The Insolvency and Bankruptcy Code, 2016 [“Code”] is one of the most dynamic legislations that has been brought in force to aid the revival of stressed companies. The order of priority of the payment under the waterfall mechanism (Section 53) gives primacy to the financial creditors and other secured creditors. Government dues and other operational creditors have been placed lower in the priority. However, the tax authorities often exercise their power to recover their dues from the corporate debtor once the resolution plan is approved. The fresh slate approach provides that after the successful approval of the plan, the disputed liabilities cannot be claimed through the resolution applicant. The doctrine of fresh slate approach safeguards the resolution applicant post the approval of the plan against any claim filed by the statutory authority and enables him to start the company with a fresh slate. The fresh slate approach finds its place under sections 31 and 32A of the Code, which has further been interpreted by the Apex Court in the case of Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta.
Recently, the Jharkhand high court in Electrosteel Steels Limited v. State of Jharkhand held that only those stakeholders are bound by the resolution plan who were a part of the resolution process. This court took a different approach from that the judgment of the Rajasthan High Court in Ultra tech Nathdwara Cement Ltd. v. Commissioner, Central Goods and Service Tax and Central Excise Commissionerate. The Rajasthan High Court had held that the tax authority cannot claim any dues from the corporate debtor post the approval of the plan as the resolution plan is binding on all the stakeholders. This contrasting position has raised doubts and let irregularities creep into the fresh slate approach. This post analyzes the judgement of the Jharkhand High court vis-à-vis fate of the tax liabilities prior to the Corporate Insolvency Resolution Process [“CIRP”] in light of the settled precedents and legislations.
The decision of Jharkhand High Court
In the present case, after the successful completion of the CIRP against Electrosteel, M/S Vedanta emerged as a successful resolution applicant. The adjudicating authority approved the resolution plan allowing a proportional payment of the dues owed to the creditors. However, the Jharkhand VAT department could not submit their claims to the Resolution Professional [RP] as there were no public announcements made by the Electrosteel in its registered office at Jharkhand. Consequently, claims of the VAT department were not included in the resolution plan. Soon after, the department started sending a garnishee order to the banker of Electrosteel for the payment of the outstanding dues. Electrosteel filed a writ petition to challenge these orders contending that once the plan is approved by the adjudicating authority it becomes binding on all the stakeholders involved under section 31 of the Code. The question which arose for the consideration before the court, was whether the approved plan is binding on tax authority or not.
Given the facts, the Honorable High Court of Jharkhand held that the conjoint reading of section 13(1) of the Code and Regulation 6 of CIRP Regulations shows that the public announcement of the insolvency process has to be made at the place of registered as well as the principal office of the corporate debtor for inviting the claims from creditors. In the present case,the petitioner did not make any public announcement at the registered office of the company i.e. in Jharkhand thereby the VAT department was never aware of the CIRP process and could not submit their claims to the resolution professional. Consequently, it never became the party to the resolution plan so approved. Therefore, the resolution plan so approved is not binding on the VAT department under section 31 of the Code as the Tax authority never became a stakeholder in the entire insolvency process. The court further held that the IBC amendment 2019, by virtue of which the resolution plan is binding on government authorities is prospective in nature and not retrospective.
Additionally, the High Court also distinguished between the direct debt and the indirect debt which is to be considered as operational debt. In the instant case, since the company collected the VAT in dispute from its customer on behalf of the government, it will not be covered under operational debt and this would amount to misappropriation of the government money. Thus, the government is entitled to realize such debt.
Analysis
A. Non Consideration of JGST laws over subsumed JVAT laws
The court obscured its chance to declare the said garnishee proceeding initiated by the tax authority as void ab initio. As the court did not consider that the Jharkhand Value Added Tax [JVAT] stands repealed by virtue of the section 174 of the Jharkhand Goods and Service Tax [JGST]. Further, section 142 of the JGST Act provides that any dues recoverable with respect to the proceeding under the JVAT shall be recovered under the JGST act. Therefore, the proceedings initiated by the authorities under the repealed JVAT act (and not under the JGST Act) were void ab initio. Furthermore, section 82 of the JGST Act specifies that GST is the first charge on the property except as otherwise provided under the IBC. Therefore, in the present case the tax dues were not recoverable as the GST law clearly identifies supremacy of the Code in relation to the demand and recovery. Thus, these vital aspects were not considered by the court.
