Inter-se priority amongst secured

creditors under the insolvency regime

in India: striking the right balance
Avikshit Moral Ashish Mukhi Kamlendra Pratap Singh
Partner, Juris Corp, Mumbai Principal Associate, Juris Corp, Mumbai Associate, Juris Corp, Mumbai
[Link]@[Link] [Link]@[Link] [Link]@[Link]

Introduction that in essence will be equality among equals. Before

the Essar Insolvency Case, the definition of ‘financial
Clarity, as regards payouts to creditors, remains the
creditor’ and ‘financial debt’ under section 5(7)2 and
fulcrum of success of any insolvency regime globally.
(8)3 of the Code was interpreted erroneously to hold
One of the critical considerations which determines
that all financial creditors constitute a single unified
the payouts for financial creditors is the ranking and
class and there cannot be any distinction based on
priority which a secured creditor enjoys. The ranking
the security interest held by a creditor, let alone the
of a secured financial creditor vis-à-vis an unsecured
distinction based on nature of the security interest held
financial creditor and the ranking of secured financial
by secured creditors.
creditors amongst themselves determines the quantum
We have seen the development of this jurisprudence
of payouts for secured creditors in an insolvency or a
under the current insolvency regime in India through
liquidation scenario.
various judgments passed by the Honourable Supreme
Under the Indian insolvency regime, the distinction
Court and Indian insolvency tribunals, ie, the National
between a secured and unsecured creditor stands
Company Law Tribunal (NCLT) and the National
categorically recognised by the Honourable Supreme
Company Law Appellate Tribunal (NCLAT). However,
Court in the case of Committee of Creditors of Essar Steel
the issue of inter-se priority amongst secured financial
India Ltd v Satish Kumar Gupta and Others1 (the ‘Essar
creditors still remains an area of discussion leading
Insolvency Case’). This is in the context of priority
to judicial dichotomy on the subject. This article
in distribution of resolution proceeds under the
addresses this issue and discusses how different
comparatively new insolvency regime brought up by the
ranking charge holders are a ‘class within a class’ and
advent of the Insolvency and Bankruptcy Code 2016
therefore their quantum of payouts in any resolution
(the ‘Code’). However, the distinction between secured
should be worked out based on the charge each
creditors holding first charge and second charge or
secured financial creditor holds. This, in the authors’
exclusive charge and pari passu charge has not yet been
view, would be the approach leading to rightly
clearly fleshed out and remains an area where creditors
‘balancing the interest of all stakeholders’, which is a
in an insolvency regime are still taking differing views
key objective of the Code.
on distribution of proceeds.
The Honourable Supreme Court in the Essar
Insolvency Case, also opined that financial creditors,
Relevant provisions of the Code
holding security interests are secured creditors. It
was further said that their security interests must be The priority rights of a secured financial creditor
protected to ensure that they do not enforce their under section 53 of the Code should be considered
security in separate legal proceedings, but instead are and cannot be ignored for determining the rights of
incentivised to ensure successful turnaround of the a secured financial creditor in a corporate insolvency
corporate debtor within the framework of the Code. resolution process (CIRP). The Indian Government,
Separate classes of financial creditors can be divided through an amendment brought by the Insolvency
into different classes and not one uniform class, so that & Bankruptcy Code (Amendment) Act 2019 (the
there may be a real equality at the stage of distribution ‘Amendment’), amended the Code to include the
of resolution proceeds amongst financial creditors, prescription of payment of minimum liquidation value

