Liquidation Under IBC: Can Secured Creditors Be Treated Differently?

Indian rupee banknotes of various denominations sit in a cash register. (Photographer: Dhiraj Singh/Bloomberg)

The Supreme Court of India has agreed to examine whether there's a hierarchy among secured creditors at the liquidation stage under the Insolvency and Bankruptcy Code.

Gujarat Oleo Chem Ltd. is under liquidation and three of its secured creditors have reached the apex court. Stressed Asset Stabilisation Fund and Gujarat Finance Corp. said distribution of liquidation proceeds must be done on the basis of charge held by creditors. But Technology Development Board said at the liquidation stage, all secured creditors stand on an equal footing.

The National Company Law Appellate Tribunal in April agreed with the latter view. Against this, Stressed Asset Stabilisation Fund and Gujarat Finance Corp. have approached the apex court this week.

The NCLAT View

Gujarat Oleo Chem went into liquidation in 2018. All three of its secured creditors—Stressed Asset Stabilisation Fund, Gujarat Finance Corp. and Technology Development Board—relinquished their security interest towards the liquidation estate.

Technology Development Board, which has a second charge on some of the movable properties of the insolvency company, argued it held 14.4% voting rights as part of the creditors' committee. And that it's entitled to liquidation proceeds in proportion of its vote share.

Stressed Asset Stabilisation Fund and Gujarat Finance Corp. have first charge on the immovable properties of the company. They argued that voting rights don't subsist when liquidation begins. And the liquidation proceeds will have to be distributed as per the class of creditors and the nature of security held by them.

The appellate tribunal dismissed this argument saying Section 53 of the IBC doesn't discriminate between secured creditors. This section lays down the creditor hierarchy once the company reaches the liquidation stage.

It interpreted Section 53 to say all secured creditors who've relinquished their security interest have to be treated as one class ranking equally. It would make no difference that one creditor held the first charge and other had the second charge on an asset.

Sale proceeds in such cases must be distributed equitably among the secured creditors who rank equally and it would be irrespective of any charge they were holding prior to the relinquishment of security interest.

National Company Law Appellate Tribunal judgment

NCLAT's View A ‘Grave Error', Appeals Say

Stressed Asset Stabilisation Fund in its petition before the apex court has called NCLAT's interpretation of Section 53 a "grave error".

The appellate tribunal, it said, made an error in equating the claim of a secured creditor holding the first charge with that of a creditor holding second charge. If the NCLAT's view is upheld, Technology Board—which is a second charge holder— will get a substantial share from the sale of immovable properties, something it was never entitled to.

Each creditor strikes its own bargain with the company and has its own priority in case of liquidation of the company. Section 53 of IBC doesn't obliterate such distinct bargains and valid intercreditor and subordination agreements.

Appeal by Stressed Asset Stabilization Fund

Relying on the Essar Steel precedent, it argued that the apex court had held equitable treatment of creditors can apply only within creditors falling in the same class. This principle will apply even at the liquidation stage, Stressed Asset Stabilisation Fund said in its appeal.

The case came up before a bench of Justice S Abdul Nazeer and Justice V Ramasubramanian. The top court has issued notice and granted a stay on the NCLAT judgment.