Expansion of the Rights of Secured Creditors to Recover Debts

[Isha Gupta is a III Year B.A.LLB. (Hons.) student at National Law University, Delhi]

The legislature and the judiciary have both adopted a rather pro-creditor approach towards insolvency in the recent past, which is apparent from the enactment of Insolvency and Bankruptcy Code 2016 (“IBC”) and the decision of the Supreme Court in Swiss Ribbons Pvt Ltd v Union of India, wherein the Court upheld the constitutional validity of the IBC. Following the same approach, the Supreme Court has once again rendered a major decision in favor of creditors in Swaraj Infrastructure Pvt. Ltd v. Kotak Mahindra Bank Ltd.

In this case, the Court delved into the question whether a secured creditor has a right to file a winding-up petition under Companies Act, 1956 (“Companies Act”) after such secured creditor has obtained a decree from the Debt Recovery Tribunal (“DRT”) and a recovery certificate based thereon under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“Recovery of Debt Act”).

Factual Background

The present case was initiated after Swaraj Infrastructure Pvt. Ltd who owed INR 48 crores by way of loans to Kotak Mahindra Bank failed to repay it. The Bank had filed three separate applications before the DRT, Mumbai to recover the debt. All the applications were allowed and, pursuant to those applications, recovery certificates for the said amounts were issued under section 19(19) of the Recovery of Debt Act. However, even after several efforts to auction the property secured, the Bank was unable to recover the outstanding amount.

Proceedings before the Bombay High Court

The Bank issued statutory notices for winding-up of Swaraj Infrastructure under sections 433 and 434 of the Companies Act, and a company winding-up petition was filed before the High Court. An appeal was filed against the order of the admission of the petition which was heard by a division bench of the Bombay High Court.

A twofold argument was put forth before the division bench by Swaraj Infrastructure to dismiss the winding-up petition – firstly, a secured creditor cannot file a winding-up petition under the Companies Act, if such creditor has already obtained an order from the DRT. The rationale behind the same as propounded by Swaraj Infrastructure was that the Recovery of Debt Act is a special legislation while the Companies Act is a general statute. Also, an exclusive jurisdiction has been vested in the DRT by excluding Companies Court. Secondly, a secured creditor can file a winding-up petition only on giving up its security, which has not been done in the present case. However, the division bench rejected both of these arguments and dismissed the appeal.

Supreme Court’s Pro-Creditor Approach

To decide the maintainability of a winding-up petition before the Companies Act, when a decree has been obtained from the DRT, the proceedings before the Supreme Court revolved around the two main issues – exclusive jurisdiction of the DRT and the requirement of relinquishment of securities before filing a petition for winding-up.   

Exclusive Jurisdiction of Recovery of Debt Act

Swaraj Infrastructure contended that the Recovery of Debt Act is a special statute created for the recovery of debts due to banks and financial institutions, and a conjoint reading of sections 17 and 18 of that legislation provides for exclusive jurisdiction in its favour. The corollary is that a winding-up petition is barred under the Companies Act. The relevant portions of sections 17 and 18 of the Recovery of Debt Act are as follows:

“17. Jurisdiction, powers and authority of Tribunals.—

(1) A Tribunal shall exercise, on and from the appointed day, the jurisdiction, powers and authority to entertain and decide applications from the banks and financial institutions for recovery of debts due to such banks and financial institutions……”

“18. Bar of jurisdiction.—On and from the appointed day, no court or other authority shall have, or be entitled to exercise, any jurisdiction, powers or authority (except the Supreme Court, and a High Court exercising jurisdiction under Articles 226 and 227 of the Constitution) in relation to the matters specified in Section 17……”

To buttress its argument, Swaraj Infrastructure heavily relied on Allahabad Bank v. Canara Bank wherein the Supreme Court decided that the Recovery of Debt Act has exclusive jurisdiction. The Court took the opportunity in the present case to clarify the scope and the extent of the Allahabad Bank case. It was observed that the issue in the Allahabad Bank case was limited to answer the requirement of leave of the company court to initiate, continue with, and execute orders passed under the Recovery of Debt Act. While deciding that issue, the Court looks at section 34 of the Recovery of Debt Act which provides for the overriding effect of the Recovery of Debt Act over other law to the extent of the inconsistency. In this context, the court in the Allahabad Bank case opined that since section 17 of the Recovery of Debt Act provides for recovery of debt and liability, no other court or even the company court can go into the questions relating to the liability and the recovery.

