Treatment of Guarantor’s property during Insolvency & Liquidation of CD.

Treatment of Guarantor’s property during Insolvency & Liquidation of CD.

Lately the Adjudicating Authorities (NCLT) are permitting Resolution Professional / Liquidator to deal with the properties of guarantors, mortgaged with the FC, by either including the  same in the Resolution Plan or permitting the Liquidator to auction the same alongwith the properties of the CD.

2. Case Law (Insolvency Resolution Process)

1.  NCLAT (04.03.2021) in Vanguard Credit & Holdings Pvt. Ltd. Vs. Kshitiz Chhawchharia (RP) of Ramsarup Industries Ltd. & Anr.  [Company Appeal (AT) (Ins.) No. 1125 of 2019 ] held that; 

• # 158. By implication of Section 13(4) of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, a secured creditor can take possession of the secured assets, including the right to transfer by way of lease, assignment or sale for realising the secured asset. Accordingly, the mortgagees will have the right to enforce the mortgage over the land. The Resolution Plan provides the mechanism for the transfer of the land, which is as follows;  ARCIL and Axis Bank would assign a portion of the debt to Narantak Dealcom limited (a nominee of the Resolution Applicant).  Pursuant to such assignment, Vanguard will be required to take all actions is required to transfer the land to the Resolution Applicant.  This obligation to transfer the land will be pursuant to discharging of Vanguard's Corporate Guarantee and mortgage obligations.  In case of no consensual transfer of Vanguard, the creditors shall have the right to enforce the mortgage for the transfer of land.  In pursuance to the obligations of the Applicant under the guarantee obligations and the mortgage provided, the Resolution Applicant's 1st seeking a direction to allow the transfer of the land from the Applicant to the Corporate Debtor.  Failing this, the Resolution Plan suggests that the assignee of the loan and security should be allowed to enforce under SARFAESI Act and transfer the land to the Corporate Debtor.  [ Link - Synopsis ]

 

3. Blogger’s comments; 

Mechanism proposed in the resolution plan for transfer of the property (land) of the guarantor, mortgaged with the financial creditor (bank) is as follows;

1. The guarantor / owner of the property transfers the mortgaged property to the successful resolution applicant.

2. In case the guarantor/ owner of the land does not agree to transfer the property to the successful resolution applicant, than;

1. Financial Creditor (Bank) will assign the loan & security interest to the nominee of the resolution applicant.

2. Assignee of the loan will enforce security interest under SARFAESI Act and transfer the secured asset (land) to the Corporate Debtor. 

 Now the questions arise;

1. Whether a non financial institution secured creditor (nominee of the successful resolution applicant in the present case) can enforce security interest under SARFAESI. Secured creditor in SARFAESI has been defined as under;

(zd) “secured creditor” means—

(i) any bank or financial institution or any consortium or group of banks or financial institutions holding any right, title or interest upon any tangible asset or intangible asset as specified in clause (l);

2. Whether a secured creditor while enforcing security interest can transfer the secured asset without competitive bidding or auction, to a predetermined successful resolution applicant, under the provisions of SARFAESI.

 

Apparently, the Hon’ble Adjudicating Authority (NCLT) granted waivers for the above provisions of the SARFAESI & the Hon’ble Appellate Authority (NCLAT) upheld the orders of NCLT. 

 

4. Case Law (Liquidation Process)

1. NCLAT (13.05.2022) in Ayan Mallick Vs. Pratim Bayal, Liquidator & Ors.  [Company Appeal (AT) (Insolvency) No. 456 of 2022] held that;

• 13.05.2022: Heard learned counsel for the Appellant, Shri Ashish Makhija, learned counsel for the Liquidator and learned counsel appearing for the Bank. This Appeal has been field against the order dated 01.02.2022 by which the Adjudicating Authority (National Company Law Tribunal), Kolkata Bench, Kolkata has dismissed the I.A. No. 32/KB/2022 filed by the Applicant/Appellant. In the I.A. the prayer made by the Appellant who is Suspended Director of the Corporate Debtor was that e-auction sale notice dated 16.12.2021 for sale of the assets of the Corporate Debtor under liquidation and assets of the guarantor under SARFAESI Act be stayed until the disposal of the I.A.

