations, voluntary liquidation regulations and IP regulations, in the year 2022 is provided below. A brief discussion can also be referred to in our video on the same.

Key Amendments in IBBI (Insolvency Resolution Process For Corporate Persons) Regulations, 2016[1]

IBBI introduced several changes in the IRPCP Regulations vide Notifications dated 9th February, 2022, 14th June, 2022, 13th September, 202216th September, 2022, and 20th September, 2022. The amendments mostly focused on reducing the timeline of corporate insolvency resolution process, removing ambiguities, facilitating IPs thereby increasing value and realisation for stakeholders.

Resolution Professionals have been empowered to invite EOI for resolution plans for one or more assets of CD with approval of CoC,  if no resolution plan for CD is received within the given timeline. Resolution plan shall  also provide for the manner of pursuing  avoidance transaction application and distribution of realisation therefrom, if any. Timelines for certain activities during CIRP have been reduced.

Further, the regulations now also provide for payment of a regulatory fee at the rate of 0.25% of the realisable value  under approved resolution plan to the Board w.e.f 1st October, 2022 which will form part of CIRP cost.

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Secondment contract as ‘services’: Supreme Court held under Indian taxation regime

– Neha Sinha, Assitant Legal Advisor | neha.sinha@vinodkothari.com 

Background

Secondment of employees have become increasingly popular amongst corporate entities which enter into secondment arrangements to leverage the expert knowledge and specific skill sets. The seconded employees work on a deputation basis in the seconded companies they are seconded to which require their technical expertise on certain matters. Since the seconded employee works for the seconded company during the secondment period, a pertinent question arises on whether the seconded employee becomes an employee of the seconded company. If yes, then what are the likely implications in the context of service tax. 

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Supreme Court ruling revives the quandary, holds tax authorities to be secured creditors

Sikha Bansal, Partner, Vinod Kothari & Company

Neha Sinha, Executive, Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

Lawmakers might have put the best of efforts to frame the law in the clearest possible way, however, there may still be possibilities of diverse readings (and thus, diverse interpretations). Such a scenario is often addressed by the judiciary which, as and when circumstances arise, determines the questions arising out of law. However, there is also a possibility where the judiciary itself would render diverse interpretations on the same subject matter. This would, of course, lead to confusion and chaos.

A similar situation arose in the recent case of State Tax Officer v. Rainbow Papers Limited,[1] wherein the Hon’ble Supreme Court (‘SC’) dealt with the question as to whether the provisions of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), specially section 53, overrides section 48 of the Gujarat Value Added Tax Act, 2003 (‘GVAT’). Section 48 of GVAT is a non-obstante clause and creates a statutory first charge on the property of the dealer in favour of tax authorities against any amount payable by the dealer on account of tax, interest or penalty for which he is liable to pay to the Government.

SC held that if the resolution plan excludes statutory dues payable to government or a government authority, it cannot be said to be in conformity to the provisions of IBC, and as such, not binding on the government. As such, the same must be rejected by the Adjudicating Authority. Further, section 48 of GVAT is not inconsistent with IBC and hence, it was held that IBC does not override GVAT. The SC went on to rule that by virtue of the ‘security interest’ created in favour of the Government under GVAT, the State is a ‘secured creditor’ as per the definition in  IBC. Hence, as workmen’s dues are treated pari passu with secured creditors’ dues, so should the debts owed to the State be put at the same pedestal  as the debts owed to workmen under the scheme of section 53(1)(b)(ii).

In the most humble view of the authors, the conclusions as above may not in consonance with the well-settled jurisprudence around the subject matter of conflict between IBC and tax statutes and the question of priorities between these, and may also not fit well with the construct of the IBC, the intent of the lawmakers and the Bankruptcy Law Reform Committee (‘BLRC’), as well as several judicial precedents set by SC itself, as discussed below. A plethora of rulings, including by SC itself, go on to hold that crown debts would be subordinate to the dues of secured creditors, and none of these rulings ever equated tax dues to secured dues. The authors thus, analyse the SC ruling in light of the construct of the IBC, intent of the lawmakers and policymakers, and various past precedents and offer their views as to how this ruling has actually reopened a can of worms and how it may impact success of ongoing and future resolution processes.

