Fresh Slate Theory under the Insolvency & Bankruptcy Code, 2016

-Ritik Khatri

INTRODUCTION

The soul of Insolvency and Bankruptcy Code [Code] lies in its Corporate Insolvency Resolution Process [CIRP] for the corporate restructuring of debts. The initiation of CIRP is followed by a Resolution Plan [RP] which is then approved by the Committee of Creditors [CoC] and a Successful Resolution Applicant [RA] comes into the picture. The RP approved is binding on all the stakeholders of the Corporate Debtor including the RA. The CIRP proceedings have witnessed grievances revolving around the claims submitted at the approval stage of RP mainly by Operational Creditor who opines that their claims have been left unheard. Recently such contentions were heard by Hon’ble Rajasthan HC in case of Ultra Tech Nathdwara Cement v. Union of India and by Hon’ble Jharkhand HC in the case of Electrosteel Steels Ltd. v. The State of Jharkhand wherein both the judicatures dealt with the similar moot question in law. Both the Courts gave a contradictory opinion on the Fresh/Clean slate that emerges after the completion of CIRP proceedings. The rulings by the Courts evolve the jurisprudence of Fresh Slate theory in the Code.

DEFINING THE FRESH SLATE

The term Fresh Slate marks its coinage in the Hon’ble Supreme Court’s judgment in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta. The Theory says that once the CoC approves the RP, it will be binding on all stakeholders and RA cannot suddenly be faced with undecided claims or the baggage of past (in the form of liabilities) looming over the company. The primary intent behind the enactment of Code is the maximisation of the value of assets of the company and promoting entrepreneurship while ensuring the availability of credit, keeping the economy rolling by resolution instead of liquidation of a distressed company. The Fresh Slate Theory approves this objective of the Code.

THE RAJASTHAN HC

Binani Cements Ltd. (Binani) had gone through the CIRP proceedings u/s 7 of the Code and further, the CoC was formed and the RP submitted by Ultra Tech Cement (Ultra Tech) was approved. Subsequently, the RP was approved by Hon’ble NCLAT vide order dated 15 November 2018 and the same was upheld by Hon’ble Apex Court vide order dated 19 November 2018. Pursuant to the SC order Ultra Tech took over the management of Binani and made payment to all the creditors including statutory dues of the Tax Department of Binani as per the terms of the approved RP. Despite the completion of whole CIRP proceedings the Tax Department issued fresh Demand Notices to Binani. Aggrieved by this Binani filed a writ petition before Hon’ble Rajasthan HC praying for the quashing of Demand Notices and a mandatory injunction restraining the Tax Department from raising any further Notices.

Section 31 of the Code states that the approved RP is binding on all stakeholders and will include the Tax Department too. The Insolvency and Bankruptcy Code (Amendment) Act, 2019 (Amendment) amendment to Section 31(1) mandates the binding of RP on the Central Government, State Government or any local authority. While the Amendment was being adopted in the Lok Sabha, the Hon’ble Finance Minister said, “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. There will be no criminal proceedings against successful resolution applicant for fraud by previous promoters. So, I hope that is absolutely clear. I would want all the Members to recognise this message and communicate further that this Code, therefore, gives that comfort to all new bidders. So, now, they need not be scared that the taxman will come after them for the faults of the earlier promoters. ”

This clears the stance of the Code that it is for the Government to make a sacrifice for the revival of a company and it also instils faith in the prospective applicant that once the RP is approved it need not worry for claims other than in the RP.

The Hon’ble Court relied on the Essar (Supra) that “ a successful resolution Applicant cannot suddenly be faced with undecided claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution Applicant who successfully takes over the business of the corporate debtor” and ruled that the interest of Tax Department is better served if Binani is resolved because in liquidation the assessment of Tax Department is ‘nil.’ Further, the Court admonished the Department for raising frivolous litigation and thus preserving the Fresh Slate Theory.

