This article is written by Sneha Inampudi, pursuing a Certificate Course in Insolvency and Bankruptcy Code from Lawsikho.com.
Table of Contents
Introduction
The Insolvency and Bankruptcy Code, 2016 (hereinafter referred as IBC) is an Act that consolidates and amend the law relating to the insolvency resolution and bankruptcy process of the corporates, partnership firms, and the individuals in a time-bound manner. Though the term insolvency and bankruptcy are used as synonyms, there exists a thin line of difference between the two. While the former is the situation where the entities or the individuals could not meet their financial obligation at that time, the latter is the situation when the court of law passes an order for the dissolution.
The framework of IBC has provided in a manner that a financial creditor whether secured or unsecured and even operational creditors can file a petition for the Corporate Insolvency Resolution Process (CIRP) of the Corporate Debtor (CD) before the Adjudicating Authority. Further, the committee of creditors (CoC) comprises secured and unsecured creditors, and both are given equal powers in decision making and voting. However, in the event of the liquidation, the secured creditors are given primacy over the unsecured creditors. In this article, I am going to analyse the rights and obligations of the secured creditor in the liquidation process under the provisions of IBC.
Secured creditor and security interest
The IBC provided definitions for both secured creditor and security interest, the secured creditor is a “creditor in favor of whom security interest is created.’’ [i]The security interest means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secured the payment or performance of an obligation includes:
- Mortgage
- Charge
- Hypothecation
- Assignment
- Encumbrance
Or any other agreement or agreement of securing payment or performance of any obligation of any person’’.[ii]
In simple terms, if the debt is secured by the mortgage of immovable property, hypothecation of the stock, pledge of the shares or in any other form of encumbrance, the said debt is considered as the secured debt and the creditors as the secured creditors. If the debtor failed to meet the repayment obligation, the secured creditor may enforce the security interest and recover the amounts due.
Secured creditor in the liquidation
In case, the CoC has failed to arrive at a resolution of the corporate debtor, the Adjudicating Authority will pass an order for the liquidation and the liquidator would be appointed. In the event of the liquation, the code has provided two options for the secured creditor i.e.:
- The secured creditor may relinquish his security interest in the secured asset and receive the proceeds from the liquidation estate under the waterfall mechanism[iii].
- The secured creditor may realise the security interest as provided in section 52 of the Code.
Thus, the secured creditor will have to make the choice as to relinquish or realize the security interest depending on the facts and circumstances of the case.
Relinquishment of the security interest
Upon the relinquishment of security interest by the secured creditor under Section 52 (1)(a), the secured asset becomes part of the liquidation estate and would be under the control of the liquidator. The secured creditor need not take any effort for the realization (sale) of the asset and would be in second place in the waterfall mechanism enumerated under section 53 of Code, paid right after appropriation of the liquidation costs and placed at the par of the workmen dues for 24 months prior the commencement of the liquidation date.
For Example:
XYZ Pvt Ltd goes into liquidation, wherein ABC Ltd is the secured creditor having the security interest over the worth of Rs. 10 Crore, IRP, and liquidation Costs amount to 10 Lakhs and workmen dues for 24 months are Rs. 5 Crores. If the ABC Limited decided to relinquish its security interest and on an assumption that the liquidator has sold the assets for Rs. 7 Crores and after deducing the liquidation costs, the workmen would get their share of Rs. 2.3 crores and the secured creditor share would be Rs. 4.6 Crores.
Realization of the secured asset
The security interest is regarded as the ‘real interest’ and is created right in the property. The secured creditor may on the default of the debtor, enforce its right in the property, and recover the dues. Thus, the Code has provided the right to the secured creditor to enforce his security interest outside the liquidation. Further, as per the proviso of regulation 32, the liquidator is barred to sell the asset subjected to security interest until the secured creditor has relinquished the security interest.
To realize the security interest, the secured creditor must submit his proof of claims in Form D of Schedule – II and shall inform the decision to relinquish his security interest within 30 days from the commencement of the liquation process[iv] by proving the security interest based on:[v]
- Records available in an information utility,
- Certificate of charge registered with the Registrar of Companies (ROC), or
- Charge Registered with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI).
As emphasized in the proviso of the regulation 21A of the liquidation rules, if the secured creditor has not informed the liquidator about the decision as to realisation of the security interest, the secured asset shall be presumed to be a part of the liquidation estate.