B. Binding Nature of Resolution Plan
The court while interpreting section 31 of the Code which provides that “the resolution plan approved by the NCLT will have a binding effect overall stakeholder” held that only those stakeholder will be bound by the approved resolution plan who were involved in the insolvency resolution process. On the other hand, the High Court of Rajasthan in the case of Ultratech Nathdwara Cement case while dealing with the different set of facts but on a similar legal issue, wherein the Revenue Authority had filed a claim seeking pending GST dues for the period prior to the insolvency commencement date had held that the debt in respect of the payment of dues arising under any law, for the time being, is brought under the purview of the resolution plan approved by the NCLT and hence binding on all the stakeholder. The court delved deep into the intent of the legislature behind section 31 of the Code and noted that the amendment in itself provides for the forfeiture of the government claims once the resolution plan is approved. After the approval of the resolution plan, it becomes binding on all the stakeholders, even on those who were not involved into the CIRP, so as to give the resolution applicant a steady opportunity to revive the business. The Supreme Court in Swiss Ribbons v. Union of India case was of a similar view and had stated that the CIRP proceedings are proceeding in rem i.e. they are binding on the public at large.
It is pertinent to mention here the finding of Essar steel, where the court while upholding the binding nature of the resolution plan noted that the resolution applicant cannot be suddenly made to face the undecided claims after the approval of the resolution plan as it will put an unreasonable burden on the resolution applicant and will put the entire resolution process of the distressed company on the back foot. The only criteria that resolution applicant has to satisfy is that the value given to the operational creditor should not be less than the value given at the time of liquidation. Non-compliance of these criteria by the resolution applicant can attract challenges to such approved plan.
C. Retrospective/Prospective application of section 31(1)
The legislative intent behind enacting section 31 of the Code was always that the resolution plan once approved will be binding on all the stakeholders. However, the practical challenges that arose after the approval of the plan on account of the claims and demands by the tax authority of unpaid taxes, forced the legislature to introduce a clarification to section 31 through an amendment which stated as follows:
“to amend sub-section (1) of the Code to clarify that the resolution plan approved by the Adjudicating Authority shall also be binding on the Central Government, State Government or any other Local Authority to whom a debt of payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed including tax authorities.”[Emphasis Supplied]
This amendment clarifies the existing standing of the law rather than carving out a new provision. Therefore, the High Court’s observation of the prospective application of the amendment is in the teeth of the intent and standing position of the law. Thus, the finding of the Electrosteel case regarding the binding nature of the resolution plan runs contrary to the fresh slate theory which is to provide a fresh start to the distressed companies.
D. The distinction between Indirect and Direct Tax
The court's observation of not including the indirect tax under the purview of the operational debt is in contrast to section 5(21) of the Code as it states that “debt in respect of the payment of dues arising under any law for the time being in force and payable to the Government, or any local authority”. This section does not primarily differentiate between the direct and indirect debt rather provides for any debt which is payable to the government as operation debt. Further, the NCLAT in the case of Director General of Income Tax v M/s Synergies Dooray Automotive Ltd. held that operational debt is a debt that has a direct connection with the operation of the company and the statutory claim will arise only when the company is operational. Thus, the Income Tax, Value Added Tax and Statutory Tax are to be referred to as operational debts. Thereby the tax collected by the company on behalf of the government but not paid to the government will also qualify as operational debt as it is a debt due to the state government.
Conclusion
The objective of the IBC is the revival and the same is unachievable if the binding nature of the plan is foregone. The fresh slate approach safeguards the applicant from any undecided liability after the approval of the plan. The court's approach in the instant case runs contrary to the intent of the fresh slate approach. If the government and other local authorities are allowed to raise their claim after the approval of the plan, it will only de-incentivize the applicant from bidding for the distressed company. Further, the court’s decision of not considering the indirect tax as an operational debt is uncalled for, since this position has already been settled by the NCLAT. This contrary decision by the High Court has resulted in a dangerous precedent and has put the fate of the resolution applicant in a turmoil that needs to be settled through a proper authority to keep the intent of the Code intact.
[i] Vishesh Jain is a Penultimate year law student at National Law University Odisha, Who has a keen interest in Insolvency laws as well as arbitration laws. Any query on the article can be directed to 17bba060@nluo.ac.in. Preferred Citation: Vishesh Jain, Electrosteel Steels Ltd. v. Jharkhand -End of Fresh Slate Approach in Indian Insolvency, Arbitration & Corporate Law Review, Published on 24th July, 2020.
This article was reviewed by Deeksha Sahni and Shruti Dhonde.