[Shreya Dagar is a 3rd year B.A. LL.B. (Hons.) student at National Law University Jodhpur]
The National Company Law Appellate Tribunal (“NCLAT”) on 18 June 2020 decided in favour of the liquidator in Srikanth Dwarakanath v. Bharat Heavy Electricals Limited (BHEL). The case dealt with the liquidation of Surana Power Limited (“SPL”). The tribunal imported a provision of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”)in order to answer a question pertaining to the Insolvency and Bankruptcy Code, 2016 (“IBC”).
In this post, the author argues that the reliance placed on the provision of SARFAESI Act was unjustified, as BHEL cannot be bound by the same. It is then proposed that the principles of the IBC could have been used in order to yield the same conclusion. It is further argued that the abovementioned judgment could lead to unintended results and set a bad precedent for certain cases in future.
Background
Section 52(1) of the IBC provides two ways for realizing the outstanding amount of the assets due to the secured creditors. They can either relinquish their security interest to the liquidation estate by virtue of section 52(1)(a) or realize their security interest in terms of section 52(1)(b). Section 52(1)(b) provides that the creditors can take recourse to section 52(4) and “may enforce, realize, settle, compromise or deal with the secured assets in accordance with such law as applicable to the security interest”.
Facts of the Case
In this case, an application was filed under section 9 of IBC for initiation of corporate insolvency resolution process in respect of SPL. Since no resolution plan was approved, the liquidation of the corporate debtor was initiated. At the time of liquidation, BHEL commenced arbitration proceedings and was awarded a lien over the assets of SPL, thereby making it a secured creditor. However, these assets were already hypothecated to other secured creditors and, thus, BHEL did not have an exclusive charge over them. The liquidator sought to proceed with a slump sale of SPL. All the secured creditors agreed to relinquish their individual security interests, although BHEL refused to do so. As a result, the liquidator could not undertake the slump sale. The liquidator then filed an application to the National Company Law Tribunal (“NCLT”) seeking to proceed with the sale of the assets. BHEL, refusing to relinquish its security interest, contended that it had an “unqualified and unbridled” right to realize its security interests, in accordance with any law, by virtue of section 52(1)(b) of the IBC.
The application was subsequently rejected. The liquidator appealed to the NCLAT, which decided in his favour by applying a provision of the SARFAESI Act. It applied section 13(9) of the SARFAESI Act and held that BHEL cannot realize its security interest according to section 52(1)(b) as it lacks a minimum of 60% value in terms of the total assets.
Application of the SARFAESI Act was Unwarranted in the Present Case
It applies only to banks and financial institutions
BHEL cannot be bound by the principles of SARFAESI Act, as its application is confined to banks and financial institutions. Section 2(1)(m)(iv) of the SARFAESI Act defines a financial institution. According to this section, a financial institution is “any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934…which the Central Government may, by notification, specify as financial institution for the purposes of this Act”.
In Kotak Mahindra Bank Ltd v. Trupti Sanjay Mehta, the Bombay High Court considered the circumstances which led to the enactment of the SARFAESI Act. In this case, it was held that the statement of objects and reasons of the Act provide that it was specifically enacted for the benefit of financial institutions and banks, and to ensure a speedy recovery of non-performing assets. Later, non-banking finance companies were also included under the purview of this Act. Therefore, the Act cannot be extended to BHEL, as it is an engineering and manufacturing company.
Precedence cannot be given to the SARFAESI Act over the IBC
In the present case, the proceedings were originally taking place under the provisions of the IBC. By applying the SARFAESI Act, the NCLAT has accorded it priority over the IBC. Courts have held that in case of a conflict between the IBC and the SARFAESI Act, preference must be given to the IBC. In Canara Bank v. Sri Chandramoulishvar Spinning Mills, the NCLAT referred to the judgment of the Supreme Court in Innoventive Industries Ltd. v. ICICI Bank and held that, in case two simultaneous proceedings are commenced under the IBC and the SARFAESI Act, the proceedings under the IBC shall take precedence over proceedings under the SARFAESI Act. Moreover, it flows from section 14(1)(c) of the IBC, which imposes a moratorium and precludes any action under SARFAESI Act as long as the corporate insolvency resolution process is in force.
Application of IBC was sufficient to provide a similar conclusion
The NCLAT should have applied the provisions of the IBC, as it would have provided the same conclusion. In JM Financial Asset Reconstruction Company Ltd. v. Finquest Financial Solutions Pvt. Ltd., the question dealt with the absence of an exclusive charge pertaining to the assets concerned. More than one secured creditor sought to realize its security interest against the same assets. The NCLAT ruled that the liquidator is required to verify the interest in terms of section 52(3) of IBC and determine who has the first charge so that the preference could be given to the first charge holder in terms of realization of its security interests.
The same could have been applied in this case as well. The NCLAT should have refrained from the application of SARFAESI Act and directed the liquidator to find out whether BHEL had the first charge on the securities vis-à-vis the other secured creditors. BHEL became a secured creditor by virtue of an arbitral award which granted it a lien on the assets of SPL in 2018; whereas, the other secured creditors had an interest against the same assets by way of a hypothecation deed executed in 2010. The circumstances of the case prove that BHEL did not have a prior charge pertaining to the assets. A charge which is created prior in time is considered to be superior. This flows from section 48 of the Transfer of Property Act, 1882. In ICICI v. Sidco, the Supreme Court had held that a priority of charges can exist between secured creditors as well, and it should be respected. The application of this principle by the NCLAT could have precluded the use of the SARFAESI Act and would have resulted in a similar conclusion.
Sets a flawed precedent
The ruling will certainly act as a bad precedent. Following it would lead to an unjust conclusion in certain cases. For instance, consider a situation where secured creditors possess an inferior charge that accounts for 65% value of the total assets, while there is a secured creditor having prior charge that accounts to merely 35% value of the total assets. The latter will be prevented from realizing their interest by way of section 52(1)(b) in case the other secured creditors refuse to grant their consent for the same.
Concluding Remarks
According to section 52(2) of the IBC, when a secured creditor intends to realize its security interest by way of section 52(1)(b), it has to inform the liquidator regarding its intention towards the same. The liquidator then verifies the existence of such a security interest in accordance with section 53(3) and permits the creditor to proceed with section 52(4). The secured creditor can file an application to the adjudicating authority in case there is a resistance against it by the corporate debtor or any other connected person under section 52(6) of IBC. The issue arose in this case because BHEL failed to follow the above procedure. However, this could not be deemed as a valid reason to foreclose all forms of recourse. Section 13(9) of the SARFAESI Act, used by the NCLAT in the present case, may work in cases where all the parties possess a similar charge. However, an absence of a recourse in IBC does not render the use of the SARFAESI Act justified. This is especially so if used broadly to accommodate all types of situations.
– Shreya Dagar
The article is well written. But Sarfasesi may be applicable as BHEL is only one secured creditor. The other secured creditors, who may also be be banks/financial institutions are not prevented by Regulation 37 (Liquidation Process rules) from enforcing their liquidation interest under SARFAESI. Also, the question of first charge or prior charge overriding other charges does not arise in the context of IBC. Section 53 gives priority to all secured creditors on an equal footing once security interest has been relinquished under section 52.