Articles 31st May 2024
The issue of settlement and distribution amongst secured creditors has long been a contentious topic within the banking sector, particularly under the Insolvency and Bankruptcy Code (IBC). The complexity arises from the dual pressures of ensuring fair treatment for all creditors and maintaining an efficient resolution process. The recent judgments by the Supreme Court of India, including the DBS Bank Limited Singapore v. Ruchi Soya Industries Limited and Another[1] and in India Resurgent ARC Private Limited v. Amit Metaliks Limited & Another [2] cases, have significantly shaped the discourse around the rights of dissenting secured creditors and the commercial wisdom of the Committee of Creditors (CoC).
These decisions underscore the delicate balance necessary to prevent strategic dissent by secured creditors aiming for higher payouts while safeguarding the legitimate claims of minority creditors. This analysis explores the legal complexities and jurisprudence surrounding these matters, examining how the principles of equitable distribution and commercial wisdom can be aligned to promote a fair and effective insolvency resolution process.
In a recent judgment, the National Company Law Appellate Tribunal (NCLAT), New Delhi has again reaffirmed the current position relating to distribution amongst secured creditors as per the commercial wisdom of the Committee of Creditors (CoC). In this case[3] the NCLAT upheld the decision of the CoC in deciding the distribution of payments under the plan, emphasizing equitable treatment within creditor classes. Dissenting Financial Creditors were not entitled to special treatment based on their security interests.
The issue of settlement and distribution among secured creditors has long troubled the banking fraternity, creating a significant obstacle to the final settlement of resolution amounts. Banks themselves bear some responsibility for this controversy, as they have taken inconsistent stances on the issue to suit their convenience. Initially, banks agree to security sharing arrangements through inter-creditor agreements at the time of lending. However, they later disregarded these priority arrangements if doing so could result in a better entitlement under IBC. There have been instances where secured creditors have dissented just to leverage their position as a secured creditor for better payout especially in cases where the plan value was less than the liquidation value. There have also been instances where majority members of the CoC have used their voting power and have ignored the entitlement of minority secured creditors under Sections 30(2)(b) and 53(1) of the Code, thereby depriving minority creditors of their legitimate right to the liquidation value of their security.
The above inconsistency in distribution by CoC,has led to multiple legal challenges, with the Supreme Court and the National Company Law Appellate Tribunal (NCLAT) considering the issue in several cases. Currently, this issue is before a larger bench for reconsideration due to the divergent views expressed by different benches of the Supreme Court, particularly in the cases of India Resurgence ARC and DBS Bank Limited.
The issue of distribution of the amount under a resolution plan has seen various judicial interpretations:
In Technology Development Board vs. Mr. Anil Goel & Ors., the NCLT, Ahmedabad, held that once secured creditors relinquish their security interests into the liquidation estate, they should be treated equally, regardless of their original inter-se priorities. This decision was initially supported by the NCLAT, which emphasized the non-obstante clause of Section 53 of the Code, that the relinquishment of security interests necessitates equal treatment among secured creditors in liquidation.
However, this view was contested and led to an appeal in the Supreme Court in Kotak Mahindra Bank Limited vs. Technology Development Board & Ors[4].The Apex Court stayed the NCLAT’s order, indicating that the final stance on inter-se priority under the IBC was yet to be settled. Meanwhile, the Oriental Bank of Commerce vs. Anil Anchalia & Anr[5]. case reiterated that the principles laid down in India Resurgence ARC Private Limited vs. Amit Metaliks Limited (where it was held that amount be paid to different classes or subclasses of creditors is essentially the commercial wisdom of the CoC, and a dissenting secured creditor cannot suggest a higher amount to be paid to it with reference to the value of the security interest), should guide the treatment of dissenting financial creditors, further cementing the evolving jurisprudence on this issue.
In the case of Small Industries Development Bank of India (SIDBI), Vs Vivek Raheja, Resolution Professional, M/s. Gupta Exim (India)[6] the decision of the CoC was upheld by NCLAT. It held that distribution of the proceeds of the plan value as per voting share of the secured creditor in no manner contravenes the provisions of Section 30(2)(b) of the Code.
The Supreme Court of India faced a pivotal issue in the case of DBS Bank Limited Singapore v. Ruchi Soya Industries Limited and Another, on whether dissenting secured creditors are entitled to receive their proportionate share of the resolution plan in line with the value of their security interest and went on to hold that dissenting secured creditors should receive the liquidation value of their security interest This judgment diverged from a prior decision in India Resurgent ARC Private Limited v. Amit Metaliks Limited & Another where the Bench had ruled in favour of commercial wisdom of CoC and rejected the argument for distribution on the basis of value of security interest, and thus was referred to a larger bench for a more conclusive determination.
The adjudication of the above matters centred around the interpretation of Section 30(2)(b) and Section 53 of the Insolvency and Bankruptcy Code (IBC), 2016. These sections detail the treatment of claims in the resolution plan and liquidation process, respectively, ensuring that dissenting financial creditors receive at least the liquidation value of their security interests.
