Electrosteel Steels Limited vs The State of Jharkhand on IBC: One Step Forward Two Steps Backward

The Authors, Adv. Arvind Thapliyal and Adv. Manik Ahluwalia are working with P&A Law Offices.

Introduction:

The Insolvency Bankruptcy Code, 2016 (“IBC”) has been one of the most interesting piece of legislation ever since its enactment in the year 2016. The law in the past 4 years has been subject to interpretation by various judicial forums including the High Courts and the Hon’ble Supreme Court. The interpretations given by these judicial forums has resulted in the IBC being amended almost every quarter since its enactment. Such is the rate of amendment that a new version of the IBC bare Act has to be purchased in every 4 -6 months just in order to keep up with the new amendments being brought to book.

While the judicial interpretations and amendments are rapid one thing that emerges from the trend is the inclination of the Courts/Tribunal and the Government in ensuring that IBC proves out to be successful legislation and furthers the objects as stated in its preamble i.e. reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit. The entire intent and purpose of the enactment is to ensure maximization of assets, promote entrepreneurship and availability of credit.

Under the provisions of the IBC, a prospective resolution applicant is called to take over a financially distressed corporate debtor to revive the said corporate debtor from its distress. While the prospective resolution applicant is made aware of the assets and liabilities of the corporate debtor, the resolution applicant has been permitted to deal with the same in the method and manner the applicant deems proper subject to the safeguards and guidelines as mandated in the IBC and corresponding regulations as enacted by the Insolvency and Bankruptcy Board of India (“IBBI”) from time to time.

In the trend as has been observed in the matter of IBC, a prospective resolution applicant agrees to invest crores of rupees and take over a stressed asset/corporate debtor without any past liabilities and obligation. The sentiment behind the same is very clear and well acceptable that a person investing in a debt-ridden entity shall be allowed to take over the same with a clean slate so an enable the resolution applicant to get the debtor out of its financial distress. The sentiment has been validated by the Supreme Court vide its various judgements and the legislature has also resonated the same vide various provisions of IBC such as section 31 and 32 A. The entire impetus being that a company should not be liquated, and the resolution applicant be permitted to turn the fortunes of the same.

In the above background the judgment of Electrosteel Steels Limited vs The State of Jharkhand passed by a Division Bench of the Hon’ble High Court of Jharkhand (“High Court”) on May 01, 2020 makes some very interesting observations which may have far reaching consequences to the very basic intent of the IBC and may even dilute the effect of the judicial pronouncements and amendments made in the IBC.

CHALLENGE:

• Electrosteel Steels Limited i.e. the Petitioner had challenged the garnishee order dated 21.11.2019, issued under Section 46 of the Jharkhand Value Added Tax Act, 2005 seeking a demand to the tune of Rs.37,41,41,602/-, from the Bank of the Petitioner Company on account of tax / penalty due under the Jharkhand  VAT Act (“JVAT”), from the Petitioner Company, who failed to deposit the taxes for the period from 2011-12 & 2012-13 (“Judgment”).

FACTS:

