India - Is A Third-Party Security Holder A Financial Creditor Under The Insolvency And Bankruptcy Code?

Legal News & Analysis - Asia Pacific - India - Insolvency & Restructuring

Asia Pacific Legal Updates

 

9 June, 2018

 

India - Is A Third-Party Security Holder A Financial Creditor Under The Insolvency And Bankruptcy Code?

 

In its judgment pronounced on May 9, 2018, the National Company Law Tribunal (NCLT), Allahabad, in the case of ICICI Bank Limited v. Mr. Anuj Jain (Resolution Professional of Jaypee Infratech Limited), addressed the issue of the rights of third-party security holders of a corporate debtor under the Insolvency and Bankruptcy Code, 2016 (IBC).

 

The judgment negated ICICI Bank Limited’s contention that it should be considered a financial creditor of Jaypee Infratech Limited, the corporate debtor. ICICI Bank’s claim was based on the corporate debtor having created mortgages on its property to secure loans provided to Jaiprakash Associates Limited, the holding company of the corporate debtor.

 

The NCLT concluded that there was no financial debt owed to ICICI Bank by the corporate debtor, and so it could not be considered a financial creditor of the corporate debtor.

 

We consider here the correctness of the judgment and whether the NCLT has considered all the implications of its finding.

 

If a third-party mortgagee were to be considered as a financial creditor of a corporate debtor, then the third-party mortgagee would have the benefit, upon the filing of a claim, of being considered as a creditor in the committee of creditors, which would bring with it the protections available to such creditors, including those for dissenting creditors.

 

It would also allow the creditors and the resolution applicant to have a comprehensive resolution as, by including the third-party mortgagee in the committee of creditors, and by considering them as a stakeholder, the resolution plan would be binding on the third-party mortgagee. This would mean that a resolution plan could propose variation of the mortgage or a release of the mortgage and satisfaction of payment to be made to the creditor.

 

The NCLT in holding that a third-party mortgagee is not a financial creditor has left some key questions unanswered. These are:

 

(a)        Can a third-party mortgage be discharged or released in a resolution plan where the mortgagee is not considered as a financial creditor?

 

(b)        Can the recourse that the mortgagee has for the debt secured by third-party mortgagee be, in any way, amended by the resolution plan?

 

Under the Transfer of Property Act, 1882, the mortgagor in an English mortgage or a simple mortgage binds himself to repay the mortgage money. The mortgage deed that was the subject matter of the judgment seemed to be an English mortgage, which should have a covenant to pay. The NCLT judgment does not consider whether such a covenant to pay ought to have qualified as a financial debt for the purposes of the IBC.

 

Whilst the judgment holds that a third-party mortgagee is not a financial creditor, we still consider that the third-party mortgagee would be entitled to the rights of a secured creditor upon a liquidation of the corporate debtor. Under Section 53 of the IBC, a secured creditor is entitled to a distribution in a liquidation. And under Section 52, a secured creditor has the option to enforce its security separately.

 

Importantly, the definition of Secured Creditor is not premised on securing “financial debt” as defined under the IBC, but is defined as a creditor in whose favour a security interest is created. “Security Interest” is defined to include various forms of security interest, including a mortgage, for “securing payment or performance of any obligation of any person”.

 

We also note that Section 53 (1) (B) (ii) refers to debts owed to secured creditors. It does not use the word “financial” debts owed to secured creditors. So, it is clear that third-party mortgagees can stand outside winding up or they can ask the liquidator to sell the assets and receive payments. Whilst the judgement holds that a third-party mortgagee is not a financial creditor, it does not consider that in liquidation the third-party mortgagee will be entitled to enforce the mortgage subject to the Insolvency and Bankruptcy Board of India (Voluntary Liquidation) Regulations, 2017 (Liquidation Regulations).

 

Since a secured creditor will be entitled to enforce security once the moratorium ceases and will be entitled to proceeds in liquidation under Section 53, a third-party mortgagee would also be treated as a stakeholder on whom the resolution plan is binding under Section 31 (1) of the IBC, given that a “stakeholder” as defined in the Liquidation Regulations is a person who is entitled to distribution of proceeds under Section 53 of the IBC.

 

As a result, the judgement creates an anomaly in not allowing such third-party mortgagees a say in the resolution plan. If a resolution plan provides for the modification or extinguishment of a third-party mortgagee’s security interests, it will leave such a resolution plan vulnerable to attack on the ground that it cannot take away the property that is secured in favour of a third-party mortgagee without allowing them participation in the committee of creditors.

 

Applying the judgment, the resolution plan cannot modify or extinguish the third-party security interest created in favour of a third-party mortgagee. Therefore, resolution applicants would have to acquire the corporate debtor subject to the third-party mortgage, and at the risk of losing such secured assets on enforcement by the third-party mortgagee. This will add uncertainty to the resolution efforts.

 

The NCLT should have considered an alternative: to admit the claim of the third-party mortgagees as financial creditors of the corporate debtor, with its attendant protection that the third-party mortgagee is then bound by the resolution plan, and is entitled to dissenting creditor or approving creditor status, as the case may be.

 

Whilst this issue has been considered in the context of a mortgage, similar difficulties could arise with respect to other forms of third-party security, such as third-party pledges, which are fundamental to several types of financing. A more balanced approach would be to include third-party security holders as financial creditors and subject them to the same rights and obligations as any other creditor of a corporate debtor.

 

 

For further information, please contact:

 

L. Viswanathan, Partner, Cyril Amarchand Mangaldas

l.viswanathan@cyrilshroff.com