The NCLAT judgment seriously undermined a well-settled principle of law regarding superior rights of secured creditors in recognition of commercial reality, where lenders are able to lend at low cost based on the availability of security interest. The impact of the decision was so significant that the government swiftly moved an amendment to clarify that priority and value of security interest was a relevant factor for the CoC to consider for the purposes of distribution of proceeds of a resolution plan. Additionally, payment of an amount that would have been received in liquidation (liquidation value) was guaranteed as a minimum payment to a dissenting financial creditor as a safeguard to protect the minority financial creditors. The decision of the NCLAT and the constitutional validity of these amendments were challenged before the Supreme Court of India.

While upholding the constitutional validity of the amendments, the Supreme Court set aside the decision of the NCLAT and held that the NCLAT did not have jurisdiction to interfere with the commercial decision of the CoC regarding distribution of resolution plan proceeds. The Court further held that it was permissible and rather desirable for a distinction to be made between different classes of creditors for the purposes of payment under a resolution plan. It also upheld creation of distinction amongst the secured creditors themselves on the basis of differential security value. A later judgment for India Resurgence vs Amit Metaliks, however, undermined this position.

The Supreme Court repelled the challenge of a dissenting financial creditor to the distribution of resolution proceeds by the CoC in a manner so as to entirely disregard its priority and value of security interest citing paramountcy of commercial wisdom of the CoC. The Court also held that the dissenting financial creditor cannot seek payment of its security value in terms of the amended provision.

This has led to several cases where majority secured creditors with inferior security interests are seeking to squeeze out minority secured creditors with superior security interest without even giving them their statutory entitlement of minimum liquidation value. Often, the liquidation value attributable to a dissenting financial creditor is being calculated in proportion to admitted claims irrespective of their inter se priority or value of security interest. By this logic, a secured creditor having a charge on a vehicle is being placed at par with another secured creditor having charge over cash and receivables and/or mortgage over valuable immovable property.

The justification of such inequitable treatment amongst the secured creditors is being proffered to be commercial wisdom, when clearly, the statute as well as law laid down in Essar Steel emphasises on equitable treatment based on differential security interest. Surely, the Code intends to give wide commercial play to the CoC while deciding on contours of a resolution plan including distribution of resolution proceeds, but certainly, the guidance provided by the statute listing priority and value of security interest as a relevant factor cannot be entirely ignored.More importantly, certainly, the CoC cannot deprive a dissenting financial creditor of its liquidation value by calculating the value in a manner to entirely write off the priority and value of the security interest. It’s not only contrary to the statute and the specific amendment made thereto to safeguard minority financial creditors. It also equally makes the provisions of the Code liable to a serious constitutional challenge for taking away a right to property without due process.

After few years of quandary, the Supreme Court in its latest decision of DBS vs Ruchi Soya has doubted the correctness of the decision in India Resurgence and referred the issue to a larger bench. It has held that although a dissenting financial creditor cannot challenge the commercial decision of distribution of resolution plan proceeds, they are entitled to the value of their security interest.

Apart from the aspects highlighted above, there are nuanced legal issues with respect to interpretation and calculation of liquidation value due to a dissenting financial creditor which would need to be examined and decided by the larger bench. Additionally, there are serious questions with respect to treatment of secured creditors during liquidation which will have a bearing on the issue relating to inter-se treatment and rights amongst the secured creditors during insolvency resolution. It is hoped that these issues are taken up for adjudication by the apex court urgently.

This article was originally published in Financial Express on 2 March 2024 Written by: Misha, Partner. Click here for original article

Read Less-