• The State Bank of India had filed a Company Petition before the National Company Law Tribunal, Kolkata Bench, Kolkata, (“NCLT”), under the IBC, which was admitted by NCLT and an Interim Resolution Professional/Resolution Professional (“IRP/RP”) was appointed. The said RP filed the Resolution plan of M/s. Vedanta Limited i.e. the resolution applicant, for the approval by the NCLT under Section 31(1) of the IBC, which was approved by the NCLT on 17.04.2018. The said resolution plan was also approved by the National Company Law Appellate Tribunal, (“NCLAT'), on 10.8.2018. The matter had been taken to the Hon'ble Apex Court by some operational creditors in which the Hon'ble Apex Court, vide order dated 27.11.2019, sent the matters back to the NCLT, observing "We make it clear that the implementation of the Resolution Plan is not stayed". Accordingly, upon approval of the Resolution Plan, M/s. Vedanta Limited took over the management of the Petitioner Company. The Resolution Plan of the resolution applicant thus became final and a binding document under Section 31(1) of the IBC.
• Petitioner’s submission:  No claim was filed by the State Government as regards the impugned tax liability during the corporate insolvency resolution process (“CIRP”) of the Petitioner. The said claim was accordingly extinguished under the approved Resolution Plan. Thus, the impugned claim of the Government/ Respondents contrary to the terms of the approved resolution plan is now barred under Section 31 of the IBC. Further the impugned tax liability is also included in definition of “operational debt” as defined under 5 (21) and State Government shall also be deemed to be the operational creditor under Section 5 (20) of the IBC.  The Petitioner also submitted that provisions of IBC shall override provisions of JVAT by virtue of section 238 of IBC which provides overriding effect to provisions of IBC on any other law to the extent inconsistent to it.
• Respondent’s submissions: The Petitioner had collected the VAT from its purchasers / customers but failed to deposit the same in the State Exchequer, thus, amounting to criminal misappropriation of the Government money entrusted to the Petitioner and has thus committed the offence of criminal breach of trust. Further, the public announcement relating to the commencement of the CIRP of the Petitioner was not made in State of Jharkhand i.e. the principle place of business of Petitioner, the State Authorities were not aware of the commencement of the CIRP of Petitioner and thus, no claim was filed. Since no claim was filed, the State Authorities cannot be said to have participated in the CIRP, therefore the approved Resolution Plan under section 31 of IBC is not binding on them.  Finally, the state also contended that because the Petitioner had availed alternate remedy by filing revision application before Statutory Authority, the Writ Petition is not maintainable.
• Judgement: The High Court after considering the arguments advanced by both parties passed the judgment in favour of the State of Jharkhand and dismissed the Writ Petition. The High Court amongst other observation made very interesting observations which in the authors personal opinion are fundamentally flawed in perspective of the aim and intent of IBC. The observations are as follows:
• Indirect tax is not an operational debt:  It is debatable whether the amount of VAT shall be covered by the expressions "debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government", so as to bring it within the definition of "operational debt", as defined in the IBC. The tax liability as sought to be recovered from Petitioner is one which has already been collected by the Petitioner from its customers and was not deposited further by the Petitioner with State Govt. It is not a direct tax payable by the Petitioner to Govt., thus it may not come within the definition of “operational debt” as defined under IBC.
• Amendment to the IBC Act prospective: The IBC (Amendment) Act, 2019, to make the approved resolution plan binding on the Government Authorities in relation to the statutory dues was brought in effect from 16.08.2019 and was given prospective effect. Since the Resolution Plan of Petitioner was approved on 17.04.2018, thus the said amendment is not applicable on Petitioner Company with retrospective effect.
• No Knowledge of the CIRP: The Hon’ble High Court observed that they are not inclined to entertain these writ applications, even though there is a resolution plan in favour of the petitioner Company, approved by the Adjudicating Authority, i.e., the NCLT, for the simple reason that it was never brought to the knowledge of the Commercial Tax authorities of the State of Jharkhand that the corporate insolvency resolution process had been initiated against the petitioner Company, and no public announcement of the corporate insolvency resolution process was made in the State of Jharkhand. Section 31 of the IB Code clearly lays down that the approved resolution plan shall be binding only on those stakeholders who were involved in the resolution plan. Admittedly, the State Government was never involved in the corporate insolvency resolution process, and as such, the resolution plan cannot be said to be binding on it.
• Reassessment was confirmed: Since the original assessment was challenged by the Petitioner in revision, which was sent back for re-assessment vide order dated 11.08.2016 (prior to CIRP). The said reassessment was confirmed on 17.08.2018 (after approval of Resolution Plan). Thus, there was in fact no claim to be filed by the State Government during CIRP i.e. from 21.7.2017 to 17.08.2018.

ANALYSIS:

• Indirect tax is not an operational debt.

The said observation of the High Court primarily runs counter to the observation made by it the same judgement. The High Court in very judgment para 21 has itself held that State Government shall fall within the definition of 'operational creditor', and the taxes payable by the petitioner shall fall within the definition of 'operational debt', as defined in the IBC. The High Court herein relied and referred to Section 5(20) and 5(21) of the IBC which defined the said terms respectively.

Despite holding that State govt. is an operational creditor under IBC, the Hon’ble High Court took a third route by making a distinction of direct taxes and indirect taxes, however without giving any explanation as to how the nature of taxes i.e. direct or indirect,  will change the definition of operational debt under IBC. The definition of the terms operational debt under Section 5(21)[1] does not make any such distinction and provides that as long as the debt is a due payable to the Central of State Government under a law for the time being in force, the same shall be an operational debt. The distinction made by the High Court in fact runs contrary to the intent of the IBC, which will not only haunt any successful resolution applicant but also under mine the very intent of the IBC i.e. financial resolution.

