Between the Lines | Karnataka High Court: If the departments of ‘Central’ or ‘State’ government(s) do not file an application or participate in the corporate insolvency resolution process, their claims automatically get extinguished

The High Court of Karnataka (“KHC”) has in its judgment dated May 27, 2021 (“Judgement”), in the matter of Union of India and Others v. M/s. Ruchi Soya Industries Limited [Writ Appeal No.2575/2018 (T-TAR)], held that if the departments of Central or State government(s) do not file an application or participate in the resolution process, their claims automatically get extinguished.

Facts

M/s Ruchi Soya Industries Limited (“Respondent”), is a public limited company registered under the provisions of the Companies Act, 1956. The Respondent entered into a contract on July 27, 2015 with ‘M/s. Aavanti Industries Private Limited, Singapore,’ for import of 10,000 metric tons of ‘Crude Palm Oil of Edible Grade’ in bulk. On September 16, 2015, four bills of entry had received clearance. The Respondent, as per ‘Notification No.12/2012-Cus’ dated March 17, 2012, was liable to pay duty at 7.5% (“Notification”). The goods arrived at Mangalore Port on September 17, 2015. Coincidentally, on the very same day another notification was issued enhancing the customs duty from 7.5% to 12.5% (“Impugned Notification”). Under the aforesaid circumstances, the Commissioner and Deputy Commissioner of Customs, (“Appellants”) sought for payment of differential duty on the subject goods on the basis of Section 15 (Date for determination of rate of duty and tariff valuation of imported goods) of the Customs Act, 1962 (“Act”). The Respondent contended that the Appellants were not right in demanding the enhanced duty at the rate of 12.5% as per the Impugned Notification on September 18, 2015 as that was subsequent to the assessment of the bills of entry already made on September 16, 2015. Therefore, the Respondent had initially filed a petition before KHC, seeking a declaration that the reassessment of the bills of entry on September 18, 2015, consequent to issuance of the Impugned Notification and demanding the higher rate of duty was illegal. The learned ‘Single Judge’ of KHC held that, the Impugned Notification was not applicable to the subject goods and that, the Appellants could not claim the differential rate of duty on the basis of the said Impugned Notification. Consequently, the demand made to pay differential duty was quashed and it was declared that the importer was liable to pay duty at 7.5% based on the Notification only. Being aggrieved by the order of the learned ‘Single Judge’, the Appellants preferred the said appeal before a division bench of KHC.

The matter was listed along with an application (I.A.No.1/2021) seeking dismissal of the said appeal based on Section 31 (Approval of resolution plan) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) on the premise that no proceeding could have been initiated for recovery of the dues from the Respondent, which is a corporate debtor within the meaning of the provisions of the IBC. This was because, the dues were not part of the resolution plan approved by the National Company Law Tribunal (“NCLT”) under Section 31 of the IBC. Moreover, based on the judgement of Hon’ble Supreme Court (“SC”) in the case of Ghanashyam Mishra and Sons Private Limited through the Authorized Signatory v. Edelweiss Asset Reconstruction Company Limited through the Director [2021 SCC Online SC 313], the claims of the Appellants as well as the liability of the Respondent, would stand extinguished permanently.

In an affidavit in support of the application, the Respondent stated that, by an order dated December 08, 2017 read with an order dated December 15, 2017, the NCLT had admitted the petition filed and the corporate insolvency resolution process had commenced. Thereafter, a public notice inviting claims from all the creditors of the respondent was issued by the interim resolution professional on December 21, 2017. No claim was filed by the Appellants. In terms of the provisions of IBC, a resolution plan was submitted by the consortium of Patanjali Ayurved Limited, Divya Yog Mandir Trust (through its business undertaking, Divya Pharmacy), Patanjali Parivahan Private Limited and Patanjali Gramudhyog Nyas with the resolution professional. The resolution plan was approved by the committee of creditors of the Respondent on April 30, 2019 as per Section 30(4) of the IBC and the orders dated July 24, 2019 and September 04, 2019 were passed by the NCLT in terms of Section 31 of the IBC.

Issue

• Whether the claims of the departments of Central or State Government(s), automatically get extinguished, if they do not file an application or participate in the corporate insolvency resolution process.

Arguments

Contentions raised by the Appellants:

It was submitted by the Appellants that it was not known, whether, the claim of the Appellants was a part of the resolution plan vis-à-vis the Respondent. It was further submitted that, if the said claim, which was in the nature of an operational debt, was covered under the resolution plan and if the Appellants succeeded on merits, they could initiate proceedings for recovery of the dues from the Respondent.

