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SC AFFIRMS IBC SUPREMACY OVER ELECTRICITY ACT: CRITICIZING RAINBOW PAPER'S JUDGEMENT

[Astha Agarwal and Ananya Karnwal are final year law students at National Law University Odisha]


On 17th July 2023, a two-judge bench of Supreme Court of India, in the case of Paschimanchal Vidyut Vitran Nigam Limited v. Raman Ispat Private Limited and Others, has settled a contentious legal issue, affirming that the Insolvency and Bankruptcy Code of 2016 (IBC) holds supremacy over the provisions of the Electricity Act 2003 (2003 Act). The ruling solidifies the priority of creditors’ rights under the IBC and establishes that they must be repaid first before dues owed to the State or the Central government are settled.


Facts


Raman Ispat Private Limited (Corporate Debtor) and Paschimanchal Vidyut Vitran Nigam Limited (PVVNL) had entered into an agreement for supply of electricity, and according to the agreement, the outstanding dues were to be treated as a charge on the company’s assets. Since the dues remained unpaid, PVVNL attached the corporate debtor’s properties by an order passed on 12th January 2016.


The corporate debtor initially underwent a resolution process under the IBC, but it was not successful, leading to the company’s liquidation. The liquidator, responsible for managing the company’s assets during liquidation, expressed concern that potential buyers would hesitate to purchase the property due to uncertainty about the authority of the liquidator to sell it. The liquidator argued that PVVNL’s claim should be treated according to the priority prescribed under Section 53 of the IBC and be entitled to a pro-rata distribution of proceeds with other secured creditors from the sale of liquidation assets. The National Company Law Appellate Tribunal (NCLAT) ultimately directed to release the attached property in favor of the liquidator. This would enable the sale of the property, and after realizing its value, the proceeds would be distributed in accordance with the relevant provisions of the IBC. The NCLAT also endorsed National Company Law Tribunal’s (NCLT) reasoning that PVVNL fell within the definition of an “operational creditor” and was entitled to realize its dues through the liquidation process as per the law.


Arguments


Mr. Pradeep Mishra, the advocate for PVVNL, argued that Sections 173 and 174 of the 2003 Act had an overriding effect on all other laws, except for a few specific Acts. He contended that the 2003 Act being a special law related to electricity has primacy over the IBC, which was a general law dealing with corporate insolvency implemented later.


He further relied on the decision in State Tax Officer v. Rainbow Papers Ltd., where the court held that tax authorities were secured creditors under the IBC. He argued that if a resolution plan excluded tax or statutory dues payable to the government, it would not be binding on the State and would not conform to the IBC provisions.


Additionally, it was contended that electricity dues could be considered ‘security interests’ in favor of electricity service providers based on the definition of ‘secured creditor’ in the IBC. He highlighted that the IBC’s definitions of ‘security interest’ and ‘transfer’ were broad enough to include all claims, including statutory claims arising under the law, against the corporate debtor, making obligations and statutory charges also ‘security interests’.


On the other hand, Mr. Arvind Kumar Gupta, the learned advocate representing the liquidator argued that government dues were placed in the “waterfall mechanism” under Section 53(1)(e)(i) of the IBC. He argued that the IBC, being a special law dealing with insolvency, bankruptcy, and winding up of companies, prevailed over the Electricity Act due to Section 238 of the IBC, which granted it overriding effect.


Observations


Firstly, the two-judge bench analyzed the objective and the procedure to be followed under IBC, wherein it discussed about the formation of Committee of Creditors (COC), role of Resolution Professional (RP) and completion of process in a time-bound manner. It further discussed the procedure of liquidation in case the CIRP fails.


Secondly, the “waterfall mechanism” given under Section 53 of IBC, specifying the priority in distribution of assets of Corporate Debtor, was discussed. It provides that secured creditors who have relinquished their right to enforce security at the time of liquidation should be given priority second only to costs incurred during CIRP and liquidation costs. Addressing PVVNL’s reliance on a previous Supreme Court judgment in State Tax Officer v. Rainbow Papers Limited, the bench pointed out that this case had overlooked the waterfall mechanism established by the IBC.


