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  • Saksham Chaturvedi

Government as a Secured Creditor: Reconciling Rainbow Papers and the IBC

Saksham Chaturvedi*




A division bench of the Supreme Court in Sanjay Kumar Agarwal v. State Tax Officer (1) & Anr. ( “Sanjay Kumar Agarwal”) dismissed a batch of review petitions assailing the propriety of the judgment rendered in State Tax Officer (1) v. Rainbow Papers Limited (“Rainbow Papers”). The pith of the arguments in the review petitions centred around the alleged incongruence of the ratio in Rainbow Papers with Section 53 of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

In Rainbow Papers, the SC allowed the State Tax Officer to claim the status of a secured creditor. The ruling was seen as incongruent with Section 53 of the IBC, as one of the primary purposes of the IBC was to revise the priority of crown debt – dues owed to the government or state authorities.

Section 53 of the IBC provides the order of priority for the distribution of assets from the proceeds of sale out of the liquidation estate, popularly known as the ‘waterfall mechanism’. The waterfall mechanism is a fundamental precept of the IBC – requiring scrupulous adherence in both insolvency and liquidation proceedings. Apart from its use in liquidation proceedings, the proportionate compliance of Section 53 is one of the grounds to check the validity of the resolution plan, as stipulated under Section 30(2) of the Code.

The thrust for the review petitioner’s case in Sanjay Kumar Agarwal was the observations rendered by the SC in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited & Ors (“Raman Ispat”) – doubting the ratio of Rainbow Papers and restricting its application to the specific facts of that case. However, the Supreme Court squarely rejected the review on technical grounds and also found no error in the impugned judgment.

This article purposively attempts to examine the treatment of the government as a secured creditor under the IBC. First, the article traces the background of the 3 cases and examines the position of a security interest and accordingly of a secured creditor under the IBC. Second, the article explores the possibility of treating the government as a secured creditor through a nature-based classification of dues – saving the intention of revising the priority of crown debt under the IBC. Third, the article posits the scope of reconciling the critically discarded judgment of Rainbow Papers with the waterfall mechanism and the IBC.


A. Rainbow Papers: The Genesis

In Rainbow Papers, the appellant State Tax Officer filed a claim for unpaid Value Added Tax (VAT) and Central Sales Tax (CST) dues, roughly amounting to Rs. 47 crores under the Gujarat Value Added Tax Act 2003 (“GVAT Act”). However, the claim was rejected by the resolution professional.

Before the SC, the appellant claimed the status of a secured creditor. The claim of the appellant State tax authority, as a secured creditor was premised on Section 48 of the GVAT Act – a non-obstante clause allowing a first charge on the property of a defaulter.

The SC found no inconsistency between the IBC and the GVAT Act. The SC reasoned that since the appellant by operation of Section 48 of the GVAT Act has a security interest over the property towards unpaid dues, they would qualify as secured creditors.

B. Raman Ispat: The Spoilsport

In a similarly knit factual matrix of Raman Ispat, the appellant (PVVNL) claimed dues worth Rs. 4 crores as unpaid electricity dues. The supply of electricity by State authorities is governed by the Electricity Act 2003. Under Clause 4.3(f)(iv) of the Electricity Supply Code 2005, any outstanding electricity dues will be a first charge on the assets of the defaulting company. This arrangement of a first charge on the assets of the company in case of a default was also recorded in an agreement between the parties.

Thus, the appellant claimed the status of a secured creditor. The SC did not find fault with this position of the appellant. However, the division bench, departing from Rainbow Papers, noted that even if a statutory charge or security interest were created in favour of the State, it would not put them in a conjugate position with secured creditors.

This is because Section 53 of the IBC apprehends a distinct treatment for the amount due to the State. Therefore, the State has to be treated as a distinct class of creditors, and their qualification as a secured creditor would not enable them to rank any higher in the order of priority under the waterfall mechanism. For this, the Court found strength in Section 238 of the IBC – overriding power of the IBC over other statutes. The Court reasoned that as such IBC would prevail over other non-obstante clauses, namely, Sections 173 and 174 of the Electricity Act 2003.

The Court ruled that the judgment in Rainbow Papers failed to notice the waterfall mechanism under Section 53 of the Code and therefore the ratio could not be applied in the present case. The Court even observed that the ruling in Rainbow Papers should be confined to its specific facts.

