PUFE Transaction Under IBC Vis-À-Vis Real Estate Sector

Since the implementation of the Insolvency and Bankruptcy Code, 2016, (“Code”), the Real Estate Sector has been in turmoil, with many transactions entered into by the Builder(s) undermining and jeopardising the legitimate interests of innocuous creditors. The Code encompasses a collection of transactions that the Interim Resolution Professional (“IRP”) and the liquidator appointed by the National Company Law Tribunal (“NCLT”) for companies in insolvency or liquidation should avoid, as stated below. Preference, Undervalued, Fraudulent, and Extortionate Transactions (“PUFE Transactions”) is how the group of transactions is known. Each of the aforementioned has been examined in relation to the Indian real estate sector in order to advance the conceptual nature.

Understanding PUFE Transactions

 

Preferential Transactions

The factors that may lead to transactions being classified as preferential in character are discussed in Section 43 of the Code. Thus, if specific criteria exist in a set of transactions conducted by the corporate debtor that may be preferential in character, they can only be avoided if the IRP or liquidator files an application with the NCLT.

When a court determines that a transaction was not carried out in the ordinary course of business to create a new value in the corporate debtor’s interest, but instead acted to give preferential advantage to a related party or other parties, the transaction is to be avoided under Section 44 of the Code. Its main goal was to reverse the consequences of preferential transactions by requiring the person who received the preference to refund any profit gained as a result of the preference.

 

Undervalued Transactions

An undervalued transaction occurs when a corporate debtor has the malafide intention of causing a wrongful gain to a linked party or selling assets for a cheap price in a short period of time to boost cash liquidity.

In addition, the time frame for challenging an undervalued transaction has been classified according to whether the party is linked or unrelated. As a result, an undervalued transaction with a ‘related party’ might be called into question two years prior to the start of insolvency proceedings, whilst an undervalued transaction with a ‘unrelated party’ could be called into question one year prior to the start of bankruptcy proceedings.

If the NCLT determines that the transaction was undervalued and that the Resolution Professional (“RP”) or liquidator failed to report it despite having sufficient information or opportunity, the NCLT can order the position to be restored to its pre-transaction state and order the insolvency board to initiate proceedings against the liquidator or RP.

 

Fraudulent Transactions

The Code’s scope and ambit for identifying fraudulent transactions are rather broad in order to protect creditors’ legitimate rights against the corporate debtor. The phrasing used in Section 66(1) of the Code, which deals with deceptive dealing, demonstrates the same. As a result, if the corporate debtor conducted business with the intent to defraud creditors or for any other fraudulent purpose, the NCLT can issue an order directing any individual who was knowingly a party to the corporate debtor’s business conduct to make such contributions to the corporate debtor’s assets as the NCLT deems appropriate during the insolvency process.

While Section 66(2) of the Code covers wrongful trading (i.e., conduct that is not fraudulent but falls short of the standards governing directors’ duty to behave correctly in the case of insolvency), the NLCT has the authority to impose a pecuniary penalty on the director or partner.

 

Extortionate Transactions

Extortionate transactions are covered under Section 50 of the Code, which requires the corporate debtor to make exorbitant payments to any of its creditors in the two years preceding the bankruptcy beginning date. An NCLT order may be used to prevent such transactions. If a person’s debt is in line with the law, this rule does not apply.

The two-year period before the start of bankruptcy is crucial for establishing whether a transaction is excessive.

As a result, before engaging in any transaction, contractual parties and creditors must confirm that they have evaluated the company’s most recent financial status, particularly those involving the transfer of assets or value from such a business, to identify any financial crisis indicators.

 

Analysis

Troubled businesses must be prohibited from engaging in activities that may block creditor recovery if insolvency proceedings were to be commenced. In India, where promoter groups typically control enterprises, such measures are essential. Through opaque arrangements, promoter groups may seek to move income from assets to other group companies for their own benefit. As a result, the NCLT has the jurisdiction under the Code to reverse any such transaction in order to safeguard creditors’ and other stakeholders’ interests.

The case of IDBI Bank Ltd. v. Jaypee Infratech Ltd[1]. (“IDBI”), which was confirmed by the Supreme Court in Jaypee Infratech Ltd. Interim Resolution Professional v. Axis Bank Ltd.[2], is an important precedent for PUFE Transactions.