Contentions raised by the Respondent:

The Respondent contended that the Appellants had not produced any evidence to establish the fact that the dues to the Appellants were part of the resolution plan. The Respondent relied on the judgement of Ghanashyam Mishra (supra) wherein the issue raised in the instant case had been answered in favour of the Respondent, in as much as a creditor, including the Central Government and State Government or any local authority, is bound by the plan under Section 31(1) of the IBC. The SC in Ghanashyam Mishra (supra) laid down that the said authorities are not entitled to initiate any proceeding for recovery of any of the dues from the corporate debtor, if the operational debt is not a part of the resolution plan approved by the adjudicating authority. It was submitted that, in Ghanashyam Mishra (supra) it has also been held that, the amended Section 31 of the IBC is clarificatory, declaratory and substantive in nature. Therefore, it was submitted that, the claim of the Appellants be held to have abated.

It was further submitted that the resolution plan was successfully implemented on December 18, 2019, and there was a change in the control and ownership of the present Respondent with effect from that date. It was further submitted that as per Section 32A (Liability for prior offences) of the IBC, upon completion of the corporate insolvency resolution process, the liability of the corporate debtor would cease as the said provision has a non-obstante clause. It was further submitted that the present proceedings concerning the subject import leading to demand of the duty relates to the year 2015, that is, a period prior to the commencement of the corporate insolvency resolution process and in any case, the same relates to the period prior to the effective date under the resolution plan and therefore, the same shall stand extinguished. It was further submitted that, therefore, the prayer in the application to dismiss this appeal was infructuous.

It was contended that since the dues claimed by the Appellants was within the scope of ‘operational debt’, the Central Government would be the ‘operational creditor’ as defined under Section 5(20) of the IBC. The dues to the Central Government including the statutory dues would be covered within the definition of “operational debt” owed to a creditor, in terms of Section 3(10) of the IBC. Unless the statutory dues owed to the Central Government are covered or made part of the resolution plan, it would stand extinguished.

Observations of the Karnataka High Court

The KHC noted that, the SC in the case of Ghanashyam Mishra (supra) answered the key issues, pertaining to whether any creditor including the Central Government, State Government or any local authority is bound by the resolution plan once it is approved by NCLT under Section 31(1) of the IBC and whether, after the approval of the resolution plan by the NCLT, is a creditor including the Central Government, State Government or any local authority entitled to initiate any proceedings for the recovery of any of the dues from the corporate debtor, which are not a part of such an approved resolution plan.
The KHC noted that the objective of the IBC was to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of government dues and for matters connected therewith or incidental thereto. The KHC noted that Section 2 (Application) deals with the application of the IBC to the entities mentioned under the IBC. The KHC noted the submissions made by the Respondent that since the dues claimed by the Appellants were within the scope of ‘operational debt’, the Central Government would be the ‘operational creditor’, and unless the said statutory dues owed to the Central Government is covered in the resolution plan, it would stand extinguished. The KHC affirmed that this contention of the Respondent was in consonance with the judgement passed in Ghanashyam Mishra (supra).

The KHC noted that by an amendment to the IBC in 2019 (“2019 Amendment”), the following words were inserted in Section 31 of the IBC, that is, “including the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed.”

The KHC noted that, the SC in the case of Ghanashyam Mishra (supra) had arrived at the following conclusions that:

• Once a resolution plan is duly approved by the adjudicating authority under Section 31(1) of the IBC, the claims as provided in the resolution plan shall stand frozen and will be binding on the corporate debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority, guarantors and other stake holders. On the date of approval of the resolution plan by the NCLT, all such claims, which are not a part of the resolution plan, shall stand extinguished and, no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan.
• The 2019 Amendment is clarificatory and declaratory in nature and therefore will be effective from the date on which the IBC came into effect, that is, May 28, 2016.
• Consequently, all the dues including the statutory dues owed to the Central Government, any State Government or any local authority, if not part of the resolution plan, shall stand extinguished and no proceedings in respect of such dues for the period prior to the date on which the adjudicating authority grants its approval under Section 31 of the IBC, could be continued.

The KHC noted that a bare reading of Section 31 of the IBC made it abundantly clear, that once a resolution plan is approved by the NCLT, on being satisfied, that the resolution plan, as approved by the committee of creditors, meets the requirements, as referred to in Section 30(2) of the IBC, it would be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders. Further, the SC, in Ghanashyam Mishra (supra), deemed such a provision as necessary since one of the dominant purposes of the IBC is the revival of the corporate debtor and to make it a running concern.