C. Sanjay Kumar Agarwal: The Final Word(?)

The review petitioners in Sanjay Kumar Agarwal flagged Rainbow Papers’ dissension with Section 53 of IBC. In their support, the petitioners relied upon observations rendered in Raman Ispat.

The division bench in Sanjay Kumar Agarwal observed that instant review could not showcase a mistake or error apparent on the face of the record to merit a review of the judgment. The bench also observed that comments extended by a bench of equal coram strength cannot be ground for review.

Herein, the Court speculated that the approach adopted in Raman Ispat – departing from the judgment of an equal coram strength, was unideal. A bench of equal coram strength, when it finds itself at variance with another judgment, should ideally refer the matter to a larger bench, lest it should throw the legal position in a pit of uncertainty.[See ¶ 21,24]

Even otherwise, the Court did not find any apparent error with Rainbow Papers. The Court noticed that Rainbow Papers had discussed and considered Section 53, and it would be imprudent to say that the judgment was rendered in ignorance of Section 53. Accordingly, the Court ruled that no mistake or error was apparent in the impugned judgment.


Part of the problem that has contributed to the issues starting in Rainbow Papers is the lack of clarity in the position of Government dues.

Section 3(30) of the IBC defines a secured creditor as a creditor in whose favour a security interest is created. Section 3(31) of the IBC defines a security interest as a right or claim to property created to secure payment by a transaction for a secured creditor. The structure of the two definitions is such that they are interdependent definitions – exhibiting mutual contingency for the construction of either.

As seen in Rainbow Papers and Raman Ispat, even though the Government qualified as a secured creditor in both of the cases, there was lingering confusion regarding their position in the order of priority under Section 53. Thus, it was inconclusive whether qualification as a secured creditor under Section 3(30) would continue to apply under Section 53.

This is because the definition of a secured creditor, including for Section 53, does not expressly exclude the Government. In Rainbow Papers, the appellant State sought to be covered as a secured creditor during the liquidation proceedings and relied on a first charge created under Section 48 of the GVAT Act. The concerned section is reproduced below for reference.

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 or account of tax, interest or penalty for which he is liable to pay to the Government shall be a first change on the property of such dealer, or as the case may be, such person.

Section 3(31) of the Code provides that the creation of a charge qualifies someone as a secured creditor. The appellant Government in Rainbow Papers successfully argued that such a charge on the property of the defaulter created a security interest in its favour. While the State’s claim was substantiated by the existence of a security interest, the construction of Government entities as secured creditors, especially in this manner, may not align with the scope of the IBC.

Thus, Rainbow Papers highlights the problem of a statutory definition taking a theoretical departure from the practical application of the IBC. Even though the appellant State soundly argued that there was a security interest in their favour and that they should accordingly qualify as a secured creditor, this is an extraneous construction (through external aid of construction of statute) of a security interest, and may not be what the IBC intended.


At this juncture, it would be useful to analyse whether the creation of a charge and subsequently a security interest through the operation of law in Rainbow Papers was correct. While commentators have repeatedly criticised Rainbow Papers for its strife with the concept of crown dues and ranking of government as a secured creditor, the Central Government has affirmed the possibility of Government being a secured creditor for the purposes of Section 53. This demonstrates that much of the critique of Rainbow Papers is misplaced. This portion argues that Rainbow Papers is partly correct and partly wrong, but not for the common reasons that have been discussed in the available literature. 

The SC in Rainbow Papers determined that the definition of a security interest under Section 3(31) is comprehensive enough to include a security interest created through a charge by statutory force or operation of law. This determination was reached even though Section 3(31) provides for the creation of security interest through a ‘transaction’.

Section 3(33) of the IBC defines a transaction as an agreement or arrangement in writing for the transfer of assets, funds, goods, or services, from or to the corporate debtor. Therefore, it can be circumscribed that the legislative intent behind recognising a ‘security interest’ covers instances wherein the corporate debtor undertook a voluntary transaction. The concoction of treating a charge created through an operation of law precisely obviates the legislative intent which can be culled from the relevant definitions.

A. Clarification Post Rainbow Papers

Ministry of Corporate Affairs’ (“MCA”) discussion paper published on 18th January 2023 (post-Rainbow Papers), attempted to clarify that the intention behind curating the definition of a ‘security interest’ was to limit such interest to cases arising out of transactions. The logic behind restricting the creation of a ‘security interest’ to a transaction underscores the statutory definition of a security interest. Additionally, this clarification affirms that a security interest can be created out of a contract that was willingly undertaken between a creditor and the debtor.

