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Cracking the Code: Government Entities as Secured Creditors under the Insolvency Regime

The authors are Pratishtha Shrivastava and Palash Varyani, third year students at Institute of Law, Nirma University.


In a recent development, the Chennai bench of the National Company Law Appellate Tribunal (NCLAT) has pronounced a verdict in the case of Assistant Commissioner of Central Tax v. Ms. Sreenivasa Rao Ravinuthala, addressing a pivotal question: "To what extent can governmental entities assume the status of secured creditors?". Preceding this, in the case of “State Tax Officer v. Rainbow Papers Limited, the tribunal had adjudicated that governmental bodies could indeed qualify as secured creditors within the purview of the Gujarat Value Added Tax Act. However, the incumbent case undertakes a discernment of whether the same disposition holds true under the Central Excise Act. The case is significant for narrowing down the interpretation of “secured creditors” under the insolvency regime. This article delves into the case by demystifying the distinction between the GVAT Act and Central Excise Act, understanding the interpretation of secured creditors, analyzing the implications and future prospects of the case, and it concludes by highlighting the precedential value and potential of this verdict in influencing the upcoming cases.

Background of the case

The case involves an appeal by the Central Excise Authority against the approval of a Resolution Plan. The core contention was that the Corporate Debtor was liable for a substantial amount of Rs. 22,60,32,948/- due to default in payment of Central Excise Duty, along with interest and penalty, based on the Central Excise Returns submitted to the Appellant Department. The Resolution Plan, however, allocated a mere 0.13% of the plan towards settling Government dues, whereas the Financial Creditor was slated to receive 44.5% of the total claim amounts, and Operational Creditors were to receive just 0.51% of their claims, a distribution that the Appellant perceived as inequitable. The Appellant contended that its claim should be treated as that of a 'Secured Creditor' due to the attachment of the Corporate Debtor's property.

In response, the Respondent argued that the Appellant's challenge came after the approval and implementation of the Resolution Plan on 08/02/2022, involving an expenditure of around Rs. 69,00,00,000/- by the Successful Resolution Applicant. The Respondent pointed out that the Appellant had not raised objections when the claim amount was initially communicated.

The tribunal's analysis revolved around the interpretation of Section 11E of the Central Excise Act, which contains an exception clause: “save as provided in” and sought to exclude cases covered by various acts including the “Companies Act, 1956”, “The Recovery of Debts due to Banks and the Financial Institutions Act, 1993”, “SARFAESI Act, 2002”, and “IBC, 2016”. The tribunal noted that the definition of 'Secured Interest' under the Code specifically excludes charges created by the operation of law. It also clarified that the provisions of the “Central Excise Act, 1944”, notably Section 11E, are distinct from those of the 'Gujarat VAT Act, 2003', rendering the decision in “State Tax Officer v. Rainbow Papers Limited” inapplicable to the present case.

Considering the aforementioned factors, the NCLAT Chennai Bench held that:

“Keeping in view, Section 11E of the ‘Central Excise Act, 1944’ is quite different from the ‘GVAT Act, 2003’ and Clause 20 of the aforenoted Circulation, this ‘Tribunal’ is of the considered view that the Appellant herein, cannot be treated as a ‘Secured Creditor’.”

Demystifying GVAT Act v. Central Excise Act

Under the Gujarat Value Added Tax Act, Section 48 deals with tax to be “first charge” on the property. The provision states that:

“Notwithstanding anything to the contrary contained in any law for the time being in force, any amount payable by a dealer or any other person or account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case may be, such person.”

On a plain reading of the provision, it is clear that it emphasizes the government’s authority to pursue dealers or private parties for unpaid taxes, interest, or penalties. It guarantees that, in the event of non-payment, the government's claim on the property will take precedence over other claims, including those of other creditors.

However, in the case of the Central Excise Act, Section 11E talks about the liability under the Act to be “first charge”. It states that:

“Notwithstanding anything to the contrary contained in any Central Act or State Act, any amount of duty, penalty, interest, or any other sum payable by an assessee or any other person under this Act or the rules made thereunder shall, save as otherwise provided in Section 529A of the Companies Act, 1956 (1 of 1956), the Recovery of Debts Due to Banks and the Financial Institutions Act, 1993 (51 of 1993) 1 [the Securitisation and Reconstruction of Financial Assets and the Enforcement of Security Interest Act, 2002 (54 of 2002) and the Insolvency and Bankruptcy Code, 2016], be the first charge on the property of the assessee or the person, as the case may be.”

