In a recent judgement of Vistra (ITCL) India & Ors. Vs. Mr. Dinkar Venkatasubramanian & Anr., the Hon'ble Supreme Court of India1 ("Supreme Court") quashed the order passed by National Company Law Appellate Tribunal ("NCLAT") wherein the NCLAT held that Amtek Auto Limited ("Corporate Debtor") who had created a pledge over certain shares in favour of Vistra (ITCL) India Limited ("Security Trustee"), did not owe any financial debt towards Appellants and that since the Appellants did not advance any money to the Corporate Debtor as a financial debt, the same would not come within the purview of a financial creditor under the terms of Insolvency and Bankruptcy Code, 2016 ("IBC").

The view taken by the NCLAT that the Appellants would not fall within the ambit of a "financial creditor" is in line with the judgments of the Supreme Court in Anuj Jain IRP for Jaypee Infratech Ltd. vs. Axis Bank Ltd2. and Phoenix ARC Private Limited vs. Ketulbhai Ramubhai Patel3 both of which have been discussed by us in our earlier articles4. In view of these judgments, a creditor in whose favour security has been created by the corporate debtor over its asset/s to secure debts owed by a third party to such creditor, but to whom the corporate debtor itself does not owe any debt, cannot be recognized as a financial creditor of such corporate debtor and therefore does not get a seat on the Committee of Creditors ("CoC"). However, in view of the corporate resolution insolvency process, such person also cannot enforce his security over the assets of the corporate debtor.

While the Supreme Court has not deviated from this position in the present judgment in Vistra (ITCL) India & Ors. Vs. Mr. Dinkar Venkatasubramanian & Anr., it has recognized the tricky and unenviable position in which such third-party creditors are placed and has issued directions to come to a fair solution.

I. Background:

  1. The Corporate Debtor had approached KKR India Financial Services Private Limited and L&T Finance Limited (collectively known as "Lenders") for extending a short-term loan facility of INR 500 Crores to Brassco Engineering Ltd. and WLD Investments Private Ltd ("Borrowers") for the use and benefit of the Corporate Debtor.
  2. The Corporate Debtor created a first ranking exclusive pledge on certain equity shares of JMT Auto Limited held by the Corporate Debtor in favour of Security Trustee to secure the financial assistance availed by the Borrowers from the Lenders.
  3. A year later, an application was filed before the National Company Law Tribunal ("NCLT") under Section 7 of the IBC against the Corporate Debtor. The claim filed by the Lenders and the Security Trustee ("Appellants") as secured creditor, claiming their principal amount was rejected by the resolution professional ("RP") in the year 2017 which then was not challenged by the Appellants. Subsequently, the NCLT passed an order to consider the resolution plan of Deccan Value Investors ("DVI").
  4. Thereafter, an application was filed in 2020 under Section 60(5) of IBC by the Appellants for claiming rights on the basis of the pledged shares which was also dismissed by the NCLT.
  5. Thus, aggrieved by the NCLT's order, the Appellants filed an appeal before the NCLAT which was also dismissed on the grounds of limitation and also on the grounds that the Appellants could not be treated as financial creditors of the Corporate Debtor. Further aggrieved by the order passed by NCLAT, the Appellants preferred the present appeal.

II. Important Issues Raised:

  1. Whether Appellants can be treated as secured creditor?
  2. Whether the resolution plan can dilute, negate, or override pledge agreement?
  3. What would be the treatment of rights of a secured creditor who neither fell under the category of a financial creditor nor an operational creditor?

III. Contentions

It was contended on behalf of the Appellants that:

  1. The judgement of the Supreme Court in the cases Anuj Jain (Supra) and Phoenix ARC (Supra) cannot be relied upon as the facts of this case are distinguishable.
  2. There was existence of a creditor-debtor relationship between the Appellants and the Corporate Debtor as the loan facility availed by the Borrowers was in fact for the end use and benefit of the Corporate Debtor.
  3. The pledge of shares constituted as financial debt under IBC and is defined as "security interest" under section 3(31) of IBCThe Appellants further submitted that the amended and restated pledge agreement dated 5th July, 2016 specifically mentions the creation of charge by way of pledge over shares of JMT Auto Limited created a financial obligation on part of the Corporate Debtor to pay to the extent of such pledged shares for securing payment or performance of obligation of the Borrower.

