Author name: CBCL

[By Rohan Srivastava & Priyanshu Mishra] The authors are students of National Law School of India University, Bengaluru.   Introduction In 2022, the Supreme Court in the case of State Tax Officer v Rainbow Papers, (hereinafter “Rainbow Papers”) held that Security Interests, which are placed at the second highest priority under the Insolvency and Bankruptcy Code (IBC) waterfall mechanism (contained in Section 53) may be created by operation of statutes. The controversial verdict has since then attracted a lot of criticism for undoing the economic and creditor-friendly rationale of the IBC. Recently, in the case of Paschimanchal Vidyut Vitran Nigam Ltd(PVVNL) v Raman Ispat Private Limited and Ors, (hereinafter “Paschimanchal Vidyut”) the Supreme Court has attempted to limit the applicability of the Rainbow Papers verdict by confining it to its own peculiar sets of facts. This has been commented upon as essentially “quarantining” the ratio of Rainbow Papers from future applicability. This piece shall delve into the reasoning in Paschimanchal Vidyut to highlight how it deviates from Rainbow Papers and can be seen as a part of the judicial trend of diluting the applicability of the Rainbow Papers verdict. In doing so, this post shall also attempt to shed light on the current applicability of Rainbow Papers, in light of various contradictory verdicts given by the courts on the meaning of “statutory dues” etc and also highlight the lack of uniformity in the jurisprudence. The Verdict in Paschimanchal Vidyut In Paschimanchal Vidyut, the appellant, PVVNL had entered into an agreement with Raman Ipsat for the supply of electricity. Clause 5 of the said agreement provided that “any outstanding dues shall be a charge on the assets of the company”. Reliance was placed on such wording by PVVNL to attach the property of Raman Ipsat upon non-payment of dues for recovery under regulations framed under the Electricity Act, 2003. The said attachment was challenged by the respondent claiming that it interfered with the liquidation proceedings that were ongoing against Raman Ipsat under the IBC, after failure of the resolution process. The NCLT set aside the impugned attachment order as it interfered with the Liquidation proceedings and declared that the assets of the company would be distributed according to the waterfall mechanism contained in the IBC. The NCLAT also endorsed the NCLT’s holding and held that PVVNL had to recover its dues under the IBC as a secured operational creditor within the waterfall mechanism. In the Supreme Court, PVVNL had argued that it was entitled to recover its dues under the Electricity Act and the mechanism provided in regulations framed under it by virtue of it being a special law and having non-obstante clauses. Alternatively, it had also argued, that in light of the Rainbow Papers verdict, the electricity dues were “secured interests” and the same had also been held by the impugned NCLT and NCLAT orders. In opposition, the Liquidator had argued that the IBC, having already provided a different section for government dues, does not view the government as a secured creditor under the waterfall mechanism and the said dues were covered under Section 53(1)(e) as an amount owed to the government. The Supreme Court firstly affirmed the overriding nature of the IBC over the Electricity Act and clarified that PVVNL cannot seek recovery under the Electricity Act but only under the IBC’s waterfall mechanism. On the second question, the SC clarified that PVVNL will be a secured creditor under the waterfall mechanism. This post shall focus on the reasoning used by the court in arriving at its second conclusion. Contrasting Rainbow Papers and Paschimanchal Vidyut In distinguishing the State as a “Secured Creditor” from “amount due to the government” under 53(1)(e), the court alludes to the wording of 53(1)(e) which makes a reference to the consolidated fund. The Court reasons that the liquidator’s argument that the electricity dues were an amount due to the government under 53(1)(e) is unfounded as it is a due owed to a corporation created by statute which has a separate juristic entity. The Court uses a functional test and concludes that PVVNL’s functions were something which could be performed by private entities as well and was not a governmental function. While the reasoning in Rainbow Papers and the Court’s reasoning, in this case, both arrive at the same conclusion, the Supreme Court explicitly negates the applicability of Rainbow Papers. The approach in the current case is one which defines State very narrowly, with reference to the consolidated fund and Article 165 of the Constitution, having defined the state narrowly and excluded statutory corporations from its ambit, the court then evaluates the nature of the dues as to whether they are secured or not. Contrary to this, the Rainbow Papers’ decision does not allude to 53(1)(e) to exclude “State” but directly jumps to the evaluation of the nature of interest, regardless of whether the dues come under 53(1)(e) or not. Such an approach is more textually fitting to the scheme of the IBC given that the code’s preamble along with its provisions has sought a different treatment of government dues. Having a two-stage enquiry as laid down by the court in this case by first applying the definition of State to the party and only if the question is answered in the negative, then going to the question of secured interest, is thus more appropriate than broadly giving the status of the secured creditor to the statutory first charge. Being a coordinate bench, however, the Supreme Court could not overrule Rainbow Papers but instead distinguished it on the ground that Rainbow Papers was not in the context of liquidation, hence was not binding in the given case and must be confined to its factual matrix. This distinction however stands on flimsy grounds as the court did not provide any principled arguments as to why Rainbow papers’ verdict shall not apply to liquidation proceedings and be limited to the CIRP. This can be seen as a part of the broader judicial course-correction trend which has

