The Conundrum of Inter-se Priorities between Secured Creditors in Liquidation

[Arvind Tiwari is a IV year student at the National Law University, Delhi]

The recent ruling of the National Company Law Appellate Tribunal (“NCLAT”) in Oriental Bank of Commerce v. Anil Anchalia has rekindled the debate concerning the significance of inter-se priorities among secured creditors in the process of liquidation. In this matter, it was held that once a secured financial creditor has relinquished its security interest over the corporate debtor’s assets, such secured financial creditor cannot seek priority over other secured creditors in the process of distribution of the amount received from the sale of the secured asset. Effectively, the NCLAT held that after relinquishing the security, a secured financial creditor is only entitled to receive sale proceeds on a pro-rata basis along with the other secured creditors in accordance with section 53 of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

This post argues that the interpretation of the NCLAT is based on a faulty application of a precedent.

Factual Background

Bala Techno Industries Ltd. (“Corporate Debtor”) availed a loan from the Oriental Bank of Commerce (“Appellant”) in 2014. The loan was secured with an exclusive charge created in favour of the Appellant over factory land, plots and building of the Corporate Debtor located in West Bengal. However, the Corporate Debtor defaulted in clearing its outstanding dues, and consequently, the Appellant declared its loan account as a Non-Performing Asset. The Appellant commenced a Corporate Insolvency Resolution Process (“CIRP”) against the Corporate Debtor in October 2019. During the CIRP, no resolution plan for the Corporate Debtor was approved, and consequently, the National Company Law Tribunal, Kolkata Bench (“NCLT”), passed an order of liquidation on 15 February 2021. Thereafter, the Appellant relinquished its security interest over the secured assets of the Corporate Debtor. Since the secured assets were a part of the liquidation assets, they were sold by Anil Anchalia (“Liquidator”). The Appellant claimed the sale proceeds on the ground that it was the first and exclusive charge-holder with respect to the secured assets. Despite the claim of the Appellant, the Liquidator distributed the amount received in the sale of the secured assets on a pro-rata basis in accordance with section 53 of the IBC.

The Appellant, being aggrieved by this, approached the NCLT seeking an order to direct the Liquidator to distribute the entire sale proceeds of the secured assets in question in favour of the Appellant as it had an exclusive charge over the secured assets, which were a part of the liquidation assets. The NCLT dismissed the Appellant’s Application, and subsequently, the Appellant filed an appeal against the order passed by NCLT. The Appellant referred to the judicial developments concerning NLCAT’s decision in Technology Development Board v. Anil Goel , in the appeal against the NCLT’s order. The NCLAT in Technology Development held that once secured creditors have relinquished their security interest over the asset of the corporate debtor, they are not entitled to receive any sum realized from the sale of the specific secured asset, and are governed by the distribution waterfall laid down in section 53 of the IBC. The Appellant argued that since the Supreme Court stayed the order passed by the NCLAT in Technology Development, it is entitled to be paid in priority in terms of its exclusive charge over the secured assets (notwithstanding that they were part of the liquidation pool).

The Tribunal’s Decision

The NCLAT set aside the appeal stating that the issue in question is no longer res integra and has been settled by the Supreme Court in its judgment in India Resurgence ARC Private Limited v. Amit Metaliks Limited, which was delivered after Technology Development. The Supreme Court, in Amit Metaliks, held that it is the wisdom of the committee of creditors that will prevail in relation to the question of what sum is to be paid to various classes or sub-classes of creditors, and it was not the intention of the legislature to bestow upon one dissenting financial creditor the right to claim an amount higher than the proposed receivable liquidation value for the same class of creditors in the resolution plan. Based on Amit Metaliks, the NCLAT, in the instant appeal, held that after relinquishing its security interest, Secured Financial Creditors cannot seek priority over other similar creditors during the distribution of sale proceeds of the secured assets.

