Customs dues lose priority to banks when a company is wound up

A company imported machinery, took a loan from IDBI, and then went bust. Customs wanted to sell the goods for unpaid duty. IDBI said: we have first claim.

The dispute landed before the Supreme Court in Industrial Development Bank of India v. Superintendent of Central Excise and Customs and Others. At stake was a simple question with enormous consequences for every lender in India: when a company collapses, who gets paid first — the bank that lent the money, or the government that is owed customs duty?

When the Italian machinery arrived

During 1998-1999, a company imported machinery from Italy. The goods were stored in a bonded warehouse — a customs-controlled facility where imported goods can be kept without paying duty immediately, as long as they remain under customs supervision. The silence of that warehouse, filled with crates of Italian machinery waiting for clearance, masked a brewing financial storm. The company had taken loans from IDBI (Industrial Development Bank of India, a secured creditor) and hypothecated the machinery as security. Hypothecation means the borrower keeps physical possession of the asset, but the lender holds a legal charge over it — if the borrower defaults, the lender can take and sell the asset to recover the loan.

Then things went wrong. The company did not pay customs duty on the imported machinery. Customs authorities confirmed a duty demand of Rs. 3.27 crore and another Rs. 10.48 crore — a total of nearly Rs. 14 crore. In December 2000, they ordered the sale of the warehoused goods under Sections 72(2) and 142 of the Customs Act, 1962 (provisions that allow customs to sell goods to recover unpaid duty). The official stamp on that detention order, pressed into paper at the customs office, set in motion a legal battle that would take over two decades to resolve.

The winding up that changed everything

Before customs could sell the machinery, the Andhra Pradesh High Court stepped in. In December 2003, the High Court passed a winding up order — a formal declaration that the company was insolvent and would be dissolved. An Official Liquidator was appointed to take custody of all company property and distribute it among creditors according to a legal priority list. The liquidator's file, thin at first, began to swell with competing claims — customs demanding the right to sell, IDBI asserting its charge over the machinery.

The Official Liquidator applied to the High Court, asking that customs authorities be directed to hand over the imported machinery. A single judge of the High Court agreed in September 2004. The judge reasoned that once a winding up order is passed, the company's property vests in the Official Liquidator under Section 456 of the Companies Act, 1956 (a provision that places custody of all company assets with the liquidator). Customs was told to give the goods to the liquidator. The courtroom fell silent as the order was read — for a moment, the secured creditor seemed to have won.

Customs appealed. A full bench of the Andhra Pradesh High Court reversed the single judge's order in August 2008. The full bench ruled that customs authorities had the first right to sell the goods and recover the duty owed. The bench reasoned that Sections 72(2) and 142 of the Customs Act gave customs a statutory charge that could not be defeated by the Companies Act's priority scheme. IDBI, the secured creditor, would have to wait. The wooden benches of the full bench courtroom creaked as the judgment was delivered — the government's claim had been placed ahead of the bank's.

What the law says about who gets paid first

The Companies Act, 1956 has a clear priority system for when a company is wound up. Section 529A (overriding preferential payments) gives the highest priority to two categories of creditors: workmen's dues (wages and benefits owed to employees) and secured creditors' debts (loans backed by collateral). These two categories rank equally — pari passu — meaning they share the available money proportionally before anyone else gets a rupee. This provision contains a non-obstante clause — a legal phrase meaning "notwithstanding anything to the contrary" — which makes it override all other laws.

Section 530 (preferential payments) lists other creditors who get paid next, but only after Section 529A creditors are fully satisfied. This includes government dues like customs duty, but only if the debt was both "due" and "due and payable" within twelve months before the winding up began. The court noted these are cumulative requirements — the government cannot simply claim any old debt; it must prove the debt was actually payable within that specific window. A debt can be "due" in the sense of being owed, but not yet "due and payable" if the payment deadline has not arrived.

