2021 (4) TMI 301 - AT - Insolvency and Bankruptcy

Equal ranking for Secured Creditors relinquishing security interest under I&B Code

The Tribunal held that Secured Creditors relinquishing security interest should be treated as one class for asset distribution under Section 53(1)(b)(ii) ... Relinquishment of security interest to the liquidation estate - distribution of assets under Section 53(1)(b)(ii) of the I&B Code - realisation of security interest under Section 52 - doctrine of election (choice between realisation and relinquishment) - equal ranking of secured creditors who relinquish security - priority of charge (first charge v. second charge) upon enforcement - overriding effect/non-obstante clause of Section 53Relinquishment of security interest to the liquidation estate - distribution of assets under Section 53(1)(b)(ii) of the I&B Code - equal ranking of secured creditors who relinquish security - Whether secured creditors who relinquish their security interest must be treated as a single class ranking equally for distribution from the sale proceeds under Section 53(1)(b)(ii). - HELD THAT: - Sections 52 and 53 read together give a secured creditor, in liquidation, a statutory option: either to realise its security interest under Section 52 or to relinquish that interest and claim from the liquidation estate under Section 53. Relinquishment divests the secured creditor of enforcement rights qua the secured asset and brings it within the waterfall in Section 53. Section 53(1)(b)(ii) expressly ranks debts owed to secured creditors who have relinquished their security equally among themselves, second only to insolvency resolution process costs and liquidation costs. The non-obstante opening of Section 53 gives it overriding effect over contrary provisions of other laws. Thus once secured creditors elect to relinquish, they rank equally for distribution under Section 53(1)(b)(ii), and the liquidator must distribute proceeds accordingly. [Paras 6, 7, 8, 9]Secured creditors who relinquish their security interest must be treated as one class ranking equally for distribution under Section 53(1)(b)(ii).Realisation of security interest under Section 52 - priority of charge (first charge v. second charge) upon enforcement - doctrine of election (choice between realisation and relinquishment) - Whether the prior inter-se priority (first charge v. second charge) survives where a secured creditor elects to relinquish its security, and when priority remains relevant. - HELD THAT: - The distinction between Sections 52 and 53 is pivotal. If a secured creditor elects to realise its security interest, the priority attached to the security (for example first charge over second charge) is material in enforcement against the particular secured asset; the first charge holder will have precedence in realisation. However, if the secured creditor elects to relinquish the security interest to the liquidation estate, the right to enforce the prior charge is foregone and distribution is governed by Section 53. Further, a secured creditor who enforces its security but does not realise the full debt is relegated, for the unpaid part, to a lower priority under Section 53(1)(e)(ii). Thus the doctrine of election determines whether pre-existing charge priority continues to operate in liquidation. [Paras 7, 8]Pre-existing inter-se priority (first v. second charge) remains relevant only if the secured creditor elects to realise its security; relinquishment causes the creditor to be governed by Section 53 and lose enforcement priority.Overriding effect/non-obstante clause of Section 53 - distribution of assets under Section 53(1)(b)(ii) of the I&B Code - Whether earlier judicial authority recognizing priority of first charge (pre I&B Code) can control distribution under Section 53 where Section 53 has overriding effect. - HELD THAT: - A pre-IBC decision affirming primacy of a first charge holder under general property law cannot displace the specific distribution scheme enacted by the I&B Code. Section 53 contains a non-obstante clause and an overriding mandate; it therefore governs distribution in liquidation notwithstanding earlier case law to the contrary. The tribunal held that reliance on pre Code precedents to preserve first charge priority in the face of a statutory relinquishment and the Section 53 waterfall is misplaced. [Paras 10, 11]Section 53's overriding scheme governs distribution in liquidation and supersedes prior judicial pronouncements that would preserve first charge priority contrary to Section 53.Maintainability of application under I&B Code challenging distribution - Whether the application by the appellant challenging the liquidator's distribution was maintainable. - HELD THAT: - The Adjudicating Authority had held the application non-maintainable