[By Akshay Dhekane] The author is a student of National Law University, Delhi.   INTRODUCTION Professor Roy Goode has succinctly put the importance of security in banking as “vast sums of money which might not otherwise be dispensed are lent in reliance on real security over all kinds of asset, including land, goods and receivables”. However, the complexity of raising finance increases when third-party security beneficiaries are involved. A third-party security is an arrangement where the creditors receive security to secure the debt of a borrower from a third-party (generally a parent or subsidiary company). When dealing with these beneficiaries, one of the most contentious matters that arises is the determination of the status of third-party security beneficiaries. For this reason, this article will examine key cases, particularly focusing on the recent Supreme Court decision in M/S Vistra ITCL (India) Ltd & Ors. v Mr. Dinkar Venkatasubramanian & Anr (“Vistra ITCL”). The article explores a way in which third-party security beneficiaries can be treated as financial creditors. For this, it analyzes the current legal framework and expresses the needed alterations by analyzing the definition of financial debt under Section 5(8) of the IBC. Two approaches had emerged regarding the treatment of third-party security beneficiaries. The first approach, as taken by the NCLT in SREI Infrastructure Finance Limited v Sterling International Enterprises Limited considered such creditors as financial creditors of the third-party security provider, based on the mortgagor’s liability for repaying the underlying debt. Here, the mortgagor (vide the Transfer of Property Act, 1882) was held to be obligated to repay the mortgage money hence, it was vital to recognize their security interest and treat them as a financial creditor. This approach, however, failed to gain traction and was overruled. The second approach as laid down in Anuj Jain IRP for Jaypee Infratech Limited v Axis Bank Limited (“Anuj Jain”) states that providing security does not qualify as a ‘financial debt’ under Section 5(8) of the Code, and therefore, such creditors should not be categorized as financial creditors vis-à-vis the security provider. This position was reaffirmed by the Supreme Court in Phoenix ARC Pvt. Ltd. v Ketulbhai Ramubhai Patel (“Phoenix ARC”). In Phoenix ARC, the creditor was held to be a secured creditor only against the third-party security provider. However, while treating Phoenix as a secured creditor, the scope of the decision was limited to deciding the claims only. THE SAGA CONTINUES The recent decision of the Supreme Court in Vistra ITCL attempted to tweak the prevailing legal framework by holding Vistra (the third-party security beneficiary) to be a secured creditor and entitled to all the rights and obligations available to a secured creditor. While adjudicating the case, the court decided not to recognize Vistra as a financial creditor, citing the prevailing legal position established in Anuj Jain and Phoenix ARC. In Anuj Jain, the court held that the mortgage in that case did not create a financial debt as the definition of financial debt was interpreted in a narrow manner. In Phoenix ARC, the court held that the “pledge of shares” did not meet the criteria of constituting a “disbursement of any amount against the consideration for the time value of money.” Consequently, the pledge of shares did not fall within the purview of subclause (f) of sub-section (8) of Section 5 of the IBC. SOLVING THE THIRD-PARTY SECURITY CONUNDRUM The jurisprudence that has evolved from these cases (in a broad and abstract manner) establishes that a debt can be classified as a “financial debt” when it is disbursed against the time value of money. The courts have taken the view that the debt so “disbursed” must be towards the corporate debtor. As per Vistra ITCL, even if the corporate debtor was the direct and real beneficiary of the debt, the creditor cannot be treated as a financial creditor considering the lack of an obligation to repay, perform the promise, or discharge the liability of the borrower. The corporate debtor’s liability is distinguished and limited by the fact that it needs to have entered into a contract to perform the promise, or discharge the liability of the borrower in case of their default to make the third-party creditor to be their “financial debtor”. The features of the expressions used in Sections 5(7) and 5(8) of the Code in defining the terms “financial creditor” and “financial debt” should be revisited. A third-party security can be treated as a financial debt under Section 5(8) of the IBC in the following ways: For convenience, the requirements under Section 5(8) of the IBC are divided into three parts. First, it is shown that the term ‘debt’ as used in defining ‘financial debt’ includes third-party security. Second, the argument progresses to explicitly demonstrate the fulfillment of the disbursal requirement. The third part involves assessing whether this disbursement was made ‘against the consideration of the time value of money’. a.     there exists a debt Firstly, it needs to be noted that the definition of financial debt must be construed in an extensive manner. When the words “means and includes” are used together, they become difficult to interpret.[1] When ‘include’ is used in a definition after ‘mean’, it is used to imply a comprehensive explanation of the meaning that must be consistently associated with these words or expressions for the purposes of the Act. In Swiss Ribbons Private Limited v. Union of India (“Swiss Ribbons”) the definition of financial debt was interpreted to be an inclusive one. Further, in Nikhil Mehta & Sons v AMR Infrastructure Limited (“Nikhil Mehta”) to clarify the position of homebuyers/allottees as financial creditors, the definition was read in an extensive manner. The Insolvency Law Committee hereafter the “ILC”) in its 2018 report backed the same viewpoint, deeming this definition inclusive. A collective reading of Section 5(7), Section 5(8), and Section 3(11) of the IBC makes it clear that for someone to become a creditor, there must be a debt owed by any person, or it must be transferred or assigned. So,