As per Para 14.1 of the discussion paper, any interest arising out of a statutory law would not create a security interest where a consensual transaction between the parties did not take place. 

In para 14.2, the MCA informed that it is under consideration to rank all Government dues, created anyhow, to rank with unsecured creditors. However, presently where a security interest is created under a transaction of the Central or State Government with a corporate debtor, the Government will be treated as a secured creditor. This is because the judgment in Rainbow Papers, now technically affirmed by Sanjay Agarwal, holds the field qua the position of the government as a secured creditor.

It must be noted, that the clarification issued by the MCA discounts Rainbow Papers, to the extent that the latter recognized that a security interest can be created through a force of statute. In the absence of any agreement between the parties, the Government in Rainbow Papers ought not to have inured to the benefit of a secured creditor.

Contrastingly, in Raman Ispat, the service for the supply of electricity was also recorded as an agreement between the parties. Therefore, following strict stead from the clarification in the discussion paper, the SC shouldn’t have interpreted secured creditors as exclusive of the Government.

B. The Mere Creation of a Charge Should not Create a Security Interest

The ratio in Rainbow Papers treating the creation of charge through an operation of law is problematic.

There are examples of statutory laws which subject the creation of charge to provisions of other Central Laws. Examples include Section 37 of the Maharashtra VAT Act, Section 142A of the Customs Act 1961, and Section 82 of the CGST Act 2017. All of these laws provide that liability on the first charge shall be subject to any other provision of Central Laws, including IBC.

Contrastingly, provisions of the Electricity Act 2003, and the GVAT Act 2003 have an overriding effect concerning the creation of the first charge. Such differing positions pose an important question: Can such distinction created by way of an overriding effect in a provision, creating a charge be countenanced?

The mere provision of an overriding effect, concerning the creation of the first charge, cannot justify a distinction between creating the liability arising out of the laws any differently under the IBC. This is because such a distinction is arbitrary – without any basis for prioritizing one statutory provision over another, and accordingly dues arising out of one statute over the other. This is especially relevant when the dues are of a similar nature.

Such application creates another problem: Nothing impedes the Government from simply amending any statute to provide for the creation of a first charge, through a non-obstante clause. This introduces an element of unpredictability and opens the door to potential manoeuvring by governmental entities seeking preferential treatment under the IBC. One primary purpose of the IBC was to ensure that secured creditors are ranked in priority over other creditors. Section 238 of the IBC aids this by ensuring that IBC operates over other statutes. However, if such circumscription of a statutory mandate can be overcome by a simple operation of law through other legislation, this could also go so far as to frustrate the purpose of the IBC. To ensure that the process under the Code is fair, equitable, and predictable, it is imperative to apply a uniform standard to dues.


Under Section 53, debts owed to secured creditors are accorded the second-highest priority, while any amount due to the Government is placed fifth in the order of priority – creating a substantial gap. Additionally, the amount due to the Government can sometimes make up for a lion’s share of the liquidation estate. Therefore, it becomes crucial to provide clarity on the law regarding the prioritization of Government debt to facilitate the smooth completion of proceedings under the Code.

A. Are all Dues the Same: Need for a Nature-Based Classification of Government Dues

The issue in Rainbow Papers and Raman Ispat concerned whether government as secured creditors would rank equally with other secured creditors (Section 53(1)(b)) or rank further lower in priority (Section 53(1)(e)). A major missing thread in the above judgments is the failure to recognise that government dues are not of a uniform character. However, such omission cannot be attributed to the judgments, when IBC does not itself categorize government debt between secured and unsecured debt.

It is indubitable that fulfilling the requirements under Sections 3(30) and 3(31) qualifies one as a secured creditor. However, such statutory qualification fails to conceive the nature of debt owed to the secured creditor. Instances of governmental dues, such as taxes, electricity or water charges, customs, duties, and other ejusdem generis dues are in the nature of operational debt and should not be construed as secured debt. However, if a debt is in the nature of a financial debt, it may be categorized as a secured debt.