on the basis that inter se priorities among secured creditors prevail. Having concluded that secured creditors who relinquish security must be treated as a single class under Section 53(1)(b)(ii), the tribunal held the impugned non maintainability finding unsustainable. I.A. No. 514 of 2019 was therefore held to be maintainable and deserving of relief directing the liquidator to distribute proceeds in accordance with Section 53(1)(b)(ii). [Paras 2, 11, 12]The application challenging the distribution was maintainable; the impugned order rejecting it is set aside.Final Conclusion: The appeal is allowed. The impugned order is set aside; I.A. No. 514 of 2019 in CP(IB) No. 04/2017 is held maintainable. The Liquidator is directed to treat secured creditors who relinquished their security interest as one class ranking equally and to distribute the sale proceeds in accordance with Section 53(1)(b)(ii) of the I&B Code. Issues Involved:1. Sub-classification inter-se the Secured Creditors in the distribution mechanism of a Resolution Plan.2. Distribution of sale proceeds among Secured Creditors.3. Applicability of Section 53 of the Insolvency and Bankruptcy Code (I&B Code), 2016.4. Priority of claims among Secured Creditors.5. Validity of relinquishment of security interest and its impact on distribution.Detailed Analysis:Issue 1: Sub-classification inter-se the Secured Creditors in the distribution mechanism of a Resolution PlanThe primary issue in this appeal was whether there can be no sub-classification among Secured Creditors in the distribution mechanism of a Resolution Plan. The Appellant argued that giving priority to the first charge holder would leave nothing to satisfy the claim of the Appellant, who is also a Secured Creditor.Issue 2: Distribution of sale proceeds among Secured CreditorsThe Appellant, a Financial Creditor of the Corporate Debtor under liquidation, contended that the distribution by the Liquidator was not in consonance with the provisions of the I&B Code. The Appellant's claim was admitted, and it was granted voting rights with a 14.54% share. However, the Liquidator distributed the sale proceeds among other Secured Creditors without considering the Appellant's claim. The Appellant argued that the distribution should be as per the admitted claims of Secured Creditors based on their voting rights.Issue 3: Applicability of Section 53 of the Insolvency and Bankruptcy Code (I&B Code), 2016The Liquidator defended the distribution of the sale proceeds based on Section 53 of the I&B Code, which outlines the order of priority for distribution of liquidation assets. The Liquidator relied on the interpretation provided in the Insolvency Law Committee Report dated 26th March 2018. The Appellant argued that once Secured Creditors relinquish their security interest, the priority of charge loses significance, and the sale proceeds should be distributed equitably among all Secured Creditors.Issue 4: Priority of claims among Secured CreditorsThe Respondents argued that the Appellant, being a second charge holder, was not entitled to any amount disbursed to the Secured Creditors with the first charge. They cited Section 48 of the Transfer of Property Act, which gives precedence to the first charge holder. However, the Appellant countered that upon relinquishment of security interest, all Secured Creditors should rank equally under Section 53 of the I&B Code.Issue 5: Validity of relinquishment of security interest and its impact on distributionThe Tribunal examined Sections 52 and 53 of the I&B Code. Section 52 provides an option to Secured Creditors to either relinquish their security interest to the liquidation estate or realize their security interest. Section 53 deals with the distribution of assets and has an overriding effect over other laws. The Tribunal clarified that relinquishment of security interest does not make a Secured Creditor lose its status. It emphasized that once Secured Creditors relinquish their security interest, they rank equally for distribution under Section 53(1)(b)(ii), irrespective of their prior charge status.Conclusion:The Tribunal concluded that the argument against sub-classification among Secured Creditors is untenable. It stated that Sections 52 and 53 provide distinct mechanisms for Secured Creditors either to realize their security interest or to relinquish it and participate in the distribution of liquidation assets. The Tribunal held that the relinquishment of security interest mandates equal ranking among Secured Creditors under Section 53(1)(b)(ii). Consequently, the appeal was allowed, the impugned order was set aside, and the Liquidator was directed to treat the Secured Creditors relinquishing their security interest as one class for distribution of assets under Section 53(1)(b)(ii) of the I&B Code.