The High Court also failed to take into the consideration the observation that has been made by the Hon’ble High Court of Calcutta in case of Akshay Jhunjhunwala and Ors. Vs. Union of India and Ors.[2] wherein while discussing the definition of Operational Creditors the High Court of Calcutta has observed that it would also include a statutory authority on account of money receivable by the authority pursuant to an imposition by a statute. Thus, the distinction of direct or indirect serves no purpose.

The observation of the High Court also becomes interesting as it run counter to one of the judgments of the National Company Law Appellate Tribunal (“NCLAT”) which had already specifically held that statutory dues including value added tax shall be operational debts and the corresponding statutory authority/department shall be operational creditors as defined by the IBC.

The NCLAT in the matter of Pr. Director General of Income Tax (Admin and TPS) Vs M/s Synergies Dooray Automotive Ltd. And Ors. (Company Appeal (AT) (Insolvency) No. 205 of 2017)[3]  while specifically dealing with the question whether Value Added tax or other statutory dues such as Municipal Tax, Excise duty etc. come within meaning of Operational Debt or not, had affirmatively held that all the said taxes/duties are indeed operational debts and the concerned departments are operational creditors.

• Amendment to the IBC Act prospective.

That High Court in the judgment has failed to appreciate that that the amendment made to Section 31(1) of the IBC is a clarificatory amendment[4]. The Statement of Objects and Reasons, the Insolvency and Bankruptcy (Amendment) Bill, 2019 categorically provide that the amendment to Section 31(1) is being done to clarify that the resolution plan approved by the NCLT shall also be binding on the Central Government, any State Government or any local authority to whom a debt in respect 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. The relevant portion is being reproduced herein for ready reference: -

“(f) to amend sub-section (1) of section 31 of the Code to clarify that the resolution plan approved by the Adjudicating Authority shall also be binding on the Central Government, any State Government or any local authority to whom a debt in respect 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;”

Since it is evident that the amendment to Section 31(1) is clarificatory amendment, it is applicable retrospectively in nature. It is a settled position of law that a clarificatory amendment is retrospective in nature. The Hon’ble Supreme Court in the recent judgment of State Bank of India Vs. V. Ramakrishnan and Anr.[5] while discussing the effect of clarificatory amendments has reiterated that amendments which are clarificatory in nature shall be applicable retrospectively.

It is also not out of place to mention that while the amendment was being adopted in the upper house of the Parliament, Hon’ble the Finance Minister with reference to the questions/issues raised by the Members of the Parliament, clarified the legislative intent behind the amendment in Section 31(1) of the IBC in the following terms:

“There is also this question about indemnity for successful resolution applicant. The amendment now is clearly making it binding on the Government. It is one of the ways in which we are providing that. The Government will not raise any further claim. The Government will not make any further claim after resolution plan is approved. So, that is going to be a major, major sense of assurance for the people who are using the resolution plan.”[6] (Emphasis supplied)

It is not out of place to mention herein that a Division Bench of the Hon’ble High Court of Rajasthan, while employing the express language of the amended Section 31(1) of the IBC has categorically held that Central and Statement Government are bound by the approved Resolution Plan[7].

Therefore, by virtue of the express language used in the statement of objects and the settled position of law pertaining to clarificatory amendment, it can safely be stated that the amended Section 31(1) is applicable retrospectively. The said observation by the Hon’ble High Court will have disastrous effects as the same may reduce the confidence of a prospective resolution applicant. Afraid of being entangled in nefarious tax litigations, a resolution applicant may be dissuaded from investing in an IBC initiated company. Further, the observation runs against the very intent of the amendment which was to provide indemnity to the resolution applicant and promote entrepreneurship.

• No Knowledge of the CIRP

The said observation run contrary to a very fundamental principle of IBC proceedings i.e. the proceedings are in the nature of rem. The entire purpose of public notices as provided in the IBC is to make the general public including the creditors of the corporate debtor aware of the initiation of IBC proceedings. No obligation has been cast upon the IRP/RP, the corporate debtor or the resolution applicant to inform each and every operational creditor separately/independently regarding the initiation of IBC proceedings.

