[Mr. Neelabh Niket and Mr Pranav Jain are 5th year and 3rd year B.A., LL.B. (Hons.) students at HNLU, Raipur]
In May 2023, the Hon’ble Supreme Court in M/s Vistra ITCL (India) Ltd & Ors. v. Mr. Dinkar Venkatasubramanian & Anr.(‘Vistra’) delved into the rights of Third-Party security holders in whose favour shares are pledged in order to secure loans taken by the group companies of Corporate Debtor facing CIRP proceedings. The non-inclusion of secured creditors as Financial Creditors within the definition u/s 5(7) of the Insolvency and Bankruptcy Code (‘Code’) happens to be a settled position considering the recent rulings of the Supreme Court. However, the court in Vistra (supra) has called for a reconsideration of the same by a larger bench. In this article, the authors have critically analysed the solutions provided by the Supreme Court with regard to the position of secured creditors in the situation of Corporate Debtor facing CIRP proceedings.
Briefly, Amtek Auto Limited (‘Corporate Debtor’) approached Vistra ITCL India Ltd., KKR India Financial Services Limited and L&T Finance Limited to extend a short-term loan facility to its group companies. In order to secure the same, the Corporate Debtor pledged equity shares of JMT Auto Ltd. held by it as security. An application u/s 7 of the Code led to the commencement of CIRP proceedings against the Corporate Debtor. Subsequently, the appellant's claim as a secured financial creditor was rightly rejected by the NCLAT based on the fact that the Corporate Debtor did not owe any financial debt to the appellants. The judgements of the Hon’ble Supreme Court in the case of Anuj Jain IRP for Jaypee Infratech Ltd. v. Axis Bank Ltd. as well as Phoenix ARC Private Limited v. Ketulbhai Ramubhai Patel acted as valid precedents for the same. The Supreme Court dealt with the question of inclusion as financial creditors and came up with two possible solutions to the issue at hand which need to be analysed.
Solutions Provided: A Critique
While expansively reading the rights available to these ‘Secured Creditors’, the Hon’ble Court came up with two possible solutions so as to ensure justice to them. First, to consider these Secured Creditors as Financial creditors to the extent of their security interest on the date of commencement of CIRP. Second, to allow these secured creditors to exercise their rights as per section 52 of the Code and receive the proceeds from the sale of assets as per the water-fall mechanism u/s 53 of the Code. Both these solutions seem very attractive but suffer from serious lacunae in terms of implementation and practical application.
Third Party Security Holders as Financial Creditors
Admittedly, these Security Trustee Agreements relating to Pledge of Shares lack all aspects which are must in a Financial Debt. For instance, there is no involvement of any disbursement of credit facility in consideration for time value of money. Consequently, the pledge of shares cannot fall within the purview of Section 5(8)(f) of the Code. The landmark judgement of the Supreme Court in Phoenix (Supra) affirms this view. Further, a Third Party Security Holder may be considered a ‘Financial Creditor’ to the Subsidiary Company who directly avails the debt and defaults. However, it is difficult to establish such a creditor-debtor relationship between such a Security Holder and the Pledgor Company, who neither is a direct beneficiary of the Loan nor has defaulted on the payment timelines.
Inter-Relation Between Secured and Financial Creditors
The consideration of security holders as Financial Creditors would lead to a situation where the secured creditors would be placed at a pedestal even higher than that of Financial Creditors. While financial creditors take up a haircut in the Resolution Plan, the secured creditors would be allowed to retain their security interest and claim full amount as per the interest. This would go against Regulation 37(b) of the IBBI CIRP Regulations, 2016 which provides,
“A Resolution Plan shall provide for the measures, as may be necessary, for insolvency resolution of the Corporate Debtor for maximization of value of its assets, including but not limited to the sale of all or part of the assets whether subject to any security interest or not.”
As is clear, there is no distinction created by the said regulation in terms of treatment of the security interest held by the Secured creditors or Financial creditors either. Consequently, none can be created by the judiciary.
