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INTER-CREDITOR AND SUBORDINATE AGREEMENTS UNDER IBC: AN ENIGMA OF SECTION 53

CONDONATION OF DELAY IN SUBMISSION OF RESOLUTION PLAN: Late Bidders And Unlocking Maximum Value

ABSTRACT

With the advent of the Insolvency and Bankruptcy Code, 2016 there has been tremendous improvement in saving companies from a corporate death as well as in securing the rights of the secured financial creditors of the corporate debtor. However, there has been ambiguity as to how the pay-outs shall be made during the liquidation process of a corporate debtor to those secured financial creditors holding a simultaneous or subsequent charge over the same asset by way of inter-creditor and subordinate agreements.

The author, through this article, shall delve into the grey area of inter-se priority charge and explain the validity of inter-creditor and subordinate agreements under the Insolvency and Bankruptcy Code, 2016. Further, the author has thrown light upon the dichotomous judicial interpretations of the Supreme Court and the National Company Law Tribunals. Finally, suggesting the way out by striking a balance among all stakeholders.

INTRODUCTION

Section 53 of the Insolvency and Bankruptcy Code (‘the Code’) provides for what is called a “liquidation waterfall”. However, it has substantially failed to create a distinction between secured creditors based on inter-creditor or sub-ordinate agreements. Simply speaking, inter-creditor or sub-ordinate agreements are those agreements that provide multiple charges on a single asset.  There can be a creation of a pari-passu charge or a secondary charge to the primary charge of an asset.

Apart from the clear distinction made between a secured financial creditor and an unsecured financial creditor by the Hon’ble Supreme Court of India[1], the Code does not create a preference among classes of secured financial creditors and views them under the same umbrella.[2] Therefore, a conflict can arise when the company goes into liquidation and the assets of the company are to be liquidated amongst the classes of secured creditors holding a primary and secondary charge over the same asset.

WHAT THE INSOLVENCY LAW SAYS

The main objective of the Code is to rescue corporate debtors in distress and to ensure equitable treatment of all creditors of the corporate debtor. However, no clarity has been provided under the Code concerning the treatment of inter-creditor and sub-ordinate agreements.

The Indian Government added to section 30 (4) by way of the Insolvency & Bankruptcy Code (Amendment) Act 2019 (the ‘Amendment)[3]. The Amendment provided clarification for the differential treatment of secured creditors. It stated that while determining the feasibility and viability of a resolution plan, the concept of priority and value of security amongst financial creditors should be taken into consideration as per section 53 (1) of the Code.

However, the ambiguity persists while determining pay-outs during the liquidation process. This conundrum has been deliberated by the Insolvency Law Committee (‘the Committee’) in their report of 2018[4], wherein the Committee resolved that valid inter-creditor and sub-ordinate agreements should be following the liquidation waterfall under section 53 of the Code.

The Report of 2020[5] once again took cognizance of this ambiguity and recommended that an amendment through section 53 (2) should be inserted to validate inter-creditor and subordinate agreements. However, no substantial amendments have been made in the Code pertaining to the treatment of second charge holders by way of sub-ordinate and inter-creditor agreements.

EXISTING LEGISLATIONS COVERING THE CONCEPT OF CHARGE

It is pertinent to comprehend the existing principles of law that cover the concept of charge to get a holistic understanding of a pari-passu charge and a sub-ordinate charge.

The Companies Act has defined charge as an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage.[6] The Transfer of Property Act, 1882 states that a charge is created towards repayment of the loan as security and not as a mortgage.[7]

It is section 48 of the Transfer of Property Act, 1882 that recognises the concept of sub-ordinate charge by way of priority of rights. Thus, a person holding a prior right will be given priority over an immovable priority following the second charge holder and so forth.

The Hon’ble Supreme Court while determining the case of ICICI Bank Ltd v. Sidco Leathers Ltd and Others[8], held that as per section 48 of the Transfer of Property Act, 1882 repayment of debts the claim of first charge holder has to be paid off first and subsequently that of the second charge holder. Further, the Court also interpreted section 529A of the Companies Act and upheld that since the Companies Act does not explicitly state the priority amongst secured creditors, the same cannot be concluded by the Court.

INTERPRETATION BY THE NCLT

The establishment of NCLT with the advent of the Code has brought about varied judicial interpretations with respect to the rights of secured creditors vis-à-vis inter-creditor and sub-ordinate agreements.

In the case of State Bank of India v. M/s Adhunik Alloys & Power Ltd[9], the NCLT Kolkata held that the classification among financial creditors based on their security interest cannot be termed illegal. Contrary to the judgment given by the Supreme Court in the ICICI Bank case, the National Company Law Appellate Tribunal (‘NCLAT’) in the case of IREDA v. Bhuvnesh Maheshwari[10], while deciding the issue of priority and pari-passu charges, disregarded the principles of prior and sub-ordinate charges and upheld that on account of the overriding effect of the IBC over other laws[11], the judgment passed in ICICI Bank case does not hold any stand.

