The ruling of the division bench of the Supreme Court in the State Tax Officer vs. Rainbow Papers Limited[1], (Popularly known as the Rainbow Papers Case) is not just another conventional ruling under Insolvency and Bankruptcy Code but holds pivotal significance in the Insolvency framework of the nation. Further, what follows adds to the dramatic row in the insolvency regime of the country. The Conundrum revolves around the question –
“Is the Government a secured creditor under the Insolvency and Bankruptcy Code and hence entitled to the benefit u/s 53 outlining the Waterfall Mechanism? “
Rainbow Papers Case: A Brief Perusal
The Respondent Rainbow Papers Pvt. Ltd has been in the business of crafts, oars, etc since 1990. On the other hand, the Appellant is the State Tax Officer. The Appellant assessed the Respondent and determined that an amount of 53 crores is due as Value Added Tax (VAT) and CST (Central Sales Tax) to the sales tax authorities under Section 48 of the Gujarat Value Added Tax (GVAT) Act, 2003. In pursuance of the assessment, the Appellant initiated recovery proceedings against the Respondent.
Meanwhile, an operational creditor, Neeraj Papers Pvt Ltd. initiated CIRP (Corporate Insolvency Resolution Process) against the Respondent for default of debt under Section 9 of the IBC, 2016. This incepts an incongruous situation and forms the bedrock for the dispute.
In furtherance of the CIRP, an Interim Resolution Professional (IRP) was appointed by the National Company Law Tribunal (Gujarat Bench) followed by the constitution of the Committee of Creditors (CoC) which appointed a Resolution Professional (RP). The appellant’s claim was still to be addressed.
Amid the proceedings, the appellant filed a claim before the RP claiming that a default of Rs.47.36 crores (approximately) as sales tax has been committed by Respondent. In an incongruous manner, RP conveys to the Appellant that the claim has been waived off in its entirety. A scrutiny of the turn of events makes it evident that RP and the CoC dismissed the claim as the government doesn’t constitute a secured creditor under IBC and is thus not a beneficiary under the Waterfall mechanism.
Aggrieved by such, the Appellant challenged the order of the RP in the NCLT (Ahmedabad Bench) asserting that the waiver doesn’t align with law and that government dues cannot be waived off under the apparatus provided in IBC. The Bench dismissed the challenge stating that the Appellant approached the RP after the resolution plan was already approved by a 79.79% majority, thus at a belated stage. At this stage, the issue of whether the Government constitutes a secured creditor under IBC or not was not deliberated upon by the Adjudicating Authority (NCLT).
The Appellant subsequently approached the NCLAT (National Company Law Appellate Tribunal). While dismissing the petition of the Appellant, the NCLAT for the first time touched upon the question of law forming the seed of the dispute and answered it in the negative.
Aggrieved by the NCLAT’s order, the Appellant approached the Supreme Court u/s 62 of the IBC. The Division Bench consisting of Hon’ble Justices Indira Banerjee and A.S. Bopanna gave a reasoned judgment which sparked legal debate nationwide. The Bench dismissed the ruling of NCLT and NCLAT and answered the question in the affirmative. To arrive at a concrete decision, the verdict relied on two issues which squarely covered the entire facade-
- Whether the Appellant can be categorized as a secured creditor u/s 3(30) of the IBC and ancillary provisions of IBC?
- Does Section 53 of IBC override Section 48 of GVAT?
The Hon’ble Bench held that the claim of the Tax Department of the State, squarely falls within the definition of “Security Interest” under Section 3(31) of the IBC and the State ipso facto qualifies as a secured creditor under Section 3(30) of the Code.
Aftermath
The aftermath of the Rainbow Papers Judgment was marked by the ruling in Paschimanchal Vidyut Vitran Nigam Ltd. vs. Raman Ispat Private Limited & Ors[2], (popularly known as the Raman Ispat Case) and Sanjay Agarwal vs. State Tax Officer, 2023[3]. Whereas the former throws light on the subtle aspects of the Rainbow Papers’ ruling and furthers more clarity to the subject matter, the latter constitutes a review petition where the Court reiterates the Rainbow papers’ ruling and tries to settle the matter in question.
