Reversing Rainbow Papers, Revealing New Risks: The CIIRP Gap in 2026 IBC Amendment

[Addepalli Aaditya and Prajjwal are students at Hidayatullah National Law University.]

The Insolvency and Bankruptcy Code 2016 (Code) rests on the premise that credit markets function efficiently when creditors can accurately price risks. This is reflected in Section 53 of the Code, which, through its waterfall mechanism, places secured financial creditors under Section 53(1)(b) while subordinating government dues under Section 53(1)(e). The rationale behind this positioning is to rank creditors who voluntarily extend capital after assessing commercial risks and negotiating security arrangements above sovereign claims, which, by contrast, arise ipso jure.

However, in State Tax Officer v. Rainbow Papers Limited (Rainbow Papers), the Supreme Court (SC) disrupted this system by holding that the statutory claims of the tax department fall squarely within the definition of “security interests” and that the State becomes a “secured creditor” under Sections 3(31) and 3(30) of the Code. As a result, tax authorities ought to be treated on par with secured creditors during liquidation proceedings.

The fundamental error in Rainbow Papers lied in conflating a statutory charge with a security interest. Under the Code, security interests are understood as arising from consensual commercial transactions, whereas tax claims arise automatically by operation of law. By equating these two distinct concepts, Rainbow Papers created commercial uncertainty, as lenders faced the prospect of sovereign claims circumventing negotiated contractual credit, effectively disrupting the carefully structured waterfall mechanism.

The Judicial Confusion and Legislative Reversal of Rainbow Papers

The uncertainty deepened in subsequent judicial decisions. While the SC in Sanjay Kumar Agarwal v. State Tax Officer, declined to disturb the reasoning in Rainbow Papers, later observations in Paschimanchal Vidyut Vitran Nigam Limited v. Raman Ispat Private Limited, reaffirmed the primacy of the Code’s waterfall mechanism. These diverging opinions did little to bring clarity on the hierarchy of statutory dues vis-à-vis contractual dues.

Against this backdrop, the Insolvency and Bankruptcy Code (Amendment) Act 2026 (Amendment) added an explanation to Sections 3(31) and 53 of the Code which directly overturned the interpretive foundation of Rainbow Papers. This newly inserted explanation to the definition of “security interests” restricted its meaning to consensual commercial agreements of extending credit. By doing so, it expressly excluded statutory charges arising solely by operation of law. To complement this, the explanation added to Section 53(1)(e) further clarifies that government dues cannot acquire the status of secured credit merely because a different statute creates a charge in favour of the State. 

This correction restores the hierarchy originally envisaged by the Code by re-subordinating government dues below secured financial creditors. The Amendment therefore operates not merely as a legislative override, but as a clearer statutory reaffirmation of the Code’s original creditor-priority framework.

The Pre-Moratorium Enforcement Gap in CIIRP

While the Amendment effectively restores creditor primacy, it may also create perverse enforcement incentives, such as leading tax authorities to maximise pre-emptive asset recovery before the moratorium under Section 14 of the Code kicks in and bars all recovery proceedings.

Prior to the Amendment, tax authorities could rely on Rainbow Papers to preserve secured status within insolvency proceedings. Following the Amendment, however, statutory dues stand firmly restricted to Section 53(1)(e). Consequently, the expected recoveries available to tax authorities through the insolvency process are significantly diminished. Due to this reduced prospect of recovery, revenue authorities may be incentivised to maximise recoveries before insolvency proceedings commence rather than wait for their turn under the waterfall mechanism.

This incentive assumes a greater significance due to a structural loophole in Chapter IV-A of the Code, which governs the creditor-initiated insolvency resolution process (CIIRP). The corporate insolvency resolution process (CIRP) operates on a ‘creditor-in-control’ model, wherein an interim resolution professional takes the position of the management under Section 17 of the Code to prevent asset dissipation. On the other hand, the CIIRP introduces a ‘debtor-in-possession’ model. For this model to function effectively, the incumbent management must have operational liquidity and working capital. However, the legal architecture of CIIRP in its present form, fails in protecting this operational window because an interim moratorium is activated under Section 58G(2) only upon formal filing for CIIRP. Additionally, Section 58B(2)(b) introduces a mandatory 30-day prior notice window to the corporate debtor before that filing can occur. This is the period during which the tax department can execute extra-judicial recoveries even before the moratorium protection comes into play. 