M/s Jaiprakash Associates (“JAL”) established a special purpose firm, M/s Jaypee Infratech Ltd. (“JIL”), to manage the project design, engineering, development, and construction. JAL controlled 70 percent of JIL’s equity. Significantly, JIL encountered financial difficulties and failed to satisfy contractual deadlines for project completion and debt repayment. As a result, JIL’s account was designated non-performing by the Life Insurance Corporation (“LIC”). Since JIL’s account was deemed non-performing, its financial creditors, including IDBI, filed an application with the NCLT’s Allahabad Bench under Section 7 of the Code, which was granted, and the NCLT appointed an IRP. The IRP filed an application with the NCLT after reviewing the transactions, requesting that they be declared as PUFE Transactions.

According to the NCLT, JIL failed to strive diligently to decrease the creditors’ losses and mortgaged the land without JAL’s counter-guarantee since it completed the series of transactions while in financial distress. JIL had also failed to acquire the essential approvals for the challenged acquisition from the JLF lenders as well as the shareholders. As a result, the NCLT determined that the contested transactions occurred during the relevant period and that they were preferential transactions under Section 43 of the Code.

 

Conclusion

PUFE transactions in the real estate sector have become a threat, and the changes have proven unsuccessful in facilitating the filing of a lawsuit against infrastructure and real estate behemoths. The real estate industry in India is one of the few to have risen at an exponential rate during the previous two decades. It has drawn significant investments from many who have put their life savings into realising their ambitions of buying a home. The most sought-after investment channel, on the other hand, has lost favour owing to stagnation.

On the other hand, a careful examination of the modifications reveals that they are helpful to homebuyers. The amendment to the Code is favourable to buyers who are facing difficulties due to incomplete real estate developments. Homebuyers are affected by project delays since they invest a considerable portion of their cash in a down payment and an EMI on the loan while continuing to pay rent in their current location. This situation has now altered as a result of the recent Code modification.

References:

[1] Company Petition NO.(IB)77/ALD/2017

[2]  Civil Appeal NOS. 8512-8527 OF 2019

Photo by: Tierra Mallorca on Unsplash

PUFE transactions in the real estate sector have become a threat, and the changes have proven unsuccessful in facilitating the filing of a lawsuit against infrastructure and real estate behemoths. The real estate industry in India is one of the few to have risen at an exponential rate during the previous two decades. It has drawn significant investments from many who have put their life savings into realising their ambitions of buying a home. The most sought-after investment channel, on the other hand, has lost favour owing to stagnation.

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Remuneration of Insolvency Professionals – A Progressive and Performance Oriented Approach  

An Insolvency Professional (IP) is entrusted with the management and administration of a Corporate Debtor’s affairs throughout the Corporate Insolvency Resolution Process (CIRP). He is responsible for managing, operating, and running the Corporate Debtor as a going concern during the said period by taking over the day-to-day affairs of the Corporate Debtor, complying with all the applicable laws, etc. An IP is also entrusted with the obligation of calling for the Resolution Plans, putting them before the Committee of Creditors (CoC) and having the best of all the Resolution Plans approved by the CoC, putting in his best efforts while doing so, and then by the Adjudicating Authority (AA). His obligations necessitate the highest level of professionalism, dexterity, and honesty. Therefore, taking into account his abilities, obligations, and responsibilities that he discharges, he needs to be compensated fairly for the professional services he provides.

Insolvency Professional’s Remuneration in Foreign Jurisdictions

Different jurisdictions have different frameworks for dealing with the insolvency matters arising in their jurisdictions. As a result, it is only natural for such jurisdictions to have different parameters for determining fees for their IPs (or the person equivalent to or performing the functions and duties of Indian IP in their jurisdictions).