• # 2. The e-auction notice was issued for sale of factory and land. Apart from the assets of the Corporate Debtor, the land was owned by the Promoter/ Guarantor, hence, e-auction notice was for a joint sale of the assets. It was submitted before the Adjudicating Authority that joint sale will maximize the value of assets of the Corporate Debtor, hence the Court should permit the same. After hearing the learned counsel for the parties, the Adjudicating Authority rejected the application and observed that if there is maximization of the assets, selling it as a combined should not prejudice the applicant in any manner as it is going to get a better value for the corporate guarantor.

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• # 5. We have considered submissions of learned counsel for the parties and perused the record. When the Adjudicating Authority is satisfied that joint sale shall bring maximization of assets of the Corporate Debtor and the possession of the properties of the Guarantors have already been taken under SARFAESI and both land and factory need to be sold together to maximize the value of the assets, we fail to see that how the Appellant shall be prejudiced in any manner. We do not find any error in the order of the Adjudicating Authority rejecting the I.A. We dismiss the Appeal. We, however, observe that it shall be open to the Appellant to take such remedy under SARFAESI with regard to auction in accordance with law. [ Link - Synopsis ]

 

5. Blogger’s comments; The following questions needs to be answered;

1. Whether Liquidator can include the property of guarantor in the Liquidation Estate.

2. Whether Liquidator can deal/auction any property outside the Liquidation Estate.

3. Whether Liquidator has powers to take into possession any property under the provisions of SARFAESI.

4. Whether a bank/financial institution can appoint Liquidator as its authorised officer to deal with the property (secured asset) under the provisions of SARFAESI.

5. Whether a Liquidator can work as representative of a stakeholder during the liquidation process.

6. In joint reserve price /joint auction notice how the money will be distributed of the realisation post auction.

 

Following are the provisions of the Code & regulations’

 

Quote.

# Section 36. Liquidation estate. -

(1) For the purposes of liquidation, the liquidator shall form an estate of the assets mentioned in sub-section (3), which will be called the liquidation estate in relation to the corporate debtor.

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(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following: -

(a) any assets over which the corporate debtor has ownership rights, including all rights and interests therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;

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(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation: -

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(c) personal assets of any shareholder or partner of a corporate debtor as the case may be provided such assets are not held on account of avoidance transactions that may b avoided under this Chapter;

 

Unquote,

As per the provisions of the Code, personal assets of any shareholder can not be the part of the “Liquidation Estate” and can not be used for recovery in the liquidation process under the Code. However, a bank (SFC) can deal/realise mortgaged properties, other than those owned by CD , held by the bank as collateral security, outside the liquidation process as per existent laws.

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Although, Liquidator, in his personal capacity, can accept assignment for disposal of properties mortgaged to the bank, (owned by shareholders) , as authorised agent/ representative of the bank, but the moment Liquidator, agrees to act as agent/representative of a stakeholder (bank), he renders himself ineligible to work as Liquidator & has to voluntarily vacate the office of Liquidator.

 

Quote;

Liquidation Regulations

# Regulation 3. Eligibility for appointment as liquidator.

(1) An insolvency professional shall be eligible to be appointed as a liquidator if he, and every partner or director of the insolvency professional entity of which he is a partner or director, is independent of the corporate debtor.

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(3) An insolvency professional shall not continue as a liquidator if the insolvency professional entity of which he is a director or partner, or any other partner or director of such insolvency professional entity represents any other stakeholder in the same liquidation process.

 

Unquote,

In my opinion, the best way forward for the bank, in the present situation, is to enforce its security interest for the property of CD (Factory plant & machinery) under section 52(1)(b) and realise the same, as permitted under section 52(4) read with Liquidation Regulation 37(7) in SARFAESI, along with the guarantor’s property (Land) mortgaged with the bank, under section 13(8) of SARFAESI. This way SFC will be able to maximise the value of assets (Land, building, plant & machinery), without violating the provisions of either the Code (IBC.2016) or SARFAESI.

Lastly, following are some interesting provisions of the regulations for insolvency of Personal Guarantors.

Quote;

Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtor) Regulations, 2019, 

# Regulation 4. Eligibility of resolution professional. (1) An insolvency professional shall be eligible to be appointed as a resolution professional for a resolution process, if 

(a) he, the insolvency professional entity of which he is a partner or a director, and all the partners and directors of the said insolvency professional entity are independent of the guarantor; 

(b) he is not subject to any ongoing disciplinary proceeding or a restraint order of the Board or of the insolvency professional agency of which he is a professional member; and 

(c) the insolvency professional entity of which he is a partner or a director, or any other partner or director of such insolvency professional entity does not represent any party in the resolution process. 

