Right of payment to dissenting FCs holding security interest
The cases of: (a) Small Industries Development Bank of India v. Vivek Raheja & Others (Vivek Raheja); (b) Union Bank of India v. Mr. Rajender Kumar Jain, Resolution Professional of M/s Kudos Chemie Ltd. & Others (Kudos Chemie); and (c) Andhra Pradesh State Financial Corporation v. Kalptaru Steel Rolling Mills Ltd. & Another (Kalptaru), concern the right of payment to dissenting FCs holding security interest under the CIRP.
Key facts
In all these cases, appellants, being secured and dissenting FCs, had challenged the resolution plan on the grounds that the amount being offered to each appellant was as per its voting share and not as per the liquidation value of its ‘security interest’, in violation of section 30(2)(b) of the Code. For instance, in Vivek Raheja, the appellant had contended that it was entitled to receive the liquidation value of the securities exclusively charged to it, i.e., Rs 5.64 crore, which was 6.93% of the liquidation value of the CD. However, the resolution plan had provided for a payment of Rs 1.65 crore to the appellant as per its voting share of 2.03% in the CoC by completely disregarding the provision of section 30(2)(b) of the Code.
The rulings
In all these cases, the NCLAT, New Delhi upheld the resolution plan providing for payments to dissenting and secured FCs as per their voting share rather than the liquidation value of their security interest. The NCLAT, New Delhi relied on the decision of the Supreme Court in India Resurgent ARC Private Limited v. Amit Metaliks (Amit Metaliks), and held that the CoC has the discretion to decide the amounts of payments to be made to different classes or sub-classes of creditors as per its commercial wisdom under section 30(4) of the Code.
In Vivek Raheja, the NCLAT, New Delhi, also held that as per section 30(2)(b) of the Code, a dissenting FC is entitled to receive the liquidation value of its ‘debt’, which refers to the entitlement of a dissenting FC computed as per its ‘voting share’ and not as per the liquidation value of its ‘security interest’. Examination Section 30(2)(b) of the Code provides that dissenting FCs shall be paid an amount, which shall not be less than the amount payable in the event of liquidation of the CD, i.e., the liquidation value of their debt.109 Section 30(4) of the Code provides that the CoC may approve a resolution plan after taking into account 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.’
In the case of Essar Steel, the Supreme Court, while upholding the constitutional validity of the amendment to section 30(4), requiring the CoC to consider the ‘manner of distribution’ while approving a resolution plan, had noted that the term ‘may’, employed in section 30(4) indicates that a discretion has been conferred upon the CoC to consider the ‘manner of distribution’ while taking the business decision of acceptance or rejection of a resolution plan. However, it is pertinent to note that in Essar Steel, the Supreme Court had not considered the interplay between section 30(2) and section 30(4) of the Code.
Further, the reliance on Amit Metaliks by the NCLAT, New Delhi, is not apt in the facts and circumstances of these cases. In Amit Metaliks, while the Supreme Court had noted that section 30(4) is a mere guideline, which only amplifies the considerations to be taken into account by the CoC while exercising its commercial wisdom, the Supreme Court had also clarified that the amount to be paid to a dissenting FC is innate in section 30(2)(b) of the Code and that a dissenting FC is entitled to receive the liquidation value. The case of Amit Metaliks does not elucidate the manner of computation of liquidation value of debt. While the Supreme Court in Amit Metaliks, had rejected the contention of the appellant, a secured and dissenting FC, to receive payment as per the ‘valuation of its security interest’, the judgment was silent on whether the appellant had sought the ‘liquidation valuation of its security interest.’ It is to be noted here that the liquidation value of an asset, which refers to the value an asset would fetch if it is to be sold immediately with limited exposure to potential purchasers, is typically lower than the fair value of the asset.
In our view, the decision in Amit Metaliks upholds the right of dissenting FCs to receive minimum liquidation value as per section 30(2)(b) of the Code, and should be restricted to the facts of that particular case, given that it renders no finding on computing entitlement of dissenting FCs as per the liquidation value of their security interest.
In light of the above, in order to discern the mode of computation of the liquidation value of the debt of dissenting FCs, it is useful to discuss the treatment of secured creditors and dissenting creditors as discussed under the UNCITRAL Legislative Guide, which was instructive in drafting the Code and has been referred to in numerous landmark decisions.
