Supreme Court Prioritizes Secured Creditors over Customs Dues in Company Liquidation: IDBI vs. Superintendent of Central Excise (2023)

Date of the Judgment: 18 August 2023
Citation: 2023 INSC 746
Judges: Sanjiv Khanna, J. and Sudhanshu Dhulia, J.

Can a secured creditor’s claim take precedence over the customs department’s right to recover dues when a company is being liquidated? The Supreme Court of India recently addressed this critical question, clarifying the hierarchy of claims in company winding-up proceedings. This judgment clarifies the interplay between the Companies Act, 1956 and the Customs Act, 1962, particularly concerning the distribution of assets during liquidation. The bench comprised Justices Sanjiv Khanna and Sudhanshu Dhulia, with the majority opinion authored by Justice Sanjiv Khanna.

Case Background

The Industrial Development Bank of India (IDBI) had provided financial assistance to M/s. Sri Vishnupriya Industries Limited (the Company) between 1994 and 2000. As security, the Company hypothecated movable properties and created an equitable mortgage on immovable properties, which was duly registered. The Company also had promoters and guarantors who provided personal guarantees.

The case concerns machinery and components imported from Italy in 1998-1999, which were warehoused in a private bonded warehouse under Section 59(1) of the Customs Act. The goods were not cleared for home consumption under Section 47 of the Customs Act, even after extensions. Consequently, the customs authorities issued show-cause notices and orders, confirming customs duty levies amounting to Rs. 3,27,22,191 and Rs. 10,48,29,017. When the Company failed to pay, the authorities ordered the sale of the warehoused goods under Section 72(2) read with Section 142 of the Customs Act, to recover the dues.

Meanwhile, a winding-up petition was filed against the Company, which was admitted on April 1, 2003, and a winding-up order was passed on December 1, 2003. The Official Liquidator then applied to the High Court, seeking possession of the imported goods, which were up for auction by the customs authorities. The single judge of the High Court allowed the application, stating that the customs authorities had not followed the correct procedure before ordering the sale and that the assets of the company in liquidation vest with the Official Liquidator under Section 456 of the Companies Act. The customs authorities appealed this order.

Timeline

Course of Proceedings

A single judge of the Andhra Pradesh High Court allowed the Official Liquidator’s application, stating that the customs authorities had not followed the correct procedure under the Customs Act before ordering the sale of goods. The judge also held that, under Section 456 of the Companies Act, the assets of a company in liquidation vest with the Official Liquidator, who is entitled to deal with them. The customs authorities’ claim to sell the goods to recover their dues was rejected.

The customs authorities then appealed to a division bench, which referred the matter to a full bench of the Andhra Pradesh High Court. The full bench, relying on the Calcutta High Court’s decision in Collector of Customs v. Dytron (India) Ltd., held that the customs authorities had the first right to sell the imported goods and adjust the proceeds towards customs duty. This decision disagreed with a full bench decision of the Madras High Court in UTI Bank Ltd. v. Deputy Commissioner of Central Excise and Another.

Legal Framework

The Supreme Court examined several key provisions of the Companies Act, 1956, and the Customs Act, 1962. These include:

