Battle for Claiming Secured Assets: Insolvency Code vs SARFAESI Act

[Jai Bajpai is a student at the School of Law, University of Petroleum and Energy Studies, Dehradun]

The objective of the Insolvency and Bankruptcy Code 2016 is to determine solutions for non-performing assets. It is to provide a collective mechanism for resolving insolvency within a framework of equity and fairness to all stakeholders and to preserve economic value in the process. It prescribes a time bound process that either ends in maintaining the firm as a going enterprise, or in liquidating the firm and distributing the assets to the various stakeholders through a collective mechanism for resolving insolvency.

On the other hand, the objective of the  Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act) was to allow financial institutions to determine the asset quality in different ways. In other words, the SARFAESI Act was enacted to identify and rectify the problem of non-performing assets through multiple mechanisms. The SARFAESI Act deals with assets in a legal manner, addresses the financial assets of banks and other secured creditors. According to multiple provisions under the SARFAESI Act , the financial institutions enjoy the rights and power to handle different types of bad asset issues.

Both the Code and the SARFESI Act largely deal with recovering bad debts by identifying and directing the assets of a debtor to fill the dent of bad debt. While making an attempt to grab control of such assets, it was inevitable then that both legislation were to cross paths at one point of time. This happened to be the case in Encore Asset Reconstruction Company Pvt. Ltd v. Ms. Charu Sandeep Desai. This case has cleared the woes regarding the two laws at loggerheads. The Code in this case has emerged as a clear winner with the deft reasoning of the National Company Law Appellate Tribunal. (NCLAT)

Facts of the case

In 2011 Calyx Chemicals and Pharmaceuticals Limited, the corporate debtor, secured a loan from Dena Bank by mortgaging its property. A charge was created in the favour of the bank against the property owned by the corporate debtor. There was default on repayment of the loan and, pursuant to this, Dena Bank initiated proceedings under the SARFAESI Act and the physical possession of the property was taken over by the bank in the year 2017.

Later, in October 2017, an application was filed under section 7 of the Code against the corporate debtor by State Bank of India before the National Company Law Tribunal (NCLT). This application was admitted in February 2018 and an insolvency resolution professional (IRP) was appointed. Moratorium was declared under Section 14 of the Code. Dena Bank then approached the NCLT seeking an interim order to stop the IRP from demanding custody of the property which was already in the possession of the bank as a result of the SARFESI proceedings.

Judgement of the NCLT

Relying on the Supreme Court’s decision in Transcore vs Union of India (2008 (1) SCC 125), Dena Bank argued that once the possession of a secured asset has been taken, then all rights to the property lie with the bank. The NCLT found that the Supreme Court had observed in the Transcore judgment that the rights in the asset can be claimed by the financial institution “as if” it is the owner of the asset and the words “as if” denote deemed ownership and not actual ownership of the property. Further, since the property continued to reflect as an asset in the balance sheet of the corporate debtor, the IRP was bound under section 18 of the Code to take control and custody of such property. It was also held that any further action by Dena Bank to enforce its security interest would be covered under the moratorium. As a result, all the properties a corporate debtor should be taken together for further consideration for liquidation.

Section 18 of the Code provides for the ‘duties of interim professional’ and specifically clause (f) and (f)(i) allow for the IRP to take “control” and “custody” of assets of corporate debtor. The clauses read as:

18. The interim resolution professional shall perform the following duties, namely:-

(f) take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets including—

(i) assets over which the corporate debtor has ownership rights which may be located in a foreign country; (ii) assets that may or may not be in possession of the corporate debtor; (iii) tangible assets, whether movable or immovable; (iv) intangible assets including intellectual property; (v) securities including shares held in any subsidiary of the corporate debtor, financial instruments, insurance policies; (vi) assets subject to the determination of ownership by a court or authority.

The decision of the NCLAT

The NCLAT observed that section 18 of the Code stipulates that it is the duty of the IRP to control and take control and custody of the assets of the corporate debtor in which he has “ownership rights” as stated in the balance sheet of the corporate debtor, including the assets that may or may not be in possession of the ‘corporate debtor’. Such an observation can be made from a direct reading of clauses (f) and (f)(1)  both of which stipulate at the starting that the IRP can “take control and custody of any asset over which the corporate debtor has ownership rights.”

Thus, the NCLAT rejected the appeal, holding that although the asset was not in the possession of the corporate debtor. Encore was bound to transfer the property to the IRP because the title still remained with the corporate debtor. It was even not the case that of the title of the property was transferred or that the asset had been sold in terms of section 13(4) of the SARFAESI, which allows for the secured creditor to take recourse to selling a secured asset in case a borrower fails to discharge his liability; this right lies with the creditor among other rights enshrined under section 13.

Further, the NCLAT stated that Transcore was a judgement given in 2008 which was much prior to the existence of the Code. Now that the Code is in force, section 238 (non-obstante clause) makes it clear that the Code prevails over any inconsistent provision of the SARFAESI Act.

Conclusion

The Encore case offers us clear and deft reasons for the Code to prevail over SARFESI Act. The Code must be allowed to pool all the necessary assets of the corporate debtor in order to satisfy the claims of creditors. A financial institution having a security over an asset cannot make claims with regard to the ownership, as the title still lies with the corporate debtor and, in so far as it lies with the corporate debtor, the asset should be managed according to the Code. This case has then clearly demarcated the line for future disputes and issues regarding the management of an asset of a corporate debtor which is held by a bank or financial institution as a security.

Jai Bajpai

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