Explanation.- For the purposes of this sub-regulation, - 

(i) a person shall be considered independent of the quarantor, if he 

• (a) is not an associate of the guarantor; 

• (b) is not a related party of the corporate debtor; and 

• (c) has not acted or is not acting as interim resolution professional, resolution professional or liquidator in respect of the corporate debtor; 

(ii) the expression "related party" shall have the meaning assigned to it in sub-section (24) of section 5. 

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Unquote; Legislative intent of the above provision is clear that interim resolution professional, resolution professional or liquidator in respect of the corporate debtor should not be allowed to deal with the properties of the personal guarantor of the CD. In my opinion all the case laws mentioned in the blog (supra) are "Per Incuriam", being violative of the provisions of the Code & SARFAESI.

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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Immovable Properties - Void Transactions

Hon’ble High Court Madras in Janata Sahakari Bank Ltd. vs Tax Recovery Officer VII, Income Tax Department (W.P.No.15437 of 2014 and M.P.No.1 of 2014) observed as under;

• It is necessary to consider the conflicting provisions of the Income Tax Act, SARFAESI Act and Recovery of Debts and Bankruptcy Act, 1993.

• Therefore, it is unambiguous that, during pendency of the proceedings (section 281 of Income Tax Act) if any charge is created, then such charge created by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever shall be void.

• In such cases, the Income tax proceedings are known only to the tax defaulter and not to the third party purchaser or the mortgagee Bank or otherwise. 

• Thus, the void transfers or transactions made during the pendency of the Income tax proceedings cannot be the subject matter for any mortgage or further transfers or transactions etc., This being the possible perceptions, the Courts are bound to consider, which transaction will prevail over and which Act would be applicable with reference to the facts and circumstances.

• Admittedly, the SARFAESI Act and Recovery of Debts and Bankruptcy Act, 1993 provides priority to the secured creditors and the Income Tax Act provides priority to the tax arrears to be recovered. Under these circumstances, this Court is inclined to consider the common law "Doctrine of priority of crown debts"

As far as the matter of priority of charge with the financial institution or its validity (void) is concerned or the matter is limited between the financial institutions &  the Govt. Authorities, the borrower(s), have little or no concern. 

The Income tax proceedings are known only to the tax defaulter. Provisions of  “The Income Tax Act”, renders any charge created by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever as ab initio void, during the pendency of Income Tax proceedings, though without any public notice of such proceedings. 

These provisions (Section 281 of Income Tax Act) thus have significant implications for the members of the general public, who enter into some transaction (sale, mortgage, gift, exchange or any other mode of transfer whatsoever) in respect of these properties, in absence of any public notice of such proceedings. 

Propriety & natural justice demands that the information of initiation of Income Tax proceedings should be placed in public domain (preferably on CERSAI) so that public at large may be able to take informed decisions before entering into any transaction with owners of such immovable properties.

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.

Sale of Assets & Liabilities of CD as a going Concern during Liquidation - Violation of Fundamental Rights of Equality (Article 14 of Constitution) of claimants (liabilities)

Recently Appellate Authority (NCLAT) in Visisth Services Ltd. Vs. S. V. Ramani, Liquidator of United Chloro-Paraffins Pvt. Ltd. [Company Appeal (AT) (Insolvency) No.896 of 2020] upheld the orders of Adjudicating Authority (NCLT) confirming sale/auction of Assets & Liabilities of CD as a going concern during liquidation process. 

Genesis of the orders of NCLT & NCLAT lies in the following regulations;

a). Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016.

# 39C. Assessment of sale as a going concern.

(2) Where the committee recommends sale as a going concern, it shall identify and group the assets and liabilities, which according to its commercial considerations, ought to be sold as a going concern under clause (e) or clause (f) of regulation 32 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.

b). Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.

# 32A. Sale as a going concern.

(1) Where the committee of creditors has recommended sale under clause (e) or (f) of regulation 32 or where the liquidator is of the opinion that sale under clause (e) or (f) of regulation 32 shall maximise the value of the corporate debtor, he shall endeavour to first sell under the said clauses.

(2) For the purpose of sale under sub-regulation (1), the group of assets and liabilities of the corporate debtor, as identified by the committee of creditors under sub-regulation (2) of regulation 39C of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 shall be sold as a going concern. 

