Sales Tax now a “Secured Creditor”: Liquidation prioritised over Resolution? – By Adv. Nipun Singhvi and Adv. Mayur Jugtawat

Sales Tax now a “Secured Creditor”: Liquidation prioritised over Resolution?

Authored by:
Adv. Nipun Singhvi, Adv. Mayur Jugtawat
(Practising before NCLT, High Court, Supreme Court)

Hon’ble Supreme Court verdict in State Tax Officer (1) v. Rainbow Papers Limited (2022) 107 SC has declared State Tax (Gujarat VAT department) as secured creditor within the ambit of IBC recognising under Section 3(30) of the Insolvency and Bankruptcy Code, 2016 (IB Code). Hon’ble Supreme Court has categorically held that definition of secured creditor in the IBC does not exclude any Government or Governmental Authority.  Further, another important issue discussed is relating to claims by the Statutory authority is that claims should be considered in plan as per books of account and also prefers liquidation in case the interest of State is not taken care in the resolution plan. This article attempts to analyse the judgment keeping in mind objectives of the Code.

Factual background

The State tax preferred an appeal against the order of NCLAT and NCLT wherein the claim was rejected on grounds of delay in filing the claim and also the status of the Gujarat VAT (State Sales tax) was considered as ‘operational creditor’ and unsecured creditor.

Claim of the State : Belated to be rejected?

The view taken by Hon’ble Supreme Court in the matter of Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd[1] was that once the resolution plan is approved then the belated claim cannot be accepted. However, in the Rainbow Papers (supra) the Hon’ble Court relied upon the NCLT judgements in the matter of Vishal Saxena & Anr. v. Swami Deen Gupta Resolution Professional[2] and Assistant Commissioner of Customs v. Mathur Sabhapathy Vishwanathan[3] held that the timelines are directory and not mandatory.

The timelines have been considered as directory for filing of claim from time to time but it appears that the fact of considering the claims after timeline has not been considered by the Court. The consistent view taken is the resolution applicant cannot be allowed to face surprise claims after the approval of resolution plan. [4]

Hon’ble Apex Court in the matter of COC of Essar Steel Vs. Satish Gupta & Ors. recognized the concept of  “Clean Slate theory” , relevant para is reproduced below : [Para 67]

“A successful resolution applicant cannot suddenly be faced with “undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution applicant who successfully take over the business of the corporate debtor. All claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. This the successful resolution applicant does on a fresh slate, as has been pointed out by us hereinabove.”

This means that the resolution applicant cannot be expected to be burdened with the claims but the judgement in the matter of Rainbow Papers states that the timelines for the proceedings are directory. It appears that this statement needs to be reconsidered in light of the timelines which are made sacrosanct and even the time is the essence of the insolvency process which otherwise would be marred by delays and latches. The importance of strict time lines and restriction on withdrawal of plan has been discussed and upheld in the matter of Ebix Singapore Private Limited v. Committee  of Creditors of Educomp Solutions Limited and Another[5]

 Not conformity with Section 30 and 31

Hon’ble Supreme Court held that the erroneous view has been taken by NCLT and NCLAT and the resolution plan should not have been passed as the requirements of Section 30 and 31 were not fulfilled.

It appears that the question of law whether the ‘Sales tax’ department can claim belatedly and as operational creditor had never come up in fact in the matter of Ghanshyam Mishra (supra) it was held that taxes are operational creditor. Therefore, in the authors opinion the same cannot be held to be non-conformity as the COC had approved the plan in its commercial wisdom.

At the best the plan could have altered the payment to creditors but holding the same to be illegal shall unsettle the approved and implemented plans.

Waterfall disturbed Section 53 (1)(b)(ii) vs Section 53 (1) (e)?

Even while reading the Section 53 (1) (e) it is clearly mentioned that the dues owed to Central government or State government shall fall in this clause and therefore any interpretation that the same was intended to be paid as per priority under Section 53 (1)(b)(ii) as secured creditor shall be contradictory to the intention of legislature. The words used in the legislature wisdom would be rendered nullity in case the government dues are shifted from level 5 to level 2.

Registration of Charge : Mandatory or optional?

Now the analysis of definition and the view taken was that the secured creditor are required to register charge with ROC as per Section 77 of the Companies Act, 2013[6] . NCLAT in the matter of Volkswagen Finance Private Limited Vs Shree Balaji & Ors[7] has held that the charge registration is mandatory.  

Hon’ble Court has held that by operation of law the State tax department is secured creditor. Court analysed the provision of Section 48 of Gujarat Vat Act, 2003 and held that the department has first charge over the property.

