When insolvency proceedings begin, one of the first conflicts that surfaces is between financial creditors and government authorities. Both believe their claims deserve priority. However, the Insolvency and Bankruptcy Code has fundamentally altered this landscape, and government departments often approach insolvency with a legacy mindset, assuming statutory dues carry inherent priority. In practice, we have seen that this assumption no longer holds under the IBC framework.

Today, the position is no longer ambiguous. A consistent line of Supreme Court and appellate tribunal judgments has clarified that government dues under IBC are treated as operational debt and rank below secured creditors. The reasoning is not merely technical but deeply rooted in the economic objectives of the Code.

Government Dues Under IBC as Operational Debt

The classification of government dues flows directly from the IBC's statutory scheme. Section 5(21) explicitly includes dues payable to the government within the ambit of operational debt, and the confusion arises because statutory dues are backed by sovereign authority, which historically enjoyed priority under various recovery laws. However, the IBC introduces a unified framework that overrides such distinctions.

A common mistake clients make is assuming that statutory first charges automatically convert into secured status under IBC. Practically, what we have seen is that unless there is a recognised security interest within the meaning of the Code, government authorities remain operational creditors. This classification becomes critical at the stage of distribution under Section 53, where secured creditors are placed significantly higher in the priority waterfall.

Supreme Court Clarity on Priority and Distribution

The foundation of creditor hierarchy under IBC was decisively settled in Committee of Creditors of Essar Steel India Ltd vs Satish Kumar Gupta (2020) 8 SCC 531. The Supreme Court upheld the primacy of financial creditors and the commercial wisdom of the Committee of Creditors. The Court clarified that equitable treatment does not imply equal treatment. It recognised that financial creditors are best equipped to evaluate the viability of a resolution plan and therefore deserve priority in distribution. Operational creditors, including government authorities, are entitled only to the minimum protection provided under the Code.

This judgment has had a structural impact on how resolution plans are negotiated and approved. Practically, what we have seen is that government dues are often significantly reduced under resolution plans, and such reductions are upheld as long as the statutory minimum is satisfied. Another landmark decision is Ghanashyam Mishra and Sons Pvt Ltd vs Edelweiss Asset Reconstruction Company Ltd (2021) 9 SCC 657, where the Supreme Court addressed the finality of resolution plans.

The Court held that once a resolution plan is approved under Section 31, all claims that are not part of the plan stand extinguished. This includes statutory dues owed to the central and state governments. The judgment emphasised that allowing post-resolution claims would defeat the objective of providing a clean slate to the successful resolution applicant, and what we have seen is that this ruling has forced government authorities to actively participate in CIRP and submit their claims within prescribed timelines. Failure to do so results in a complete loss of recovery rights, which has significantly changed the approach of tax departments.

IBC Overriding Effect Over Tax and Recovery Laws

The interplay between IBC and other statutes has been another area of intense litigation. This issue was conclusively addressed in Principal Commissioner of Income Tax vs Monnet Ispat and Energy Ltd (169 DTR 262 (SC)).

The Supreme Court held that Section 238 of the IBC gives it an overriding effect over all other laws, including the Income Tax Act. The Court made it clear that once insolvency proceedings are initiated, the provisions of the IBC will prevail in case of any inconsistency, and this judgment has had a direct operational impact. Further clarity on government dues came in State Tax Officer vs Rainbow Papers Ltd, where the Supreme Court examined whether statutory dues could be treated as secured claims due to statutory charge provisions, and the Court held that if a statute creates a valid charge over the property of the debtor, such dues may qualify as secured debt. However, this is not automatic and depends on the existence of a legally enforceable charge.

Practically, what we have seen is that this judgment has introduced a nuanced position. While government dues are generally operational, in specific cases where a statutory charge is clearly established, authorities may attempt to assert a secured status. This has opened a new layer of litigation and strategic positioning in insolvency cases.

Practical Implications for Creditors and Debtors

The evolving jurisprudence has significantly altered the expectations of all stakeholders. For financial creditors, the framework provides clarity and predictability in recovery, and their priority status strengthens confidence in lending and credit evaluation.

For government authorities, the shift requires a transition from enforcement-driven recovery to participation within a collective insolvency process. A common mistake clients make is assuming that statutory powers can be exercised independently of CIRP. Practically, what we have seen is that such actions are routinely set aside.

For debtors, the implications are equally significant. Once CIRP begins, control shifts away from management, and all liabilities are addressed within a structured framework. This creates a strong incentive for early resolution and financial discipline.

Balancing Fiscal Interests and Economic Objectives

The apparent subordination of government dues is not a legislative oversight. It is a deliberate policy choice aimed at strengthening the credit ecosystem and thereby giving overriding priority to government dues, which would discourage secured lending and increase systemic risk. Practically, what we have seen is that the current framework strikes a balance between fiscal recovery and economic stability.

The IBC ensures that government authorities are part of the process while preventing them from disrupting resolution through parallel enforcement.

Conclusion

Government dues under IBC are firmly positioned as operational debt and rank below secured creditors in the priority hierarchy. This position has been consistently reinforced through Supreme Court jurisprudence. In our experience, stakeholders who understand this hierarchy are better equipped to navigate insolvency proceedings. Practically, what we have seen is that aligning expectations with the Code leads to more efficient and predictable outcomes and is designed to maximise value and ensure finality, and government dues must operate within this structured and evolving legal framework.