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Pledge as transfer: Several SEBI Regulations may require review post SC Ruling

– Vinita Nair | Senior Partner, Vinod Kothari & Co. | corplaw@vinodkothari.com

Hon’ble Supreme Court, in the matter of PTC India Financial Services Limited v. Venkateshwar Kari and Another (PTC India ruling), brought out a very important distinction between the meaning of beneficial owner under the Depository law, and the right of the pledgee/ pawnee/ security interest holder) to cause the sale of goods pledged by pledgor/ pawnor in terms of the rights arising under the pledge[1]. The PTC India ruling inter-alia holds that “beneficial ownership” in the context of the Depositories Act should not be confused with beneficial ownership in law. Getting registered as a “beneficial owner” in terms of Section 10 of Depositories Act, 1996 read with Regulation 58 (8) of the SEBI (Depositories and the Participants) Regulations, 1996[2] (‘Depository law’) does not amount to any transfer of title to the pawnee – it is merely a procedural precondition to sale by the pawnee. It further stipulates that there is no concept of ‘sale to self’ by the pledgee and that the pledgee is bound by the two options provided under Section 176 of the Indian Contract Act, 1872 (‘ICA, 1872’), viz., right to bring a suit against the pawnor and retain the goods pledged as collateral security, or sell the thing pledged on giving reasonable notice to the pawnor and sue for the balance, if any. This ruling triggers the need to review current practice followed by companies and also validity of orders pronounced by Securities Appellate Tribunal (‘SAT’) and SEBI from time to time w.r.t. pledge.

The Apex Court referred to the decision of Securities Appellate Tribunal (‘SAT’) in the matter of Liquid Holdings Private Limited v. The Securities Exchange Board of India[3] where SAT held that the banks being recorded as beneficial owners of the shares pursuant to invocation of pledge became the members of the target company and subsequent transfer of the said shares by the banks back to the appellants resulted in purchase by the appellants attracting the open offer obligations under SEBI (Substantial Acquisition and Takeovers) Regulations, 1997 [Repealed by SEBI (Substantial Acquisition and Takeovers) Regulations, 2011] (‘Takeover Code’). The Apex Court observed that SEBI should examine the provisions of Depository law and the Takeover Code to avoid discord or ambiguity resulting in  instability or confusion especially on applicability of Takeover Code when the pawnee exercises his right to be recorded as a ‘beneficial owner’, while reserving his right to sell the pledge. Additionally, in the author’s view, there is an equal need to examine the applicability of SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) in the context of pledges[4], for reasons discussed in the latter part of this article.

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Broken Pledge? Apex Court reviews the law on pledges

By Vinod Kothari, Managing Partner, Sikha Bansal, Partner and Shraddha Shivani, Executive | corplaw@vinodkothari.com

The Supreme Court ruling in  PTC India Financial Services Limited v. Venkateshwar Kari and Another is significant in many ways – not that it categorically rewrites the law of pledges which is settled with 150 years of the statute[1] and even longer history of rulings, but it surely refreshes one of the predicaments of a pledge. Importantly, since most of the pledges of securities currently are in the dematerialised format, it brings out a very important distinction between the meaning of beneficial owner under the Depository law, and the right of the pledgee (a.k.a. pawnee or security interest holder) to cause the sale in terms of the rights arising under the pledge. Also, very importantly, the SC dwells upon the essential principle of equity of redemption in pledges and renders void any provision in the pledge agreement which allows the pledgee to make a sale of the pledged article without notice to the pledgor, or to forfeit the pledged article and convert the same as pledgee’s own property. There are also observations in the ruling that seem to give an indefinite time to the pledgee for the sale of the pledged property – this is a point that this article discusses at some length.

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