• Section 529A of the Companies Act: This section provides that, in the winding up of a company, workmen’s dues and debts due to secured creditors rank equally and have priority over all other debts. It states, “Notwithstanding anything contained in any other provision of this Act or any other law for the time being in force, in the winding up of a company,— (a) workmen’s dues; and (b) debts due to secured creditors to the extent such debts rank under clause (c) of the proviso to sub-section (1) of Section 529 pari passu with such dues, shall be paid in priority to all other debts.”
• Section 530 of the Companies Act: This section deals with preferential payments, which are paid after the dues under Section 529A. It includes revenues, taxes, cesses, and rates due to the government or local authority, provided they became due and payable within twelve months before the relevant date. It states, “In a winding up, subject to the provisions of Section 529-A, there shall be paid in priority to all other debts—(a) all revenues, taxes, cesses and rates due from the company to the Central or a State Government or to a local authority at the relevant date as defined in clause (c) of sub-section (8) and having become due and payable within the twelve months next before that date;”
• Section 447 of the Companies Act: This section states that a winding-up order operates in favor of all creditors and contributories as if it were made on a joint petition. It states, “An order for winding up a company shall operate in favour of all the creditors and of all the contributories of the company as if it had been made on all the joint petition of a creditor and of a contributory.”
• Section 456 of the Companies Act: This section mandates that the liquidator take custody of all the company’s property and actionable claims. It states, “Where a winding up order has been made or where a provisional liquidator has been appointed the liquidator or the provisional liquidator, as the case may be, shall take into his custody or under his control, all the property, effects and actionable claims to which the company is or appears to be entitled.”
• Section 468 of the Companies Act: This section allows the Tribunal to direct any contributory, trustee, receiver, banker, agent, officer, or other employee of the company to deliver any money, property, or books and papers to the liquidator. It states, “The Tribunal may, at any time after making a winding up order, require any contributory for the time being on the list of contributories, and any trustee, receiver, banker, agent, officer or other employee of the company, to pay, deliver, surrender or transfer forthwith, or within such time as the Tribunal directs, to the liquidator, any money, property or books and papers in his custody or under his control to which the company is prima facie entitled.”
• Section 528 of the Companies Act: This section provides that all debts and claims against the company are admissible for proof. It states, “In every winding up (subject, in the case of insolvent companies, to the application in accordance with the provisions of this Act of the law of insolvency), all debts payable on a contingency, and all claims against the company, present or future, certain or contingent, ascertained or sounding only in damages, shall be admissible, to proof against the company, a just estimate being made, so far as possible, of the value of such debts or claims as may be subject to any contingency, or may sound only in damages, or for some other reason may not bear a certain value.”
• Section 529 of the Companies Act: This section applies insolvency rules in the winding up of insolvent companies, including the rights of secured and unsecured creditors. It states, “In the winding up of an insolvent company, the same rules shall prevail and be observed with regard to—(a) debts provable; (b) the valuation of annuities and future and contingent liabilities; and (c) the respective rights of secured and unsecured creditors; as are in force for the time being under the law of insolvency with respect to the estates of persons adjudged insolvent:”
• Section 15 of the Customs Act: This section specifies the date for determining the rate of duty and tariff valuation of imported goods. It states, “The rate of duty and tariff valuation, if any, applicable to any imported goods, shall be the rate and valuation in force,—(a) in the case of goods entered for home consumption under Section 46, on the date on which a bill of entry in respect of such goods is presented under that section; (b) in the case of goods cleared from a warehouse under Section 68, on the date on which a bill of entry for home consumption in respect of such goods is presented under that section; (c) in the case of any other goods, on the date of payment of duty:”
• Section 46 of the Customs Act: This section deals with the entry of goods on importation. It states, “The importer of any goods, other than goods intended for transit or transhipment, shall make entry thereof by presenting electronically on the customs automated system to the proper officer a bill of entry for home consumption or warehousing in such form and manner as may be prescribed:”
• Section 68 of the Customs Act: This section deals with the clearance of warehoused goods for home consumption. It states, “Any warehoused goods may be cleared from the warehouse for home consumption, if—(a) a bill of entry for home consumption in respect of such goods has been presented in the prescribed form; (b) the import duty, interest, fine and penalties payable in respect of such goods have been paid; and (c) an order for clearance of such goods for home consumption has been made by the proper officer:”

Arguments

Appellant (IDBI) Arguments:

• IDBI, being a secured creditor, argued that its dues should have priority over the customs department’s claims.
• IDBI relied on Section 529A of the Companies Act, which gives overriding preferential status to secured creditors and workmen’s dues.
• IDBI contended that the customs dues did not qualify as preferential payments under Section 530 of the Companies Act because they were not ‘due and payable’ within the twelve months before the winding-up order.
• IDBI argued that the Customs Act does not create a first charge that overrides the rights of secured creditors.

Respondent (Customs Authorities) Arguments:

• The customs authorities argued that they had a first charge on the imported goods under the Customs Act, which should take precedence over all other claims.
• They relied on the full bench decision of the Andhra Pradesh High Court, which favored their claim.
• The customs authorities contended that the goods were under their control and that they had a right to sell them to recover their dues.

Official Liquidator’s Arguments:

• The Official Liquidator argued that all assets of the company, including the imported goods, should be under his control after the winding-up order.
• The Official Liquidator contended that the customs authorities had not followed due procedure before ordering the sale of goods.
• The Official Liquidator stated that all claims should be proved before him as per the Companies Act.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issue:

1. Whether the claim of a secured creditor has precedence over the right of the customs authorities to recover customs duty in the winding up of a company?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

The Court also considered the following legal provisions:

Judgment

How each authority was viewed by the Court?

