[By Gourav Kathuria & Awantika Yash]
The authors are students at NALSAR University of Law, Hyderabad.
Recently, the National Company Law Appellate Tribunal (“NCLAT”) in Technology Development Board v. Anil Goel & Ors. held that there can be no inter se priority among the secured creditors who relinquish their security interest at the time of liquidation under Section 53 of the Insolvency & Bankruptcy Code, 2016 (“the Code”). It further observed that secured creditors holding the first charge and subsequent changes in the security interest stand at an equal pedestal. This observation has caused confusion with respect to the preferential rights inter se secured creditors. This post aims to provide a critical evaluation of this judgment.
Understanding ‘Charge’ & ‘Inter se Priority’
Section 2(16) of the Companies Act, 2013 defines “charge” as an interest created on the assets to secure the repayment of debt. Multiple charges can be created over an asset. Charges over an asset are frequently shared on a pari passu basis, placing all the charge holders at an equal pedestal. However, there can be inter se priority of charges as well, that allows first charge holders to satisfy their claim before the subsequent charge holders. Section 48 of the Transfer of Property Act, 1882 (“TOPA”) establishes the priority of the first charge holders over the subsequent charge holders in satisfying their claim.
Section 52 of the Code provides two options for the secured creditors to realize their debts. Firstly, they can realize their security interest outside the liquidation process. Secondly, they can relinquish their security interest in favour of the liquidation estate and receive their share as per the waterfall mechanism laid down under Section 53 of the Code. However, Section 53 is silent on the inter se priorities among secured creditors. It does not provide whether the first charge holders will have priority over subsequent charge holders at the time of distribution of proceeds from liquidation estate.
Factual Matrix
In this case, the liquidator distributed the sale proceeds of the asset only among the first charge holders. Aggrieved by the liquidator’s decision, Technology Development Board (“the Appellant”), the second charge holder, filed a claim before the National Company Law Tribunal (“NCLT”). NCLT affirmed the inter se priority among the secured creditors and ruled in favour of the liquidator. The Appellant challenged this order before the NCLAT.
The NCLAT held that inter se priority among secured creditors is allowed only when the security interest is realized outside the liquidation process but not during the relinquishment of security interest. It premised its order on the reasoning that in case of relinquishment, sale proceeds must be distributed as per Section 53 of the Code. The NCLAT further noted that Section 53 of the Code has a non-obstante clause and hence, overrides the application of Section 48 of the TOPA. The NCLAT concluded that there is no inter se priority among the secured creditors.
Critical Analysis
Overlooked judicial precedents and established principles
In the present case, the respondent had relied on ICICI Bank v. Sidco Leathers Limited (“Sidco”) for one of his arguments. In Sidco, while interpreting Sections 529 and 529A of the Companies Act 1956, the Apex Court ruled that even though the debts of workmen and secured creditors are pari passu with each other, it does not nullify the inter se priority among secured creditors. To come to this conclusion, the court had relied on Section 48 of the TOPA. The Hon’ble Court observed that as the provisions of the Companies Act, 1956 are silent on inter sepriority among the secured creditors, the general law given under the TOPA must prevail. The judgment further noted that if the statute intended to take away the right to property of secured creditors, it would have explicitly stated so. However, the NCLAT disregarded this precedent. The NCLAT observed that the Sidco case was decided before the enactment of the Code. Furthermore, it noted that Section 48 of the TOPA would be inapplicable to this case as the non-obstante clause under Section 53 of the Code overrides any law enacted by the Parliament or State Legislatures.
The authors submit that this interpretation given by the NCLAT is flawed. Firstly, Section 52 of the Code and Section 529 of the Companies Act, 1956 originated from the same provision, i.e., Section 47 of the Provincial Insolvency Act 1920. Section 52 of the Code states that in case of relinquishment, sale proceeds must be distributed in accordance with Section 53. Section 529 of the Companies Act, 1956 also talks about the waterfall mechanism during liquidation. As these provisions of the law have the same origin and are used in the same context of the waterfall mechanism during liquidation, their interpretation must also be alike. Therefore, if the Supreme Court in Sidco had interpreted Section 529 of the Companies Act, 1956 to be respecting inter se priority among secured creditors, then Sections 52 and 53 of the Code must also be given the same interpretation
Secondly, In State of Bihar v. Bihar Rajya Mahasangh, the Hon’ble Supreme Court held, “A non-obstante clause is generally appended to a section with a view to give the enacting part of the section, in case of conflict, an overriding effect over the provision in the same or other act mentioned in the non-obstante clause.” On the reading of Section 48 of the TOPA and Section 53 of the Code, it is clear that there is no conflict between these sections as Section 53 is silent on inter se priority among secured creditors. Therefore, the NCLAT’s observation was erroneous as the non-obstante clause of Section 53 of the Code will not operate to override Section 48 of the TOPA.
Incognizance of the Insolvency Law Committee Report 2018
Section 53 of the Code lays down the waterfall mechanism for distributing the proceeds of liquidation assets in a particular order of priority. Section 53(1)(b) puts the secured creditors and workmen at an equal ranking. Section 53(2) o the Code disregards all kinds of agreements that disrupt this equal ranking laid down under Section 53(1)(b). However, this section is silent on the inter se priority among the secured creditors. Realizing this gap in the provision, the Insolvency Law Committee Report 2018 (“the report”) had discussed the issue in detail and unequivocally. It clarified that “a plain reading of Section 53 was sufficient to establish that valid inter-creditor and subordination provisions are required to be respected in the liquidation waterfall under Section53 of the Code”. Hence, the report concluded that even in the case of relinquishment of security interest, the first charge holders must be given preferential rights to satisfy their claim before the subsequent charge holders. Regarding Section 53(2), the report clarified that it applies only to agreements disrupting the priority between the workmen and secured creditors and not to subordinate agreements inter se secured creditors. In the present case, although the respondent had referred to this report, the NCLAT neither discussed it nor rejected it while coming to its conclusion.
Failure in considering the ‘Principle of Equality
In Committee of Creditors of Essar Steel Limited v. Satish Kumar Gupta and Ors., the Hon’ble Supreme Court had observed that “though the Code posits a fair and equitable treatment of creditors, it does not mean that all the creditors can be treated equally.” Moreover, in UNCITRAL Legislative Guide on Insolvency Law, it has been stated that proceeds must be distributed among the creditors in accordance with their ranking and interest. By treating the first charge holders and subsequent charge holders as equals, the NCLAT places unequal on an equal pedestal and thus, fails to acknowledge this principle of equality.
Undesirable Implications
This order will also have unfavourable implications for financial institutions. It is well-known that most of the secured creditors are banks and financial institutions, and if they are not given inter se priority after relinquishment, it will disincentivize them from lending.
Also, this order gives the scope for abuse of Section 13(9) of the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 by the subsequent charge holders. Section 13(9) states that for the realization of a security interest in an asset with multiple charges, the first charge holders must take the consent of the secured creditors with at least 60% of the total value of the secured debt. A combined reading of Section 13(9) and the present NCLAT order concludes that as realization prioritizes the claim of the first charge holders whereas relinquishment equally satisfies the claims of all the charge holders, the subsequent charge holders will not give their consent for realization, harming the interest of the first charge holders.
Conclusion
This judgment will have wide-reaching consequences in the financial sector. The first charge holders will be reluctant to consent to the creation of multiple charges, limiting the credit availability to the borrowers. Thus, the Supreme Court must step in immediately and reinterpret it to be in consonance with existing jurisprudence. The legislature can also fill this gap by adding an explanation to Section53 of the Code.