The SC in M/s Radha Krishan Industries v. State of Himachal Pradesh (Radha Krishnan), held provisional attachment under Section 83 of the Central Goods and Services Tax Act 2017 to be a draconian measure requiring strict objective satisfaction that the taxpayer will dissipate assets to evade tax. However, the moment a financial creditor serves a statutorily-mandated thirty-day CIIRP notice, the notice may furnish a persuasive factual basis upon which tax authorities could seek to establish the requisite objective satisfaction. Authorities may seek to justify an attachment under Section 83 by arguing that the imminent insolvency application itself creates a threat to public revenue recovery. Therefore, this structural lacuna significantly weakens the practical protection envisaged in Radha Krishan. By freezing bank accounts and halting the flow of working capital during the notice gap, tax authorities can dismantle the debtor-in-possession model. Such disruptions may increase the likelihood of conversion into a conventional CIRP under Section 58H, thereby entirely undermining the legislative objective of a streamlined, debtor-led resolution in insolvency proceedings. 

How Other Jurisdictions Balance Tax and Creditor Claims 

The United States takes a balanced approach to public revenue and corporate insolvencies. Section 507(a)(8) of the US Bankruptcy Code grants unsecured tax claims an eight-level priority status to protect an important public revenue stream, but at the same time, it combines this with an automatic stay under Section 362 of the US Bankruptcy Code. The result is that the Internal Revenue Service cannot provisionally freeze or issue any extra-judicial levies, thereby preserving the Debtor-in-Possession Model. 

Singapore has a strong statutory framework in the Insolvency, Restructuring and Dissolution Act (IRDA) to protect corporate rescue and refinancing. Under Section 64 of the IRDA, filing an application for a scheme of arrangement triggers a thirty-day automatic interim moratorium. This injunction plays an important role as it binds all creditors, including the Inland Revenue Authority of Singapore. The moratorium bars sovereign tax departments from executing pre-emptive attachments, freezing bank accounts, or engaging in any other form of debt enforcement, effectively ensuring that the Debtor in Possession model remains functional.

India’s statutory framework, even after the amendment, does not possess an effective guardrail against the extra-judicial strength of sovereign tax authorities. Furthermore, while the Singaporean regime remedies the notice gap by imposing  an automatic interim moratorium to bind tax authorities, India’s CIIRP framework creates a mandatory thirty-day notice period that lacks any concurrent legal protection. This failure in the statutory framework effectively transforms a restructuring notice into an open call for sovereign asset raiding, foundering the debtor-in-possession model before the resolution process even begins.

Bridging the CIIRP Enforcement Gap 

The effectiveness of CIIRP post-Amendment will ultimately depend upon preventing disruptive pre-insolvency enforcement that frustrates restructuring efforts. The Parliament should therefore consider introducing an interim fiscal stay that is automatically triggered upon filing of a CIIRP notice. Such a measure would temporarily suspend coercive tax recovery measures, including provisional attachments and bank account freezes, during the notice period preceding the commencement of liquidation proceedings. This would preserve the debtor’s operational liquidity while creating a breathing space for making efforts to restructure without extinguishing statutory claims.

Additionally, a blanket subordination of all tax claims may result in failing to distinguish the purpose of different categories of taxes. A more nuanced reform would be to create a limited exception for more operational tax liabilities, such as GST collected from consumers and TDS deducted from employees, which can be collected immediately before insolvency, while leaving accumulated tax arrears firmly subordinated. Such a distinction would better reflect the distinct character of each tax.

Together, these reforms would reduce incentives for panic-driven enforcement, protect restructuring value during the notice period, and better align government recovery behaviour with the broader principle that consensual commercial credit retains primacy under the Code.