Section 30(2) mandates that the resolution professional must ensure that the insolvency resolution process costs are prioritized. Operational creditors receive an amount not less than their liquidation entitlement. Dissenting financial creditors receive at least the liquidation value of their claims.
Section 30(4) IBC: Section 30(4) empowers the CoC to approve the resolution plan, considering the order of priority amongst creditors and the value of security interests. This section implicitly trusts the commercial wisdom of the CoC while safeguarding the minimum entitlements of dissenting creditors.
While the portions of Section 30(4) and Section 53 of the Code, are quite clear, complications have arisen on account of divergent views taken by the Courts on the issue.
The DBS Bank Limited judgment asserted that dissenting secured creditors should receive the liquidation value of their security interest, aligning with the principles of secured credit. This view supports the minority autonomy of creditors and aims to protect their financial interests during resolution processes. The judgment referenced the UNCITRAL Legislative Guide, emphasizing the necessity of fair treatment for dissenting creditors to uphold their rights and ensure they receive at least the value of their security in liquidation.
Conversely, in India Resurgent ARC, the Supreme Court ruled that dissenting financial creditors are not entitled to enforce their entire security interest value but are limited to the liquidation value as per the resolution plan. This interpretation aimed to prevent an inequitable scenario where dissenting creditors might receive more than their proportional share, potentially disrupting the resolution process and favouring liquidation over resolution, contrary to the IBC’s objectives.
In the judgment of DBS Bank Limited vs. Ruchi Soya Industries Limited[7], the Supreme Court referred to several key judgments to elucidate the rights of dissenting financial creditors under the Insolvency and Bankruptcy Code (IBC). These included India Resurgence ARC Private Limited, Jaypee Kensington Boulevard Apartments Welfare Association vs. NBCC (India) Ltd[8]., and Vistra ITCL (India) Limited & Ors. v. Dinkar Venkatasubramanian & Anr[9]. In India Resurgence ARC Private Limited, the Court acknowledged the role of the CoC’s commercial wisdom in approving a resolution plan but emphasized that dissenting secured creditors must receive at least the liquidation value of their security interest as stipulated under Section 30(2)(b)(ii). The Supreme Court India in Resurgence ARC judgment interpreted Section 30(2)(b)(ii) read with Section 30(4) of the IBC, has laid down that dissenting financial creditors cannot claim higher payouts based on the value of their security interests than what is prescribed under Section 53(1). This ensures that dissenting creditors do not create an inequitable situation by receiving excess amounts out of the liquidation value of the Corporate Debtor, thereby safeguarding the interests of other creditors.
The Jaypee Kensington judgment reiterated that dissenting financial creditors are entitled to the monetary value equivalent to their security interest, ensuring this compensation is provided in money rather than enforcement of the security interest, to avoid jeopardizing the resolution plan. The Vistra ITCL case further clarified that dissenting financial creditors must receive payments reflecting the value of their security interest, aligning with Section 53(1) of the IBC, thereby affirming their right to equitable treatment and priority in payment. These judgments collectively underscore the principle that dissenting financial creditors should be compensated fairly and not be worse off compared to other creditors, ensuring the resolution plan’s integrity and the equitable treatment of all creditors.
United Kingdom
In the UK, the Corporate Insolvency and Governance Act 2020 introduced mechanisms similar to those discussed in the DBS Bank judgment. Notably, the “cross-class cram down” allows a restructuring plan to be sanctioned by the court, even if some classes of creditors dissent, provided that certain fairness criteria are met. This was demonstrated in the case involving Deep Ocean[10] (first ever judgment from UK High Court sanctioning a restructuring plan under Part 26A of the Companies Act 2006, invoking the new cross class cram down procedure introduced into UK law in June 2020). Here the High Court bound a dissenting class of creditors to a restructuring plan. The court emphasized the need for a balanced approach that considers the interests of all creditors, ensuring that the plan treats creditors equitably and justifiably.
United States
In the US, Chapter 11 bankruptcy provisions also recognize the concept of “cram down” under Section 1129(b) of the Bankruptcy Code. This allows a reorganization plan to be confirmed despite the objections of some classes of creditors, as long as the plan does not unfairly discriminate and is fair and equitable towards dissenting creditors. This approach ensures that secured creditors’ rights are preserved while facilitating the company’s restructuring.
European Union
EU restructuring frameworks, under the EU Restructuring Directive, similarly empower courts to confirm restructuring plans over the objections of dissenting creditors if the plan complies with specific fairness and equity requirements. This directive aims to harmonize restructuring laws across member states, ensuring that creditors receive fair treatment and that viable businesses can be rescued efficiently.
