Introduction
The Insolvency and Bankruptcy Code (Amendment) Act, 2026 (‘IBC Act, 2026’) – inter alia – amends Section 53 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’). The amendment is, largely, in response to the Supreme Court’s decision in State Tax Officer v Rainbow Papers Limited (‘Rainbow Papers case’). The Supreme Court in the Rainbow Papers case held that government or a governmental authority could be considered a secured creditor under the IBC. Immediate effect of the Rainbow Papers case was that the government could claim a higher rank as a secured creditor under Section 53(1)(b)(ii) instead of claiming amounts alongside unsecured creditors under Section 53(1)(e). The Rainbow Papers case detracted from the legislative intent to place government at par with unsecured creditors.
The legal position got further entangled when subsequently in Paschimanchal Vidyut Vitran Nigam Ltd v Raman Ispat Private Limited & Ors (‘Raman Ispat case’) the Supreme Court confined decision in the Rainbow Papers case to facts of that case alone. And, also commented that the Supreme Court in the Rainbow Papers case did not adequately examine Section 53 and the waterfall mechanism. This was followed by a review petition where the Supreme Court refused to consider its observations in the Rainbow Papers case. And instead took exception to comments made in the Raman Ispat case. The Supreme Court questioned propriety of a co-ordinate bench commenting on judgment of another bench instead of referring the case to a larger bench and observed:
If a Bench does not accept as correct the decision on a question of law of another Bench of equal strength, the only proper course to adopt would be to refer the matter to the larger Bench, for authoritative decision, otherwise the law would be thrown into the state of uncertainty by reason of conflicting decisions. (para 20)
Unsurprisingly, the law was ‘thrown’ into uncertainty after the above set of events.
The Rainbow Papers case, the Raman Ispat case, and the Supreme Court’s observations in the review petitions meant that position of government as secured creditor was both valid and under scrutiny. And certainty was an enemy. The Rainbow Papers case could be relied on as a binding precedent or plausibly be confined only to facts of the particular case depending on proclivities of the stakeholders involved. It is to rectify this unwelcome legal position that the IBC Act, 2026 inserted an Explanation to Section 53(1)(e) to clarify that amounts due to the Central Government and the State Government shall be distributed under that sub-clause. Thereby, placing the government at par with unsecured creditors and undoing ratio of the Rainbow Papers case. However, I conclude that the amendment to Section 53 may not completely eliminate effect of the Rainbow Papers case. I suggest that one of the Supreme Court’s observations in the Rainbow Papers case: tax claims should be necessarily part of the resolution plan, still survives the IBC Act, 2026.
In this article, I provide a descriptive context and background that necessitated the amendment to Section 53 effectuated by the IBC Act, 2026. I begin by elaborating on the rationale that underpinned the Rainbow Papers case, the discomforts it caused, and limits of the amendment made to Section 53 by the IBC Act, 2026.
The Rainbow Papers Case and its Aftermath
In the Rainbow Papers case, the Supreme Court had to answer the question that whether Section 53 of the IBC overrides Section 48 of the Gujarat Value Added Tax Act, 2003 (‘GVAT Act, 2003’). The latter stated that:
48. Tax to be first charge on property.—
Notwithstanding anything to the contrary contained in any law for the time being in force, any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person.
Similarly, Section 53 of the IBC begins with a non-obstante clause and provides for distribution of assets ‘Notwithstanding anything to the contrary contained in any law …’.
To begin with, the Supreme Court condoned delay by the tax department in filing its claim by reasoning that timelines under the IBC are directory. And even if the claim was not filed before the deadline announced by the resolution professional, it was incumbent on the resolution professional to revise the admitted claims once he came across additional information – relating to outstanding tax claims – warranting such revision.
The second issue was about the States’ status as a secured creditor. The State’s argument was that definition of secured creditor under Section 3(30) read with definition of security interest under Section 3(31) was wide enough to include a statutory charge such as under Section 48 of the GVAT Act, 2003. The Supreme Court accepted the State’s argument and held that the latter was not contrary to the IBC and:
Section 3(30) of the IBC defines secured creditor to mean a creditor in favour of whom security interest is credited. Such security interest could be created by operation of law. The definition of secured creditor in the IBC does not exclude any Government or Governmental Authority. (para 57)
And thus, the Supreme Court concluded that debts owed to the State under the GVAT Act, 2003 were to rank equally with other debts owed to a secured creditor under Section 53(1)(b)(ii). The Supreme Court’s conclusion was based on the definition of security under Section 3(31) which does not exclude a statutory charge as well as the definition of secured creditor which does not exclude the State. The Supreme Court was also influenced by the fact that the impugned resolution plan completely ignored tax dues owed by the corporate debtor to the State and it questioned the validity of a resolution plan that did not incorporate tax dues.
