India: Respecting Inter Se Priorities Of Secured Creditors – Key To Value Maximization In Liquidation Process

In its interim order dated 29^th June 2021 in Stressed Asset Stabilisation Fund (SASF) Vs. Technology Development Board¹, the Supreme Court of India has stayed the operation of the judgement of the National Company Law Appellate Tribunal (“NCLAT”) in Technology Development Board v. Anil Goel (“Technology Development Board”)². In Technology Development Board, the NCLAT had ruled that inter se priorities of secured creditors will not prevail in the liquidation waterfall under section 53 the Insolvency and Bankruptcy Code, 2016 (“IBC”). In this article, we will briefly discuss the need for an intervention by the Supreme Court in this regard.

In its observations while overseeing the drafting process of the Insolvency and Bankruptcy Code, the Bankruptcy Law Reforms Committee (“BRLC”) identified that the mechanism for resolving insolvency was a key factor holding back the credit market in India. One of the primary objectives of the Insolvency and Bankruptcy Code, 2016 (“IBC”) as it stands today, is the maximisation of the value of assets of the debtors to promote, inter alia, availability of credit and to balance the interests of all the stakeholders.

The BRLC, in its report dated 04^th November 2015 (“BRLC Report”), had identified that lenders in India recover about 20% of the value of the debt, on a net present value basis³. Prior to the enactment of the IBC, India's recovery rate for creditors as per the Doing Business 2015 report stood at 25.7%⁴ when measured in the cities of Mumbai and Delhi. This rate of recovery as per the Doing Business Report 2020 now stands at 71.6%⁵. The role played by the IBC in this drastic improvement cannot be discounted.

The comfort provided to the lenders by the improvement in the rate of recovery aided by the reforms brought in by the IBC is evidenced by the fact that between 2015 and 2020, India's score for getting credit improved from 65 to 80 in the annual Doing Business reports⁶. This is further proof of a cause-effect relation between how the IBC is enforced to balance the interest of the stakeholders and the availability of credit.

One important factor that provides comfort to the lenders is that the Doctrine of Priority is maintained in enforcement of security interests during insolvency proceedings. However, in Technology Development Board, the NCLAT had ruled that inter se priorities of secured creditors do not survive when a secured creditor opts to relinquish his security interests under section 52 of the IBC and elects to recover his dues from the proceeds of the sale of assets of the corporate debtor by the liquidator under section 53 of the IBC.

Under the IBC, a secured creditor has two options to enforce the security interests in the assets of the corporate debtor. Firstly, a secured creditor may opt to stand outside the liquidation process by opting to enforce his security interests on his own in the manner as provided under section 52 of the IBC. Otherwise, the secured creditor may opt to relinquish his security interest in favour joining the liquidation process under section 53 of the IBC. The secured creditor who has opted to enforce the security interests under section 52, may also join the liquidation process under section 53 to recover any balance amounts, albeit at a much lower priority.

It is a common banking practice to have variable ranking priorities over a single asset. It is the commercial interests of a lender that dictates the ranking of the charge that is created over an asset of the borrower. A lender who creates a first ranking charge will do so under the comfort provided by the priority of the ranking of such a first charge in the event of enforcement of the security interests. Similarly, a lender who creates a second ranking charge will do so acknowledging the presence of a first ranking charge holder.

A similar question arose before the Supreme Court in ICICI Bank Ltd. v. SIDCO Leathers Ltd. & Ors. ⁷ (“SIDCO”), when it was called upon to decide, inter alia, if in view of section 529A of the Companies Act, 1956, significance of inter se right of priority between secured creditors would be lost. The Supreme Court also deliberated if the non-obstante clause in section 529A would override the doctrine of priority under the section 48 of the TP Act.

In paragraph 21 of SIDCO, the Supreme Court held that right to property, being a constitutional right, cannot be presumed to have been taken away by section 529A of the Companies Act 1956, unless it explicitly stated to do so⁸. The Ahmedabad bench of the NCLT relied on this ratio in SIDCO, when it upheld the priority rights of the secured creditors in IA 514/209 in C.P. (I.B) No. 4/NCLT/AHM/2017⁹ (“Impugned Order”).

Nevertheless, in Technology Development Board, the NCLAT has opted to give a creative interpretation to this dual option provided to a secured creditor under sections 52 and 53 of the IBC. Citing the non-obstante clause in section 53 of the IBC, the NCLAT held that the Impugned Order was erroneous to rely on the law laid down in SIDCO, while also noting that IBC was enacted after the decision of the Supreme Court in SIDCO. It is important to note here that while both section 53 of the IBC and section 529A of the Companies Act, 1956 contain a non-obstante clause, neither provision explicitly waives the right of priority of a secured creditor, which is derived from the section 48 of the TP Act.