Categorization of government debts should be primarily based on the classification between financial and operation debt, as well as on the inherent nature of the obligation. Acknowledging that not all government debt merits equal prioritization would help balance the interests of other secured creditors and government entities. Instances where government debt merits prioritization have been discussed in following sub-chapter. Secured debt when it is ex-facie in the nature of statutory dues should not be afforded higher priority, merely because of statutory qualification under the definition clauses. While the definition clauses were provided to ensure that secured creditors are better placed than their unsecured counterparts, it is palpable that inadvertent issues have unfortunately arisen out of the statutory matrix.

Therefore, classifying secured creditors based on nature of dues under Section 3(31), including instances where the government is a secured creditor, would ensure equitable distribution based on security interest, and would make the application of Section 53 clearer.

B. Can the Government Never be a Secured Creditor? 

The determination in Raman Ispat, that the Government cannot be a secured creditor in terms of Section 53(1)(e) is erroneous. The possibility of the Government as a secured creditor under Section 53 was affirmed by the MCA’s discussion paper. Even otherwise, owing to a nature-based classification, there can be arrangements that enable the Government to qualify as a secured creditor.

As discussed above, not all dues payable to the Government are similar. Different contractual arrangements provide for the possibility of the Government to be a secured creditor, emanating from its position as a financial creditor. A financial debt may be owed by the corporate debtor to the Government through some instrumentality or otherwise. A good case in point is the position of Government banks. There is a plethora of arrangements where a corporate debtor has taken a financial debt from a state bank. In such circumstances, the fiscal health of the bank would be contingent upon successfully realising the debt advanced to the corporate debtor. If in such circumstances, the corporate debtor goes into liquidation, then the state bank, as per Raman Ispat would be ranked conjugatively with unsecured creditors.

This example exacerbates that the ratio in Raman Ispat  reducing any debt due to the Government, even in cases of financial debt, to the status of statutory dues and ranking it co-equally with unsecured creditors, is rather impulsive.

In this respect, the observations extended by the MCA in its discussion paper, and the position in Rainbow Papers – deeming that the Government can be a secured creditor are apposite. The question of whether such debt due to the Government is necessarily of a nature which should rank with secured creditors is a triable question.


To summarize, Rainbow Papers’ assertion that a security interest can be created through an operation of law is inconsistent with the definition of security interest and should be read down. Nevertheless, Rainbow Papers correctly underscores that the Government, under Section 53, can qualify as a secured creditor. In contrast, Raman Ispat’s treatment of any and all government debt as unsecured overlooks the potential for the Government to act as a secured creditor, particularly in cases related to debt other than statutory dues. This oversight warrants reconsideration, to align with the clarifications provided in the MCA’s discussion paper – affirming that the Government can be a secured creditor.

There is lingering ambiguity in definitions of secured creditor and security interest, which requires rectification. A progressive resolution would involve categorizing government debt as either statutory dues – akin to operational debt, or secured debt – resembling financial debt. This approach clarifies the Government’s eligibility as a secured creditor under Section 53 based on the nature of the debt.

There are some marked differences between the IBC and its predecessor Companies Act in the treatment of Government dues. The intention behind these changes was to rank Government in a lower order of priority owing to its greater fiscal capacity, than other secured creditors. Thus, it was felt that debt recovery under the Code could be maximized for secured creditors, by ranking them not pari passu, but higher than government dues. While the article does not doubt the rationale behind this legislative design, it still ponders whether the position post Rainbow Papers can remedy the Government where it is a secured creditor in the true sense of the IBC.

As of the writing of this article, the review preferred against Rainbow Papers was rejected by Sanjay Kumar Agarwal. Another review of the judgment looks unlikely unless a division bench refers the underlying issue to a larger bench comprising three or more judges. 

In the alternative, as a response to Raman Ispat, the Government could amend IBC provisions for clarity. The MCA’s discussion paper stated that considerations are underway to treat all government debt as unsecured and accordingly put them in the fifth order of priority under Section 53. Such an amendment would come as a much-needed relief to other secured creditors. However, it would result in increased financial stress on government entities which would be disadvantaged even in cases where a secured financial debt to their benefit exists.

Therefore, it would be prudent to adopt a nature-based classification of governmental debt under the IBC, allowing the Government to enjoy the benefits available to a secured creditor, wherever the legal and financial considerations so allow. 

*Saksham Chaturvedi is a 5th year student pursuing B.A., LL.B. (Hons.) from National Law University, Odisha.

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