IBC Bill, 2025: End of confusion for priority of Government Dues

The Insolvency & Bankruptcy Code, 2016 (“Code”) was aimed at providing an adequate framework for resolution and liquidation in a time bound manner and provided for manner of distribution of assets to stakeholders in case of liquidation of the Corporate Debtor. Section 53 of the Code signifies the intention of the legislature that the dues owed to Government would be lower in priority than the dues of financial creditors. Even prior to the enactment of the Code, the Courts have consistently held that the Crown Debts would not take precedence over the debts of secured creditors.

Judgment in Rainbow Papers and unintended consequences

The above understanding came to be disturbed with the judgment of Hon’ble Supreme Court in the case of State Tax Officer vs. Rainbow Papers Ltd., wherein it was held that the tax authorities would qualify to be a secured creditor under the provisions of the Code and consequently, the Government can claim the first charge over the assets of the Corporate Debtor (in cases where the statute provides so). While holding so, the Court considered the definitions of ‘secured creditor’ and ‘security interest’ under Sections 3(30) and (31) of the Code respectively and observed that the security interest can also be created by operation of law and not only by virtue of an agreement or arrangement. The above view appeared to be at odds with the scheme of the Code and the earlier rulings by the Supreme Court itself. [1] The Review Petition filed in the above matter was also dismissed by the Hon’ble Supreme Court, while a curative petition is presently pending.

If the ratio of Rainbow Papers (Supra) were to be followed, the fall-out would be that other statutes which provide for dues therein to be first charge, such as Employees Provident Funds and Miscellaneous Provisions Act, 1952 and Employees State Insurance Act, 1948 would prevail over the Code, which appears contrary to what Section 238 of the Code provides, thus defeating the very purpose of its enactment.

The issue pertaining to government dues arising out of electricity laws came to be considered again by the Supreme Court, [2] wherein, dismissing the appeal filed by PVVNL, it was observed that the dues payable to the Government are placed much below in priority than the dues of secured creditors, and the Court in the case of Rainbow Papers (Supra) did not take note of the provisions pertaining to the waterfall mechanism under Section 53 of the Code and the ratio laid down therein must be confined to the said case alone. The dues of customs authorities were also held to be paid as per the waterfall mechanism, without according the status of ‘secured creditor’ to them. Thus, even the Supreme Court seemed uninclined to endorse the view taken by Rainbow Papers (Supra). However, the fact that it was not overruled specifically and did hold precedential value led to a state of uncertainty, particularly for the resolution professionals who had no clarity as to whether the statutory dues are to be considered as secured debts or not. This apparently led to legislature’s intervention and introduction of the Insolvency & Bankruptcy Code (Amendment) Bill, 2025 (“Bill”).

IBC (Amendment) Bill, 2025

With the introduction of the Bill in the Lok Sabha, the intention of the Government that the statutory dues shall not be at par with the secured debt of the financial creditors has further been clarified by insertion of explanation to Section 3(31) of the Code, [3] wherein it is stated that the security interest shall exist only if it creates a right pursuant to an agreement or arrangement and shall not include any security interest created by operation of law. The intent of the Government was also evident from the report of Bankruptcy Law Reforms Committee (BLRC) submitted in November 2015, which recommended that the right of the Central and State Government would be lower in priority than the dues of secured/unsecured creditors. Thus, the rationale adopted by the Hon’ble Supreme Court in the case of Rainbow Papers (Supra) appears to be an aberration from the scheme of the Code, as also seems from the subsequent judgments.

Analysis

It is a common practice by the Revenue authorities to attach the property of the assessee to avoid any alienation of the same for protecting the tax dues even before the formal adjudication or exhaustion of appeal remedies by the assessee. Although it does not amount to creation of charge as per the Code, because a combined reading of the definitions of ‘security interest’ under Section 3(31) and ‘transaction’ under Section 3(33) of the Code signifies that the term ‘transaction’ is defined to include any agreement or arrangement in writing and hence, no security interest can be created without any underlying transaction. In commercial sense of the term also, a transaction cannot include the tax dues payable to the Government as tax is a compulsory exaction of money, and the dues do not arise due to any arrangement or agreement.

The tax authorities, however, do wrongfully claim that they have a vested right merely by virtue of passing of assessment order or attachment proceedings and given the ratio laid down in Rainbow Papers (Supra), the Courts may be inclined to endorse the aforesaid view, as done recently by Hon’ble Madras High Court, [4] wherein it was observed that Tax Department is a secured creditor if an assessment order has been passed and the assets of the assessee/Corporate Debtor have been attached. Holding so leads to a consequence never intended by the legislature and it is this anomaly which is sought to be conclusively settled by the Bill by restoring the priority accorded to the creditors, by effectively nullifying the judgment in the case Rainbow Papers (Supra).

Prior to the introduction of the Bill, it was felt that the judgment in the case of Rainbow Papers (Supra) must be referred to the larger bench to settle the disruption caused by it. However, the Bill makes the legislative intent clear that only enforceable contracts between the parties would lead to creation of ‘security interest’ and it cannot be created unilaterally due to operation of law. The way Explanation has been worded leaves no doubt that it is clarificatory in nature and shall be applicable retrospectively and hence, there is no need for Rainbow Papers (Supra) to be referred to larger bench now. Even otherwise, it could have been argued that the Supreme Court did not have any occasion to discuss the significance of the definition of ‘transaction’ under the Code, and thus, there was no occasion to deal with that aspect of the matter.

It is anticipated that the passage of the Bill and its enactment would go a long way in providing certainty and confidence to the resolution applicants, as statutory claims due to mere default in purported tax dues by Corporate Debtor or passing of assessment order / initiation of attachment proceedings by the Revenue authorities would not grant them the status of ‘secured creditor’, thus, reaffirming the predictability in the resolution/liquidation process.

[1] PCIT vs. Monnet Ispat & Energy Ltd.
[2] Pashchimanchal Vidyut Vitran Nigam Ltd. vs. Raman Ispat Pvt. Ltd.
[3] Explanation — For the removal of doubts, it is hereby clarified that the security interest shall exist only if it creates a right, title or interest or a claim to a property pursuant to an agreement or arrangement, by the act of two or more parties, and shall not include a security interest created merely by operation of any law for the time being in force;
[4] Avenue Realty vs. Assistant Commissioner

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