Section 48 of the GVAT Act which is set out herein below for convenience:-

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.”

The interpretation given to the interplay of Section 53 of Code and Section 48 of GVAT Act is that they both operate in separate field. The deeming fiction of Section 48 presumes that the charge is created and therefore court held the same to be secured creditor.

Issue of Secured Creditor

As per the Code, the secured creditor is one which has security interest. It is important to discuss the definition of “Security interest”. The “Security Interest” is defined under Section 3(31) of the Code which states following;

“security interest” means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:

Provided that security interest shall not include a performance guarantee;

In authors view the presumption if interpreted in light of the object of the Code shall mean that the charges created by law shall be subservient to the charge of the financial creditors. The lending by the bankers happen due to security interest they create and tax department earns tax on the sales/income they effect. If the presumption of law is taken to be overriding the charge of banks or even pari passu to them the banking industry shall stop lending immediately. It is seen from the past that the financially distressed company shall always have huge tax liability since if the debt is not getting served, it is logical that the taxes which are normally paid on periodically basis would have been defaulted.

Further, if such unregistered charges (not registered on ROC) shall lead to undecided claims and conflict in every cases with the lenders.

Some issues for pondering

Per Incuriam:

It is to be seen that the judgement in the matter of Ghanshyam Mishra (supra) which was a larger bench judgement and considered the issue of State tax in detail and held the same to be operational creditor should be followed. Also, the judgement referred to the Finance minister speech and object of the Code that it shall lead to ‘alteration in priority of Government dues’ Further, it will have to be seen that this judgement is reviewed immediately.

Whether ‘Ratio decidendi’ or ‘Obiter dicta’ :

Para Text of relevant para Observation
48 A resolution plan which does not meet the requirements of Sub- Section (2) of Section 30 of the IBC, would be invalid and not binding on the Central Government, any State Government, any statutory or other authority, any financial creditor, or other creditor to whom a debt in respect of dues arising under any law  for  the  time  being  in  force is owed.  Such a resolution plan would not bind the State when there are outstanding statutory dues of a Corporate Debtor.

This shall lead to all state institutions to challenge the plans even the approved plans under implementation shall be reopened and restitution may be claimed.
Pending plans with NCLT, already approved by COC shall be remanded back.

52 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. Non-acceptance of claim has been treated as ‘Ignoring’ which means that all the demands even when disputed and pending in judicial forum will have to be considered in the plan marring the recovery to banks and leading back to pre-IBC era.
53 In other words, if a company is unable to pay its debts, which should include its statutory dues to the Government and/or other authorities and there is no plan which contemplates dissipation of those debts in a phased manner, uniform proportional reduction, the company would necessarily have to be liquidated and its assets sold and distributed in the manner stipulated in Section 53 of the IBC. Tax department and even statutory authorities are now on equal footing and shall ask for proportionate payment which shall lead to only states getting payment.
54 In our considered view, the Committee of Creditors, which might include financial institutions and other financial creditors, cannot secure their own dues at the cost of statutory dues owed to any Government or Governmental Authority or for that matter, any other dues. The object of the Code was that the sacrifice shall happen by government in order to revive the companies as after revival they shall lead to future revenue.
57 As observed above, the State is a secured creditor under the GVAT Act. 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. Secured creditor definition has been widened and inferred to include all governmental authority



It shall be difficult to convince the statutory tribunals that the order if not reviewed , the observations made are obiter dicta. In case the same are considered as ratio decidendi then the same shall impact the approval of resolution plans. The faith in Code shall go away back to pre-IBC era as the liquidation shall be preferred mode due to amendment in the SARFESI law wherein the Section 26E has categorically stated that the debt due to secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.

Another aspect of matter is that the GST has been enacted to subsume the State tax laws and the Section 89 of GST Act, 2017 categorically states that the first charge shall be subject to the Code. In case these untouched areas are placed for reconsideration before Hon’ble Apex Court,  the Rainbow paper judgement shall continue to haunt the insolvency framework as the bankers have started thinking of withdrawing from insolvency proceedings and also the various statutory authorities have started filing applications to be treated as secured creditors. The observations have led to opening of Pandoras Box and it is hoped that an urgent amendment by way of ordinance and filing of review is the best recourse which the legislature should take immediately.


[1] (2021) 54 SC

[2] (2020) SCC Online NCLT 2734

[3] (2021) 83 NCLT

[4] Para 61 of Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd 

[5] (2021) 153 SC

[6] [erstwhile Section 125 of the Companies Act,1956]

[7] NCLAT, New Delhi (2020) 302 NCLAT

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