The KHC noted the reliance placed by the Respondent on the case of Ultra Tech Nathdwara Cement Limited vs. Union of India in D.B. [Civil Writ Petition No.9480/2019], wherein it was observed that since the 2019 Amendment was clarificatory and declaratory in nature, it would have a retrospective operation. The KHC further noted the observation of the SC in Ultra Tech (supra), that, if the resolution plan, approved by the NCLT, does not comprise all the claims of the Central or State Governments or the local authority, all claims shall stand extinguished and the proceedings relating thereto shall stand terminated. Hence, the SC in Ultra Tech (supra) held that, with regard to any claim prior to the approval of the resolution plan cannot be continued and would stand extinguished, if not made a part of the plan. Thus, the claims which are not part of the resolution plan, shall stand extinguished.

The KHC noted, that it was clear, that the mischief, which was noticed prior to amendment of Section 31 of the IBC was, that though the legislative intent was to extinguish all such debts owed to the Central Government, any State Government or any local authority, including the tax authorities, once an approval was granted to the resolution plan by NCLT, on account of there being some ambiguity, the State/Central Government authorities continued with the proceedings in respect of the debts owed to them. In order to remedy the said mischief, the legislature thought it appropriate to clarify the position, that once such a resolution plan was approved by the adjudicating authority, all such claims/dues owed to the State/Central Government or any local authority including tax authorities, which were not part of the resolution plan, shall stand extinguished. The KHC noted that, the legislative intent behind allowing such extinguishment of claims was, to freeze all the claims so that the resolution applicant starts on a clean slate and is not flung with any surprise claims. Further that if, such extinguishment of claims was not permitted, the very calculations on the basis of which the resolution applicant submits its resolution plan, would go haywire and the plan would be unworkable.

The KHC noted that the provisions of Section 238 (Provision of this code to override other laws) of the IBC states that the provisions of the IBC shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law. Further, it was noted that crown debts do not take precedence even over secured creditors, who are private persons. This was clear on a reading of Section 238 of the IBC, which provides for the overriding effect of the IBC, notwithstanding anything inconsistent contained in any other law for the time being in force or effect by any such law.

Decision of the Karnataka High Court

The KHC held that, if the departments of the Central or State Governments do not file an application or participate in the resolution process, their claims automatically get extinguished having regard to the judgment of the SC in the case of Ghanashyam Mishra (supra). Therefore, the appeal was dismissed on merit and the application in I.A.No.1/2021 was allowed.

VA View:

The KHC in this Judgement has rightly observed that, the legislative intent of making the resolution plan binding on all the stake-holders on approval from the NCLT, which depends upon NCLT’s satisfaction, that the resolution plan as approved by committee of creditors meets the requirement as referred to in Section 30(2) of the IBC. In other words, as per the scheme of IBC, after the approval of the resolution plan, no surprise claims should be flung on the successful resolution applicant. The legislature, noted that on account of an obvious omission, that is, since governmental authorities were not mentioned in Section 31 of the IBC, certain tax authorities were not abiding by the mandate/scheme of IBC and were continuing to pursue recovery proceedings against the corporate debtor. Consequently, the legislature brought out the 2019 amendment so as to cure the said mischief.

The dominant purpose is, that a resolution applicant should start with a fresh slate on the basis of the approved resolution plan. Consequently, the corporate debtor should be revived and made to function as a running establishment in the form of a going concern.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Supreme Court: Dissenting secured creditor cannot challenge an approved resolution plan basis the value of security held by it over the corporate debtor.

In the matter of India Resurgence ARC Private Limited v. M/s Amit Metaliks Limited & Another [Civil Appeal No. 1700 of 2021] decided on May 13, 2021 (“Judgement”) the Supreme Court (“SC”) held that a dissenting secured creditor cannot challenge an approved resolution plan under the Insolvency and Bankruptcy Code, 2016 (“IBC”) and insist on a higher amount to be paid to it on the basis of the value of the security interest held by it over the corporate debtor. It was further held that, in the scheme of IBC, every dissatisfaction does not partake the character of a legal grievance and cannot be taken up as a ground of appeal.