It is crucial to note here that the Recovery of Debt Act overrides the Companies Act to the extent of the inconsistency only qua recovery of debts due to banks and financial institutions. Therefore, in order to decide the sustainability of the winding-up petition in the present case, the court has to see if winding-up is a mode of realization of debt. The Supreme Court relied upon Amalgamated Commercial Traders (P.) Ltd. v. A.C.K. Krishnaswami and Ors., M/s IBA Health (India) Pvt. Ltd. v. M/s Info-Drive Systems Sdn. Bhd., and Harinagar Sugar Mills Co. Ltd. v. M.W. Pradhan to hold that winding-up proceedings cannot be referred to as proceedings for the realisation of debts. The Court in the Harinagar Sugar Mills case in paragraph 5 observed:

It is true that “a winding-up order is not a normal alternative in the case of a company to the ordinary procedure for the realisation of the debts due to it”; but nonetheless it is a form of equitable execution……”

Since the winding-up proceedings are not proceedings for recovery of debt, the bar on proceedings by virtue of section 18 read with section 34 of the Recovery of Debt Act will not apply. The corollary to this is that the overriding effect of the Recovery of the Debt is not applicable in the case of winding–up proceedings. Therefore, winding-up proceedings and proceedings under the Recovery of Debt Act can carry on simultaneously.

Relinquishment of the Security

It was also argued by Swaraj Infrastructure that, in any case, a conjoint reading of Companies Act and the Provincial Insolvency Act, 1920 show that, if the recovery of debt is sought under the Companies Act, the secured creditor has to relinquish the security before initiating winding-up proceedings. Section 9(2) of the Provincial Insolvency Act states:

 “(2) If the petitioning creditor, is a secured creditor, he shall in his Petition either state that he is willing to relinquish his security for the benefit of the creditors in the event of the debtor being adjudged insolvent or given an estimate of the value of the security. In the latter case, he may be admitted as a petitioning creditor to the extent of the balance of the debt due to him after deducting the value so estimated in the same way as if he were an unsecured creditor”.

Furthermore, Swaraj Infrastructure relied on section 441(2) of the Companies Act to claim that the winding-up of a company is deemed to commence at the time of presentation of the petition for winding-up. Therefore, it is the stage of the presentation of the petition at which a secured creditor has to relinquish the security. Contrary to this, the Bank argued that the decision to relinquish security has to be made at the stage of proof of claims, which is only after a winding-up order has been passed.

The Supreme Court, at this point, clarified the position by relying on Hansraj v. Official Liquidators, Dehradun Mussoorie Electric Trading Company Limited, and observed that a winding-up petition of a secured creditor is maintainable similar to the petition of a creditor under section 439(2) of the Companies Act. Moreover, the application of section 9(2) of the Provincial Insolvency Act at the time of presentation of winding-up petition was also disregarded. Under the Companies Act, section 528 and 529 provides for application of insolvency rule in winding-up of an insolvent company. These sections fall under the chapter dealing with ‘Proof and Ranking of Claims’ in the Companies Act. Therefore, the rules of insolvency are applied only in the matter of proof of debts as per section 529(1) of the Companies Act which is a stage after the order of insolvency. It is only section 47 of the Provincial Insolvency Act which reflects the stage envisaged under section 529. Therefore, if insolvency rule has to be applied in winding-up proceedings of an insolvent company, then section 47 of the Provincial Insolvency Act will be applied and not section 9(2).

Conclusion

In this order, the Supreme Court has held that the recourse available with a secured creditor under the Companies Act and the Recovery of Debt Act are not mutually exclusive. Moreover, it is not necessary for a secured creditor to relinquish the security before filing for a winding-up petition. Through this order the rights of a secured creditor has been further expanded and it has been ensured that secured creditor are able to recover what is legitimately due to them.

Isha Gupta

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