The Customs Act, 1962, on the other hand, gives customs authorities powerful recovery tools. Sections 72(2) and 142 allow customs to seize and sell goods to recover unpaid duty. The question was whether these provisions created a "statutory first charge" — a legal priority that overrides even secured creditors' rights under the Companies Act. The court examined whether the Customs Act contained any express language creating such a charge, and found none.

Why the Supreme Court said no to customs

A bench of Justice Sanjiv Khanna and Justice Sudhanshu Dhulia delivered the judgment on August 18, 2023. The court held that the Customs Act, 1962 does not create a statutory first charge on customs dues that overrides the charge created in favour of secured creditors under Section 529A of the Companies Act.

The key reasoning turned on Section 529A itself. The court said Section 529A overrides not just other provisions of the Companies Act, but also all other enactments in force, including the recovery provisions of the Customs Act. The non-obstante clause in Section 529A was decisive — it made the priority for secured creditors and workmen absolute in winding up proceedings.

The court also examined the precedents carefully. In Dena Bank v. Bhikhabhai Prabhudas Parekh & Co. — (2000) 5 SCC 694 — the Supreme Court had already held that secured creditors' rights under Section 529A prevail over government dues. In Rajratha Naranbhai Mills Co. Ltd. v. Sales Tax Officer, Petlad — (1991) 3 SCC 283 — the court had applied similar reasoning to sales tax dues. The present case extended that logic to customs duty. The Calcutta High Court's decision in Collector of Customs v. Dytron (India) Ltd. — 1998 SCC OnLine Cal 674 — and the Madras High Court's decision in UTI Bank Ltd. v. Deputy Commissioner of Central Excise — (2007) 135 Company Cases 329 (Mad.) — were also considered, though the Supreme Court's own precedents carried greater weight.

"In winding up, customs duty owed by a company is treated as preferential payment under Section 530(1)(a) of the Companies Act, 1956," the court held, "but cannot override or take precedence over overriding preferential payments due to secured creditors under Section 529A." The court further clarified that for government debt to qualify as preferential under Section 530(1)(a), it must be both "due" and "due and payable" within twelve months before the relevant date — cumulative requirements with distinct meanings.

What this means for lenders and liquidators

The judgment reverses the Andhra Pradesh High Court full bench decision and restores the single judge's order. Customs authorities must hand over the goods to the Official Liquidator. The sale proceeds will be distributed according to the waterfall mechanism under the Companies Act: first to workmen and secured creditors equally under Section 529A, then to other preferential creditors like the government under Section 530, and finally to unsecured creditors under Section 528 (debts of all descriptions admissible to proof).

This waterfall mechanism is not merely a list — it is a cascading priority system that ensures every rupee from the sale of the company's assets is allocated in a strict order. Imagine a series of buckets arranged from highest to lowest. The first bucket, shared equally by workmen and secured creditors under Section 529A, must be filled completely before a single drop spills into the next bucket for preferential creditors like the government under Section 530. Only when that second bucket is full does the remainder flow to unsecured creditors under Section 528. In this case, the customs authorities had hoped to place their bucket ahead of the secured creditors', but the Supreme Court ruled that the Companies Act's priority scheme does not permit such a reordering. The liquidator, sitting in a quiet office with stacks of claims and a single pile of sale proceeds, must now apply this sequence precisely — starting with the workmen and IDBI, then moving down the line.

The practical effect for lenders is significant. Every bank that lends against hypothecated assets now has clearer assurance that in a winding up, its claim will rank above customs dues. For liquidators, the judgment provides a definitive guide: the Customs Act's recovery powers, while real, do not create a super-priority that disrupts the Companies Act's distribution scheme. The judgment also underscores the importance of the twelve-month window under Section 530(1)(a) — customs authorities cannot simply assert any old debt; they must prove it was due and payable within that period, a burden that may sometimes be difficult to discharge when records are old or incomplete.

THE PLAY: When a company is wound up, secured creditors under Section 529A of the Companies Act rank above customs authorities — even if the Customs Act gives customs the power to seize and sell goods.

The appeal was allowed. Customs duty is subordinate to secured creditor rights under Section 529A. The full bench judgment of the Andhra Pradesh High Court stands reversed.