While setting aside the Impugned Order, the NCLAT further held that ranking of security interests is only material when the secured creditor opts to enforce the security interests under section 52¹⁰. As an effect, any inter se priorities that the secured creditors may have with respect to their security interests will stand negated after such secured creditors opt to relinquish their security interests and therefore, they will stand equal in the waterfall mechanism under section 53.

The NCLAT has also refused to rely on the clarifications offered by the Insolvency Law Committee (“ILC”) in its reports dated 26^th March (“First ILC Report”) 2018 and 20^th February 2020 (“Second ILC Report”) on the treatment of intercreditor agreements within the liquidation waterfall. In the first ILC Report, the ILC, while relying on, inter alia, the ratio in SIDCO, has clarified that valid intercreditor agreements or subordination agreements will continue to govern the relationships between secured creditors even in the liquidation waterfall under Section 53 of the IBC¹¹. However, no amendments were proposed to the IBC in this regard.

In the Second ILC Report, the ILC made further clarifications on this point. Firstly, the ILC clarified that the priority of recovery offered to the secured creditors under section 53(1)(b)(ii) of the IBC shall only be applicable to the extent of the value of the security interest that is relinquished¹². Furthermore, the ILC also recommended that a clarificatory explanation may be inserted in the section 53 of the IBC to provide the correct interpretation of the said section as was explained in the First ILC Report¹³.

Further, in the Second ILC Report, the ILC also noted that intent behind providing the second highest priority in the liquidation waterfall under section 53 to those secured creditors who have relinquished their security interests, ranking only behind insolvency resolution process and liquidation costs, is to encourage a collective liquidation process, that promotes value maximization[14].

The interpretation of NCLAT in Technology Development Board directly conflicts with this interpretation of the IBC which places importance of value maximisation. If inter se priorities of secured creditors established by valid intercreditor and subordination agreements are not accounted for in the liquidation waterfall under section 53 of the IBC, it will result in more lenders opting to stand outside of the liquidation process to enforce the security interests on their own. This will not only derail the collective liquidation process which promotes value maximation but also will result in a reduced efficiency of the liquidation process, directly affecting the rate of recovery.

Furthermore, this interpretation will also result in more lenders refusing to cede priority ranking over security interests through valid intercreditor agreements, thereby creating a tougher environment for obtaining credit. In conclusion, by not accounting for the inter se priorities of secured creditors in the waterfall mechanism under section 53, the interpretation offered by NCLAT in Technology Development Board, conflicts with the objective of the IBC to promote value maximation and improve availability of credit. Therefore, a timely intervention by the Supreme Court in this regard will help reiterate the doctrine of priority as laid down in SIDCO.

Footnotes

1 Stressed Asset Stabilisation Fund (SASF) & Anr. Vs. Technology Development Board & Anr. [2021], Supreme Court of India, C.A. No. 2206/2021 (XVII) (order granting stay of impugned judgement).

2 Technology Development Board v. Anil Goel Liquidator of Gujarat Oleo Chem Limited and Ors. [2021] National Company Law Appellate Tribunal, Company Appeal (AT) Insolvency No. 731 of 2020.

3 Ministry of Finance, Government of India, 2015. The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design. [online] Available at: https://dea.gov.in/sites/default/files/BLRCReportVol1_04112015.pdf [Accessed 12 June 2021].

4 World Bank Group, 2015. Doing Business 2015. Going Beyond Efficiency. [online] p.192. Available at: https://www.doingbusiness.org/content/dam/doingBusiness/media/Annual-Reports/English/DB15-Full-Report.pdf [Accessed 12 June 2021].

5 World Bank Group, 2020. Doing Business 2020. Economy Profile India. [online] p.4. Available at: https://www.doingbusiness.org/content/dam/doingBusiness/country/i/india/IND.pdf [Accessed 12 June 2021].

6 ibid

7 2006 10 SCC 452

8 ibid (n-6)

9 [9] Technology Development Board v. Anil Goel Liquidator of Gujarat Oleo Chem Limited and Ors. [2020] National Company Law Tribunal, Ahmedabad Bench, IA 514/2019 in C.P. (I.B) No. 4/NCLT/AHM/2017.

10 Technology Development Board (n 5)

11 Ministry of Corporate Affairs, Government of India, Report of the Insolvency Law Committee (2018) para 21.6 https://ibbi.gov.in/uploads/resources/ILRReport2603_03042018.pdf

12 Ministry of Corporate Affairs, Government of India, 2020. Report of the Insolvency Law Committee. [online] p.77. Available at: https://ibbi.gov.in/uploads/resources/c6cb71c9f69f66858830630da08e45b4.pdf [Accessed 12 June 2021].

13 ibid 80

14 ibid 76

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