Supreme Court: IBC Section 238 Overrides Electricity Act, Secured Creditor Enjoy Priority over Dues Payable to Central & State Government

Supreme Court: IBC Section 238 Overrides Electricity Act, Secured Creditor Enjoy Priority over Dues Payable to Central & State Government

The Supreme Court observed that Section 238 of the Insolvency and Bankruptcy Code, 2016 overrides the provisions of the Electricity Act, 2003. The Supreme Court upheld the National Company Law Appellate Tribunal’s decision, stating that the Insolvency and Bankruptcy Code, 2016 takes precedence over the Electricity Act and that electricity dues do not enjoy priority.

The bench of Justices S. Ravindra Bhat and Dipankar Datta observed, “The provisions of the IBC which treat the dues payable to secured creditors at a higher footing than dues payable to Central or State Government.”

In the present case, an appeal was filed by Paschimanchal Vidyut Vitran Nigam Limited (PVVNL) against an order issued by the National Company Law Appellate Tribunal (NCLAT).

PVVNL contested the order of the National Company Law Tribunal, Allahabad (NCLT), which allowed the release of attached property, previously attached by PVVNL, in favor of the liquidator of the Respondent, Raman Ispat Pvt. Ltd.

The purpose of releasing the property was to facilitate its sale and subsequent distribution of proceeds in accordance with the Insolvency and Bankruptcy Code, 2016 (IBC). The liquidator argued that the attachment orders needed to be set aside by the NCLT in order to enable the sale of the property, as potential buyers were hesitant due to uncertainties surrounding the liquidator's authority to sell.

The liquidator also contended that PVVNL's claim would be classified according to the priority prescribed under Section 53 of the IBC, entitling PVVNL to a pro rata distribution of proceeds along with other secured creditors from the sale of liquidation assets.

The NCLAT upheld the NCLT's decision and directed the District Magistrate and Tehsildar, Muzaffarnagar, to release the attached property in favor of the liquidator. This decision aimed to facilitate the sale of the property and ensure its distribution in accordance with the relevant provisions of the IBC.

The NCLAT also agreed with the NCLT's interpretation that PVVNL fell within the definition of an ‘operational creditor’ and could recover its dues through the liquidation process as prescribed by the law.

At the outset the Court remarked that, the initiation of the insolvency process by financial creditors and operational creditors is controlled by Sections 7 and 8 of the IBC, respectively. The corporate debtor can contest a debt within a specified time period. The Adjudicating Authority determines the existence of a default based on the records of the information utility or evidence furnished by the creditors.

The Apex Court upon perusal and analyzing the provisions of the IBC observed that, during the insolvency resolution process, a secured creditor is not permitted to realize its dues by initiating any proceeding.

The Supreme Court affirmed that by virtue of Section 14 (1) (c) which enables the imposition of a moratorium period, during which a secured creditor is precluded from bringing any action to foreclose, recover or enforce any security interest. Secured creditors’ rights are restored only in the event of failure of the insolvency resolution process, at the stage of liquidation.

The Court elucidated that Section 53 of the IBC, contains the ‘waterfall mechanism’, which provides for the order of distribution of assets. The priority of claims, indicated in the hierarchy of preferences, under the waterfall mechanism is therefore:

Firstly, insolvency resolution process costs and the liquidation costs; Secondly, workmen’s dues for the period of 24 months preceding the liquidation commencement date and debts owed to a secured creditor in the event such secured creditor has relinquished security; Thirdly, wages and any unpaid dues owed to employees other than workmen for the period of 12 months preceding the liquidation commencement date; Fourthly, financial debts owed to unsecured creditors; Fifthly, any amount due to the central government and the state government and debts owed to a secured creditor for any amount unpaid following the enforcement of security interest; Sixthly, any remaining debts and dues; Seventhly, preference shareholders; and Eighthly equity shareholders or partners.

The Supreme Court further added that Debts owed to a secured creditor receive a higher priority if the secured creditor has relinquished security in the manner set out in Section 52, IBC. In cases where the secured creditor does not relinquish security, the priority of claim is lower in respect of any amount unpaid following the enforcement of security interest under (Section 53(1)(e)(ii)), IBC. It was asserted by the bench that Section 52 of the IBC provides an option for secured creditors to either relinquish their security interest or proceed to enforce it.

The Court emphasized that if the secured creditor chooses to enforce its security interest, it must indicate its option within the prescribed time and can realize the proved dues as security debts with the permission of the liquidator. Any excess amount realized should be tendered to the liquidator.

“It is thus, apparent, that a secured creditor has to take a calculated decision, at the outset of the liquidation process, whether or not to relinquish its secured interest. In case it does so, its dues rank high in the waterfall mechanism. In case it chooses not to relinquish its security interest, and instead proceeds to enforce it without success or is unable to realize all its dues in the process of enforcement, it has to then perforce stand lower in priority, and await distribution of assets upon realization of the liquidation estate, by the liquidator, vis-à-vis the balance of its dues,” the bench discerned.

With respect to the recovery mechanism under the Electricity Act, 2003 and Uttar Pradesh Electricity Supply Code, 2005, the Court held that the expression ‘government dues’ is not defined in the IBC - it finds place only in the preamble.

However, the bench stated that what constitutes such dues is spelt out in the ‘waterfall mechanism’ under Section 53(1)(e), which inter alia states that, any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of the State ranks lower in priority to the class of creditors described in Clauses (a) to (d) of Section 53(1).

Thus, the Court was of the view that there exists a separate enumeration or specification of the Central Government and State Government dues, as a class apart from other creditors, including creditors who may have secured interest (in respect of which amounts may be payable to them).

Averting to the present case, the Court noted that PVVNL undoubtedly had government participation. However, that does not render it a government or a part of the ‘State Government’. Its functions can be replicated by other entities, both private and public. The Court avowed that the supply of electricity, the generation, transmission, and distribution of electricity has been liberalized in terms of the 2003 Act barring certain segments. Private entities are entitled to hold licenses.

For these reasons, the bench held that in the present case, dues or amounts payable to PVVNL do not fall within the description of Section 53(1)(f) of the IBC.

Lastly, the Court was of the view that the liquidator cannot urge to register charges under Section 77 of the Companies Act, 2013 at this stage, because of the concurrent findings of the NCLT and the NCLAT that PVVNL is a secured creditor.

Accordingly, the Supreme Court dismissed PVVNL’s appeal and directed the liquidator to consider PVVNL's claim in accordance with the law and complete the process within 10 weeks.