[By Kartik Kalra]
The author is a student at the National Law School of India University, Bangalore.
The principle of inter-se priority has its roots in equity, having as its core purpose the prevention of the jeopardization of the first charge-holder’s security interests.[1] When multiple persons hold a security over the same indivisible unit of property who then also opt for its liquidation, the order in which the receipt of such liquidation occurs is navigated by inter-se priority. The security-holder who has an earlier security interest is preferred first, and those whose security interest develops later are preferred subsequently.
This principle is present u/s 48 of the Transfer of Property Act, 1882 (“TP Act”),[2] and the Court has gone to the degree of pedestalizing it as an aspect of the constitutional right to property in ICICI Bank v. SIDCO Leathers.[3] This principle is applicable to secured creditors, given the subjection of subsequent interests in immovable property to those created priorly.[4] The Insolvency and Bankruptcy Code, 2016 (“IB Code”) is an integral component of India’s financial regime and a domain where the operation (and obliteration) of inter-se priorities can be vividly observed.
The IB Code aims at the effective resolution or liquidation of Corporate Persons (“CP”),[5] with the mandate for the former conferred upon the Committee of Creditors (“CoC”).[6] In circumstances of a failure of the Corporate Insolvency Resolution Process (“CIRP”) due to statutorily stipulated reasons,[7] the Adjudicating Authority (“AA”) may order the CP’s liquidation.[8] Section 53 of the IB Code presents a waterfall mechanism to be followed in the distribution of the proceeds of such liquidation,[9] whose competing interpretations lie at the core of this piece.
This piece argues that the abandonment of inter-se priorities in the distribution of liquidation proceeds u/s 53 of the IB Code is akin to a veritable war waged by the National Company Law Appellate Tribunal (“NCLAT”) against inter-se priorities, characterized by no fidelity to the law, past precedent, policy considerations or legislative intent. In order to make this argument, I first discuss the present infrastructure of the insolvency regime that necessitates the application of inter-se priority, followed by an evaluation of doctrinal developments concerning inter-se priority in the Companies Act and the IB Code. I then propose that the recent decision in Anil Anchalia is per incuriam, for it ignores long-standing precedent while applying unrelated precedent for incorrect propositions. I conclude that a continued application of inter-se priorities to the waterfall mechanism u/s 53 of the IB Code is the correct position of the law.
Inter-se Priorities and the Text of the IB Code
The framework of the IB Code is such that liquidation is undertaken due to a failure to reach an effective resolution.[10] At the stage of resolution, the Resolution Professional invites applicants to submit Resolution Plans (“Plans”) to discharge the CP’s debts through mechanisms other than its liquidation.[11] If the stage of resolution fails due to statutorily stipulated conditions,[12] the AA is entitled to order the CP’s liquidation.[13] In distributing the proceeds of such liquidation, the question of priority arises. Section 53 mandates the priority to be followed in the distribution of proceeds and holds that the dues owed to workmen and the debts owed to a secured creditor shall be pari passu.[14] For a secured creditor, the options of recovery are two: either enforce the security interest on their own u/s 52(1)(b)[15] or relinquish the same and let the Liquidator realize the proceeds and obtain it via their priority u/s 53.[16] Only when the secured creditor elects the latter option, do they qualify as ranking pari passu the workmen u/s 53(1)(b)(ii).[17] When the secured creditor refuses to relinquish their security interest u/s 52(1)(b) and is unable to enforce their interest themselves, they rank below those who relinquished.[18]
The question of inter-se priorities arises when there are multiple creditors with security interests over the same units of property who desire its liquidation and the receipt of its proceeds. Does the IB Code have space for inter-se priority among secured creditors, where the interests of subsequent creditors become subordinated to prior ones? The IB Code does not expressly call for any such priority u/s 53(1)(b)(ii) while also containing non-obstante clauses u/ss. 238 and 53(1).[19] It considers the distribution of proceeds obtained via liquidation to “rank equally between and among” the classes mentioned u/s 53,[20] and it can be argued that there shall be no differential priority among creditors of a single class. This might be interpreted to mean a pro-rata distribution of proceeds within each class, with no necessity of the satisfaction of debts owed to secured creditors with prior interests. On the other hand, it may also be interpreted to mean that the IB Code’s omission in expressly abandoning inter-se priority means that it continues to operate via the TP Act. These competing interpretations of the IB Code, along with the presence of Section 48 of the TP Act, mean that a definite answer to the question of inter-se priorities is unavailable in statute.
