Section 26E and Government Dues: The Priority Contest

The sharpest priority fight is between a secured creditor and the taxman. Until Section 26E took effect the Act was silent, and the courts held that a state tax first charge could prevail over the lender. Section 26E, with its parallel in the Recovery of Debts Act, reversed that for registered secured creditors. This note sets out the old position in Central Bank of India v State of Kerala, the shift the amendment made, and the settled view that the registered secured creditor now ranks first.

1. The Old Position

Before Section 26E, the state could rank first

Figure 1: Before Section 26E, the state could rank first

Central Bank of India v State of Kerala (2009). The Supreme Court held that, as the Act then stood, a secured creditor had no statutory priority over state tax dues (Topic 6)
The state first charge prevailed. State sales-tax and VAT laws often created a first charge on the defaulter's property, and that charge was held to prevail over the lender.
Because SARFAESI was silent. The Act at that time contained no provision giving secured creditors priority, so the ordinary position left the state ahead.
The gap it exposed. Lenders found their security subordinated to government dues, which weakened the very recovery the Act was meant to secure.

2. The Shift under Section 26E

Section 26E reversed the balance

Figure 2: Section 26E reversed the balance

Section 26E, in force 2020. The 2016 amendment inserted s.26E, brought into force on 24 January 2020, expressly giving a registered secured creditor priority over all other debts and government dues (Topic 49)
Parallel s.31B, RDB Act. A matching provision, s.31B of the RDB Act, gives secured creditors the same priority in the recovery regime, so the two laws align.
The crown debt displaced. Together these provisions displace the old crown-debt-first rule where the security interest is registered.
Priority, not immunity. The priority is over the distribution of proceeds; it does not wipe out the government dues, which simply rank after the secured creditor.

3. The Settled View

The registered creditor ranks first

Figure 3: The registered creditor ranks first

Registered creditor wins. The High Courts have consistently upheld a registered secured creditor's priority over state VAT, GST and tax dues after s.26E.
Attachment alone is not enough. A mere tax attachment, without more, does not defeat the registered secured creditor's priority under the Act.
Registration is the key. Priority turns on registration under s.26E, so the creditor must have registered its interest with the Central Registry to claim it (Topic 44)
Outside insolvency. This priority governs enforcement under the Act; in an IBC process the s.53 waterfall decides distribution instead (Topic 76)

⚠ Exam trap

Tell the story in two acts. Before Section 26E: in Central Bank of India v State of Kerala (2009) the Supreme Court held a secured creditor had no statutory priority over state tax first charges, because the Act was silent, so the state could rank first. After Section 26E came into force on 24 January 2020, it, with the parallel Section 31B of the RDB Act, gives a registered secured creditor priority over all other debts and government dues, displacing the crown-debt-first rule. Stress that priority depends on registration, that a mere attachment does not defeat it, and that it ranks the dues rather than extinguishing the government claim. In insolvency, the IBC waterfall applies instead.

4. Frequently Asked Questions

What was the position on priority between secured creditors and tax dues before Section 26E?

Before Section 26E was brought into force on 24 January 2020, the SARFAESI Act contained no provision giving secured creditors priority over government dues. In Central Bank of India v State of Kerala (2009), the Supreme Court held that, as the Act then stood, a secured creditor had no statutory priority over state tax dues, and that where a state sales-tax or VAT law created a first charge on the defaulter's property, that statutory first charge prevailed over the secured creditor. The result was that a lender's security could be subordinated to government dues, which undermined the recovery the Act was designed to deliver. This was the gap that the 2016 amendment set out to close.

Does a registered secured creditor now rank ahead of state tax dues?

Yes. Section 26E, inserted in 2016 and in force from 24 January 2020, gives a secured creditor that has registered its security interest priority over all other debts and over the revenues, taxes, cesses and other rates of the Central or State Government or a local authority, and Section 31B of the Recovery of Debts Act provides a matching priority. The High Courts have consistently upheld a registered secured creditor's priority over state VAT, GST and other tax dues, and have held that a mere attachment by the tax authorities, without more, does not defeat it. Priority depends on registration, and it ranks the dues rather than extinguishing the government claim, which is paid after the secured creditor. In an insolvency, distribution follows the IBC waterfall instead.

5. Related Topics

Topic 49: Section 26E Priority of Secured Creditors. The provision that created the priority.
Topic 6: Sections 35 and 37 Override. The override and the earlier priority debate.