One other prism for reviewing escrow and custodial agreements? – Finance and banking

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Escrow and custody account (TRA) Mechanism1, a
Common feature of infrastructure projects, finds its origin in
one of the first guidelines of the Reserve Bank of India
(RBI) for infrastructure financing, namely
Circular on the financing of infrastructure projects of April 23
1999 with reference number IECD. No. 26 / 08.12.01 / 98-99 issued by
RBI. The TRA mechanism is in control of future cash flows
Taken from the hands of the borrower and with one
independent agent named TRA agent / trustee (appointed and acting)
in favor of the lender). With such earmarking of cash flows
Allocation in a predetermined manner for various purposes
including debt service, for state and statutory taxes,
Operating and maintenance costs (among other things) can be incurred and
transparently monitored. When fulfilling predefined line items from
Expenses (usually in line with pre-approved budgets),
Remaining cash flow is given to the borrower subject to
Meeting certain conditions (typically known as restricted)
Terms of payment or sales conditions). While TRA
Agreements can vary across the board in relation to a particular line
Articles and the overall look and feel, especially a large part of
the marrow and substance are based on the above.

In this part of (the intended) three-part
of articles on this subject, we limit our analysis
on the treatment / priority given to state and statutory taxes
against the rights of the creditors.

Treatment of state and statutory taxes in trust and
Retention account in the light of the insolvency and bankruptcy regulations, 2016

Position (as it currently stands?) In front of IBC

In the context of TRA agreements, state and statutory taxes (for
Payout, of which a separate sub-account is usually created)
First priority in terms of use / end-use of revenue
Receipts or other collections. Sometimes you also find
Determinations according to priority of the government and
Statutory charges in the event of payment competition / lack of money
flow (on a specific date / time period) to meet everyone
Liabilities as they have passed. One of the main reasons
(historically) for this priority is that government and legislature
Fees have the aftertaste of "crown debts", with the principle
Priority of crown debts based on the necessity rule, and
public order – the state is authorized to raise money,
Taxation because unless the state receives revenue and it is
in possession of the necessary funds, she would not be able to fire herself
at all its functions. The Honorable Supreme Court of India too
determined that the tax arrears due to the state can claim priority
about personal debt in terms of common law doctrine in terms of
Priority of Crown Debt (Doctrines of Common Law would be the force
of law within the meaning of Article 372, paragraph 1, of the Constitution of
India) 2. Looked at from a different angle when taxes
Contributions remain unpaid, government and authorities would have
the right to seize the property and tax debts from the
Disposal of these assets, thereby making the functioning of the
Project overall and justify top priority
State and statutory taxes within the TRA waterfall.

IBC – Lender Rights in

While the Companies Act (2013 or, for that matter, 1956) provides:
special distribution priority when processing a
Company, IBC is a derogation within the meaning of Section 53 thereof. In one
Liquidation scenario, crown debt (state and statutory fees)
ranks below the bankruptcy / liquidation process
Costs, workers' fees / fees from the secured creditors, fees from
to employees (except workers) and financial debts
unsecured creditors. There are now several court decisions
who have recognized the rights of government agencies in
in relation to such charges, the unsecured operational

That begs the question

Since this is specifically a liquidation scenario, the
The natural question is why shouldn't TRA agreements give priority?
on state and statutory taxes, as this is in the
ordinary course of business as well as during the company
Insolvency settlement procedure (CIRP) and also
because any TRA agreement that has a waterfall / distribution
contrary to Section 53 of the Code, in any case

Treatment of state and statutory taxes in CIRP

It is true that as far as the banks / financial institutions
according to the IBC scheme, both at CIRP and at
Liquidation, their rights are protected as they are financial
Creditors with recognized state and statutory taxes
than business debt and the Apex Court has more than
an opportunity that equality is among equals and financially and
operational creditors are on a different basis3.

Overall position

The overall scheme on this topic has changed due to the
Adoption / enforcement of the code leading to changes to the
Companies Act, 20134 and now in the event of liquidation
Litigation of a company under the aegis of the courts, government and
Statutory taxes no longer have the same priority. There are
Changes to certain other laws5 relating to debt recovery, the
they can be said to have their origins in the adoption of the Code, but
these are not of direct importance for the purposes of this agreement.

Then why look around?

It should be noted that the Hon & # 39; ble Supreme Court of India
stated in one of his recent decisions on the matter that unless
The crown debt is given preference by law, the duties of a
secured creditors take precedence over crown debts6. For the
The purpose of this agreement is the most important judicial finding in this
Decision as Connectwell Principle.