In the United Kingdom (UK), matters relating to insolvency are dealt with under the Insolvency (England and Wales) Rules, 2016. The said rules provide for the determination of the “administrator, liquidator or trustee” (the IP equivalent) on the basis of either a percentage of the value of the property realised or distributed, or time spent in attending to the matter, or a fixed amount, or any combination of the aforesaid three parameters. In the United States of America (US), Section 326 of the US Bankruptcy Code provides that a court may allow a reasonable compensation to the “trustee” (the IP equivalent) that should not be more than a varied percentage of the amount disbursed or turned over by him to the creditors. While the US and UK follow a variable fee model, in Canada, the law relating to insolvency provides that the trustee’s (the IP equivalent) fees are to be fixed by the creditors by way of an ordinary resolution and in case the creditors fail, the trustee shall be entitled to a maximum of 7.5% of the amount remaining after the secured creditors have been paid out of the amount realised from the properties of the Corporate Debtor.

Insolvency Professional’s Remuneration in India

In India, the relevant provisions having a bearing on fees and other expenses of CIRP are envisaged under the Insolvency and Bankruptcy Code, 2016 (the Code) and regulations made thereunder. Section 5(13) & Section 208(2) of the Code, regulations 31, 33, 34 and 34A of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, (CIRP Regulations) clauses 16, 25, 25A, 26, and 27 of the First Schedule (under regulation 7(2)(h)) to Insolvency and Bankruptcy Board of India (Insolvency Professionals) Regulations, 2016, and the circulars issued by the Insolvency and Bankruptcy Board of India (the IBBI) dated 16th January 2018 bearing no. IBBI/IP/004/2018 and 12th June 2018 bearing no. IBBI/IP/013/2018 deal with the fees of IPs.

While the sections and regulations lay down what costs amount to the CIRP Cost and how such costs including an IP’s fees are to be dealt with, the circulars mainly provide that an IP shall render services for a fee that is a “reasonable reflection” of his work, raise bills/invoices in his name towards such fees, and have such fees paid to his bank account. However, none of the provisions or the circulars provide for a specific parameter to determine the IP’s fees. The fixation of the fees of the IPs, therefore, is a duty cast upon the Applicant and the CoC and that of the AA upon their failure. In the absence of a specific parameter and proper definition of “reasonable reflection”, the AA is often faced with cases involving fee disputes between IP and Applicant and IP and the CoC. The AA had been issuing various directives to the Board, directing it to fix the fees of the IP and to consider issuing guidelines or preparing a reasonable fee structure.

The IBBI has dealt with the AA’s references with respect to the fixation of IP’s fees on a case-to-case basis up until now. However, to avoid unnecessary disputes between the parties leading to litigation and to save the time of the parties as well as the AA from it, on 9th June 2022, the IBBI issued a discussion paper addressing the issue of fees payable to the IPs acting as IRPs and RPs. The paper proposes amendments to regulations 34A and the insertion of regulations 34B and Schedule II in the CIRP Regulations, specifying a model fee structure for the IPs. The fee structure proposes not only to resolve the issue with respect to the fixation of fees but also encourages IPs to facilitate timely resolution of a Corporate Debtor keeping in mind the maximisation of its value through the introduction of performance linked incentive fees, while very aptly mentioning in the discussion paper that “Maximisation of value does not mean maximum recovery from the assets during the process of liquidation. It is a concept that helps CD to get a fair valuation in return.”

Fixed Fee Structure

The proposed regulation 34A provides that the Applicant, the AA and the CoC shall fix the IP’s fee that shall be payable to him from the date of his appointment till the submission of the Resolution Plan before the AA after approval of the CoC, in accordance to the following minimum fee: –

 

Quantum of Claims Admitted

 

Minimum Fee Per Month

(Rs. Lakh)

(i)     

<= Rs. 50 crores

1.50

(ii)   

> Rs.50 crore < = Rs.100 crores

2.00

(iii)           

 > Rs.100 crore < = Rs.500 crores

2.50

(iv)  

> Rs.500 crore < = Rs.1,000 crores

3.00

(v)    

> Rs.1,000 crore < = Rs.2,500 crores

3.50

(vi)  

> Rs.2,500 crore < = Rs.10,000 crores

5.00

(vii)          

> Rs.10,000 crores

7.50

The regulation also enables the CoC to ratify an amount higher than the amount envisaged in the aforesaid table. It further provides that the CoC may also decide the fee for the interregnum period between the submission of the Resolution Plan before the CoC and its approval by the CoC.

