Implication of SARFESI Act in Relinquishment of Security Interest during Liquidation
– K.Amoghavarsha & Vishesh Jain
Introduction
The Insolvency and Bankruptcy Code, 2016 [‘Code”] through various amendments, with the most recent one being the IBC Ordinance, 2020, has consistently tried to maximise the value of assets of the corporate debtor. If the insolvency resolution process fails, then, under section 33 of the Code, the liquidation process is initiated. In the liquidation process, the secured creditors can realize their dues from the security against the debt either in entirety or in part. Theother creditors will be given their dues following the preference as per waterfall mechanism under section 53 of the Code. Under the code, a secured creditor can opt for either of the two alternatives regarding the security interest against the debt i.e. the security can either be realised or relinquished. The realisation of the security interest can be done either under section 52(1)(b) of the Code, read with Regulation 37 of the “Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016”, or under section 52(4) of the Code read with Section 13(9) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest 2002 [“SARFAESI Act”].To relinquish security interest, section 52(1)(a) of the Code comes into the picture.
A situation may arise where one of the creditors refuses to relinquish his security interest, wherein multiple creditors have obtained security against the same asset. This situation is cleared by arecent judgment of the NCLAT in the case of SrikanthDwarkanath v. Bharat Heavy Electricals Limited. This article analyzes the aforementioned judgement and the consequent situations which may arise, where multiple creditors having security against the similar assets refuse to relinquish its security interest.
Understanding the NCLAT’S Judgement
A three-judge bench of the NCLATheld that BHEL, who was one of the eleven secured creditors (by the way of an arbitral award dated 24th January 2018), had no right to realise its security interest as it would be harmful to the liquidation proceedings and the interest of the remaining creditors would be jeopardized. The tribunal consequently applied the ‘majority rule’, which made relinquishment of security interest compulsory for the creditors.
The problem arose subsequently after the order of liquidation was passed for Surana Power Ltd., when BHEL, one of the eleven secured creditors refused to relinquish its security interest contrary to the other ten creditors who agreed to do so. BHEL had a share of 26.24% on secured assets, due to which the official liquidator was unable to sell off the secured assets, as the assets on which BHEL was granted lien were already hypothecated to other creditors. Therefore, this created deadlock for completing the liquidation process. BHEL, while explaining its conduct, relied on the proviso to Regulation 32 of the ‘Liquidation Process Regulations’ which makes it necessary for all the creditors to relinquish their security interests before the sale of the assets into the liquidation estate. The Liquidator filed an application with NCLT Chennai Bench, seeking permission from the Adjudicating Authority to sell assets of the Corporate Debtor, which was subsequently rejected. Therefore on the rejection of the appeal, the liquidator approached the NCLAT.
To end this deadlock, the tribunal applied section 13(9) of the SARFAESI Act, which mandates the enforcement of security interest if 60% or more creditors agree to do the same. Since BHEL was the only dissenting creditor and had a minority share of 26.24 % over the secured assets, the interests of the majority creditors were upheld by NCLAT in its decision, which consequently instructed BHEL to relinquish its security interest.
Issues with the Judgement
Application of SARFESI ACT was uncalled for
Application of SARFAESI Act was unnecessary in the present case because,as per section 2(1)(zd) only ‘financial institutions, banks or assets reconstruction companies’ come under the definition of ‘secured creditor’ under SARFAESI Act and therefore, are bound by it. In Suzuki ParasrampuriaSuitings Limited v Official Liquidator of Mahendra Petrochemicals Limited, the Supreme Court has affirmed the same as it held that only the entities mentioned in Section 2(1)9zd) would fall with the definition of secured creditor under the Act. In the instant case, BHEL is neither a bank nor a financial institution, therefore it won’t fall under the category of ‘secured creditor’ for the purposes of SARFAESI Act. Therefore, BHEL cannot be made to conform to the provisions of the SARFAESI Act.
Precedence of SARFAESI over IBC
The second issue in the present case is that SARFESI was given precedence over the Code, which cannot be done so. As the codeis a special legislation, priority has to be given to the Code over SARFESI. The NCLAT inCanara Bank v. Sri Chandramoulishvar Spinning Mills,made a reference to Innoventive Industries Ltd. v. ICICI Bank and affirmed the fact that in cases where proceedings are simultaneously initiated under both IBC and SARFESI, the proceedings under the Code will be given priority. Along with this, section 14(1)(c) of the Code also comes into the picture, which imposes a moratorium and stops the action of the SARFESI Act till the time the Corporate Insolvency Resolution Process is in action.
Critical Analysis
Under section 36 of the code when the company is in liquidation,the liquidator forms the liquidation estate of all the assets of the corporate debtor. The secured creditor in such a scenario can either relinquish their security interest or can realise their security interest over the secured assets. While making a choice between the two scenarios, two different situations may arise
- Where the creditors have different charge over the same assets i.e. they are not situated pari-passu and opted for differential treatment of their security interest.
- Where the creditors have similar charge over the same assets i.e. they are pari-passu to each other and opted for differential treatment of their security interest.
The first scenario, where the creditor haves different rights of charge over the same secured assets i.e. the creditors are not pari-passu, has been settled by the court in JM Financial Assets Reconstruction Company Ltd. v. Finquest Financial Private Limited and Ors..It was held that the creditor having priority charge over other creditors can realize its security interest on the secured asset. Subsequently, the rights of other creditors to realise their security interest ceases to exist,and if more than one creditor wants to realise its security interest, the liquidator will act in terms of section 52(3) of the code to determine the first charge over the assets from the information utility.
In the case of Srikanth v. BHEL, the court tried to answer the second scenario, which arises when the creditors who are situated pari-passu, opt for differential treatment of the security interest. The court relied on section 13(9) of the SARFAESI Act for realising security interest and overlooked the section 52 of the code read with the Regulation 37 of the Liquidation Process Regulation, 2016. The NCLAT, while upholding the majority rule, overlooked the situation where the creditors with any percentage of share can enforce its security as per Regulation 37 of Liquidation process. This certainly jeopardises the interest of other creditors, as giving supremacy to the interest of one creditor may affect the whole liquidation process.
However, IBC being the special legislation, should be given primacy over other legislations. This decision may act as a bad precedent. It might lead to unjust conclusions in certain situations. For instance, the pari-passu creditors having a share percentage of 55% who wants to realise its interest but made to relinquish its interest even after having the majority share.
Thus, the problem with the tribunal judgement is not that it is based on majority rule, but that it arrived on the conclusion without considering Regulation 37 of the liquidation process as an alternative security enforcing mechanism.
Conclusion
The NCLAT’s decision, in this case, has raised certain interesting points but did not clear the same and has rather muddled them more. The application of the majority rule under the SARFAESI Act has been effective but the ignorance of alternative security enforcing mechanism under the Code cannot be ignored. To say the least, the use of SARFAESI Act in asset relinquishment is unprecedented. The position taken by the tribunal, by allowing the sale of secured assets, encroaches on the rights of BHEL. This has been validated by the NCLAT itself in the case of AnujBajpai v State Bank of India. The NCLAT held that a secured creditor is entitled to stay out of the liquidation proceedings, irrespective of whether it causes prejudice to others or not. It is not the duty of the NCLAT to take it as collateral and sell it on its own accord. This would be a violation of the right of the secured creditor.
All these points need to be taken into consideration so that the use of SARFESI Act is limited to this specific situation and not used to broadly accommodate all kinds of situations.
This article is authored by K.Amoghavarsha & Vishesh Jain. They are students of law at National Law University, Odisha.