CLEAN SLATE OR UNSETTLED DEBTS? SC’S PROACTIVE STAMP ON EXTINGUISHMENT OF PAST LIABILITIES

This post is authored by Yarabham Akshit Reddy and Yashika Lakhotia, 3rd year B.A. LL.B. (Honours) students at HNLU, Raipur.

1. INTRODUCTION

Corporate Insolvency and Resolution Processes (“CIRPs”) under the Insolvency and Bankruptcy Code, 2016 (“IBC”) are designed to provide a structured and time-bound mechanism for reviving financially distressed companies while maximizing asset values for all the stakeholders. In contrast, the Income Tax Act, 1961 (“ITA”) is recovery-focused, generating significant tax revenues crucial for public welfare and economic stability. Oftentimes, both the laws find themselves on divergent paths, as the ITA relentlessly pursue recovery of unpaid tax dues in contrast to the IBC’s objective of providing a fresh slate by wiping off all the past tax encumbrances.

In this context, the recent Supreme Court (SC) judgments in M/s JSW Steel Ltd. v. Pratishtha Thakur Haritwal and Vaibhav Goel v. Deputy Commissioner of Income Tax have strengthened the position of the judiciary on ensuring the finality of resolution plans and disallowed new proceedings for pre-CIRP claims post-approval of resolution plans. Both the cases revolved around the core facts that demand notices were issued for pending tax dues after the Resolution Plan was approved by the National Company Law Tribunal (“NCLT”). The claims were not included in the resolution plans, and the respective income tax authorities submitted their demand notices after the period for submitting the claims to the Resolution Professional (“RP”) was closed.

While the approach taken by the SC will ensure a smoother transition and boost investor confidence during resolution plans, it is imperative that courts take into consideration the books of account of the Corporate Debtor (“CD”) and the confidential nature of resolution plans to ensure a balanced approach. A complete waiver of statutory dues without conducting proper due diligence could potentially allow businesses to evade tax obligations through insolvency proceedings. Through the means of this post, the authors will critically analyse the implications of the judgement on insolvency proceedings and SC’s oversight of key factors- such as acknowledgment of debt in books of account and confidentiality of resolution plans. Finally, the post will propose a better mechanism to address the concerns of statutory departments.

Context

Section 31 of IBC deals with the powers of NCLT to approve or reject a resolution plan. As per Section 31(1), the NCLT shall approve a resolution plan once it is satisfied that it is approved by Committee of Creditors (“CoC”) under Section 30(4) of IBC and satisfies the requirements outlined under Section 30(2), it shall become binding on all the stakeholders including Government Authorities. The Clean Slate principle is one of the significant aspects enshrined in section 31 of IBC. It states that once a resolution plan is approved, all the unclaimed prior-CIRP claims shall stand extinguished. Hence, all the creditors must file their claims with proof within the stipulated timeline as per Section 15(1) (c) of IBC and Regulation 12 of CIRP Regulations, 2016.

2. STRIKING THE BALANCE: EQUITABLE EXTINGUISHMENT V. STATUTORY ACCOUNTABILITY

The SC primarily relied on the Ghanashyam Mishra & Sons Ltd v. Edelweiss Asset Reconstruction Ltd, wherein it established that the statutory dues, including tax dues, are operational debts and shall stand extinguished if they are not incorporated in the Resolution Plan. This ruling is crucial for CIRPs as it provides clarity to resolution applicants and ensures that they are not overburdened with unclaimed liabilities post-approval.

The primary objective of IBC is to ensure the revival of distressed companies and maximization of the asset value through a time-bound resolution mechanism. Section 12(3) of IBC mandates that the CIRP must be completed within 330 days to ensure swift resolution and preserve the economic value of the CD. However, permitting statutory authorities to raise claims for pre-CIRP liabilities could undermine the finality of the resolution plan and cause undue delays in resolution. Such delays could compel the adjudicating authorities to terminate CIRP and initiate a liquidation procedure under Section 33 of IBC, distributing proceeds through a rigid waterfall mechanism. This outcome not only discourages the aim of the revival of the company through entrepreneurship but also weakens the development of credit systems and the faith of stakeholders in it, as they receive minimal dues. To ensure that this outcome does not take place, the dues owed to the government, specifically the ones claimed post-approval of the Resolution Plan, have to be extinguished, providing the company a fair chance of revival and not wavering the faith of other investors and stakeholders in the credit systems.

Additionally, allowing modifications to the approved resolution plans encroaches upon the commercial wisdom of CoC, which is entrusted with evaluating the viability, feasibility and financial matrix of resolution plans. Further, if the acquirers or investors perceive any risk of additional liabilities, they may either refrain from the bidding process altogether or bid conservatively. This reduces the attractiveness of the distressed company, resulting in a lower acquisition price.