Pre-IB Code Judicial Treatment of Priority
Given such competing interpretations, there has been conflicting doctrine on the availability of priority in supposedly priority-neutral laws. Consider Section 529A of the Companies Act, 1956, which ranked workmen’s dues, and the debts owed to secured creditors pari passu in a manner analogous to the waterfall mechanism u/s 53 of the IB Code.[21] The Supreme Court offered an interpretation to the same in Allahabad Bank v Canara Bank,[22] where it held that inter-se priorities must be respected by the Liquidator in the distribution of proceeds unless specific subordination agreements create alternate priorities. The interpretation of Allahabad Bank came before the Supreme Court in ICICI Bank. In this case, the Punjab National Bank (“PNB”) had a subsequent interest in the debtor’s property but still demanded a pro-rata distribution of proceeds from liquidation, dissenting against the inter-se priority-based distribution undertaken by the Liquidator in favour of other banks.[23] PNB relied on the absence of a specific clause establishing inter-se priorities u/s 529A of the Companies Act, 1956 and the insertion of many non-obstante clauses in favour of its proposition of the unavailability of inter-se priorities therein.[24]
The odds were tilted in favour of PNB, given many provisions of the law textually favouring its proposition. The Court, however, held that the right to enforce the first charge is a right in property, and Parliament cannot be presumed to undermine a right of a constitutional status unless the same is mentioned expressly.[25] Prior to the enactment of the IB Code, therefore, the Court mandated the continuation of inter-se priorities in circumstances of the law’s silence on the same.
Priority under the IB Code
Under the IB Code, five types of creditors are provided for: secured, unsecured, decree-holders, financial and operational.[26] While the former two are distinguished based on the presence of a security interest, the latter two are distinguished based on the purpose of extending credit.[27] While the CD is indebted to the operational debtor due to the non-payment of goods and services provided to them, they are indebted to the financial creditor due to the extension of formal credit.[28] The distinction between secured and unsecured creditors is present across the legal framework, with the rights of priority of the secured creditor always preferred over their unsecured counterparts. This framework remains the same under the IB Code.
The IB Code privileges financial creditors over their operational counterparts in some respects, given the latter’s exclusion from the CoC.[29] This framework of the differential treatment rendered to financial and operational creditors was challenged on the grounds of constitutional infirmities in Swiss Ribbons (P) Ltd. v Union of India, where the Supreme Court held that it suffers from none.[30] In holding this, the Court remarked that in circumstances where the two types of creditors are placed similarly, they must be treated alike.[31] This assertion of the Court was picked up by the NCLAT in Standard Chartered Bank v Satish Kumar Gupta, which dealt with discriminatory treatment rendered towards operational creditors in the formulation of plans during CIRP u/s 30.[32] In this case, Essar Steel’s operational creditors were awarded none of their claimed amounts, whereas their financial counterparts awarded 99.19% of theirs.[33] This distribution was labelled arbitrary by the NCLAT, and its reasoning found its source in Swiss Ribbons’ assertion of the similarity in treatment to be rendered to financial and operational creditors.[34] This went into appeal before the Supreme Court in Essar Steel India Ltd. Committee of Creditors v Satish Kumar Gupta,[35] which upheld it on the point of the similarity of treatment to be rendered to financial and operational creditors.