The Hon’ble Supreme Court in the judgement of Swiss Ribbons Pvt. Ltd. and Ors. Vs. Union of India and Ors[8]. has categorically observed that the proceedings under the IBC are in the nature of rem i.e. towards public at large. Interestingly, the High Court has referred to the said judgment of the Hon’ble Supreme Court, however, still has a returned a finding contrary to the position of law settled by the Hon’ble Supreme Court.

As already stated above that entire intent and purpose of the IBC is to rehabilitate a financially distressed Company. A resolution applicant under the IBC takes over the financially distressed company with a clean slate without the baggage/liabilities of the past. The observation/conclusion of the High Court in the judgment runs absolutely contrary to the intent of the IBC. If the Governments are allowed to agitate claim pertaining to period prior to the approval of the Resolution Plan, no resolution applicant shall come forward to resolve a financially distressed company. The entire IBC shall be set to naught merely becoming a paper legislation.

The Hon’ble Supreme Court in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta[9] has already held that all claims must be submitted to the IRP in order to ascertain the liability of the corporate debtor. The Resolution Applicant, as stated above, takes over the corporate debtor with a clean slate. The Hon’ble Supreme Court has further observed in the Essar Judgment that if the claims are allowed to be agitated after the completion of the CIRP, the same would amount of “hydra head popping” with no end to the same.

It is also interesting to note that the High Court in the judgment has also mentioned the Essar Judgment and infact quotes the famous “hydra head” analogy and the “clean slate” rationale of IBC which was beautifully propounded by Justice Nariman however, no further discussion was done by the High Court on the same.

• Reassessment was confirmed

The said observation of the High Court shows a more pro-revenue and conservative approach of the High Court which runs contrary to the broad outlook required by the IBC. IBC does not contemplate priority to Government dues. The preamble of the IBC itself provides for alteration in the order of priority of payment of Government dues. The intent and purpose of the IBC towards Government dues is evident from the statute itself. The said intent can also be substantiated from Section 53 of the IBC which provides for the priority of payment in the event of liquidation. The Government under Section 53 have been given fifth position. Therefore, the thrust of the reasoning given by the Hon’ble Court runs in antithesis to the specified intent of the IBC.

As already stated, the High Court despite noting the observations made in the Essar Judgments dismissed the Writ Petition. It is not a question of “If” but “when” the petitioner in the judgment decides to challenge the judgement before the Hon’ble Supreme Court, it will be interesting to see the opinion expressed by the Hon’ble Supreme Court.

It is also not out of place mention that while the High Court allowed the dues of the State Government on account of confirmation of the reassessment, the NCLAT in judgment of JSW Steel Limited vs. Mahender Kumar Khandelwal and Ors.[10] dismissed the appeal filed by State of Odisha seeking payment of Rs. 139 Crore towards Entry Tax on the ground that no claim had been filed by the State of Odisha before the IRP/RP in terms of the IBC. It is pertinent to mention herein that the Entry Tax as levied by the State of Odisha had been confirmed by the Hon’ble Supreme Court[11], however the recovery thereof had been denied by the NCLAT on account of failure of the State of Odisha in filing its claim. The NCLAT also relied on the Essar Judgment to conclude the claims are to be filed before the IRP/RP, the resolution applicant takes over a corporate debtor with a clean slate and a Resolution Plan once approved is final and binding documents.

CONCLUSION:

The above discussion throws some light on the fact that most of the issues decided by the High Court against the Petitioner already stands adjudicated by other Courts and Tribunal. As already stated in the beginning, the finding returned by the High Court in the Judgment shall have far reaching consequences unless set aside. While the judgment may not be binding on other High Courts around the Country however, in addition to having a limited persuasive value, the same will provide an escape route to the Courts trying to balance the interest of the statutory dues with IBC. The said route would not only run contrary to the now established principles of the IBC but also take the Country back towards the previous regime which miserably failed to achieve its purpose.

The observation of the High Court that State dues are Operational Debts and State Government is Operational Creditor is a welcome step towards implementation of the IBC, however the remaining observation have rendered the said observation practically nugatory. The rewriting of tax liability on a slate, which otherwise was to be clean, by the High Court has put the entire sanctity of approved Resolution Plan and the IBC at risk. The Petitioner i.e. Electrosteel has already challenged the judgment before the Hon’ble Supreme Court[12]. It will be interesting as how the Hon’ble Supreme Court reacts to the judgments in the above said facts.

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