Government dues take a back seat when it comes to debt recovery.
When a company goes under, anxious creditors form a jostling queue at its door. The slew of suits filed by them against the defaulter who is about to shut down is only part of the story. There is also a vicious battle between the creditors for priority for recovery of their money. Government agencies also could be spotted in the melee, taxmen included. The chances of the government getting tax dues, however, are low, according to court decisions.
The old rule was that when the claim of the sovereign government and that of citizens converge on a defaulter, the government’s claim would take precedence. However, now there is a shift in the perspective. The taxman is considered to be an unsecured creditor. The secured creditors would get preference over claims of the revenue authorities.
This principle was reiterated in last month’s Supreme Court judgement in Union of India vs SIMCO Ltd. A firm borrowed money from the state financial agency, SIMCO, by a mortgage, which it could not return. The state agency took over the mortgaged property. Meanwhile, the excise authorities also jumped in the fray and wanted to seize the property of the waning firm. Thus, the creditors started a decade-long litigation over the question of priority. The taxmen lost in the end, in the Supreme Court.
This is the rule not only according to the State Financial Corporation Act but also under Section 529A of the Companies Act, the Employees Provident Fund Act, the Employees State Insurance Act and several state taxation laws. Leading judgements of the Supreme Court and the High Courts have also upheld this view, though the issue is raised repeatedly by tax authorities. In the latest judgement, the Supreme Court asserted that “a debt which is secured or which by reason of the provisions of a statute becomes the first charge over the property must be held to prevail over government debt which is an unsecured one.”
One of the earliest cases where the question of ‘first charge’ arose was in the context of income tax. In that case, Builders Supply Corporation vs Union of India (1965), the tax authorities argued that they had the first charge over the assets of the defaulting assessee. According to Section 46(2) of the Income Tax Act, the collector could proceed against an assessee to recover the arrears. However, this argument was rejected.
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A year ago, a case arose where sugar was pledged with a bank by a company for securing a loan and the loan was not repaid (Bank of India vs Siriguppa Sugars & Chemicals). The goods were forcibly taken possession of at the instance of the revenue recovery authority from the custody of the bank. The bank approached the Supreme Court which stated that the Cane Commissioner and the workers of the mills stood only as unsecured creditors and their rights could not prevail over those of the bank.
Even in the case of a simple pawn, the law is on the side of the pawnee who lent money in favour of he pawnor as it is a secured debt. In the case, Bank of Bihar vs State of Bihar (1971), the properties of the pawnor were seized leaving the pawnee without any means of recovery his loan. The Supreme Court ruled in favour of the pawnee by giving him precedence over other creditors.
The Supreme Court has consistently been on the side of the state financial corporations in the matter of recovery of debts. When it felt that its 1993 judgement in Mahesh Chandra vs UP Financial Corporation was too lenient towards the defaulter, it soon tightened the rules in a later judgement in 2002 (Haryana Financial Corporation vs Jagadamba Oil Mills). In the latter judgement, the Supreme Court said, “Indulgence shown to chronic defaulters would amount to flogging a dead horse without any conceivable result being expected.” It is one thing to assist a borrower who has the intention to repay but is prevented by insurmountable difficulties in meeting the commitments and another to help a dishonest one.
In a similar judgement, the court said that “financial corporations are not sitting on King Solomon’s mines but they too have to borrow monies from the government and other financial institutions and pay interest thereon.” (UP Financial Corporation vs Gem Cap).
There are several statutes now dealing with recovery of debts. The experiment with Sick Industrial Companies Act has failed as it has been described as a source of corruption instead of a healing agent. Then there are the Securitisation and Reconstruction of Financial Assets Act and little-known laws like the Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act. However, the rule of the game is that a government debt is not entitled to claim precedence over a prior secured debt.As in Murphy’s law, the other queue moves faster.