Thirdly, on the question of the status of PVVNL as a ‘government entity’, the bench observed that though PVVNL has the participation of the government but this does not make it a ‘government entity’ because private entities carry out similar function to that of PVVNL. Ultimately, the Court deemed PVVNL as a secured creditor, a position supported in both the NCLT and NCLAT rulings. As a secured creditor, PVVNL’s interests ranked higher in the scheme of repayment under Section 53 of the IBC.


Lastly, the Supreme Court firmly stated that Section 238 of the IBC grants it an overriding effect, allowing it to prevail over other laws, including the Electricity Act, 2003. The Court emphasized that the dues payable to creditors under the IBC are placed on a higher footing than electricity dues payable under the Electricity Act.


Explaining the Waterfall Mechanism


The Waterfall Mechanism, as prescribed under Section 53 of the IBC, establishes a sequential order for the distribution of funds recovered from the liquidation process. It sets a hierarchy of stakeholders, indicating the priority in which payments will be made. Understanding this mechanism is crucial to appreciate how creditors and other parties involved will be treated during the liquidation process.


The Waterfall Mechanism begins with allocating funds for the Insolvency Resolution Procedure (IRP) and liquidation costs. These expenses are given first preference during the distribution. After settling the costs, secured creditor are second in the list. Workmen dues are kept at par with secured creditors, workmen are entitled to their dues for the 24 months preceding the liquidation commencement date. Government dues are categorized under the fifth category in the Waterfall Mechanism. This implies that they are not given a high priority in the distribution of funds during liquidation. The government’s claims come after workmen and secured creditors have been paid.


Section 52 of the IBC grants secured creditors an option to either relinquish their right to the liquidation estate or realize their security interest separately. If they choose to relinquish their interest, their assets become part of the liquidation estate, and the liquidator can sell these assets accordingly. Recently, in Technology Development Board v. Anil Goel, the NCLAT addressed the Waterfall Mechanism under Section 53 of the IBC. It observed that when secured creditors choose to relinquish their right in favor of the liquidation estate, their repayment would strictly adhere to Section 53 of the IBC. This means that there is no distinction between different classes of secured creditors during the distribution process.


Criticizing the Rainbow Paper’s Judgement


PVVNL argued that the Electricity Act of 2003 holds a special status, prevailing over the more general Insolvency and Bankruptcy Code (IBC). In this context, PVVNL pointed to the Rainbow Papers judgment to assert that when the government establishes a security interest for tax claims under the Gujarat Value Added Tax Act of 2003, it becomes a secured creditor under the IBC. The Supreme Court's ruling in Rainbow Papers clarified that any resolution plan neglecting tax payments or statutory dues owed to the government would violate IBC provisions and lack legal validity against the State.


Building upon the Rainbow Papers precedent, the PVVNL judgment drew attention to Section 53’s meticulous arrangement. It highlighted that secured creditors and workmen’s dues follow liquidation expenses in order of priority, with government dues placed lower. The Supreme Court observed that the Rainbow Papers case failed to acknowledge this specific hierarchy, suggesting either an oversight or lack of attention. Consequently, it failed to recognize the IBC's emphasis on prioritizing secured creditors over Central or State Government dues.


Conclusion


The judgment emphasizes the significance of the IBC’s framework in resolving insolvency and bankruptcy cases in India. By upholding ‘waterfall mechanism’ and prioritizing of creditors’ interests, the Court has strengthened the trust in insolvency resolution process. The Waterfall Mechanism plays a crucial role in determining the priority of payments during the liquidation process under the IBC. It ensures a systematic distribution of funds to different stakeholders involved in the insolvency resolution. The overriding effect of the IBC over the 2003 Act further offers greater confidence and protection to creditors while promoting a more efficient and effective system for dealing with corporate insolvency in India.

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