Insolvency and Restructuring International Vol 14 No 2 September 2020      47

 Inter-se priority amongst secured creditors under the insolvency regime in India: striking the right balance

to a financial creditor who has not voted in favour of The NCLT rejected the plea and stated that the
a resolution plan. The Code was further amended provisions relating to priority in ranking under the
to include a provision (section 30(4)) which states Code are premised on parity and proportionality.
that while determining the feasibility and viability of The idea of proportionality is only as far as claims
the resolution plan, the manner of distribution of of ‘similarly ranked’ creditors are concerned. While
resolution proceeds to financial creditors will take explaining the concept of first charge and second
into account the order of priority amongst creditors as charge the NCLT obser ved that a second charge
laid down in sub-section (1) of section 53 of the Code, holder has a subsequent charge over the remainder of
including the priority and value of the security interest the assets of the company, which remains after settling
of a secured creditor. the claims of first charge holder and therefore the
It is therefore evident that the Code incorporates the charges are sequential and not proportional.
principle of honouring priority and value of security Recently, the NCLT, Ahmedabad Bench in SKE
amongst creditors (especially financial creditors) while Projects Pvt Limited v Jaihind Projects Limited6 passed a
determining payouts to them. similar order. In this case, the NCLT recognised the
right of Axis Bank Limited, a dissenting financial
creditor, to be paid liquidation value on account
Problematic judicial interpretation of holding an exclusive charge over an asset of the
The NCLAT, in a matter involving the CIRP of Jyoti corporate debtor.
Structures Ltd, rejected the claim of a sole secured The NCLT stated that a plain reading of section 30
charge holder that it is entitled to the liquidation of the Code makes it clear that Axis Bank should be
value equivalent to its value of security. The NCLAT, paid minimum liquidation value keeping in view the
relying on the principle that ‘all secured creditors are sole charge (and not pro-rata payment along with all
to be treated equally’, upheld pro-rata payments to secured creditors).
all secured creditors made in the CIRP. The Supreme
Court refused to intervene with the decision of the
NCLAT. Notably, this judgment was passed prior to Cardinal principle on treatment of
the Amendment. security interests under Indian law
However, the Honourable Supreme Court in Essar The Code cannot be intended or construed as
Insolvency Case (above), clarified the distinction between intending to override established principles of the law
a secured and unsecured creditor. The Supreme Court of mortgages and, in any event, there is no apparent
also recognised that there can be a class within a class, or actual inconsistency between the said laws and the
that is, different classes of secured financial creditors, provisions of the Code. The Honourable Supreme
however, it did not dwell into the issue of inter-se Court in ICICI Bank Ltd v Sidco Leathers Ltd and Others7
priority amongst secured creditors. has held that:
‘Section 529-A of the Companies Act does not ex facie contain
a provision (on the aspect of priority) amongst the secured
National Company Law Tribunals (NCLT) creditors and, hence, it would not be proper to read thereinto
leading the way things, which the Parliament did not comprehend. If the
In 2018, NCLT, Kolkata Bench in State Bank of India v Parliament while amending the provisions of the Companies
M/s Adhunik Alloys & Power Ltd 4 held that the creation Act intended to take away such a valuable right of the first
of classes amongst financial creditors is a well-known charge holder, we see no reason why it could not have stated
phenomenon under the law and unsecured financial so explicitly.’
creditors cannot be equated with financial creditors Although section 53 of the Code provides for the
who hold security interests. It was further held that respective rights of the secured creditors vis-à-vis
classification of financial creditors considering their unsecured creditors, it does not envisage respective
security interest cannot be held illegal. rights amongst the secured creditors, and for that
The NCLT, Ahmedabad Bench in Technology purpose, we need to be guided by the Transfer of
Development Board v Mr Anil Goel and Others5 held Property Act 1882, more particularly, section 48, which
that the ranking of secured creditors would be stipulates that the claim of the first charge holder shall
maintained during distribution of liquidation prevail over the claim of the second charge holder. Even
proceeds. NCLT was examining a plea of ‘equal under the Report of the Insolvency Law Committee,8
treatment’ of a second charge holder in distribution it was noted that inter-creditor agreements should be
of proceeds from the sale of liquidation estate. respected under the CIRP.