[By Saumya Mittal & Keerthana Rakesh] The authors are students of Gujarat National Law University.   Introduction In a dramatic chain of events, Go First, one of the most profitable and most sought-after airlines in India, had to take a flight on the wings of Section 10 of the Insolvency and Bankruptcy Code, 2016. With its faulty engines, the aviation company found itself in hot water due to mounting losses and unpaid credit. But the news didn’t bode well for the operational creditors of the company who were well aware that a Corporate Insolvency Resolution Process (CIRP) takes an average of 588 days in India and by the time a resolution plan develops, most of the value of the assets would have eroded. To counter the same, they presented the National Company Law Tribunal (NCLT) with multiple arguments, one of them being that no notice of initiation of CIRP under section 10 was served to the operational creditor by the corporate debtor, thus depriving them of the opportunity to object to the said application. Section 10 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) allows the Corporate Debtor to initiate CIRP against itself by filing an application before the Adjudicating Authority. Having heard both the sides, the NCLT vide order no. (IB)-264(PB)/2023 admitted the application and favored the Corporate Debtor by stating that a Corporate Debtor is not obliged to serve notice to its creditors as Section 10 or 11 of the IBC does not prescribe the said requirement. The position on serving of notice being clear, this article attempts to inspect the decision of the NCLT with respect to the serving of notice under section 10 and whether the same should be made mandatory. Issue and Contentions of the Parties The issue arose when Go Airlines (India) Limited filed an insolvency application under Section 10 of the IBC before the NCLT, Delhi, to initiate the CIRP proceedings against itself. The Corporate Debtor submitted that it is in financial distress due to continuous default in payments to vendors and aircraft lessors. Since it has a subsisting debt of more than Rs. 1 Crore, it is entitled to file an application under the said section of the IBC. The creditors of the Applicant, on the other hand, were against the insolvency application as they contended that the Corporate Debtor did not give them due notice before filing the application before the NCLT. They pleaded that they were entitled to prior notice and that principles of natural justice should be duly adhered to. Further, the creditors contended that they should be provided with an opportunity to file an application under Section 65 of the IBC, which provides for action to be taken against any person who initiates CIRP with malicious intent. Notice under Sections 7 and 9 similar to that under Section 10? One important observation made by the tribunal in the Go First proceedings was that serving of notice to a corporate debtor by the financial and the operational creditor under sections 7 and 9 respectively, was a matter of right as application under the two sections was in personam and in the nature of a litigation thus making the corporate debtor a respondent. Also, the tribunal noted that a corporate debtor is an ‘aggrieved party’ and thus it should be served notice. But the same was not the case for notice under section 10. Since creditors didn’t constitute an ‘aggrieved party’ and are in the nature of a third party, serving notice to them is not legally compulsory and it merely depends upon the facts of each case. Thus, the notice under sections 7 and 9 is significantly different from that under section 10. The matter of whether notice under this section is obligatory has been largely resolved by the tribunal. However, a new consideration arises: Should this requirement be mandated? Before addressing this, it is prudent to examine Section 65, which grants distressed creditors the authority to initiate fraud proceedings against any deceitful CIRP. Rationale behind notice requirement in light of Section 65 Mention of section 65 whilst dealing with section 10 is a no-brainer. Section 65 of the 2016 code deals with the fraudulent initiation of Insolvency resolution proceedings by a person in order to defraud any stakeholder. It is settled law that section 65 proceedings can be initiated even after the imposition of a moratorium under section 14 of the code, and the same has been reiterated in the Go First NCLT Order. In this order, one sound question was raised- why should notice be served under section 10 if the provision of section 65 is there? If a party has the grievance that application for CIRP is fraudulent and has been filed just to defraud the creditors of their loans, the latter can very well file an application under section 65, and the proceedings would go along with the CIRP proceedings. Why does one, then, need an intimation via notice of filing for CIRP by the corporate debtor just to make sure that no fraudulent proceedings are initiated? The answer lies in the limited scope of section 65, which deals with only those cases where ‘fraudulent intention’ exists. However, consideration must also be given to instances where the corporate debtor’s actions were not driven by malicious intent. Nonetheless, these actions still had a substantial adverse effect on the creditors. In such cases, a prompt notification of the impending CIRP filing was essential to allow creditors to strategize appropriately. For these scenarios, regardless of intent, the necessity for a notice persists, and this requirement cannot be solely addressed by the provisions of section 65. Need for serving of notice under section 10 Serving notice to creditors during the initiation of the CIRP is a prudent approach that aligns with the spirit of IBC 2016 while fostering transparency, efficiency, and the best interests of all stakeholders involved. One of the primary reasons to serve mandatory notice to creditors is to enable them to be adequately prepared for