Analysis

The NCLAT, in Oriental Bank, has wrongly applied Amit Metaliks as the core issue involved in both matters is different. Amit Metaliks primarily deals with the scope of judicial intervention in the process of consideration and approval of a resolution plan, the significance of the committee of creditors and the treatment of dissenting financial creditors in the resolution process. However, in Oriental Bank, the primary issue is whether inter-se priorities between secured financial creditors operate after they have relinquished their security interests in accordance with section 52 of the IBC.

Essentially, these judgments are dealing with different stages of a company. When a company is undergoing CIRP, the focus is on the company’s revival and rejuvenation, and the resolution process is not to be treated like a recovery proceeding. On the other hand, one of the purposes of a liquidation process is discharging the debts and liabilities of the company (as opposed to the rejuvenation of the company as a going concern). Thus, the considerations at the stages of resolution and liquidation are different. Moreover, Amit Metaliks discusses priority between secured creditors with reference to section 30(4) of the IBC, and while referring to the Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, the Supreme Court noted that the Committee of Creditors is not necessarily required to take a decision in accordance with the priority stipulated in section 53. These are merely guidelines that the Committee of Creditors may consider.

Unlike Amit Metaliks where the company was undergoing resolution process, in Oriental Bank, no resolution plan could be approved for the Corporate Debtor, and consequently, a liquidation process was initiated. During the liquidation process, the distribution of liquidation assets must be strictly in accordance with section 53 of IBC. Logically, therefore, we must look at how the question of priorities between the secured creditors at the stage of liquidation is understood in the context of section 53.

The Report of the Insolvency Law Committee released in March 2018 (“the Report”) specifically dealt with this issue and observed the principles emanating from the Supreme Court judgment in ICICI Bank Limited v. SIDCO Leathers Limited apply to section 53. In SIDCO Leathers, the Supreme Court interpreted sections 529 and 529A of the erstwhile Companies Act, 1956. These provisions also dealt with a ranking of claims during the liquidation process. The Supreme Court, in SIDCO Leather, held that a pari passu treatment of workmen’s dues and secured creditors’ claims does not imply that the concept of interse priorities between secured creditors stands extinguished during liquidation. Further, the Supreme Court noted that the claim of the chargeholder over secured assets stems from section 48 of the Transfer of Property Act, and this right exists even when the debtor is undergoing liquidation. Since the Companies Act, 1956 does not contain any provision dealing with statutory and contractual rights among secured creditors, the general provisions creating a statutory right would prevail in the event of liquidation.

The Report further added that the principle laid down in SIDCO Leathers is applicable even in situations where the secured creditors have relinquished their security interest. The justification given for the same was that secured creditors fall within the ambit of section 53(1)(b)(ii) of the IBC and are clearly distinguished from unsecured creditors under the framework of IBC. According to the Report, the reason for placing secured creditors who have relinquished their security interest above unsecured creditors in the distribution waterfall was to protect the security interest of secured creditors during liquidation and to encourage relinquishment.

The Report noted the argument in favor of disregarding priorities among secured creditors during liquidation that if inter-se priorities are recognized during liquidation, secured creditors might push for liquidation instead of resolution. However, the Insolvency Law Committee responded to this argument by highlighting that usually secured financial creditors are sophisticated entities that extend financial assistance after thorough due-diligence and evaluation of risks. Disregarding inter-se priorities of secured financial creditors during liquidation will adversely impact the credit market. Banks and other financial institutions will be discouraged from granting loans against property, and other collateral as their security interest will not be protected in liquidation.

Conclusion

The NCLAT’s decision in Oriental Bank has weakened the position of secured financial creditors during liquidation and has exacerbated the dilemma on the inter-se priorities between secured financial creditors during liquidation. Limiting the right of secured financial creditors at the stage of resolution could be justified as the focus during resolution is to revive the corporate debtor. However, extending this limitation to the liquidation phase deprives secured financial creditors of their valuable property right and diverges from the harmonious interpretation of law concerning customary banking practices and contractual rights.

– Arvind Tiwari

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