(3) Where the committee of creditors has not identified the assets and liabilities under subregulation (2) of regulation 39C of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, the liquidator shall identify and group the assets and liabilities to be sold as a going concern, in consultation with the consultation committee.

The word “Liability” or “Liabilities” is nowhere defined in the Code, CIRP Regulations, Liquidation Regulations or The Companies Act.

Elaborate provisions have been provided in the Code to identify the assets & claims (liabilities) of the CD.

a). Section 36 - Identification of Assets.

b). Section 38 to 42 - Identification of claims on CD (Liabilities of CD).

Further Section 52 & 53 provides for disposal of  assets & settlement of claims (liabilities).

As per the provisions of Section 53, after distribution of the proceeds of assets by the liquidator, all claims/liabilities stand satisfied/extinguished.

 

Now the question is how CoC can identify the liabilities (claims on CD) during insolvency process, even prior to public announcement of Liquidator calling for the claims on CD. 

Liabilities, auctioned/sold along with assets in going concern auction/sale during liquidation, will thus get novated and will be satisfied in full in due course of time. Clubbing of liabilities (claims on CD) with assets will also tantamount to preferential treatment of such liabilities vis-a-viz liabilities/claims settled by liquidator under the provisions of Section 53. 

This will also be the violation of Fundamental Rights of Equality enshrined under the Constitution of India.

• The Constitution Of India 

• Article 14. Equality before law The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India Prohibition of discrimination on grounds of religion, race, caste, sex or place of birth.

Now the questions arise;

1. What are the criterias to be adopted by CoC [Regulation 39(c)] & liquidator [Regulation 32A] for identifying the liabilities for clubbing the same with assets in going concern sale during liquidation?

2. Whether these liabilities so identified (supra) will stand attached with the assets and constitute as part of Liquidation Estate (Section 36)?

3. Whether the liquidator has powers to auction/sale any asset/liability, which are not part of Liquidation Estate?

4. Whether liquidator has to settle liabilities/creditors mandatorily as per the priority specified in section 53 or the priority of liabilities/creditors can be altered by RP/Liquidator by clubbing the liabilities with assets in consultation with CoC [CIRP Regulation 39(c)] / SCC [Liquidation Regulation 32A]

5. How will the compliance of Section 54 be taken care of?

In another case, in Nitin Jain Liquidator of PSL Ltd. Vs. Lucky Holdings Pvt. Ltd [IA 391 (AHM)/2021 in CP (IB) 37 (AHM) 2017 ] Adjudicating Authority using residuary powers of NCLT under section 60(5) granted relief to Successful Auction Bidder in liquidation process beyond the provisions of section 32A;

• Thus, considering these findings of the Hon'ble Supreme Court, it is crystal clear that this Adjudicating Authority has got adequate jurisdiction as regard to most of the issues raised in this application, being issues arising out of or insolvency resolution as well as are in relation to liquidation proceedings of the Corporate Debtor.

• Thus, in our considered view, the reliefs and concessions on the parallel line of an approved resolution plan can be granted subject to one condition that such reliefs/concessions must be central issues and also in relation to or arising out of liquidation proceedings of a Corporate Debtor so as to confer jurisdiction on Adjudicating Authority under Section 60(5)(c) of the IBC, 2016.

• The Successful Auction Bidder shall not be liable for any action/responsibility of the Corporate Debtor or its erstwhile management as per provisions of Section 32A of IBC, 2016.

Insolvency and Bankruptcy Code, 2016.

# Section 32A. (1) Notwithstanding anything to the contrary contained in this Code or any other law for the time being in force, the liability of a corporate debtor for an offence committed prior to the commencement of the corporate insolvency resolution process shall cease, and the corporate debtor shall not be prosecuted for such an offence from the date the resolution plan has been approved by the Adjudicating Authority under section 31, if the resolution plan results in the change in the management or control of the corporate debtor to a person who was not- 

(a) a promoter or in the management or control of the corporate debtor or a related party of such a person; or

(b) a person with regard to whom the relevant investigating authority has, on the basis of material in its possession, reason to believe that he had abetted or conspired for the commission of the offence, and has submitted or filed a report or a complaint to the relevant statutory authority or Court:

Provided that if a prosecution had been instituted during the corporate insolvency resolution process against such corporate debtor, it shall stand discharged from the date of approval of the resolution plan subject to requirements of this sub-section having fulfilled:

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Some other cases;

i). NCLT Hyderabad (30.06.2021) in Viswa Infrastructures Finance & Services Pvt Ltd  Vs SREI Equipment Finance Ltd  [IA (IBC)/157/2021 in CP (IB) No. 329/7/HDB/2018 ] held that; 

• Corporate Debtor is being sold on an ongoing concern basis which is more or less in the nature of resolution of the Corporate Debtor as such he has no objection if the prayers sought for in the term sheet submitted by the successful bidder are allowed by the Tribunal. Already Successful Bidder has deposited Rs. 57 crores. In order for the Successful bidder to kick start the business and follow the law laid down under the Companies Act, 2013, it is imperative for the Tribunal to grant necessary reliefs. 

• The said assets are free from any financial implications arising out of any pending proceedings before relevant authorities, if any. Further non compliance of provisions of any laws, rules, regulations, directions, notifications, circulars etc on the Corporate Debtor under various Acts and Regulations stands extinguished, qua the successful bidder. 

• The erstwhile promoters or any member, associate of the Existing and Erstwhile promoter groups is hereby restrained from doing any business directly or indirectly in connection with the products and services presently offered by the Corporate Debtor

• “Relief sought with regard to issuance/renewal of all kinds of licenses / permissions/ approvals required is allowed subject to payment of renewal fees, if any, from this date to the Licensing Authorities. 

ii). NCLT Mumbai-1 (2018.11.29) in Alchemist Asset Reconstruction Company Ltd. Vs. Abhijeet MADC Nagpur Energy Pvt. Ltd. [MA 1343/2018 IN CP (IB)-1315/MB/2017] held that;

• It is to be clarified that when sale is to be made on a going concern basis, then certainly after the transfer of undertaking, acquirer gets all right, title and interest in the whole and every part of the undertaking, without any security interest, encumbrance, claim, counterclaim, or any demur, into the acquirer.

iii). NCLT Mumbai-I (09.03.2021) in Gaurav Jain  Vs. Sanjay Gupta, [IA No. 2264 of 2020 in C.P. (IB) No. 1239/MB/2018] held that;

• The crux of the ‘going concern sale’ is that the equity shareholding of the Corporate Debtor is extinguished and the acquirer takes over the undertaking with the assets, licenses, entitlements etc.

• The Corporate Debtor survives, only the ownership is transferred by the Liquidator to the purchaser. All the rights, titles and interest in the Corporate Debtor including the legal entity is transferred to the purchaser. After the sale as a ‘going concern’, the purchaser will be carrying on the business of the Corporate Debtor.

• As far as the Liquidator is concerned, when the sale consideration is received from the bidder / purchaser, the same will be distributed to the Creditors in accordance with Section 53 of the Code. Since the amount is paid to the Creditors in terms of the Code, the liabilities of the Corporate Debtor towards the Creditors are treated as settled and the purchaser takes the assets free of any encumbrances or whatsoever.

• In the normal parlance “going concern” sale is transfer of assets along with the liabilities. However, as far as the ‘going concern’ sale in liquidation is concerned, there is a clear difference that only assets are transferred and the liabilities of the Corporate Debtor has to be settled in accordance with Section 53 of the Code and hence the purchaser of this assets takes over the assets without any encumbrance or charge and free from the action of the Creditors.

Thus, there are contradictions in the various orders (supra), in respect of the following question;

1. Whether the auction purchaser during liquidation process under IBC takes over the assets without any encumbrance or charge and free from the action of the Creditors.  

This position is negated when the assets & liabilities are clubbed together for auction/sale in going concern sale as per the existent regulations. Rather, provisions of going concern sale  in liquidation are being used as a backdoor resolution process and reliefs, concessions & protections [Section 32A(1)] of the resolution process are being allowed in arbitrary manner, in absence of Rules & Regulations. Even in the resolution process, all liabilities stand extinguished, post approval of the resolution plan by the Adjudicating Authority. Thus clubbing of liabilities with assets in going concern sale during liquidation process is antithesis of the objectives of the Code. 

Way forward; Keeping in view the letter & spirit of the section 240 (1), Board may consider amendments to the CIRP & Liquidation Regulations, in respect of treatment of going concern auction/sale during liquidation process or as a regulator propose amendments in the Code, to make Code & Regulations sync together.  

 # Section 240. Power to make regulations. –

(1) The Board may, by notification, make regulations consistent with this Code and the rules made thereunder, to carry out the provisions of this Code.

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.