A similar stance had been taken by the NCLAT previously in Stressed Assets Stabilization Fund v. Bijay Murmuria[12]. In this case, since the Appellant was unable to prove its first charge, the NCLAT overlooked the question to provide the Appellant the benefit of the first charge holder.

However, in the matter of SKE Projects Pvt Limited v. Jaihind Projects Limited[13] (‘SKE Projects Case’), the NCLT Ahmedabad Bench had recognised the exclusive right of Axis Bank Limited over an asset of the corporate debtor. Therefore, in this case, the NCLT did not approve the principle of equality among secured creditors.

Finally, the issue of the validity of inter-creditor and sub-ordinate agreements during the liquidation process was placed before the NCLAT in the case of Technology Development Board v. Mr. Anil Goel[14]. The NCLAT in this judgment held that secured creditors have an absolute right to decide either to enforce their security under applicable law and stay out of the liquidation process or to relinquish their security interest and submit to the liquidation proceedings by losing their primary or secondary charge over the asset. If the secured creditor opts for the latter, the pay-outs will be determined according to the waterfall provided in section 53 of the Code which recognises every secured creditor on the same footing and does not consider inter-creditor and sub-ordinate agreements.

The NCLT, in the case of J M Financial asset Reconstruction Co. Ltd. v. Finquest Financial Solutions Pvt. Ltd. & Others[15], opined that a secured creditor is the first in the inter-creditor ranking is entitled to enforce its right to pursue a liquidation strategy outside the liquidation process. However, in the case of Surana Power Limited v. Bharat Heavy Electricals Limited[16], it was held by the NCLT that since 73.76% of the secured creditors wish to relinquish their security interest through the liquidation process, the single creditor holding 26.24% cannot stay outside the liquidation process. Thus, the decision of the majority secured creditors was imposed on that of the nonconforming secured creditors.

Therefore, the Supreme Court becomes duty-bound to resolve this dichotomous interpretation of the NCLT and the NCLAT on the matters of priority of secured creditors based on inter-creditor and sub-ordinate agreements.

WHAT NEXT?

The way forward for this conundrum is that it needs to be thoroughly addressed by the Government or the Supreme Court to protect the main objective of the Code.

The contrasting interpretation by the tribunal may put the right of a secured creditor holding a first or prior charge into a predicament. According to the author, the fundamental principle of the Code is to have ‘equality among equals’. However, strict adherence to this principle disregards the rights of secured creditors holding a first charge based on priority and value of security interest. Thus, the decision of the NCLT Ahmedabad in the SKE Projects Case shall be taken into consideration.

Moreover, a liquidation resolution plan based on the value of security interest will incentivise the secured financial creditors to fasten the resolution process and approve a proper resolution plan. Therefore, an amendment should be brought by recognizing the rights of different classes amongst an existing class of secured creditors during the liquidation process.


[1] Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta and Others (2019) SCC OnLine SC 1478.

[2] Insolvency and Bankruptcy Code, 2016, § 53, No. 31, Acts of Parliament, 2016.

[3] Insolvency & Bankruptcy Code (Amendment) Act 2019.

[4] Report of the Insolvency Law Committee, 26th March, 2018.

[5] Report of the Insolvency Law Committee, 20th February, 2020.

[6] Companies Act, 2013, § 2(16), No. 18, Acts of Parliament, 2013.

[7] Transfer of Property Act, 1882, § 100, No. 4, Acts of Parliament, 1882.

[8] ICICI Bank Ltd v. Sidco Leathers Ltd and Others (2006) 10 SCC 452.

[9] State Bank of India v. M/s Adhunik Alloys & Power Ltd CA (IB) Nos. 1086 and 1092/KB/2018 in CP (IB) No. 387/KB/2017.

[10] IREDA v. Bhuvnesh Maheshwari, Company Appeal (AT) No.971 of 2020.

[11] Insolvency and Bankruptcy Code, 2016, § 238, No. 31, Acts of Parliament, 2016.

[12] Stressed Assets Stabilization Fund v. Bijay Murmuria, Company Appeal (AT) (Insolvency) No. 1187 of 2019 in C.P. (IB) No. 61/KB/2018.

[13] SKE Projects Pvt Limited v. Jaihind Projects Limited, IA 593 of 2019 in CP (IB) 172/NCLT/AHM/2018.

[14] Technology Development Board v. Mr. Anil Goel, Company Appeal (AT) (Insolvency) No.731 of 2020.

[15] J M Financial asset Reconstruction Co. Ltd. v. Finquest Financial Solutions Pvt. Ltd. & Others, Company Appeal (AT) (Insolvency) No. 593 of 2019.

[16] Surana Power Limited v. Bharat Heavy Electricals Limited, Company Appeal (AT) (Insolvency) No. 1510 of 2019.

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