[By Sparsh Srivastava]
The author is a student at National Law University Odisha.
Introduction
Earlier this year, the Supreme Court of India was presented with a pivotal question: Does Section 30(2)(b)(ii) of the Insolvency and Bankruptcy Code 2016 (“IBC”), as amended in 2019, entitle a dissenting financial creditor to be paid the minimum value of its security interest? The implications of this question are significant for the treatment of dissenting financial creditors and its rippling effects on the Corporate Insolvency Resolution Process (“CIRP”).
The Apex Court decided that a dissenting financial creditor (“DFC”) who did not agree with the proposed resolution plan is entitled to refrain from participating in the proceeds outlined therein unless a higher amount aligned with its security interest is approved within the resolution plan. In other words, a DFC has right to be paid a minimum amount of its security interest. It is to be noted that the amount to be paid to the DFC must adhere to the amount as prescribed in the event of the liquidation of the corporate debtor under Section 53(1). Essentially, it provided that the is entitled to a monetary value equivalent to its security interest.
It also highlighted that the conflict with section 30(2)(b)(ii) does not arise since it pertains to the minimum payment to be made to an operational creditor or a dissenting financial creditor. The idea behind such provision is to prevent jeopardizing and recognizing the rights and interests as the Dissenting financial creditors do not vote in favor of the scheme, while operational creditors do not have voting rights, therefore their interests must be secured.
The reasoning provided therein prima facie looks good in law, though it fails to look into the practical possibilities that may lead to dire consequences. The author attempts to look at the judgment through different lenses to critically appraise the judgement while drawing inspiration from other jurisdictions.
The Way to DBS Judgement
By bare reading of section 30(2)(b)(ii), it is clear that the proposed resolution plan by the resolution applicant shall provide the payment to a dissenting financial creditor, which is not less than the amount payable in the event of liquidation of the corporate debtor. The Supreme Court reinstated the position and held that a dissenting financial creditor is entitled to a minimum liquidation value.
In Jaypee Kensington Boulevard Apartments Welfare Association v. NBCC (India) Ltd., the Supreme Court clarified that a secured financial creditor who dissents may enforce their security interest to the extent of their claim. Further, in the recent DBS Bank judgement, the Supreme Court reinstated that a dissenting financial creditor is entitled to at least the value of their security interest.
The Principle of ‘First in Time, First in Right’
The legal maxim “Qui prior est tempore potior est jure” underpins the Doctrine of Priority, which is relevant in the present context of secured transactions. Section 48 of the Transfer of Property Act stipulates that when rights are created by transfer over the same immovable property at different times, each later created right shall be subject to the rights previously created unless a special contract or reservation binding the earlier transferees is in place.
Applying this doctrine in the present scenario, it can be argued that the liability of the Corporate Debtor and the right of the Financial Creditor to a specific amount arise only when the resolution plan is approved by the CoC, creating new rights and liabilities.
Section 31 of the IBC creates a binding effect on all creditors, including dissenting financial creditors, indicating the legislative intent to prioritize the resolution process. Since the resolution plan applies uniformly, no creditor’s rights can be considered as superior to another’s. Therefore, creditors, whether assenting or dissenting, should stand on equal footing as the resolution plan supersedes previous contracts and establishes new rights and liabilities.
Expert Opinion: Looking into the ILC Report
According to the Report of the Insolvency Law Committee 2018, regulation 38(1)(c) of the Corporate Insolvency Resolution Process (CIRP) Regulations mandates that dissenting financial creditors are paid at least the liquidation value in priority to other financial creditors who voted in favor of the resolution plan. The Committee suggested that prioritizing payment to dissenting creditors might not be prudent as it could incentivize financial creditors to vote against the plan, potentially hindering resolution.
The Committee recommended improving the quality of resolution plans through sustained efforts by regulatory bodies rather than altering statutory guarantees. However, this argument is flawed for several reasons. Firstly, discouraging financial creditors from voting against the resolution plan conflicts with their right to dissent and could undermine their interests. Secondly, focusing on better resolution plans does not address the core issue and instead adopts a superficial approach.
Drawing Parallels from other Common Law Countries
In the United Kingdom, under Section 901G of the Companies Act 2006, which deals with the sanction for compromise or arrangement where one or more classes dissent, the court can sanction a compromise or arrangement even if a dissenting class has not agreed, provided two conditions are met. The first condition requires that the court be satisfied that dissenting class members would not be worse off than in the event of the relevant alternative, typically liquidation. The other requirement is that the compromise or arrangement has been agreed upon by a majority representing 75% in value of a class of creditors or members who would receive a payment or have a genuine economic interest in the company in the event of the relevant alternative. In case of liquidation, the secured creditors, both would have the option to realize their security interests.
The US Bankruptcy Code contains a similar provision under 11 U.S. Code § 1129, which outlines the requirements for plan confirmation. It states that each holder of an impaired claim or interest must receive or retain property under the plan of a value not less than the amount they would receive if the debtor were liquidated under Chapter 7 of the Bankruptcy Code. This provision ensures that secured creditors receive the amount they would have received at the time of liquidation, regardless of whether they accept the plan. Additionally, the plan must be fair and equitable, ensuring that secured claims are satisfied through lien retention, deferred cash payments, or other equivalent means. Thus, it provides rather a wider set of protection to the dissenting.
The Indian law apparently draws inspiration from the above systems. However, the insolvency regime cannot be equated because of the prevailing differences in the economic system and situations between the countries. For instance, the secured creditors, unlike under IBC, have the option to enforce security outside of the liquidation estate. Such rights provide security and avoid uncalled disparities between the same class of creditors.
Implications of the Judgement: A critical view
Notably, it is not mandatory for the Committee of Creditors (“CoC”) to provide the assenting secured creditors with liquidation value. However, if a secured creditor is dissatisfied with the proposed payout, they can vote against the resolution plan or the distribution of proceeds. As a consequence, section 30(2)(b)(ii) shall be attracted and effectively providing the full liquidation value of their security as per Section 53(1) in the event of the liquidation of the corporate debtor.
This approach is fundamentally flawed as the secured financial creditors, under such circumstances, may only approve a resolution plan that offers them equal or more than their security interest, potentially hampering the resolution process and defeating the IBC’s objective of reviving sick companies and maximizing credit from assets. This could lead to increased costs of the CIRP and a higher number of liquidations.
Allowing secured creditors to invoke their security during the CIRP would also defeat the purpose of the moratorium, which aims to maximize the entity’s value by continuing operations while assessing viability. The Bankruptcy Law Reforms Committee emphasized that the moratorium is intended to prevent additional stress on the business during the IRP by staying debt recovery actions and lawsuits.
Conclusion
The treatment of dissenting financial creditors under the IBC is a complex issue with significant implications for the insolvency resolution process. Judicial interpretations and comparative analyses of laws in other common-law countries provide valuable insights. However, balancing the rights of dissenting creditors with the objectives of the IBC remains a challenging task, requiring careful consideration of both legal principles and practical implications.
The DBS judgement is apparently short-sighted and eschews the implications of providing an edge to dissenting secured creditors. Creating a distinction between assenting and dissenting creditors, as both represent one unit (CoC) in terms of the pay-out one may receive, without any intelligible differentia may violate the idea of equality. The rippling effect may also hamper the resolution process and may go against the purpose of IBC, i.e. resolution of the corporate debtor. Thus, the judgement adopts a narrow approach and negates the legislative intent behind the Code, therefore, should be revisited.