Raman Ispat Judgment: Reiteration or Defiance
In the case of PVNL vs. RIPL, 2023, the Division Bench of the Hon’ble Supreme Court held in the most outright tenor possible that the Government cannot be a secured creditor in terms of Section 53(1)(e) and the judgement of Rainbow papers has to be confined to the facts of that case alone[4].
The question at hand was regarding a liquidation process initiated by Paschimanchal Vidyut Vitran Nigam Ltd. (Appellant) against Raman Ispat Private Limited (Corporate Debtor) claiming electricity dues at default under IBC 2016.
The PVNL claimed that as per the erstwhile ruling of Rainbow Papers, it is a secured creditor under IBC and has the right of priority under the waterfall mechanism. It further claimed that as the electricity does qualify as government dues, it is thus capacitated to receive the dues under the said mechanism. Adjudicating the facts and circumstances of the case, the Bench held that only government dues are enveloped by the IBC and PVNL though has government partaking doesn’t constitute a government body in its entirety. Moreover, it was iterated that Rainbow Papers judgment was regarding a peculiar CIRP process which relinquishes its applicability to a liquidation process.
Sanjay Agarwal: Vindication
Sanjay Aggarwal revolved around a series of review petitions challenging the ‘Rainbow Papers Judgment’. The Hon’ble Supreme Court bench comprising of Hon’ble Justices A. S Bopanna and Bela M. Trivedi while dismissing the petition held that the division bench in the Rainbow Papers did consider the waterfall mechanism and arrived at an apt interpretation of the provisions of IBC.
Is the Question Settled?
The defiance in Raman Ispat opened the floodgates for challenging the legal soundness of the Rainbow Papers’ ruling. While it is obvious that Raman Ispat deviated from the rationale in Rainbow Papers, but it would be irrational to hold that it overruled Rainbow Papers. It held that only government dues constitute secured interest and government a secured creditor under the IBC’s apparatus. This is certainly not a deviation, instead, it clarifies the subject matter in question. Raman Ispat’s dictum that the rationale of the Rainbow Papers shall be quarantined to its case holds relevance as the facts and circumstances of the case revolved around a quirky CIRP process.
The lone aspect in which the Judgment erred is holding that the Government does not qualify as a secured creditor and that Rainbow Papers didn’t consider the Waterfall Mechanism outlined u/s Section 53 of the Code. Nevertheless, it was later settled by the Sanjay Aggarwal case. Hence, mutandis mutatis, the Court held that the State is a secured creditor and is entitled to the benefit under the Waterfall mechanism.
Decoding ‘Security Interest’ and ‘Secured Creditor’ under IBC
In Rainbow Papers, SC ruled that Section 3 (31) is a wide provision. It nevertheless seems to be well reasoned. Section 3 (31) reads as follows- “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.
It is evident that it does provide for an extensive definition and does not leave any scope for a narrow construction. Moreover, Section 3(30) of the Code nowhere bars the government from being a secured creditor. Section 3(31) provides that any transaction by a secured creditor which secures payment by any other person is a security interest thereby widening its scope to include government dues.
Hence, the inclusion of a charge created by the operation of law is well within the meaning of security interest. Nevertheless, Rainbow Papers has led to a widespread stir welcoming both affirmative as well as critical responses. While many scholars affirm that the interpretation confirms to intent of the statute, the critics are of the opinion that the ruling represents a reneged promise and is in consonance with the concept of crown dues[5].
[1] State Tax Officer v. Rainbow Papers Ltd., (2023) 9 SCC 545
[2] Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited & Ors, (2023) 10 SCC 60.
[3] Sanjay Agarwal v. State Tax Officer, (2024) 2 SCC 362.
[4] Saksham Chaturvedi, Government as a Secured Creditor: Reconciling Rainbow Papers and the IBC, NLSBLR (Mar. 8, 2025, 12:30 PM), Government as a Secured Creditor: Reconciling Rainbow Papers and the IBC
[5]Bahram N Vakil, Nilang T Desai, Suharsh Sinha & Saloni Thakkar, Treatment of Crown Debts in Indian Insolvency: Perspectives and Way forward, AZB&PARTNERS (Mar. 9, 2025, 10:15 AM), https://www.azbpartners.com/wp-content/uploads/2023/10/Emerging-Ideas-on-IBC-003.pdf
Author: Soumya Lenka is a 3rd Year Law Student at Faculty of Law, Utkal University.
