Financial Institutions Rejoice: Supreme Court Upholds Waterfall Mechanism under IBC

Ms. Mahi Yadav

The recent decision by the Hon'ble Supreme Court in State Tax Officer Vs Rainbow Papers Limited(hereinafter referred as "Rainbow Ruling") upholds the waterfall mechanism under the Insolvency and Bankruptcy Code (hereinafter referred as "IBC") is significant. This ruling overturns the previous Rainbow ruling in which the appellant (State Government) raised the question of whether Section 53 of the IBC overrides Section 48 of the Gujarat Value Added Tax (GVAT) Act, the NCLAT (National Company Law Appellate Tribunal) erred in its observation in rejecting the application/appeal of the appellant whereas the Hon'ble Supreme Court has now dismissed this stance, reaffirming the waterfall mechanism because Appellant falls under the purview of Section 3(30) of the IBC which defines secured creditor.

In another landmark Judgement of the Hon'ble Supreme Court in "Paschimanchal Vidyut Vitran Nigam Ltd v. Raman Ispat Private Limited" has brought significant relief for creditors and financial institutions because it clarifies that government dues including Income Tax, VAT and electricity charges etc., are to be treated as operational debt and given priority in the waterfall mechanism for distribution of funds during insolvency proceedings. This means that government dues will be paid before other debts, such as financial debts. This clarification is seen as a positive step for creditors and financial institutions for several reasons-

1. Uniform Application of Law: When there is clarity on the treatment of Government dues, it ensures a consistent and uniform application of the law across different cases. This predictability in the legal framework allows creditors and financial institutions to make informed decisions based on established rules, reducing uncertainty and legal disputes.
2. Protection of financial institutions' interests: The ruling ensures that financial institutions, which often have significant exposure to Government entities, are given due consideration in insolvency proceedings. By clarifying the treatment of Government dues, the ruling helps protect the interests of financial institutions and enhances their ability to recover outstanding debts.
3. Encouragement for lending to Government entities: The clarity provided by the ruling may encourage financial institutions to lend to Government entities with more confidence. When the treatment of Government dues is well-defined, financial institutions are more likely to extend credit to Government entities, leading to increased investment and economic growth.
4. Strengthening the insolvency framework: The Hon'ble Supreme Court's ruling contributes to the overall strengthening of the insolvency framework by providing a clear interpretation of the law.

Conclusion:

Overall, the Hon'ble Supreme Court's decision to uphold the waterfall mechanism under the IBC is a positive development for the creditors and financial institutions involved. It brings much-needed clarity and stability to the insolvency and bankruptcy process, benefiting all parties involved and now they can have a clearer understanding of their rights and priorities in the event of a company's liquidation. This clarity will help them to make informed decisions and also help them to manage their risks.

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