In the NCLAT, however, the application of the above doctrine can be characterized as hasty and uninformed. The application of this case law in the NCLAT, however, has been inconsistent and hasty. In Technology Development Board v Anil Goel, the NCLAT held that ICICI Bank is no longer good law, given the insertion of multiple non-obstante clauses in the IB Code that have an overriding effect on Section 48 of the TP Act.[36] The problem here, however, is that the Companies Act 1956 also contained multiple non-obstante clauses that would supposedly stymie the operation of Section 48 of the TP Act, including u/s 529A itself.[37] ICICI Bank held that irrespective of these non-obstante clauses, Section 48’s principles would prevail because of the absence of parliamentary intent to undermine the first charge-holder’s rights in the property.[38] Technology Development Board, it is submitted, is per incuriam the decision in ICICI Bank and has been rightfully stayed by the Supreme Court in Kotak Mahindra Bank Ltd. v. Technology Development Board.[39]
The staying of the Technology Development Board, however, has been insufficient to temper the NCLAT’s hostile treatment of inter-se priorities. In Oriental Bank of Commerce v Anil Anchalia, it held that the staying of the Technology Development Board is immaterial, for the Supreme Court decision in India Resurgence can be relied upon for the proposition that inter-se priorities must be disregarded.[40] In the following section, I propose that Anil Anchalia is also per incuriam and that the correct position of law must be derived from ICICI Bank and the parliamentary intent discernible from the Report of the Insolvency Law Committee.[41]
Anil Anchalia and the Correct Position of Law
The decision in Anil Anchalia suffers from obvious infirmities, given its incorrect application of India Resurgence and its ignorance towards parliamentary intent behind the instrumental role of the waterfall mechanism during liquidation.[42] India Resurgence dealt with the distribution of proceeds during the stage of resolution, where Section 30(4) of the IB Code itself makes the application of the waterfall mechanism optional.[43] On this basis, while India’s Resurgence was correct on the diminished role of priority during CIRP, it is no authority for the proposition of the abandonment of inter-se priorities during liquidation.
Further, if the legislative intent behind the waterfall mechanism’s instrumental role during liquidation is discernible from the Report of the Insolvency Law Committee that concurs on its indispensability,[44] why must the NCLAT go in exactly the opposite direction? Anil Anchalia offers incorrect reasoning for why ICICI Bank is no longer good law, disregarding the latter’s holding on to the role of non-obstante clauses and legislative intent.[45] The NCLAT has, therefore, waged a veritable war on inter-se priorities, one having no fidelity to the legislative intent, past precedent or policy considerations.
Conclusion
Through this piece, I have attempted to demonstrate that the text of Section 53 of the IB Code does not yield a definite answer to inter-se priorities, and therefore additional considerations such as legislative intent and policy implications may be considered in deciding on inter-se priorities.
On this basis, the correct position of lawis still ICICI Bank. The non-obstante clauses contained in the IB Code would not dent the application of Section 48 of the TP Act unless the express legislative intent of its abolition is discernible, as held in ICICI Bank.[46] The Insolvency Law Committee makes wise remarks on the necessity of respecting the rights of the first-charge holder and a failure thereof leading to adverse implications for the credit market.[47] If the NCLAT’s war against inter-se priorities does not temper, financial institutions may consider lending large amounts on the immovable property to be too risky an endeavour, given the possibility of the CD engaging subsequent creditors and their first-charge rights becoming illusory.[48]
The present concern, however, is the AA’s subsequent reliance on Anil Anchalia to further deprive creditors of inter-se priorities. This is the NCLAT’s war against inter-se priorities, a war with no stakeholder emerging as a victor.
[1] Poonam Prasad Saxena, Mulla, The Transfer of Property Act (13th edn, LexisNexis 2018) [48.1.1].
[2] TP Act, s 48 reads as follows: “Where a person purports to create by transfer at different times rights in or over the same immoveable property, and such rights cannot all exist or be exercised to their full extent together, each later created right shall, in the absence of a special contract or reservation binding the earlier transferees, be subject to the rights previously created.”