In some of the subsequent decisions, the Rainbow Papers case was sought to be limited to its facts. For example, in Department of State Tax v Ashish Chhawchharia Resolution Professional for Jet Airways (India) Ltd & Anr (October 2022), the National Company Law Appellate Tribunal (‘NCLAT) had to engage with the question if Department of State Tax was a secured creditor. The NCLAT examined Section 82 of the Maharashtra GST Act, 2017 which provided that the tax payable shall be first charge on the property of taxpayer, except as provided in the IBC. Thus, in view of the specific exception wherein the IBC triumphed the Maharashtra GST Act, 2017 the NCLAT found the Rainbow Papers case to be inapplicable in the impugned case.
The most notable example of limiting effect of the Rainbow Papers case only to facts of that case was in the Raman Ispat case. In this case, Paschimanchal Vidyut Vitran Nigam Limited (‘PVVNL’) relied on non-obstante clause in the Electricity Act, 2003, relevant clauses of agreement entered to between PVVNL and the corporate debtor, and the Rainbow Papers case to claim priority in liquidation proceedings. PVVNL claimed that it was a statutory corporation and dues owed to it amounted to dues owed to the State. The Supreme Court disallowed its claim and also expressed its disagreement with the Rainbow Papers case by observing that:
The careful design of Section 53 locates amounts payable to secured creditors and workmen at the second place, after the costs and expenses of the liquidator payable during the liquidation proceedings. However, the dues payable to the government are placed much below those of secured creditors and even unsecured and operational creditors. (para 49)
The Supreme Court in the Raman Ispat case further held that observations in the Rainbow Paper case must be confined to facts of that case. Thus, creating an uncertain legal position wherein two benches of the Supreme Court – of equal strength – took diametrically opposite positions in so far priority to be accorded to government dues under Section 53. In the absence of a reference to a larger bench, the only plausible way of reconciling the two judgments was to deduce that the Rainbow Papers case was be applicable only in cases where provisions like Section 48, GVAT Act, 2003 were applicable. While in other cases the Raman Ispat case had a more persuasive value. Irrespective of this reconciliation, the legal situation was far from satisfactory.
Limitations of the Rainbow Papers Case
The dissatisfactory legal situation was rooted in the Supreme Court’s reasoning in the Rainbow Papers case which suffered from a few obvious limitations. To begin with, one can argue that since Section 53(1)(e) was a separate category for the amounts due to the Central Government and the State Government, the legislative intent was straightforward: all dues owed to the government were to be classified in that category. And while the definition of security interest and secured creditor did not explicitly exclude the government, reliance on definitions was not conclusive that the government can be a secured creditor. The relevant definitions should have ideally been read with Section 53, which would have pointed towards the government not being a secured creditor. A harmonious interpretation of the relevant statutory definitions with the design of waterfall mechanism under Section 53 was missing from the Rainbow Papers case.
Another aspect that the Supreme Court overlooked in the Rainbow Papers case was the distinction between a voluntary charge and a statutory charge. Generally, a secured creditor acquires its status because of a voluntary commercial transaction with the corporate debtor. However, the government – especially in the Rainbow Papers case – was claiming status of a secured creditor based on a statutory provision. Equating the government to a secured creditor based on a statutory provision removes element of voluntariness of the corporate debtor and provides the government an easy way to claim status of a secured creditor by adopting similar provisions in existing and future laws. Equating an involuntary charge on property with a charge created by voluntary transaction –disrupted one of the IBC’s aims. The aim, in this context, was to give priority to private secured creditors who undertook the risk of lending capital to the corporate debtor. The waterfall mechanism under Section 53 recognizes the risk undertaken to incentivize similar transactions in the future and help development of the credit market.
Also, another one of the IBC’s aims, as mentioned in the Preamble is to alter ‘priority of payment of Government dues.’ The lowering of priority of the government’s dues is justifiable on various counts with the primary one being that the government has other avenues to recover money including levy of taxes from financial robust corporates among other taxpayers. Relevance of the IBC’s aim of lowering ranking of the government dues was missing in the Rainbow Papers judgment. And a purposive interpretation of Section 53 would have led the Supreme Court to the conclusion that the government cannot rank high as a secured creditor under Section 53(1)(b)(ii) but should remain confined to Section 53(1)(e) as an unsecured creditor.