It was contended on behalf of the Respondents that:

  1. The rejection of Appellants by RP in 2017 was never challenged by the Appellants, instead the Appellants filed the application before NCLT in 2020 for seeking admission into CoC.
  2. The issue involved in the present appeal has been fairly covered by the Supreme Court in the case of Anuj Jain (Supra) and Phoenix ARC (Supra), as the Appellants do not qualify to be a financial creditor of the Corporate Debtor since there was only a third-party security given in the form of pledged shares as a collateral security for the loan advanced to the Borrowers.

IV Judgement:

The Supreme Court while placing reliance upon the judgements in Anuj Jain (Supra) and Phoenix ARC (Supra) stated that the Appellants would not be a financial creditor of the Corporate Debtor. However, while examining the definition of "security interest" under IBC the Supreme Court also stated that the person in whose favour the security interest has been created need not be the creditor who has sanctioned the credit facility, but it can be a third person as well and such security interest can be created for credit facilities advanced to another person.

Further the Supreme Court explained the concept of pledge as elucidated in PTC India Financial Services Limited v. Venkateshwarlu Kari and Anr5, wherein it was held that the right to property lays in the hands of pawnee only as far as it is necessary to secure the debt.

While referring to amended section 30(2) of IBC the Supreme Court observed that operational creditors or the dissenting financial creditors, under the resolution plan are required to be paid the amount equivalent to the amount which they would have been entitled to, in the event of liquidation of the Corporate Debtor under Section 53 of IBC. Thus, operational creditors and dissenting financial creditors must be protected in the resolution plan by RP and the Adjudicating Authority. However, a creditor (not being a financial or operational creditor) who has been provided security by a corporate debtor has no such protection. A secured creditor was being denied of the benefit of the secured interest under section 52 of IBC i.e. the right to either relinquish its security interest to the liquidation estate and receive the proceeds from the sale of assets by the liquidator as stated in Section 53 of IBC or realise the security interest in the manner specified in Section 52 of IBC;

Thus, the Appellants neither fall under the category of financial creditors nor operational creditors which led to a very odd situation where the intent of Section 30(2), which protects the interest of creditors who are not a part of the CoC was contrary to the position of the Appellants, who were denied the benefit of Section 52 and 53 in respect of security interest created in its favour.

Two possible solutions were proposed by the Supreme Court, first the secured creditor should be treated as a financial creditor to the extent of the value of the pledged shares, which would in turn give it the voting rights in the CoC in proportion to the value of the pledged shares. However, the same would require reference of Anuj Jain (Supra) and Phoenix ARC (Supra) to a larger bench for reconsideration.

As the resolution plan had already been approved without the Security Trustee being a member of CoC, the Supreme Court while partly modifying the judgement of NCLAT opted for the other possible solution and directed that the Security Trustee be treated as a secured creditor under the approved resolution plan, who would be entitled to retain all rights and obligations of a secured creditor in terms of section 52 and 53 of IBC.

V. Conclusion

In the present case the Supreme Court has rightly recognised the unenviable position in which a "third party secured creditor" was placed after the landmark judgments in Anuj Jain (supra) and Phoenix ARC (supra). Basis these judgments, creditors taking third party security could only insist on guarantees of such third party which were often not within the commercial contours of many transactions.

By providing recourse to at least Section 52 and Section 53 of IBC, the Supreme Court has provided some relief to the anxieties of third-party security holders by providing a remedy if the security provider is under CIRP and no guarantee has been given to the security holder.

Footnotes

1. Civil Appeal No. 3606 of 2020

2. (2020) 8 SCC 401

3. (2021) 2 SCC 799

4. https://www.mondaq.com/india/financial-services/907630/third-party-mortgagee-whether-a-financial-creditor-supreme-court-decides and https://www.mondaq.com/india/financial-services/1034574/third-party-security-pledgees-not-financial-creditors

5. (2022) 9 SCC 704

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