 

Performance Linked Fee

Since time is the essence of the Code, the IPs must adhere to the timelines and facilitate a time-bound process as envisaged under the Code read with regulations made thereunder. Keeping in mind the timely resolution of a Corporate Debtor and maximization of its value, in addition to the aforesaid, the amendment further proposes that an IP may also be paid a performance linked fee to ensure timely completion of the CIRP in the following manner: –

 

Timelines

Fee as % of actual realizable value

(i)     

<= 180 days

1.00

(ii)   

> 180 days < = 270 days

0.75

(iii)           

 > 270 days < = 330 days

0.50

(iv)  

 > 330 days

0.00

The amendment further provides that the aforesaid performance linked fee shall form a part of the CIRP Cost and the same shall in no case exceed Rs.5 crore. However, the discussion paper states that the said performance linked fee is only of indicative nature, and that the CoC may devise any other incentive structure, or it may decide not to give such incentive at all. 

Escrow account mechanism

According to the IBBI, in addition to determining fees, the applicant or the CoC, is also responsible for ensuring that any amounts payable to IP are paid. As a result, an escrow account system has been proposed to ensure the timely payment of the fee to the IP.

At the first CoC meeting, IP must provide an estimate of the fixed fee and expenditure on hiring other professionals, support services, and so on, and the CoC will either contribute to an escrow account or secure interim financing for the estimated fees and expenses for the first six months. It, therefore, proposes the following additions to the CIRP Regulations through the insertion of regulation 34B.

Immediately upon his appointment as an IRP, an IP shall open an escrow account in the name of the Corporate Debtor in respect of his fee and the fee for the RP. Within 72 hours following the submission of the statement by the IP, the applicant or the CoC, as the case may be, shall deposit in the escrow account, or arrange for interim finance for deposit in the escrow account, amount fixed under regulation 34A. The IRP or the RP may withdraw money from the escrow account to cover his fee, and they must disclose the withdrawals to the CoC in the statement prepared under regulation 34A. The balance in the escrow account, if any, will be released upon approval of a resolution plan under section 31 or the passing of an order for Corporate Debtor’s liquidation under section 33.

The IBBI has invited comments from the public on the aforesaid amendment and the last date for submission of the same is June 30, 2022. Once approved, the new regulations would resolve the long pending issue with respect to the fee payable to the IP and with it, it would also decrease the number of litigations arising out of the said issue, thereby, further cutting down on the unnecessary and avoidable time consumption in the CIRP process. The performance linked fee would further encourage the IPs to work towards the maximization of value of the Corporate Debtor, reduce the amount of time consumed in the process, and keep the IPs motivated towards work.

Conclusion

Apart from decreasing the number of litigations related to IP fees, thereby reducing time consumed in the CIRP and keeping the IPs motivated towards maximisation of value of Corporate Debtor’s assets in a time bound manner, the proposed amendments would resolve several other issues.

Be it any profession, it becomes difficult to balance the efficiency, quality of work and professionalism when the remuneration of the professional involved is not decided upon or still being negotiated upon, due to which the beneficiary of the work being or proposed to be performed suffers. There have been several instances where during the CoC meetings the CoC and the IP either hard-negotiate upon the IP’s fees or the expense incurred by the IP, due to which the Corporate Debtors suffer. The proposed fixed fee structure that provides for a minimum amount to be paid as fees to the IP, if enforced, would leave no room for such hard-negotiations. By guaranteeing a minimum fixed amount to be paid to the IP based on the quantum of claims admitted, the proposed regulation ensures that the IPs as well as the CoC waste no time in fee-bargaining, thus creating more room for conducting the CIRP in a time bound manner.

Further, the proposed fixed fee structure based on the quantum of claims admitted by the IP would also ensure that the fees being paid to him are equitable and commensurate with the amount of work done by him. The professionals who were reluctant to agree to take up the baton of CIRP of the Corporate Debtors that had Creditors with a history of haggling with the IPs for their fees would also pitch to take up the CIRP of such Corporate Debtors, thereby, providing a better opportunity of resolution to such Corporate Debtors.