Overall, the Rainbow Papers had weak legs to stand on. The Supreme Court by focusing only on the definition of security interest and secured creditor did not do ample justice to other relevant provisions of the IBC. And, resultantly upset important aims of the IBC, created disharmony amongst the various provisions including between the various categories enumerated for waterfall mechanism under Section 53.
The IBC Act, 2026 Amends Section 53
To rectify the above legal position, the IBC Act, 2026 inserts an Explanation to Section 53(1)(e)(i) which states that:
For the removal of doubts, it is hereby clarified that any amount, whether or not a security interest is created to secure such amount by an act of two or more parties or merely by operation of law, due to the Central Government and the State Government, in respect of the whole or any part of the period of two years preceding the liquidation commencement date, shall be distributed under this sub-clause and any remaining amount, whether or not such security interest is created to secure the amount, due to the Central Government and the State Government, shall be distributed under clause (f);”; (emphasis added)
The Explanation intends to clarify that a security interest created through a voluntary contractual arrangement or by a statutory provision stands on the same footing in so far as the government is concerned. Irrespective of the mode, dues to the Central Government and the State Government are to be paid under Section 53(1)(e)(i) or Section 53(f). But, not under Section 53(1)(b)(ii) as interpreted in the Rainbow Papers case.
The Rainbow Papers case unleased a flurry of opinions if the ‘crown debt’ should be given priority over private creditors. There are circumstances where the government’s claims can be accorded priority, but my view is that it should flow from the statutory provisions and not judicial innovation. Amendment via the IBC Act, 2026 clearly re-establishes that the Parliament does not wish to accord priority to the government’s claims. The IBC Act, 2026 clarifies that even if relevant statutory provisions provide that the government shall have first charge and thereby status of a secured creditor vis-à-vis unpaid debts, the ranking of Section 53 shall determine the order of payment. And not any other relevant statutory provision. Thus, irrespective if the provision of tax law or otherwise results in the government being a secured operational creditor, it cannot be placed alongside other private secured creditors under Section 53(1)(b)(ii). The government’s dues are to be paid under Section 53(1)(e).
Sliver of the Rainbow Papers Case May Survive
If we confine ourselves to one aspect of the Rainbow Papers case discussed above, then the Explanation added by the IBC Act, 2026 undoubtedly negates its ratio. However, in the Rainbow Papers case, the Supreme Court also made another crucial observation: legality of an approved resolution plan. The Supreme Court observed that the NCLT should not approve a resolution plan under Section 31(2) that did not conform to requirements mentioned in Section 31(1). And, concluded that:
If the Resolution Plan ignores the statutory demands payable to any State Government or a legal authority, altogether, the Adjudicating Authority is bound to reject the Resolution Plan. (para 52)
The Supreme Court clarified that under Section 31 onus is on the NCLT to examine if a resolution plan meets the requirements enlisted in Section 30(2). The relevant parameter under Section 30(2)(b) – in respect of government’s dues – is that a resolution plan must provide for payment of debts of operational creditors. However, if an operational creditor fails to submit their claim to the resolution professional, it stands to reason that their claim is extinguished on approval of the resolution plan. However, implication of the Supreme Court’s above observations in the Rainbow Papers case, in my view, is that unless statutory demands such as tax dues are necessarily incorporated in the resolution plan the NCLT must decline to approve it. Irrespective of whether such claims were submitted within the deadline to the resolution professional. However, amendments to Section 30 and Section 53 via the IBC Act, 2026 do not address this aspect of the Rainbow Papers case. However, one could argue that the contemporaneous amendments made to Section 31 – to underline scope of the clean slate doctrine – do negate the above observation. But, given the history of uncertainty about scope of the clean slate doctrine, one can never be sure. In my view, amendment to Section 53 read with amendment to Section 31 do effectively dilute the above observation made in the Rainbow Papers case. But, there is still possibility of a sliver of ratio to survive by making a case that a resolution plan that does not contain pending tax claims cannot be legally approved by the NCLT under Section 31.
To conclude, amendments to the IBC via the IBC Act, 2026 convincingly negate ratio of the Rainbow Papers case in so far as it relates to the interpretation of waterfall mechanism under Section 53. And ensures that the government claims it tax dues only under Section 53(1)(e)(i). It is a welcome amendment and ensures that the chaos and uncertainty unleased by the Rainbow Papers case is tamed. However, a statutory amendment is always subject to another judicial ‘innovation’ that frequently erupts in the IBC landscape. Though the scope for such an innovation has been sufficiently narrowed by the IBC Act, 2026.