While the resolution plan ensures a clean slate for the company, a blanket immunity seeking a complete waiver of all statutory dues may not always align with public interest. Such an approach results in significant revenue losses for government, which could indirectly burden honest taxpayers to compensate for the revenue gap, and result in reduced public welfare spending on infrastructure, health and education. To address this, Resolution Plans should formally acknowledge the statutory claims which have not been yet crystallized at the time of CIRP under contingent liabilities. Addressing these potential future liabilities within the resolution plans mitigates the risk of raising fresh claims post-approval and ensures the financial stability of the new management undertaking the company. This balanced approach would prevent arbitrary extinguishment of prior CIRP claims while ensuring that statutory dues are properly addressed within the resolution plans.

3. STATUTORY DUES IN PLAIN SIGHT: LEDGERS AS A LEGAL PROOF OF LIABILITY

While the judgements are clear on the point of law, oftentimes the RP lacks due diligence in ensuring that the statutory liabilities present in the books of account are acknowledged as debts under the Resolution Plan, leading to oversight of such pre-CIRP debts. The books of account of a company show the financial standing of the company, including the pending dues or liabilities. At the time of preparing the information memorandum, according to Section 29 of IBC, all ‘relevant information’ has to be set out regarding the financial position of the company. Regulation 36(2) of the CIRP Regulations, 2016 provides that the information memorandum must contain all the latest annual financial statements. Further, in Asset Reconstruction Company (India) Limited v. Tulip Star Hotels Limited (“Tulip Star Hotels case”), the SC acknowledged the liability of the CD towards the financial creditor based on the entries given in the books of account.

The principle laid down in the Tulip Star Hotels case does not expressly provide that such entries would not lead to an acknowledgement of claims of Operational Creditor (“OC”). Further, according to Section 30 of IBC, the Resolution Plan has to prepare on the basis of the information memorandum. Hence, if the pending tax dues are part of the financial statements and thus a part of the information memorandum, it falls on the Resolution Applicant to acknowledge the claims in the Resolution Plan and provide the method of settling the same. Government dues, such as deferred tax liabilities, are always reflected in the books of account, and the RP has a duty to collate such claims. Further, such claims must be carefully audited and accommodated in the Resolution Plan to ensure that the claims of OCs, especially the statutory debts, are settled on a proportional basis as per Section 30(2) of IBC.

4. STATUTORY DUES IN RESOLUTION: ENSURING VISIBILITY DESPITE CONFIDENTIALITY

Moreover, Resolution Plans are confidential in nature until approved by the NCLT and cannot be handed over to the OCs prior to the same. There exists no duty to issue a notice to the OC after the Resolution Plan has already been approved by the CoC. This makes it difficult for the OCs to know whether their claims have been included in the Resolution Plan after being acknowledged by the RP. Further, OCs whose claims are already present in the books of account are not given a prior opportunity to ensure that such claims have also been acknowledged and included in the Resolution Plan. Post-approval, the plan becomes binding on the OCs, extinguishing all pre-CIRP claims not included in the Resolution Plan.

The onus should be on the Resolution Applicant to provide reasons as to why certain claims have not been included in the Resolution Plan, and the RP should communicate the same to the OC, after the Resolution Plan has been approved by the CoC, ensuring that confidentiality of the Resolution Plan is not compromised, yet the OCs have knowledge of the claims concerning them.

5. CONCLUSION AND WAY FORWARD

The traditional method of public announcement is through Form A of IBC and by announcing through newspapers. The main setback in collating statutory dues takes place due to the lack of claims being submitted by the relevant authorities, even after the RP makes a public announcement according to Section 13(b) of IBC. Apart from the cases discussed, there exists a plethora of cases wherein the statutory dues were not included in the resolution plan due to the non-submission of such claims within the stipulated timeframe.

This calls for a change in the method of public announcement to a more efficient method to ensure that the statutory authorities submit the claims on time to the RP. The advancing digitalization and technological advancements must be utilised, and the RP should be obligated to inform the relevant statutory authorities through separate notices by way of emails about the initiation of CIRP, and to submit the claims within the specified timeframe. The 2022 Discussion Paperon changes in CIRP must also be referred to, to ensure reduced delays in submitting claims are reduced by informing all creditors of the CD about the initiation of CIRP and the last date for submitting claims.

This will ensure that the relevant governmental authorities are properly notified about the CIRP and submission of claims, reducing their burden of tracking companies undergoing CIRP and performing due diligence to remain informed about the claims and their submission deadlines. The authors propose that the RP should thoroughly examine the books of accounts to identify the dues owed to the different statutory authorities. This approach ensures that the authorities are well notified of the CIRP, enabling them to submit their claims promptly. As a result, more comprehensive Resolution Plans can be submitted and approved, facilitating successful revival of the CD.