Supreme Court of India · 2019
State Tax Officer (1) v. Union of India
(2019) 10 SCC 410 · Writ Petition (Civil) No. 1055 of 2018
Court
Supreme Court of India
Bench
Constitution Bench (5 Judges)
Date
22 March 2019
Subject
IBC Waterfall — Government vs Secured Creditors
Background & Facts
When a corporate debtor is liquidated under the IBC, Section 53 prescribes a specific waterfall (order of priority) for distribution of the liquidation proceeds. Under this waterfall, secured creditors (banks and financial institutions holding security interests) rank above the Central and State governments in respect of their tax dues. Several State governments — particularly Kerala, challenging the provision through its State Tax Officer — filed writ petitions before the Supreme Court arguing that State tax statutes grant first charge (priority) to government dues over all other creditors including secured creditors.
The State of Kerala relied on the Kerala General Sales Tax Act and other State fiscal statutes that contain provisions like "first charge on all assets" for recovery of State tax dues. The argument was that these State laws created a priority for government dues that should survive the IBC waterfall. The Central government and financial creditors argued that the IBC, being a Parliamentary law operating in the Concurrent List, overrides inconsistent State legislation, and that the IBC waterfall under Section 53 is exhaustive and must prevail. The case also raised the broader question of whether government dues — both Central and State — can override secured creditors in IBC liquidation.
Key Issues Before the Court
Holdings of the Court
Holding 1 — IBC Section 53 Waterfall Prevails Over State Tax Statutes
The Constitution Bench unanimously held that the IBC Section 53 waterfall for distribution of liquidation proceeds prevails over State tax statutes that purport to give "first charge" to State government dues. This is because the IBC operates in the field of insolvency and bankruptcy — an entry in the Concurrent List (Entry 9, List III) — and a Parliamentary law on this subject overrides inconsistent State legislation by virtue of Article 254 of the Constitution. Section 238 of the IBC expressly provides that its provisions override other laws. Accordingly, State tax priority provisions are overridden by the IBC waterfall.
Holding 2 — Government Dues are Unsecured Creditors in IBC Waterfall Unless Secured by Charge
The Court held that for the purpose of the IBC waterfall, Central and State government dues (including tax arrears, customs duties, GST dues, etc.) are treated as "unsecured creditors" and rank below secured creditors, insolvency resolution costs, and workmen's dues. A government body claiming to be a "secured creditor" under the IBC must demonstrate that it holds a registered charge — a statutory first charge under a tax statute does not constitute a "security interest" within the meaning of the IBC and SARFAESI definitions. Without a registered charge, government dues rank at Step 6 in the waterfall (after secured creditors at Step 1, insolvency resolution costs, liquidation costs, workmen's dues, and employee dues).
Holding 3 — IBC Section 53 is an Exhaustive Code for Liquidation Distribution
Section 53 of the IBC is a complete code governing priority of payment in liquidation. The waterfall cannot be altered or supplemented by provisions in other statutes — whether Central or State. This was the approach taken by Parliament to ensure that IBC liquidations provide predictable and uniform priority rules for all creditors. Any creditor claiming priority in liquidation must find that priority in Section 53 itself; external priority claims from other statutes are displaced.
Holding 4 — Secured Creditors May Relinquish Security or Enforce Outside Liquidation
The Court confirmed that in IBC liquidation, a secured creditor (bank, NBFC, or ARC) can elect to either: (a) relinquish its security interest to the liquidation estate and participate in the waterfall under Section 53, or (b) realise its security interest outside the liquidation process. If the secured creditor realises its security outside, it must contribute to the liquidation estate any amount in excess of its admitted claim. This election mechanism — unique to IBC liquidation — gives secured creditors significant strategic flexibility.
Practical Implications
This judgment has profound practical consequences for the banking sector. Banks and financial institutions holding first charge over assets of companies in liquidation are now confirmed to have priority over all government dues (tax arrears, GST dues, customs duties, PF dues attributable to employer's share exceeding employee workmen's dues). This significantly improves the recovery prospects for secured financial creditors in IBC liquidations.
For asset reconstruction companies (ARCs) that acquire NPAs from banks and step into their shoes as secured creditors, the judgment confirms that their priority position in IBC liquidation is protected. Government authorities — particularly GST, income tax, and customs departments — have to accept their subordinate position in the waterfall and cannot claim first priority based on their respective statutes. This clarity has made IBC liquidation a more predictable and commercially sound mechanism for recovery by secured financial creditors compared to the pre-IBC regime where government dues often disrupted recovery proceedings.
Relevant Statutory Provisions
Practical Application for Creditors & Borrowers
Banks, NBFCs, and ARCs involved in IBC liquidation proceedings — or contesting priority claims by government tax authorities — should seek specialist advice on their rights under Section 52 and 53 of the IBC. Unified Chambers advises financial creditors on liquidation strategy, election between security realisation and waterfall participation, and contested priority disputes.