The ruling of the National Company Law Tribunal (“NCLT“) on 26th September, 2017 in the Intervention Application1 filed by JM Financial Asset Reconstruction Company (“JM“)(in the company petition of Indus Finance Limited (“Indus“) against Quantum Limited (“Quantum“)) has once caused a stir in the financial markets. In the impugned order, the NCLT has declared a moratorium i.e. the “calm- period” under the Insolvency and Bankruptcy Code, 2016 (“IBC“) and stayed the sale of the asset by a secured lender under the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI“). The brief facts leading upto the said order are as follows:

JM took over a loan of Quantum originally advanced by Corporation Bank which was in default and in respect whereof the original lender had initiated proceedings under the provisions of SARFAESI with respect to the mortgaged assets (“Property“).Subsequently, JM sought to sell the Property and an auction was held as per the provisions of SARFAESI. In the said auction, Omni Active Health Technologies Limited (“Omni“) agreed to purchase the Property and paid 25% of the sale price with undertaking to pay the balance monies on or before 14th March 2017. In the interim, Indus filed an application under section 7 of IBC for initiating corporate insolvency resolution process against Quantum which was admitted by the NCLT.

Accordingly, the NCLT declared a moratorium in accordance with the provisions of Section 14 of the IBC and Indus approached the Debt Recovery Tribunal for staying the sale of the Property in accordance with the provisions of SARFAESI. The question which therefore arose is whether the provisions of IBC were intended to overrule the provisions of SARFAESI. Therefore, JM approached the NCLT for this purpose.

NCLT RULING

The NCLT held that the sale in favour of Omni was not a concluded sale as the sale process can be treated as complete only once the sale certificate is issued and therefore the completion of the sale could not be done during the moratorium period as only 25% per cent payment was made in the present case.

NCLT HELD THAT SALE UNDER SARFAESI CANNOT BE COMPLETED DURING MORATORIUM IMPOSED UNDER IBC.

Let us now look at this judgment in view of the aims and objects of the IBC and examine its effect on secured financial creditors, particularly those having recourse under SARFAESI.

OBJECTIVE OF THE IBC

One of the objectives of the IBC as mentioned in the Statement of Objects and Reasons of the Bill is that the IBC seeks to provide an effective legal framework for timely resolution of insolvency and bankruptcy for maximization of value of assets, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders.

A look at the Report of the Bankruptcy Law Reforms Committee which was presented to the Government in 2015 also categorically states that one of the reasons for the required overhaul in current laws (i.e. SARFAESI) is the present misplaced importance on secured credit which leads to value destruction in corporate distress due to secured creditors taking control of the assets without any efforts to revive the debtor.

The IBC aims to protect the interest of all stakeholders i.e. debtors and all kinds of creditors as also open up new avenues of credit to create a more effective business atmosphere that does not favour only asset-heavy industries (which are able to provide conventional security) but also labour-intensive businesses.

 Therefore, one of the main focus of the IBC is in fact rehabilitation and revival of the corporate debtor for which purpose the resolution plan is enacted and the moratorium period is put in place so that negotiations maybe carried on unfettered during this period without any value destruction being undertaken by either parties in this period.

The NCLT judgment in JM Financial proceeds on this basis and keeping in mind that the NCLT found no reason to doubt the bonafides of Indus in filing the petition in question, the judgment appears to be in line with the end and intent of the IBC.

Whilst the position of secured creditors is definitely affected by the IBC, in our view the effect of a moratorium on a secured creditor would vary depending on its voting share in the Committee of Creditors.

A creditor having more than 25% of the voting share

ALTHOUGH SUCH CREDITOR WOULD BE FORCED TO WAIT FOR A PERIOD OF 180 DAYS, ITS RIGHT TO THE SECURITY WOULD REMAIN INTACT.

A resolution plan can be approved only with the affirmative vote of creditors having at least 75% of the voting share by value in the Committee of Creditors. Therefore, a creditor having more than 25% of the voting share in the Committee of Creditors can reject a resolution plan which does not adequately protect its interest. In the event a resolution plan is not submitted to the NCLT within the prescribed period, the NCLT has to pass an order requiring the corporate debtor to be liquidated. The aforementioned creditor in liquidation proceedings can then choose to enforce its security interest in terms of Section 52 of the IBC without relinquishing its security to the liquidation estate as the moratorium order would come to an end on an order of liquidation. In such a case, although the creditor would be forced to wait for a period of 180 days (since the extension beyond 180 days would also need consent of such creditor), its right to the security would remain intact.

A creditor having less than 25% of the voting share

A creditor having less than 25% voting share in the Committee of Creditors would not be able to reject a resolution plan that adversely affects its interest and such resolution plan could even envisage relinquishment of its security. Once a resolution plan is approved by the NCLT, the same becomes binding on all creditors in terms of Section 31 of IBC. This kind of arrangement is similar to the erstwhile arrangements under the Corporate Debt Restructuring Schemes (CDR) and the Joint Lenders Forum (JLF) of the Reserve Bank of India (RBI). Although the CDR and JLF were voluntary, once initiated all banks and financial institutions with exposure to the borrower were guided to joining the restructuring process. The Sick Industrial Companies Rehabilitation (Special Provisions) Act, 1985 (SICA) also similarly dealt with the revival of the sick industries. These arrangements also typically had stand still clauses so as to allow restructuring of the debt packages of the relevant companies and schemes for infusion of funds that maybe required. Therefore, what perhaps really sets apart the IBC from the existing enactments is firstly the compulsory attempt at revival prior to consideration of the liquidation whereas the existing statutes were largely voluntary at the instance of the lenders.

In the event the creditor dissents from the resolution plan, Regulation 38 of the Insolvency and Bankruptcy Board Of India (Insolvency Resolution Process For Corporate Persons) Regulations, 2016 (“Regulations“) provides that the resolution plan should mandatorily identify specific sources of funds that will be used to pay liquidation value due to such dissenting financial creditor and further provides that such payment is made before any recoveries are made by the financial creditors who voted in favour of the resolution plan.

It is pertinent to note that liquidation value is defined under the Regulations as the estimated realizable value of the assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date(i.e. the date of admission of the application).

The liquidation value to the dissenting financial creditor would thus mean the amount which would have become payable to such creditor under Section 53 of the IBC had the corporate debtor been liquidated on the insolvency commencement date. It thus appears that although the priority in distribution to the dissenting financial creditor remains unchanged since the liquidation value would be determined based on such priority set out in Section 53 of the IBC, the dissenting financial creditor would be entitled to payment before the other creditors who would continue to rank paripassu with such creditor in terms of Section 53.

Whether the IBC will work in the interest of all stakeholders or be misused like the SICA remains to be seen. It appears that at the moment the best way for a secured financial creditor to protect itself against any voting adverse to its interest is by ensuring the value of its debt to a corporate debtor remains at least 26% of its total debt and by incorporating necessary checks in its loan documentation and monitoring to ensure the same.

Footnote

1 IVN.P.No. 02/2017 & M.A. 222/2017 in C.P. No. 1043/I&BP/NCLT/MAH/2017

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