Secured creditors dues placed higher than government dues even when having a statutory charge – ‘Rainbow-Papers’ clarified!

Brief Overview:

Section 238 of Insolvency and Bankruptcy Code, 2016 (“IBC”) overrides the provisions of the Electricity Act and that the dues payable to secured creditors are at a higher footing than the dues covered by a statutory charge i.e., payable to the State.
See Paschimanchal Vidyut Vitran Nigam Ltd vs Raman Ispat Private Limited (Civil Appeal Nos. 7976 of 2019)Additionally, the Hon’ble Supreme Court (“Supreme Court”) also effectively distinguished Rainbow Papers [2023 INSC 625]

Technical Details:

1.   Supreme Court while placing substantial emphasis on the ‘waterfall mechanism’ under Section 53 of the IBC observed that the provision prioritizes the payment of dues to secured creditors who relinquish the right to enforce security when the liquidation process is initiated. The payment of such creditors is second only to the payment of insolvency resolution process costs and liquidation costs.

2.   Also the SC held that government debts are at a lower priority than the debts owed to unsecured financial creditors and government debts include debts covered by a statutory charge. In other words, the lower priority of government debts also extends to secured government debt.

3.   It was further held that the claims of an Electricity Company (“EC”) cannot be treated as government debt on the grounds of the EC having government participation. It was also noted that not all dues owed under a statute are treated as ‘government dues.’

JC Key Takeaways:
Creditors under the IBC, both secured and unsecured, are entitled to have their debts repaid first before dues payable to the State or the Central governments are settled. Further Rainbow Papers judgement does not deal with dues of the State in a Liquidation Proceedings and fails to recognize the waterfall mechanism, further that not all dues owed under the statute are considered ‘government dues’ as defined by Section 53 of the Insolvency and Bankruptcy Code.
For further details, please see:

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