Facts

Under Section 62 (Appeal to Supreme Court) of IBC, India Resurgence ARC Private Limited (“Appellant”) sought to question the order dated March 2, 2021 passed by the National Company Law Appellate Tribunal, New Delhi (“NCLAT”), whereby the NCLAT rejected its challenge to the order dated October 20, 2020, passed by the National Company Law Tribunal, Kolkata bench (“NCLT”), in approval of the resolution plan in the corporate insolvency resolution process (“CIRP”) concerning the corporate debtor, VSP Udyog Private Limited (“Respondent No. 2”), as submitted by the resolution applicant, M/s. Amit Metaliks Limited (“Respondent No. 1”). Respondent No. 1 and Respondent No. 2 are collectively referred to as “Respondents”. The Appellant was the assignee of the rights, title and interest carried by Religare Finvest Limited, as the secured financial creditor of Respondent No. 2, having 3.94% of voting share in the Committee of Creditors (“CoC”). When the resolution plan submitted by Respondent No. 1 was taken up for consideration by the CoC, the Appellant became a dissenting financial creditor, basis the share being proposed, particularly with reference to the value of the security interest held by it. However, the resolution plan got the approval of 95.35% of voting share of the financial creditors and was submitted for approval by the resolution professional to the NCLT. The NCLT found the plan to be feasible and viable with judicious distribution of financial bids by CoC to the stakeholders, according to their entitlements as also being compliant of all the mandatory requirements, and thereby approved the resolution plan by its order dated October 20, 2020.

The Appellant had filed an appeal before the NCLAT under Section 61(1) read with Section 61(3) of the IBC, and therein contended that the approved resolution plan failed the test of being ‘feasible and viable’ in as much as the value of the secured asset, on which security interest was created by Respondent No. 2, in its favour, was not taken into consideration. Further, the Appellant had contended that after the amendment to Section 30 (4) of IBC, which came into effect from August 16, 2019, the CoC was required to ensure that the manner of distribution takes into account the order of priority among the creditors as also the priority and value of the security interest of a secured creditor. The Appellant had argued that since Respondent No. 1 and the CoC failed to consider the existing security interest in the Appellant’s favour, the approval of the NCLT was not in accordance with law.

The NCLAT relied upon the judgement of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others. [(2020) 8 SCC 531] (“Essar Steel”), and rejected the Appellant’s contentions, on the grounds that considerations including priority in scheme of distribution and the value of security fell within the realm of CoC and such considerations, being relevant only for purposes for arriving at a business decision in exercise of commercial wisdom of the CoC, could not be the subject of judicial review in appeal within the parameters of Section 61(3) of the IBC. Thus, aggrieved by the decision of the NCLAT, the Appellant preferred this instant appeal before the SC.

Issues

• Whether the orders pronounced and NCLAT was in accordance with the law
• Whether a dissenting secured creditor can challenge an approved resolution plan on the basis of the value of the security interest held by it over the corporate debtor

Arguments

Contentions raised by Appellant:

The Appellant contended that the CoC could not have approved the resolution plan which failed to consider the priority and value of security interest of the creditors while deciding the manner of distribution to each creditor even though the legislature in its wisdom has amended Section 30(4) of the IBC, requiring the CoC to take into account the order of priority amongst creditors as laid down in Section 53(1) of the IBC, including the priority and value of the security interest of a secured creditor. The amended Section 30(4) of the IBC lays down that “The committee of creditors may approve a resolution plan by a vote of not less than sixty-six per cent, of voting share of the financial creditors, after considering its feasibility and viability the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor, and such other requirements as may be specified by the Board […]”

The primary reason for the Appellant’s dissent to the resolution plan was that the Respondent No. 1 had offered the Appellant a meagre amount of about INR 2,02,60,000 (approximately) as against the total admitted claim of INR 13,38,00,000(approximately), without even considering the valuation of the security held by the Appellant, which admittedly had the valuation of more than INR 12,00,00,000(approximately). Further, the Appellant argued that the observation of the NCLAT, deeming that, the amendment to Section 30(4) of the IBC as a mere guideline, failed to take into account the fact that CoC does not have an unfettered and arbitrary right to exercise its commercial wisdom and to approve the plan which does not stand in conformity with the provisions of the IBC.