The IBC provides two provisions in case of the realization of the security interest by the secured creditor:
- The first option is to deal with the secured asset outside the code, i.e. in accordance with the laws applicable to the realization of the security interest[vi].
- The other is a secured creditor can realise the security interest as within the code as stipulated in Regulation 37 of IBBI (Liquidation Process) Regulations, 2016.
Realisation under the security enforcement laws
If the secured creditor intends to realize his security interest outside the provisions of the code, he may enforce, realize, settle, compromise or deal with the assets as per the laws applicable to the enforcement of the security interest i.e. through SARFAESI Act, 2002[vii] or under RDDB Act[viii] and apply the proceeds to recover the debts due to it.
While realizing the security interest if the secured creditor faces any sort of resistance form the debtor, he may make an application and obtain an order form the Adjudicating Authority to facilitate to the smooth realisation[ix].
The costs of the insolvency resolution process, liquidation costs, and the workmen dues shall be deducted from the proceeds of the realization and shall be transferred to the liquidator. If the proceeds from the secured asset are excess than the admitted claims, the same shall be deposited with the liquidator and to be treated as liquidation estate.
In case, the amount realised from the secured assets is not sufficient for the debts of the secured creditor, the unrealized amount can be claimed from the liquidation estate on par with the unsecured creditor.
Realisation as per regulation 37
The code has provided regulation 37 of the liquidation rules as an alternative to the security enforcement mechanism. Pari-passu charge holders, with any percentage of share in the security, can realise its security interest through this regulation. To avail of this provision, the secured creditor shall intimate the liquidator of the price quotes to realize its security interest.
The liquidator must inform the secured creditor regarding the availability of a buyer at a higher price than quoted within 21 days of the receipt of information from the secured creditor. Further, there is an obligation on the said buyer to purchase the property within 30 days from the date of intimation to the secured creditor.
Provided, if the liquidator has not informed about the availability of the buyer within 21 days or if the sale has not been concluded in 30 days from the intimation, the secured creditor may realise the security interest at the rate initially quoted. The cost of the identification of the buyer will be borne by the secured creditor if he realizes the security interest.
Obligations of the secured creditor who proceeds to realise the security interest
As per the regulation 21A of the liquidation rules, the following obligations are cast on the secured creditors who intends to realise the security interest shall pay:
- The costs of CIRP and liquidation and the workmen dues, as it would have shared in case of the relinquishment of the security interest to the liquidator within 90 days from the date of the liquidation, and
- The excess of the realised value from the security interest over the amount admitted, to the liquidator within 180 days from the liquidation commencement date.
In case if the amount is not certain by the above stipulated time, the secured creditor shall pay the amount as estimated by the liquidator. If the secured creditor failed to comply with the said obligations, the secured asset shall become part of the liquidation estate.
Secured creditor is not allowed to sell the assets to the ineligible promoter
The secured creditor who realised its security interest may easily sell the asset back to the defaulting promoter which vitiates the whole motive of Section 29A of the Code. Hence, NCLAT in State Bank of India v Anuj Bajpai[x] ordered that the persons disqualified under section 29A shall remain to be prohibited even when the secured creditor has realised his security interest and is planning to sell his/her asset under 52(4) of the Code. The Parliament has also given sanctity to the said judicial principle by inserting in Rule 37(8)[xi], which prohibits sale or transfer of an asset which is subject to security, to any person who is not eligible to submit the resolution plan under the code.
Conclusion
The IBC has provided a robust mechanism to protect the interest of the secured creditor in the event of the liquidation. However, there exists a grey area pertaining to the parallel security enforcement provided under code and disputes in case of the enforcement of security interest the joint charges and consortiums lending which are needed to be addressed.
References
[i] Section 3 (30)
[ii] Section 3 (31)
[iii] The waterfall mechanism in the IBC provides the order for the repayment to stakeholders in the event of liquidation.
[iv] Regulation 21A of the IBBI (Liquidation Process) Regulations, 2016
[v] Regulation 21 of the IBBI(Liquidation Process) Regulations, 2016
[vi] Section 52(4) of IBC, 2016
[vii] Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002
[viii] Recovery of Debts and Bankruptcy Act, 1993
[ix] Section 52(4) & (5) of IBC, 2016.
[x] Company Appeal (AT) (Insolvency) No. 509 of 2019) (Delhi Bench)
[xi] Amendment on 06.01.2020 to IBBI(Liquidation Process) Regulations, 2016
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