The UNCITRAL Legislative Guide provides that it is paramount to ‘recognise’ and ‘enforce’ in insolvency proceedings the differing rights that creditors have in respect of the debtor and its assets prior to the initiation of the insolvency proceedings, particularly in respect of the rights and priorities of secured creditors, as it would not only generate ‘certainty in the market’ but also ensure ‘provision of credit’.
The UNCITRAL Legislative Guide further states that any measure that has the potential to diminish the ability of secured creditors to recover their debt, should be carefully examined, as it would not only impinge upon the sanctity of commercial bargains but also affect the cost of affordable credit, as a decline in the value of the protection provided to security interest would increase the risk as well as the price of extending credit.
In this context, the UNCITRAL Legislative Guide also elucidates the concept of equitable treatment as recognising that all creditors need not be treated identically but in a way that ‘reflects the different bargains they have struck with the debtor’.
This notion of equitable treatment, as provided under the UNCITRAL Legislative Guide, was also discussed in the case of Swiss Ribbons.
In respect of treatment to dissenting creditors, the UNCITRAL Legislative Guide provides that it should be ensured that the rights of dissenting creditors are not undermined. It states that: As a general principle, that treatment might be that the creditors will receive at least as much under the plan as they would have received in liquidation proceedings. If the creditors are secured, the treatment required may be that the creditor receives payment of the value of its security interest… Against this backdrop, it becomes pertinent to review the statement of objects and reasons of the Insolvency and Bankruptcy Code (Amendment) Act, 2019, pursuant to which section 30(2) was amended to provide for payment of liquidation value of debt to dissenting FCs and section 30(4) was amended to provide for the CoC to consider the manner of distribution, including ‘priority and value of security interest of a secured creditor’ while approving the resolution plan. The statement of objects and reasons notes the need to amend the aforementioned provisions in the following terms: ‘Various stakeholders have suggested that if the creditors were treated on an equal footing when they have different pre-insolvency entitlements, it would adversely impact the cost and availability of credit.’
From the above, it is amply clear that the legislature recognised the need to ensure that the rights of the creditors prior to the commencement of insolvency proceedings, i.e., ‘pre-insolvency entitlements’, are recognised and enforced as per the commercial bargain with the debtor instead of treating them all on an equal footing, as a uniform treatment would affect the cost and availability of credit. When examined against the above theory of insolvency law, it becomes evident that the liquidation value of a dissenting FC under section 30(2) is to be determined in reference to the liquidation value of the ‘security interest’ available to the creditor as opposed to its ‘voting share’, as the security interest provided to secure the debt is an essential element of the commercial bargain between the parties and only such an interpretation would be able to recognise the commercial bargain struck by each creditor with the debtor. Further, the term ‘may’ used in section 30(4), as held by Essar Steel, certainly indicates that a discretion has been conferred upon the CoC to consider the manner of distribution, including priority and value of security interest of a secured creditor. However, such a discretionary power cannot be extended to altering the priority or value of security interest of a dissenting creditor, as that would essentially amount to relinquishment of its security interest without its explicit consent, which is not permissible under law.
In Essar Steel, the Supreme Court had not considered the interplay between section 30(2) and section 30(4) of the Code.
On a constructive interpretation, the discretionary powers under section 30(4) cannot be extended to unilaterally alter the priority or value of security of dissenting secured FCs, as it would be contrary to the minimum guarantee of liquidation value assured under section 30(2)(b) of the Code and would also violate the principle of equitable treatment of recognising the different bargains struck by the creditors with the debtor. Thus, in our view, the interpretation provided in the cases of Vivek Raheja, Kudos Chemie, and Kalptaru is at odds with the principles of availability of credit, promotion of entrepreneurship, and equitable treatment of creditors embedded in the Code. In this regard, it is to be noted that as on March 15, 2023, an appeal has been preferred before the Supreme Court against the decision of the NCLAT, New Delhi in Vivek Raheja, and the same is currently pending adjudication.
This analysis has been done by L Viswanathan, Animesh Bisht and Karan Sangani, and it first appeared in IBBI’s publication Navdrishti: Emerging Ideas of IBC
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