Observations of the Supreme Court

The SC observed that the process of consideration and approval of resolution plan is essentially that of the commercial wisdom of the CoC and the scope of judicial review was limited within the four-corners of Section 30(2) of the IBC for the NCLT, and Section 30(2) read with Section 61(3) of the IBC for the NCLAT. It was observed that if all the mandatory requirements have been duly complied with and taken care of, the process of judicial review cannot be stretched to carry out quantitative analysis qua a particular creditor or any stakeholder, who may carry his own dissatisfaction. In the scheme of IBC, every dissatisfaction does not partake the character of a legal grievance and cannot be taken up as a ground of appeal. The SC opined that the provisions of the amended Section 30(4) of the IBC do not warrant interference with the resolution plan at the instance of the Appellant. Placing reliance on Essar Steel (supra) with regards to the purport and effect of the amendment to Section 30(4) of the IBC, the SC affirmed the observation of the NCLAT, that the amendment to Section 30(4) of the IBC only amplified the considerations for the CoC while exercising its commercial wisdom, to take an informed decision in regard to the viability and feasibility of resolution plan, with fairness of distribution amongst similarly situated creditors. Further, the SC upheld the view of the NCLAT that the business decision taken in exercise of the commercial wisdom of CoC does not call for interference, unless creditors belonging to a class being similarly situated are denied fair and equitable treatment. The SC noted that the proposal for payment to all the secured financial creditors was equitable and the proposal for payment to the Appellant was at par with the percentage of payment proposed for other secured financial creditors. The SC observed that, there was no case of denial of fair and equitable treatment or disregard of priority and pointed out that determining the amount to be paid to different classes or subclasses of creditors in accordance with provisions of the IBC and the related regulations, was essentially the commercial wisdom of the CoC, and a dissenting secured creditor like the Appellant could not suggest a higher amount to be paid to it with reference to the value of the security interest.

The SC noted that in Jaypee Kensington Boulevard Apartments Welfare Association and Others. v. NBCC (India) Limited and Others [Civil Appeal No. 3395 of 2020], the SC had repeatedly made it clear that a dissenting financial creditor would receive the payment of the amount as per his entitlement, and that entitlement could also be satisfied by allowing him to enforce the security interest, to the extent of the value receivable by him. It had never been laid down that if a dissenting financial creditor had security available with him, he would be entitled to enforce the entire security interest or to receive the entire value of the security available with him. His dealing with the security interest would be conditioned by the extent of value receivable by him.

The SC observed that the extent of value receivable by the Appellant was distinctly laid out in the resolution plan that is, a sum of INR 2,02,60,000 (approximately) which was in the same proportion and percentage as provided to the other secured financial creditors with reference to their respective admitted claims, The SC observed that, the repeated reference of the Appellant to the value of security at about INR 12,00,00,000 (approximately) as wholly inapt and ill-conceived.

The SC remarked that if the Appellant’s propositions were to be accepted, it would result in more liquidation with every secured financial creditor opting to stand on dissent, as against insolvency resolution and value maximization of the assets of the corporate debtor, thereby defeating the very purpose envisaged by IBC. The SC relied on the observation made in Essar Steel (supra) that if an “equality for all” approach recognizing the rights of different classes of creditors as part of an insolvency resolution process was adopted, secured financial creditors would be incentivized to vote for liquidation rather than resolution, as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved. This would defeat the entire objective of the IBC, which is to first ensure that resolution of distressed assets takes place and only if the same is not possible should liquidation follow.

Decision of the Supreme Court

It was held by the SC that the financial proposal in the resolution plan forms the core of the business decision of the CoC. The SC further held that the limitation on the extent of the amount receivable by a dissenting financial creditor is innate in Section 30(2)(b) of the IBC and it was not the intent of the legislature that a security interest available to a dissenting financial creditor over the assets of the corporate debtor gives him some right over and above other financial creditors so as to enforce the entire of the security interest and thereby bring about an inequitable scenario, by receiving excess amount, beyond the receivable liquidation value proposed for the same class of creditors. The SC, thus, rejected the contentions of the Appellant.

VA View:

Through this Judgement, the SC has confirmed that a dissenting secured creditor cannot challenge a resolution plan approved under the IBC with an argument that higher amount should have been paid to it, in light of the value of the security interest held by it over the corporate debtor. Recognizing the supremacy of the commercial wisdom of the CoC, the SC has reiterated the limited scope of judicial review and interference in business decisions that fall under the ambit of the commercial wisdom of the CoC.

The SC has rightly upheld the integral principles of IBC that is value maximization of the assets of the corporate debtor, and insolvency resolution, as against liquidation. The SC has clarified that any entitlement extended to creditors on the basis of the value of security would defeat the purpose of IBC as it would result in the financial creditors dissenting and opting for liquidation as against insolvency resolution.

For more information please write to Mr. Bomi Daruwala at [email protected]