Entitlement of Dissenting Financial Creditors under IBC

An often vexed question arises as to the claim of a secured financial creditor either on the basis of the security interest it holds or otherwise. Such creditors along with workmen are first in the order of priority under Section 53¹ of the Code. But naturally, what the other creditors would receive also depends upon how the secured creditors are settled.

In Essar Steel (India) Ltd. v. Satish Kumar Gupta² the Supreme Court has observed that a secured creditor would be entitled to the value of its security. On the other hand, in India Resurgence ARC (P) Ltd. v. Amit Metaliks Ltd.³, the Court held that the secured creditor would not be entitled to the value of its security but would receive in proportion to what the others in the same class receive. At first blush, these rulings seem to contradict one another but according to the author, it is not so. In both cases, the Court proceeded on the premise that in the insolvency regime, the Committee of Creditors (CoC) is entitled to exercise commercial wisdom in dealing with the revival of the ailing corporate debtor and determine what amounts were to be paid to each class of creditors.

The Supreme Court in Essar Steel (India) Ltd. v. Satish Kumar Gupta⁴ has held that in a corporate insolvency resolution process, as per Section 30(2)(b)⁵ a dissenting financial creditor would be entitled to at least what it would receive under Section 53(1) in case of liquidation ( i.e. minimum liquidation value). Whereas in the liquidation stage, the financial creditor has the option to stand outside the waterfall mechanism in Section 53 and enforce its security interest under Section 52⁶.

However, the position in corporate insolvency resolution process (CIRP) is much different than that in an insolvency process. In insolvency process, there is a moratorium in place where there is a freeze on the assets of the corporate debtor and all the financial creditors come together to form the CoC. Approval to a resolution plan by the requisite majority is binding on all the stakeholders including dissenting financial creditors. It is thus, possible that under the approved resolution plan a dissenting financial creditor may not receive the value of the security held by it.

A secured creditor may claim that it is entitled to the whole of its debt under Section 53(1)(b) notwithstanding the value of its security. What the CoC decides would naturally have a bearing not only on what the others in the classes lower in the hierarchy would receive but even on the other secured creditors holding higher security interests and also the workmen in the same class. It can happen that the value of the security is much less than the debt owed but the CoC decides to consider the entire debt under Section 53(1)(b). Whether this is permissible? The Insolvency Law Committee in its Report dated February 2020⁷ reasoned that even if secured creditors realise their security interest they would recover to the extent of their security interest and would claim any remaining dues under Section 53(1)(e) and thus, secured creditors could not claim priority of repayment over their entire debt as that “would amount to respecting a right that has never existed”. The Committee concluded that unless such a restriction was placed on “debts owed to a secured creditor” in Section 53(1)(b), there would be a broad scope for misuse of the priority granted as even creditors who are not secured to the full extent of their debt would rely on the mere fact of holding any form of security to recover the entire amount in priority.

However, NCLAT has not accepted the above position. In Jet Aircraft Maintenance Engineers Welfare Assn. v. Ashish Chhawchharia Resolution Professional of Jet Airways (India) Ltd.⁸, NCLAT held that going by the plain reading of Section 53(1)(b), the secured creditor is entitled to the debt owed to it even in the CIRP process. This interpretation is problematic on account of more than one reason. This observation seems to suggest that every time distribution takes place the entire debt of the secured creditor would have to be considered irrespective of the value of the security involved. In other words, the value of security is not relevant for the purpose of distribution. This approach may end up giving rise to undue preferences as indicated above. Further, it may incentivise other members of the CoC not to go in for a resolution at all and instead push the corporate debtor towards liquidation where it would be permissible to enforce the security.

The Tribunal has missed a very important point made by the Insolvency Law Committee that thus far, the law had recognised the secured creditors as being entitled at best to the value of their security and no more. A secured creditor which relinquishes its security is thus, entitled to claim priority to this extent. It follows that for the balance sum due, such a creditor may claim along with other unsecured financial or operational creditors as the case may be. The change brought about by the new law from the existing position under the Companies Act⁹/extant insolvency law was with respect to the mode of distribution and did not seek to extend undue benefits upon the secured creditors to make claims over their entire debts dehors the security they possess. If the provision was simply to be given a literal interpretation, then other consequences would also follow. All secured creditors irrespective of the nature and extent of security they hold would be entitled to their debts proportionately. Again, inter se creditor agreements or rights of first charge-holders over secondary charge-holders should not hold. This is precisely what has been held by NCLAT in another decision viz. Technology Development Board v. Anil Goel¹⁰. This judgment has been stayed by the Supreme Court and the appeal is pending.

But there is nothing in the Code¹¹ which affects such rights. The purpose of enacting Section 53(1)(b) was not to override such pre-existing rights of parties. In a somewhat similar situation, the Supreme Court in ICICI Bank v. SIDCO Leathers Ltd.¹² while holding that the Companies Act did not disturb the pre-existing rights of the first charge-holder observed that if such rights were intended to be taken away Parliament would have stated so explicitly. Thus, there is much-needed scope for a revisit by the court or the legislature on the law.