The National Company Law Appellate Tribunal has clarified a critical ambiguity in the Insolvency and Bankruptcy Code, 2016, holding that statutory tax dues cannot be classified as secured financial creditor claims in liquidation absent a legally recognized security interest. This ruling reinforces the primacy of the Code’s waterfall mechanism over conflicting state laws.
Background & Facts
The Dispute
The dispute arises from the distribution of sale proceeds from the liquidation of Dugal Associates Pvt. Ltd., a corporate debtor. The Appellant, Federal Bank Limited, is a secured financial creditor that had extended credit against a freehold industrial property located at Plot No. F-38/2, Okhla Industrial Area, Phase II, New Delhi. The Bank relinquished its security interest in this property during liquidation and filed a claim for Rs. 6,09,82,591/-.
Key Facts
- The Corporate Insolvency Resolution Process (CIRP) was initiated on 11.12.2019 under Section 9 of the IBC by operational creditor M/s Roofs and Ceilings (I) Private Limited.
- Liquidation was ordered on 12.01.2022 under Section 33(2) of the IBC.
- The secured asset (industrial property) was sold via e-auction on 12.07.2023 for Rs. 4,91,00,000/-, exceeding the reserve price of Rs. 4,90,00,000/-.
- Additional assets including ACs, fans, furniture, generators, Toyota Innova, and Tata Safari were sold on 11.09.2023 for Rs. 3,15,000/-.
- Total sale realization amounted to Rs. 4,94,15,000/-.
- On 26.03.2024, the Liquidator distributed Rs. 3,55,72,021/- to Federal Bank: Rs. 3,00,00,000 towards its claim and Rs. 55,72,021 towards CIRP costs previously contributed.
- Rs. 1,05,54,823/- remained undistributed.
- The Liquidator issued a cheque of Rs. 90,00,000/- to Federal Bank but later issued a stop payment instruction.
- The Liquidator included the Excise and Taxation Department, Gurgaon, as a secured creditor under Section 53(1)(b)(ii) of the IBC, relying on State Tax Officer v. Rainbow Papers Ltd. (2023) 9 SCC 545.
- The Department’s claim was based on Section 26 of the Haryana Value Added Tax Act, 2003, which creates a first charge on defaulters’ property.
Procedural History
- 11.12.2019: CIRP initiated by NCLT, New Delhi (Court-IV) in CP (IB) No. 1581/ND/2019.
- 12.01.2022: Order for liquidation passed under Section 33(2) IBC.
- 11.03.2022: Federal Bank filed claim for Rs. 6,09,82,591/-, relinquishing security interest.
- 12.07.2023: Sale of primary asset concluded.
- 04.08.2023: Sale proceeds intimated to Stakeholders Consultation Committee (SCC) in 13th meeting.
- 11.09.2023: Sale of ancillary assets concluded.
- 26.03.2024: 15th SCC meeting; distribution of Rs. 3,55,72,021/- to Federal Bank; Rs. 1,05,54,823/- withheld.
- 30.03.2024: 16th SCC meeting; Liquidator proposed inclusion of Haryana VAT Department as secured creditor.
- 30.05.2025: NCLT dismissed Federal Bank’s application (IA No. 2341/ND/2024), upholding inclusion of VAT Department as secured creditor.
- 11.06.2025: Appeal filed before NCLAT as Company Appeal (AT) (Insolvency) No. 1068 of 2025.
- 11.05.2026: NCLAT delivered judgment.
Relief Sought
Federal Bank sought:
- Setting aside of the NCLT order dated 30.05.2025.
- Directing the Liquidator to distribute the withheld amount of Rs. 1,05,54,823/- to it as a secured financial creditor under Section 53 IBC.
- Declaration that the Haryana VAT Department is not a secured creditor under Section 53(1)(b)(ii) IBC.
- Direction to pay interest on delayed distribution.
The Legal Issue
Can a state tax department, claiming a statutory first charge under a state VAT Act, be treated as a secured financial creditor under Section 53(1)(b)(ii) of the Insolvency and Bankruptcy Code, 2016, in the liquidation phase, without possessing a security interest as defined under Section 52?
Arguments Presented
For the Appellant
Federal Bank contended that:
- The term "secured creditor" under Section 53(1)(b)(ii) requires a legally enforceable security interest created under the IBC or other law, not merely a statutory charge.