48 Insolvency and Restructuring International Vol 14 No 2 September 2020

 Conclusion establishing the importance of the pre-insolvency
bargains done by the different secured creditors
The principle that ‘similarly situated creditors should
while extending the loans to the entities. Even in the
be treated similarly’ has been accepted by the courts to
absence of any further definitive finding by any court
be the cardinal principle while dealing with rights of the
or tribunal, the authors believe that there is enough
creditors, amongst themselves. The authors are also of
jurisprudence established to argue and have the right
the view that this principle forms the bedrock for inter-
and priority of a senior charge holder or a sole charge
se treatment of creditors which hold pari passu charges.
holder upheld under Indian insolvency laws.
However, since the inception of the Code, various
orders have applied this principle differently when
Notes
dealing with the question of treatment of different
1 2019 SCC OnLine SC 1478.
classes of secured creditors. 2 ‘Financial creditor’ means any person to whom a financial debt is owed
In the authors’ view, the correct approach is to honour and includes a person to whom such debt has been legally assigned
the ‘pre-insolvency entitlements’ of secured financial or transferred.
3 ’Financial debt’ means a debt along with interest, if any, which is
creditors during an insolvency resolution, giving due disbursed against the consideration for the time value of money and
regard to ranking and value of security of each of the includes: (i) money borrowed against the payment of interest; (ii)any
secured financial creditors. This approach, would pass amount raised by acceptance under any acceptance credit facility or
its de-materialised equivalent; (iii) any amount raised pursuant to
the muster of law, specifically on the touchstone of the
any note purchase facility or the issue of bonds, notes, debentures,
principles on which the Code is based. This approach loan stock or any similar instrument; (iv) the amount of any liability
will further bring about the right balance in insolvencies in respect of any lease or hire purchase contract which is deemed as
a finance or capital lease under the Indian Accounting Standards or
where secured financial creditors holding different
such other accounting standards as may be prescribed; (v) receivables
priority charges are involved. The interest of such secured sold or discounted other than any receivables sold on non-recourse.
financial creditors being safeguarded in the manner that 4 CA (IB) Nos 1086 & 1092/KB/2018 in CP (IB) No 387/KB/2017.
their quantum of payouts under the corporate insolvency 5 IA No 514 of 2019 in CP (IB) No 04 of 2017.
6 IA No 593 of 2019 in CP (IB) 172 of 2018.
resolution process would get protected at least to the 7 [2006] 67 SCL 383 (SC).
extent of the ‘security interest’ held by it. This would 8 March 2018, Ministry of Corporate Affairs, Government of India.
further ensure that (secured) financial creditors, who
are tasked with responsibility of finalising and approving
resolution plans of a corporate debtor, are incentivised Avikshit Moral is a Partner at Juris Corp and has more than ten
to vote in favour of resolution of a corporate debtor, years of extensive experience in the corporate law space. He
thereby meeting the foremost objectives of the Code of heads the real estate and corporate commercial practices at Juris
promoting resolution, maximising the value of the assets Corp. He has extensive experience in the fields of corporate
restructuring, joint ventures, structured transactions involving
of the corporate debtor and balancing the interest of all
various laws, conveyancing, redevelopment and corporate
stakeholders involved. commercial laws.
The Honourable Supreme Court through the Essar Ashish Mukhi is a Principal Associate at Juris Corp. He has been
Insolvency Case (above) very clearly established the involved in handling matters on varied issues in various forums in
principles of equitable treatment of similarly placed Delhi. He has been involved in matters relating to debt
creditors and the same principle was also included in restructuring, strategic debt restructuring and corporate
insolvency resolution processes. Ashish advices on pre-litigation
section 30(4) of the Code by the Amendment. However,
strategy for stressed and non-performing assets and insolvency
the Essar Insolvency Case did not flesh out the distinction related issues.
of different levels of secured creditors leaving some Kamlendra Pratap Singh is an Associate at Juris Corp. He has
scope of further clarity. Orders passed by the NCLT, been involved in matters relating to commercial and banking
Ahmedabad, upholding the sanctity of inter-se priority disputes and advisory aspects including pre-litigation strategy for
stressed and non-performing assets and insolvency related issues.
among secured creditors is an encouraging sign and
He has also been involved in handling matters on varied issues in
hopefully the NCLAT and the Honourable Supreme various forums in Delhi.
Court upholds the validity of such reasoned orders

Insolvency and Restructuring International Vol 14 No 2 September 2020      49