The Supreme Court’s judgment in DBS Bank Limited v. Ruchi Soya Industries Limited aligns with global principles governing secured creditors’ rights and the legal framework within the IBC. By ensuring dissenting creditors receive the liquidation value of their security interests, the judgment adheres to the protective measures recommended by international standards such as the UNCITRAL Model Law and practices in major jurisdictions. The Supreme Court clarified that a dissenting financial creditor must receive payment to the extent of their entitlement, satisfying Section 30(2)(b) of the IBC. This requirement ensures that dissenting financial creditors are paid an amount not less than the value of their security interest, aligning with the liquidation value under Section 53(1).
The Supreme Court elucidated that while dissenting financial creditors are entitled to monetary compensation equivalent to their security interest, they are not permitted to enforce their security interest to recover this amount. This approach prevents undermining the resolution plan’s viability and maintains the focus on financial recovery through monetary payments.
While DBS Bank Judgement is in sync with the legislative intent as captured under Section 30 and 53 of the Code, however, there have been instances where secured creditors have dissented just to leverage their position as secured creditor for better payout. The situation becomes more challenging where the plan value is less than the liquidation value. In such situations theentire value of the resolution plan would be claimed by the secured creditor relying upon their entitlement under section 30(2) of the Code.
There have also been instances where majority members of the CoC using their voting power have ignored the entitlement of minority secured creditors under Sections 30(2)(b) and 53(1) of the Code, thereby depriving minority creditors of their legitimate right to the liquidation value of their security.
Therefore, there is need to address this issue. This could be addressed if the principles laid out in the DBS Bank and India Resurgence ARC judgments are aligned with the practical implications of insolvency proceedings under the IBC. The DBS Bank and India Resurgence ARC judgments provide a framework to address the challenge of dissenting secured creditors.
The concept of the “Commercial Wisdom of the CoC is a foundational principle under the Insolvency and Bankruptcy Code in India. It acknowledges that the CoC, comprising financial creditors, is best placed to decide on the viability and feasibility of a resolution plan based on their expertise and commercial considerations. However, this commercial wisdom must be exercised judiciously to ensure fair treatment of all creditors, including dissenting secured creditors, and to safeguard against practices that undermine the integrity of the resolution process.
The CoC’s commercial wisdom should inherently include the principles of fairness and equitable treatment of all creditors.
When considering a resolution plan, the CoC should provide justifications and disclosures on how the distribution amounts are determined. This includes how the liquidation value was calculated and how the proposed payouts align with the priorities outlined in Section 53(1) of the IBC. Transparency can reduce disputes over alleged underpayment and demonstrate the CoC’s commitment to fair treatment.
By establishing robust internal checks and involving independent experts, the CoC can pre-empt potential legal challenges by demonstrating that their decisions are well-founded and justifiable. Transparency can prevent the misuse of voting power by majority creditors and provide a clear basis for any decisions made by the CoC.
If required the CoC may use mediation process to negotiate terms that are acceptable to relevant secured creditor. This approach can prevent situations where dissenting creditors feel compelled to dissent purely for better financial outcomes, thereby aligning their interests with the broader objectives of the resolution plan.
The Insolvency and Bankruptcy Board of India (IBBI) can issue guidelines to ensure that the commercial wisdom of the CoC is exercised in a manner that protects the interests of all creditors. Regular monitoring and audits of CoC decisions can help in identifying and addressing any biases or unfair practices.
Implementing these measures, supported by the jurisprudence established in the DBS Bank and India Resurgence ARC judgments, can help strike a balance between the commercial interests of creditors and the equitable treatment of all parties involved in the insolvency process. By reinforcing the principles of equitable treatment and adherence to the liquidation waterfall mechanism, these rulings ensure that no creditor can unduly benefit at the expense of others. The key lies in designing fair resolution plans, and possibly refining legal provisions to address any emerging challenges in insolvency proceedings.
We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com or write to our authors:
Mukesh Chand, Senior Counsel – Email – MukeshChand@elp-in.com
[1] [2024] 1 S.C.R. 114
[2] CIVIL APPEAL NO. 1700 OF 2021 Decided by the Supreme Court on 13.05.2021
[3] Beacon Trusteeship Ltd. Vs. Jayesh Sanghrajka, RP of Radius Estates and Developers Pvt. Ltd. and Ors.
[4] CIVIL APPEAL Diary No(s). 11060/2021 (Arising out of impugned final judgment and order dated 05-04-2021 in CAAT(I) No. 731/2020 passed by the National Company Law Appellate Tribunal)
[5] Company Appeal (AT) Ins. No. 547 of 2022 decided on 26th May, 2022
[6] Company Appeal (AT) (Insolvency) No. 570 of 2022 Decided on 16 September, 2022
[7] (Civil Appeal No. 9133 of 2019) Decided on 03 January 2024
[8] CIVIL APPEAL NO. 3395 OF 2020
[9] CIVIL APPEAL NO.3606 of 2020 Decided on 4 May 2023
[10] [2021] EWHC 138 (Ch),[2020] EWHC 3549 (Ch)