Home / Companies / News /  Unsecured debt tag for govt dues to facilitate IBC rescue

NEW DELHI : The government’s move to amend the Insolvency and Bankruptcy Code (IBC) is set to clear the air on the tax dues of failed businesses and aid their bankruptcy resolution, experts said.

The corporate affairs ministry plans to clarify in the IBC that all debts owed by a business to the Central or state government—irrespective of whether they have the status of secured creditors—shall be treated as unsecured creditors.

This, experts said, removes a major uncertainty in restructuring distressed companies. Normally, Central or state tax authorities have a right to the assets of a failed business that owes tax.

Giving these authorities the status of unsecured creditors means they will have the last claim on the assets of a failed business.

The proposed change that is part of a set of amendments the ministry is working on was released on 18 January for public consultation. The deadline for submitting comments is 7 February. The Amendments may be moved in the budget session or in the subsequent session once the cabinet clears the proposals.The clarification comes in the context of a Supreme Court ruling last September in the case of a dispute between Gujarat state tax authorities and Rainbow Papers Ltd. The apex court ruled that the state is a secured creditor under the Gujarat VAT Act in whose favour a “security interest" —or lien on the assets of the company— is created by operation of the law. The state law says the first charge on the asset of a person is on account of tax dues. However, while seeking public comments, the ministry said in its proposal that “security interest" has been defined under the IBC as a right to property created by a “transaction". It is meant to be limited to “transactions", which would preclude a tax obligation.

The concept of security interest was intended to cover a consensual transaction between parties and not any similar interest created through mere operation of a statute, the ministry explained.

“At present, there is uncertainty around the secured creditor status on account of the Supreme Court order in the Rainbow Papers Ltd. case. The proposed clarifications by the government is very much needed. Otherwise this uncertainty could undo the gains reaped from IBC," said Anoop Rawat, partner (insolvency and bankruptcy) at law firm Shardul Amarchand Mangaldas & Co.

This gives major relief to lenders that have financed a company on the back of a collateral. Under the IBC, dues to secured creditors get a higher priority over those of unsecured creditors— which means the dues of a lender would be prioritised over those of the Central or state government on account of tax dues.Dhananjay Kumar, Partner at law firm Cyril Amarchand Mangaldas said the effect of Rainbow Papers was to equate the minimum payout for government dues under a plan with those of secured creditors. “This could dip into the payouts for the financial creditors and increase the outlay for the resolution applicants. The proposal will clear the air in this regard and ensure that such dues are treated at par with other unsecured creditors in line with the objective of the IBC to alter the priority of payment of government dues," said Kumar.

Another key proposal by the ministry is a bid-challenge mechanism. The Insolvency and Bankruptcy Board of India’s regulations have sought to restrict the discretion in negotiations within a time-bound process and the plan is to incorporate the same change in the IBC as well to ensure a transparent mechanism, said Rawat.

“The other highlight of the proposal is to extend the pre-pack scheme for larger corporations which entails the concept of debtor in control, which will change to creditor in control if a fraudulent transaction is detected," said Rawat.

Yogendra Aldak, partner at Lakshmikumaran and Sridharan Attorneys said that the recommendations, once implemented properly, would result in effective resolution of insolvency. “IBBI should be conscious that these recommendations should not pave the way for further litigation, which will stall the entire process of resolution of insolvency," said Aldak.

Gireesh Chandra Prasad
Gireesh has over 22 years of experience in business journalism covering diverse aspects of the economy, including finance, taxation, energy, aviation, corporate and bankruptcy laws, accounting and auditing.
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