The provision discusses priority of charges on the property of the assessee. The section provides that charges arising under the three Acts, namely the Financial Institutions Act, SARFAESI Act and IBC, will have specific priority when it claims against the property of the assessee. This means that if the Corporate Debtor owes money or has financial obligations under these Acts, then those obligations would have precedence over other claims and charges.

In the above case, the meaning of secured interest mentioned under IBC took precedence over the Central Excise Act. Since the Demand Orders were issued to Corporate Debtors under the Central Excise Act, the provisions of GVAT were rendered inapplicable.

Understanding “Secured Creditors”

Section 3(30) of the IBC defines “Secured Creditor” as the creditor in favor of whom the secured interest is created. Further, Section 3(31) defines secured interest as the “right, title or interest or a claim to property, created in favor of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment, and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person”. The Code introduced the creditor in control mechanism and a comprehensive framework to address the problem of insolvency of corporates. Under Section 14, it is the Adjudicating Authority that can initiate the liquidation process after which the secured creditors can enforce their rights and recover, foreclose, or enforce any security interest that was created by the Corporate Debtor in respect of any property including any action under the SARFAESI Act, 2002.

According to the ruling in the case discussed above, the governmental dues do not come under the definition of “secured interest”. This is in consonance with the third objective of the IBC which intends to modify the sequence in which government dues are recovered. In order to fulfill this objective, Section 53 sets out a waterfall mechanism which places governmental dues at fifth position. The hierarchy of secured creditors is created by several statutes to protect secured creditors from losing money due to increased number of non-performing accounts and to safeguard the financial sector.

Implications of the judgment and future prospects

The implications and future prospects of the Assistant Commissioner of Central Tax case are multifaceted and significant for various stakeholders involved in corporate insolvency and resolution processes. The case centers around the treatment of Central Excise Authority's claim in a Resolution Plan, and the tribunal's decision has far-reaching implications. The tribunal's interpretation of Section 11E of the Central Excise Act, which excludes certain cases from its purview, could set a precedent for future cases involving the prioritization of claims by government authorities in insolvency proceedings. This interpretation might influence how other regulatory authorities' claims are treated in similar cases.

Moreover, the case also solves the questions about the hierarchy of creditors' claims in resolution plans. In 2015, Bankruptcy Law Reform Committee recommended that "there should be a separate declaratory provision that upholds the priority rights of secured creditors on their security interests notwithstanding anything to the contrary contained in any state or central law that imposes a tax or revenue payable to the Government by virtue of a specific statutory provision made as a first charge on the assets of the assessee; provided that such first charge may be allowed for claims that existed on the date when such security interest was created".

The tribunal incorporated the principles that were laid down by the Committee while giving these recommendations. Furthermore, the verdict also holds significance in distinguishing between secured and unsecured creditors. The tribunal's ruling on the Central Excise Authority's claim status sets a precedent for how claims based on statutory dues will be treated compared to those with collateral or security interests. This distinction can impact creditors' willingness to participate in insolvency proceedings.

Concluding Remarks

Depending on the outcome of this case and potential ensuing discussions, policymakers might consider amendments to insolvency and bankruptcy laws to address issues related to the treatment of government claims and ensure a balanced approach in distribution among various creditors. The verdict’s outcome might prompt government authorities to be more proactive in insolvency proceedings, ensuring that their claims are adequately protected and pursued within the legal framework.

The discrepancy between the meager allocation for government dues compared to substantial portions for financial and operational creditors could spark discussions about the fairness and equity of distribution among different classes of creditors. However, the decision is in consonance with the creditor in control mechanism which the IBC 2016 intends to protect and promote. It successfully puts the rights of the secured creditors to the forefront, as intended by the legislature. Finally, it also upholds the objectives enlisted in the preamble of the IBC 2016, making it a worthy precedent for the forthcoming cases involving the same contention.

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