Query ; Whether a liquidator is required to take into account the value of security interest while preparing the list of creditors for the purpose of distribution of funds under the provisions of Section 53 of the Code ?
Let’s look into the various provisions of the Code & Regulations framed thereunder.
# Section 52. Secured creditor in liquidation proceedings.
(9) Where the proceeds of the realisation of the secured assets are not adequate to repay debts owed to the secured creditor, the unpaid debts of such secured creditor shall be paid by the liquidator in the manner specified in clause (e) of sub-section (1) of section 53.
# Section 53 Distribution of assets. -
(1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period as may be specified, namely: -
(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following:
(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;
(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;
(d) financial debts owed to unsecured creditors;
(e) the following dues shall rank equally between and among the following: -
(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest.
Secured creditor can relinquish his security interest to the liquidation estate and stand second highest priority under the liquidation waterfall [Section 53(1)(b)]. This priority is given to “debts owed to a secured creditor in the event such secured creditor has relinquished security interest in favour of the liquidator”. This does not specify whether such debts owed are limited only to the extent of value of the security interest of the creditors’ debt,
Code does not specify whether such secured debts are limited to the value of the secured portion of the creditor’s debt only. This fact assumes greater significance in light of the wording of section 30(4) of Code for distribution of funds during insolvency proceedings;
Section 30 (4). The committee of creditors may approve a resolution plan by a vote of not less than sixty-six per cent. of voting share of the financial creditors, after considering its feasibility and viability, the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor and such other requirements as may be specified by the Board:
From the above, it can be observed that Code under section 30(4) specifically & separately mentions section 53(1) & value of the security interest, as the concept of value of security interest is not inherent in provisions of section 53. Had the concept of value of security interest been inherent in the provisions of Section 53, there was no need to separately mention the value of security interest in section 30(4).
There is a significant absence of the term “value of the security interest “ in Section 53 of the Code. Thus the legislative intent of the Parliament is very clear that the amount of secured credit under section 53(1)(b) will not be limited to the extent of the underlying value of the security interest.
Secondly, if debt of the secured creditor, under second priority under section 53(1)(b) is limited to the extent of value of security interest, then the provisions of the Code under section 52(9) will create imbalance between the following classes of secured creditors;
Secured creditors, who has exercised his security interest under section 52. His debt, beyond the value of security interest will rank 5th priority in waterfall under section 53(1).
Secured creditor, who has relinquished his security interest in favour of liquidator. His debt, beyond the value of security interest will rank 4th priority in waterfall under section 53(1).
Section 52(9) Where the proceeds of the realisation of the secured assets are not adequate to repay debts owed to the secured creditor, the unpaid debts of such secured creditor shall be paid by the liquidator in the manner specified in clause (e) of sub-section (1) of section 53.
Case Law;
i). NCLT Allahabad (24.07.2018) in J.R. Agro Industries P Limited V/s. Swadisht Oils P Ltd. [CA 59 of 2018 in CP 13/ALD/2017] held as under:-
(Page 33/50) “Notably, distinction under section 53 is a two-fold distinction – (i) secured/unsecured, and (ii) operational/financial. As regards secured creditors, it does not matter whether the creditor is financial or operational, since section 53(1)(b) uses the expression “secured,” and there is no indication as to the nature of debt (financial/operational) owed to such secured creditor. However, when it comes to unsecured creditors, unsecured financial creditors appear in the 4th rank; but unsecured operational creditors come in the 6th rank.”
ii). NCLAT (05.04.2021) in Technology Development Board Vs.Anil Goel, Liquidator of Gujarat Oleo Chem Limited (GOCL) & Ors. [Company Appeal (AT) (Insolvency) No.731 of 2020] held that;-
# 4. . . .Appellate Tribunal in “J M Financial asset Reconstruction Co. Ltd. vs. Finquest Financial Solutions Pvt. Ltd. & Ors.”, held that only the first charge holder i.e. the Secured Creditor being highest in the inter creditor ranking is entitled to enforce his right for the realization of its debt out the secured asset.
# 8. While it is true that the relinquishment of security interest affects the order of distribution, it is equally true that the Secured Creditor does not lose its status of being a Secured Creditor though he has elected to forego his right of enforcing security interest. Whether the Secured Creditor holds first charge or second charge is material only if the Secured Creditor elects to realise its security interest. . . . . .
# 8. . . . The two sets of Secured Creditors, one relinquishing the security interest and the other realising its security interest are treated differently. A creative interpretation has to be given to the provisions to make them workable and stand in harmony. It is significant to note that Section 53 has been given overriding effect and the non-obstante clause contained in the very opening words of the Section leaves no room for doubt that the distribution mechanism provided thereunder applies in disregard of any provision to the contrary contained in any Central or State law in force. . . . .
# 8. . . . . Of course first charge holder will have priority in realising its security interest if it elects to realize its security interest and does not relinquish the same. However, once a Secured Creditor opts to relinquish its security interest, the distribution of assets would be governed by the provision engrafted in Section 53(1)(b)(ii) where under all Secured Creditors having relinquished security interest rank equally and in the waterfall mechanism are second only to the insolvency resolution process costs and the liquidation costs.
# 12. We accordingly allow the appeal and set aside the impugned order. I.A. 514 of 2019 in CP(IB) No. 04/2017, is held to be maintainable and we allow the same with direction to the Liquidator to treat the Secured Creditors relinquishing the security interest as one class ranking equally for distribution of assets under Section 53(1)(b)(ii) of I&B Code and distribute the proceeds in accordance therewith.
Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.
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