Furthermore, this would blur the line differentiating the categories of the creditors. As pronounced in the landmark ruling of Swiss Ribbons Pvt Ltd v. Union of India and subsequently delved into with regards to the differentiation from secured creditors in Anup Jain (Supra), a financial creditor is one having direct engagement in the functioning of the Corporate Debtor. He is involved right from the beginning in assessing the viability of the Corporate Debtor and would engage in restructuring of the loan as well as in reorganisation of the corporate debtor's business when there is financial stress. Contrary to this, a person having only security interest over the assets of the Corporate Debtor is only interested in realising the value of its security owing to an absence of involvement of any significant stakes in the Corporate Debtor's growth or equitable liquidation. Consequently, a financial creditor apart from looking at safeguards of its own interests, would also and simultaneously be interested in the rejuvenation, revival and growth of the corporate debtor, unlike secured ones. The consideration of secured creditors as financial creditors stipulated in the code will be against the intent of resolving the insolvency and reviving the corporate debtor.
Treatment as Secured Creditors
The second solution delving into protection of secured creditors through the application of Section 52 and Section 53 is fundamentally flawed as well. These sections are included under Chapter – III of the Code titled ‘Liquidation Process’ which operate only as a last resort in cases where the CIRP fails to revive the Company. Thus, IBC has envisaged the Insolvency resolution process and liquidation as two different concepts with two different consequences. In pursuance of that, some additional rights have been conferred to the Secured Creditors under sections 52 and 53 only at the stage of Liquidation, and not Resolution. Thus, it is respectfully submitted that the Supreme Court has attempted to import rights available at one stage to another, which is contrary to the scheme of IBC. It is unclear as to how this interpretation would protect the interests of such Secured Creditors at the stage of Resolution.
At the stage of resolution, Section 30 (2)(b) of the IBC provides for the minimum payment to Operational Creditor(s) as well as dissenting Financial Creditor(s), which shall not be less than the amount which they are entitled to receive u/s 53 in event of liquidation of the Corporate Debtor. However, it must be noted that no similar safeguard has been provided to the Secured Creditors. The Code via Section 30(4) only advises the Committee of Creditors to keep in mind the value of the Security interest of the Secured Creditors while approving a Resolution Plan. The same has been held to be only a directory in nature. Thus, there exists a gaping hole in the legislative mandate regarding the amount to be paid to the secured creditors in the resolution plan unlike the dissenting financial creditors and operational creditors who have been categorically provided such rights by the introduction of amendment in 2019.
It is imperative to provide stronger legislative protection to Secured Creditors, especially those who function as Third-Party Security Holders, having substantial interest in the form of Shares of a Company, by mandating the CoC and the Resolution Applicant to assign a considerable and fair value to such interest. Unless such protection is given, the security interest held by the creditors would be written off, and would operate to make disbursed credit facility unsecured, rendering the Creditors remediless in the event of the eventual default by the subsidiary company. In the alternative, as there exists no liability against the distressed company in the present day, the legislature might mandate the Resolution Applicants to accept the liability arising out of such Agreement in the future and earmark an equivalent value of Shares in favour of the Third-Party Security Holders. This would be in line with the Clean Slate doctrine, and would also not contravene Section 14(1)(c) which only prohibits enforcement of the security interest, and not acknowledgement thereof.
It is very clear from the above discussion that the prevailing jurisprudence in India has ignored the plight and inconvenience caused to the Third-Party Security Holders under the IBC regime. Through legislative oversight and restrictive judicial interpretation, it has become virtually impossible for these holders to protect and enforce their Security Interest once the Pledgor Entity is forced into CIRP. Recently, in Edelweiss Asset Reconstruction Company Ltd. v. Anuj Jain, the NCLAT relying on the fact that Vistra had been decided by the Hon’ble Supreme Court under Article 142 of the Constitution of India, outrightly rejected the claim of these Security Holders, and allowed their security interest to be extinguished upon the commencement of the CIRP of the Pledgor Company. Legally, the judgement is a literal and straightforward interpretation of the IBC and thus cannot be faltered with, but it underlines the need of the legislature to intervene.