[3] (2006) 10 SCC 452 [41].
[4] Saxena (n 1) [48.2].
[5] IB Code, s 3(7). The term “Corporate Person” has been defined as a company, partnership or any other person with limited liability, but excluding a financial service provider.
[6] IB Code, s 21(2). The term “Committee of Creditors” has been defined as a unit “comprise[d] [of] all financial creditors of the corporate debtor”.
[7] IB Code, s 30(6), 31, 33(2). The IB Code stipulates, inter alia, the following to be grounds for ordering the CP’s liquidation: 1) Non-receipt of a Resolution Plan within the stipulated period u/s 30(6); 2) Non-compliance with requirements stipulated u/s 33(1)(b), u/s 31; 3) CoC’s voting of 66% or more to liquidate the CP u/s 33(2).
[8] IB Code, s 33.
[9] Section 53 of the IB Code prescribes the order of preferential payments to be made following a CP’s liquidation.
[10] Bhavini Mishra, ‘Nearly Half of Insolvency Proceedings Led to Liquidation Rather than Rescue’ (31 May 2022) <https://www.business-standard.com/article/companies/nearly-half-of-insolvency-proceedings-led-to-liquidation-rather-than-rescue-122053100717_1.html> accessed 6 September 2022.
[11] Plans are to be submitted in accordance with Section 30 of the IB Code, whereas Regulation 36A of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 stipulates the contents of the invitations to formulate Plans.
[12] IB Code, s 30(6), 31, 33(2).
[13] IB Code, s 33.
[14] IB Code, s 53(1)(b). Dues owed to workmen are calculated for 24 months preceding the date on which liquidation commences.
[15] IB Code, Section 52(1)(b). For how this enforcement occurs, see Section 13 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. See also Harshad Govardhan Sondagar v. International Assets Reconstruction Co. Ltd., (2014) 6 SCC 1.
[16] IB Code, s 52(1)(a); 53(1)(e)(ii).
[17] IB Code, s 53(1)(b)(ii).
[18] IB Code, s 53(1)(e)(ii).
[19] IB Code, s 53(1); 238.
[20] IB Code, s 53(1)(b).
[21] Companies Act 1956, s 529A; IB Code, s 53.
[22] (2000) 4 SCC 406 [37].
[23] ibid [5].
[24] Companies Act 1956, s 529A.
[25] ICICI Bank (n 3) [41].
[26] IB Code, s 3(10).
[27] IB Code, s 3(16), 3(30), 5(20).
[28] IB Code, s 3(16).
[29] IB Code, s. 21(2).
[30] (2019) 4 SCC 17 [74-77].
[31] ibid [76].
[32] 2019 SCC OnLine NCLAT 388 [149].
[33] ibid [149].
[34] ibid.
[35] (2020) 8 SCC 531 [88-90].
[36] 2021 SCC OnLine NCLAT 349 [10].
[37] Companies Act 1956, s 533, 451, 424G.
[38] ICICI Bank (n 3) [48].
[39] Civil Appeal Diary No(s). 11060/2021.
[40] Comp. App. (AT) (Ins.) No. 547 of 2022 [4]; India Resurgence (n 51) [17].
[41] Injeti Srinivas and others, ‘Report of the Insolvency Law Committee, March 2018’ (Ministry of Corporate Affairs, Government of India) 21.5.
[42] Arvind Tiwari, ‘The Conundrum of Inter-Se Priorities between Secured Creditors in Liquidation’ (IndiaCorpLaw, 21 July 2022) <https://indiacorplaw.in/2022/07/the-conundrum-of-inter-se-priorities-between-secured-creditors-in-liquidation.html> accessed 19 November 2022.
[43] IB Code, s 30(4).
[44] Srinivas and others (n 57) 21.5.
[45] ICICI Bank (n 3) [34-39].
[46] ibid.
[47] Srinivas and others (n 57) 21.5.
[48] ibid.