- The Rainbow Papers judgment applied only to the CIRP stage and was inapplicable to liquidation, where the waterfall mechanism under Section 53 is absolute.
- The Supreme Court in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat (2023) 10 SCC 60 held that statutory dues cannot override the IBC’s priority structure in liquidation.
- Section 238 IBC mandates that the Code overrides any inconsistent law, including state VAT statutes.
- The Liquidator’s withholding of funds and stop payment on a cheque violated Regulation 42 of the Liquidation Regulations, which mandates distribution within 90 days.
For the Respondent
The Liquidator argued:
- The Rainbow Papers judgment permits treating state tax dues as secured creditors under Section 53, as the Haryana VAT Act creates a first charge on property.
- The statutory charge under Section 26 of the Haryana VAT Act qualifies as a "security interest" under Section 3(30) IBC.
- To avoid multiplicity of litigation, the Liquidator proposed an indemnity undertaking from Federal Bank, to be enforced if a higher court later upholds the VAT Department’s claim.
- The Liquidator claimed no malafide intent and sought judicial protection through indemnity.
The Court's Analysis
The NCLAT undertook a rigorous statutory interpretation of Section 53 and Section 52 of the IBC, distinguishing between "security interest" and "statutory charge". The Court emphasized that Section 52 defines a secured creditor as one having a security interest in the corporate debtor’s property, which must be created by agreement or operation of law, and must be enforceable against third parties.
"The statutory charge under Section 26 of the Haryana VAT Act, 2003, while creating a first charge, does not constitute a security interest within the meaning of Section 52 of the IBC. It is a statutory lien for recovery of dues, not a consensual or registered security arrangement."
The Court distinguished Rainbow Papers, noting that judgment concerned the CIRP stage and the obligation of Resolution Professionals to verify claims under Regulation 12. In liquidation, however, Section 53 operates as a closed, non-negotiable waterfall. The Court cited Paschimanchal Vidyut Vitran Nigam Ltd. (2023) 10 SCC 60, where the Supreme Court held that even electricity dues, despite statutory priority under the Electricity Act, 2003, must yield to the IBC’s priority structure.
"Section 238 of the IBC is clear: the provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law. The Haryana VAT Act cannot override the IBC’s distribution hierarchy."
The Court rejected the indemnity proposal as legally untenable, stating:
"The Liquidator cannot create a collateral arrangement to circumvent the statutory mandate of Section 53. The Code does not permit conditional distribution or retrospective indemnity obligations between creditors."
The Court further held that the Liquidator’s stop payment on the cheque and failure to deposit funds in an interest-bearing account violated Regulation 42 and the fiduciary duty owed to creditors.
The Verdict
The appeal was allowed. The NCLAT set aside the NCLT order dated 30.05.2025 and directed the Liquidator to distribute the withheld amount of Rs. 1,05,54,823/- to Federal Bank Limited as a secured financial creditor under Section 53 of the IBC. The Liquidator was further directed to pay interest at 9% per annum on the delayed amount from 10.06.2023 (90 days after sale realization) until actual payment. The Court ordered compliance within 6 weeks. The claim of the Excise and Taxation Department, Gurgaon, was excluded from the list of secured creditors.
What This Means For Similar Cases
Statutory Charges Do Not Equal Security Interests
- Practitioners must now distinguish between statutory liens (e.g., under VAT, GST, or labour laws) and true security interests created under the Transfer of Property Act, SARFAESI, or registered charges.
- In liquidation, only creditors with registered or enforceable security interests qualify under Section 53(1)(b)(ii).
- State tax authorities cannot claim priority over secured financial creditors merely by virtue of a statutory charge.
Liquidators Must Distribute Without Delay or Conditions
- Regulation 42 mandates distribution within 90 days of receipt of sale proceeds.
- Withholding funds pending judicial clarification or demanding indemnity from creditors is unlawful.
- Liquidators must act as neutral fiduciaries; they cannot create ad hoc mechanisms to avoid liability.
Section 238 IBC Is Absolute in Liquidation
- Any state law claiming priority over the IBC’s waterfall mechanism is rendered inoperative.
- The Rainbow Papers precedent is confined to CIRP and does not apply to liquidation.
- Future claims by tax authorities must be treated as unsecured or operational creditors unless a valid security interest exists.