• The decision in Collector of Customs v. Dytron (India) Ltd. [1998 SCC OnLine Cal 674] was overruled. The Court found that it incorrectly prioritized customs dues over secured creditors.
• The decision in UTI Bank Ltd. v. Deputy Commissioner of Central Excise and Another [(2007) 135 Company Cases 329 (Mad.)] was approved. The Court agreed with the Madras High Court’s view that secured creditors have priority over government dues.
• The principle laid down in Dena Bank v. Bhikhabhai Prabhudas Parekh & Co. and Others [(2000) 5 SCC 694] was followed. The Court reiterated that the Crown’s preferential right to recovery of debts is confined to ordinary or unsecured creditors.
• The interpretation of Section 530(1)(a) of the Companies Act in Rajratha Naranbhai Mills Co. Ltd. v. Sales Tax Officer, Petlad [(1991) 3 SCC 283] was followed. The Court affirmed that for a government debt to be covered under Section 530(1)(a), it must be ‘due’ and ‘due and payable’ within twelve months before the relevant date.
• The view of D.A. Desai, J., in Sales Tax Officer, Petlad v. Rajratna Naranbhai Mills Co. Ltd. and Another [(1974) 44 Comp Cas 65 (Guj)] was approved. The Court agreed that the words ‘due’ and ‘due and payable’ have different meanings.
• The principle in J.K. (Bombay) (P) Ltd. v. New Kaiser-I-Hind Spg. and Wvg. Co. Ltd. [(1970) 40 Comp Cas 689] was followed, emphasizing that the liquidator controls the assets after a winding-up order.
• The ruling in Commissioner of Customs, Calcutta and Another v. Biecco Lawrie Ltd. [(2008) 3 SCC 264] was followed, to determine when customs duty becomes ‘due and payable’.
• The decision in Punjab National Bank v. Union of India and Others [(2022) 7 SCC 260] was followed, supporting the priority of secured creditors over government dues.
• The principles in Sundaresh Bhatt, Liquidator of ABG Shipyard v. Central Board of Indirect Taxes and Customs [(2023) 1 SCC 472] were followed, which dealt with similar issues under the Insolvency and Bankruptcy Code.
• The ruling in Builders Supply Corporation v. Union of India and Others [(1965) 2 SCR 289] was followed, to reiterate that government debts do not have precedence over prior secured debts.
• The ruling in Collector of Aurangabad and Another v. Central Bank of India and Another [(1967) 3 SCR 855] was followed, to reiterate that government debts do not have precedence over prior secured debts.
• The decision in Imperial Chit Funds (P) Ltd. v. Income Tax Officer, Ernakulam [(1996) 8 SCC 303] was distinguished, as it dealt with Section 178 of the Income Tax Act, which has specific provisions for tax dues in liquidation.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to uphold the statutory scheme of the Companies Act, particularly Section 529A, which gives overriding preferential status to secured creditors and workmen’s dues. The Court emphasized that the Customs Act does not create a first charge that overrides this statutory preference. The Court also considered the principle that government dues do not have priority over secured creditors, unless explicitly provided by law.

The Court highlighted that the customs dues in this case did not qualify as preferential payments under Section 530 of the Companies Act because they did not become ‘due and payable’ within the twelve months before the winding-up order. The Court’s reasoning focused on the interpretation of the terms “due” and “due and payable,” emphasizing that both conditions must be met for a debt to qualify as a preferential payment under Section 530(1)(a) of the Companies Act.

The Court also noted that the objective of the liquidation process is to ensure that assets are preserved and distributed according to the priority mechanism specified in the Companies Act. This involves first paying overriding preferential creditors (secured creditors and workmen), then preferential creditors, and finally ordinary creditors.

Logical Reasoning:

Decision

The Supreme Court allowed the appeal filed by IDBI and set aside the full bench judgment of the Andhra Pradesh High Court. The Court held that the secured creditors have priority over the customs authorities in the distribution of assets during the liquidation of a company. The Court directed that the sale proceeds of the goods be distributed in accordance with the provisions of the Companies Act, prioritizing the secured creditors.

Implications

This judgment clarifies the priority of claims in company liquidation, emphasizing that secured creditors have a higher claim than customs authorities. It reinforces the importance of Section 529A of the Companies Act, which provides overriding preferential status to secured creditors and workmen’s dues. The judgment also highlights that government dues do not automatically take precedence over secured debts unless specifically provided by law.

The ruling has significant implications for financial institutions and other secured creditors, ensuring that their legitimate claims are protected during company winding-up proceedings. It also provides clarity on the interplay between the Companies Act and the Customs Act, preventing confusion and conflicting interpretations in similar cases. The judgment underscores the need for government authorities to comply with the procedures laid down in the Companies Act when dealing with companies undergoing liquidation.