Also outside the scope of the Code, as far as income
Taxes or duties under the Central Goods and Services Tax Act, 2017
are in practice associated with the creation of security
(or otherwise), permission (to create collateral for assets)
would have been obtained in accordance with the relevant statutory provisions7 or
independent confirmation (often at regular intervals) regarding
as no outstanding tax debt would have been collected.

In addition, the Honorable Supreme Court of India8 has also recognized it
that Section 31B of the Debt Collection and Bankruptcy Act, 1993
and Section 26E of the Securitization and Reconstruction of
Financial Investments and Security Interest Enforcement Act, 2002
respectively have claimed priority for the restoration of. to accomplish
secured creditors through state and statutory taxes. Even if the
State tax law provides the primacy of government and law
Fees with regard to Article 246 of the Constitution of India, central
Actions will prevail. As a result, it will be decided by several high courts
that the secured creditor can recover the proceeds from the sale
of secured assets take precedence over government and statutory taxes
even if state and statutory taxes are outstanding and have already been paid
claims9. Based on the above and the
Connectwell Principle, even if government agencies
exercise their rights of judicial decision and thereby
Procedure for the attachment of assets, claims against secured creditors
would always prevail and replace such a government
and statutory taxes.

Even considering the government's larger basket
and statutory charges (as a definition of & # 39; statutory charges & # 39;
or "taxes" contained in TRA agreements or loan agreements
are usually wider) cover the pension fund or the employee state
Insurance or similar required by law
Payments / provision, the special purpose vehicles in which the
Projects typically never have workers on their roles as EPC contracts
and O&M contracts are seldom executed internally. Consequently
does not meet the compliance thresholds under various labor laws in India
normally triggered.


Although the risks related to attachment and the type of attachment recipient
Orders cannot be ruled out and such procedures remain real
Opportunities in the event of tax losses or default in payment, from
From the lender's point of view, the time has come to consider whether or not
No government or other statutory charges need to be paid above
Priority by contract. Regarding TRA agreements and draft
There is no better time than this to judge whether or not
separate sub-accounts are required by government and law
Fees or whether it is more appropriate to them than
Part of the larger outflow from an operating expense / O&M
Account or Debt Service Payment Account. Since there is a conflict between
contractual provisions and what they contain or what may result
ab, legal / judicial decisions should always be avoided, is this here?
the aspects in TRA agreements that can be dealt with with a. should go through again
to adapt the TRA agreements to the current legal provisions
Position / court order?


Sometimes named differently – for illustration as Escrow
Account. To distinguish between TRA mechanism and escrow
to the circular on the financing of
Infrastructure projects dated April 23, 1999 with reference
Number IECD No. 26 / 08.12.01 / 98-99 issued by the Reserve Bank of

Dena Bank vs. Bhikhabhai Prabhudas Parekh & Co, (2000.)
(5) SCC 694).

Essar Steel India Limited v. Satish committee of creditors
Kumar Gupta and others, (2019 SCC Online 1478).

Section 326 of the Companies Act, 2013.

Section 31B of the Debt Collection and Bankruptcy Act, 1993 and
Section 26E of securitization and reconstruction of finance
Assets and Security Interest Enforcement Act, 2002 – Also
discussed further in the article.

Connectwell Industries Pvt. Ltd. vs. Union of India,
(2020) 5 SCC 373).

7. For
for example in accordance with Section 281 (1) of the Income Tax Act,

UCO Bank & Others vs. Dipak Debbarma & Others, (2017
(2) SCC 585) – when interpreting Article 246 stated that
In doing so, the constitutional scheme must be observed, which a
federal structure that gives the Union Parliament full autonomy
as well as to the state legislators in their respective / delimited
Areas of law. In the event of a conflict, it is an absolute duty
of the Constitutional Court to see if the conflict can be resolved
by recognizing the mutual existence of the two pieces of legislation. If
this is not possible, then due to the provisions of the article
246 (1), parliamentary legislation would prevail and the state
The legislation must give way, although the
State legislation falls within the demarcated area (List II). This is
the principle of federal supremacy, article 246 of the
Constitution embodies.

9th axis
Bank Limited vs. State of Maharashtra and Anr., 2017 (3) AIR (Bom) R

For the purposes of this document, we have not considered a situation where a
Government agency goes under bankruptcy and bankruptcy
Code, 2016 for the fees owed to him because in such a scenario, even if
Government agency initiates CIRP, which they call
Real proceedings by virtue of Swiss Ribbons Pvt.
Lmt. vs. Union of India (2019 SCC OnLine SC 73) and one secured
Creditors always take precedence over the government under the

The content of this article is intended to provide a general overview
Guide to the subject. Expert advice should be sought
about your particular circumstances.