THE JHARKHAND HC

The Hon’ble Jharkhand HC dealt with a similar proposition of law in Electrosteel (Supra) but gave a contrasting opinion to the decision of Rajasthan HC. In the particular matter, the RP was approved by NCLAT and further by the Apex Court when some Operational Creditors raised the dispute. The Apex Court observed that “We make it clear that the implementation of the Resolution Plan is not stayed.” Later M/s. Vedanta became the Successful Resolution Applicant and took over the management of the Petitioner. The Tax Department (Respondent) through Garnishee Order asked the Bank which has the assets of the Petitioner to transfer them to the State Exchequer as they were unpaid GST dues. The Petitioner challenged the garnishee proceedings through a writ filed under article 226 before Jharkhand HC.

The Court dismissed the writ grounds that the Amendment to the Code which makes the Government Authorities binding is prospective, not retrospective. Since the RP was approved on 17/04/18 and the Amendment came on 6/08/19, the RP is not binding on the Tax Department. Section 13(1) (b) and Section 15 of the Code read with CIRP Regulation 6 describes the public announcement of the CIRP to be made in the newspapers with wide circulation at the location of the registered office and principal office of the Corporate Debtor which in the present case was in Ranchi but was done in Kolkata. As the Petitioner did not remit the tax collected to the State Exchequer, the Court distinguished between the direct debt of the debtor and those collected on behalf of the Government from the customers and observed that the latter could not qualify as operational debt u/s 5(20) of the Code.

ANALYSIS

With the greatest of respect, the author makes a humblest attempt to analyse both the Judgments.

Prospective/Retrospective application of Amendment to Section 31: The Amendment made to the Section 31(1) of the Code is clarificatory in nature which can be well substantiated by the Statement of Objects and Reasons of the IBC (Amendment) Bill, 2019 whose Section 3 (f) says “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 ..… including Tax Authorities.” Clarificatory Amendments are retrospective in nature and the Hon’ble Supreme Court recently upheld this proposition of law in State Bank of India Vs. V. Ramakrishnan and Anr.
The Distinction of Tax Dues: The Jharkhand HC initially admitted that Tax Authorities are operational creditors and are owed an operational debt by virtue of Sections 5(20) and 5(21) of the Code but later took a third route by classifying direct and indirect dues. Statutory dues such as Income Tax, Sales Tax, and Income Tax arise out of the company’s operations and have direct nexus with operations of the company, and thus, all statutory dues should qualify as operational debt. The Hon’ble NCLAT ruled this principle of law in Director General of Income Tax VM/s Synergies Dooray Automotive Ltd. The Jharkhand HC here seemed to follow the principle of criminal misappropriation and unjust enrichment by tax evasion.
Non Consideration of Section 32-A: The Jharkhand HC is of the view that Petitioner had criminally misappropriated the money but fails to recognise that Section 32A (2) of the Code provides that no action can be taken place against the property of the debtor concerning an offense committed before the commencement of CIRP if such property is covered under the resolution plan. While in the present matter, such property (money) was covered under the RP.
Duty of the Resolution Professional: The whole mishap happened as the Resolution Professional did not collate the claims of the Tax Department when it took over the management of the company. It is evident from the books of the debtor that a large amount of statutory tax claim was due. The Resolution Professional needs not to wait for the Government to bring to his notice the claims and should have included them suo motu in the RP. The Resolution Professional while preparing Information Memorandum should ideally include the undisputed tax dues even when Tax Authorities are filing no claims.

CONCLUSION

The Hon’ble Jharkhand HC allowing fresh claims after the CIRP proceedings are completed may prove to be against the rights of Successful RA and goes against the Code’s objective. The prospective application of the Amendment to Section 31 can create a bedlam as many creditors who have slept over their rights during the CIRP may approach the adjudicating authority, and the courts will again be inundated with litigations. The Fresh Slate theory only works if it is supported by the RP; hence a Resolution Professional owe a great responsibility while drafting the RP to make it air-tight taking into account the future and past liabilities of the debtor.

The Rajasthan HC’s decision supports the purpose of the Code but the Jharkhand HC’s ruling may have outstanding implications in the near future if not set aside. The Petitioner (Electrosteel) has already challenged the judgment before the Hon’ble Supreme Court[i]. It will be pertinent to see the findings of the Apex Court as it will decide the future of such beneficial legislation in India.

[i] Electrosteel Steels Limited vs. The State of Jharkhand, Diary No. 11168 of 2020

This article is authored by Ritik Khatri. He is a student of law at National Law University, Odisha.