The CIRPs under the Code are plagued with slow progress with most of the cases extending beyond the 180 days period and several cases crossing the 330 days’ period. The proposed provision with respect to the performance linked fee would encourage the IPs to endeavour and finish the entire CIRP within a time bound period by providing an additional maximum performance-based remuneration to them for the completion of the entire CIRP within 180 days as compared to no additional remuneration for the completion of the CIRP after the expiration of 330 days.

The amendment proposed with respect to the escrow account would resolve the issue where the CoC of the Corporate Debtors do not contribute to the running CIRP cost due to various reasons, thus slowing down, and in some cases halting, the entire resolution process. The said inclusion of regulation 34B would ensure that the IPs actually get their fees and that they have the finances to conduct the CIRP at all times. This would drastically reduce the number of litigation with respect to the payment of IP’s fees before AA and save the time wasted in pursuing such litigation.

The proposed amendments have certain drawbacks too. The fixed fee structure provides for the determination of the minimum fees based on the quantum of claims admitted. The duty to admit or reject the claim is that of the IP which, in some cases, might be affected inasmuch as some of the IPs may be encouraged to admit a larger number of claims.

Insofar as the provision relating to the performance linked fee is concerned, the same is otiose inasmuch as it provides that the performance linked fee is indicative in nature, and that the CoC may devise any other incentive structure, or it may decide not to give such incentive at all. By giving the CoC the authority to devise other incentive structures or to not give any incentive at all, the said provision would only be a toothless tiger, for in most of the cases the CoC will try to bring down such amount substantially if not completely wriggle out of paying it.

Further in addition to the aforesaid performance linked fee, to maximise the value of the assets of the Corporate Debtor, the IBBI may consider providing for value linked fee in cases where the IPs bring about resolution under which the realisable value of the Corporate Debtor is appreciably higher than the liquidation value of the Corporate Debtor. A percentage of the difference between the realisable value and the liquidation value may be paid to such IPs. This would ensure the value maximisation of a Corporate Debtor to its core.

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By guaranteeing a minimum fixed amount to be paid to the IP based on the quantum of claims admitted, the proposed regulation ensures that the IPs as well as the CoC waste no time in fee-bargaining, thus creating more room for conducting the CIRP in a time bound manner.

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Inter-Se Priority Among Secured Creditors in Liquidation - A Judicial Dichotomy  

The Insolvency and Bankruptcy Code, 2016 (“IBC”/”Code”) came into force on 28th May, 2016 with the primary objective of consolidating and amending the laws of reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner to maximise the value of their assets. The Code has been evolving over the last six years, with changing scenarios and adapting to practical circumstances along the way. As a result, the Code has undergone amendments from time to time. The provisions in the Code have also been interpreted and clarified by judicial pronouncements of the Hon’ble NCLTs, the Hon’ble NCLAT and the Hon’ble Supreme Court of India. The law relating to the Code is still emerging and there are a number of issues which are still required to be addressed with unambiguous certainty. One such issue is the distribution of proceeds in liquidation from the sale of assets under Section 53 of the Code to the secured creditors vis-à-vis the validity of inter se priority among secured creditors in respect of their security interests (charges) during liquidation.

What is the meaning of “Charge” and “Inter se Priority”?

Section 3(4) of the Code defines the term “charge” as an interest or lien created on the property or assets of any person or any of its undertakings or both, as the case may be, as security and includes a mortgage.

Several charges can be created in respect of a particular asset. This can be done by way of creating a pari passu charge over the asset where all the charge holders are placed on an equal footing or by way of the creation of a first charge and a subservient charge wherein the first charge holder can satisfy its debts in entirety prior to the subservient charge holders. This principle is embodied in Section 48 of the Transfer of Property Act, 1882. However, under Section 52 of the Code, a secured creditor has two options to realise its debts from secured assets held by it relating to a corporate debtor in liquidation:

Although the Code does not specifically indicate the validity of inter-se-priority of charges at the time of distribution in accordance with the waterfall mechanism provided under Section 53, the issue has been deliberated and decided upon by the Hon’ble NCLTs, Hon’ble NCLAT and Hon’ble Supreme Court of India in recent times, through judicial interpretation.

Pre-IBC Regime: Legal Position under the Companies Act, 1956

Under the earlier Companies Act, 1956, Sections 529 and 529A governed the ranking of creditors’ claims and the distribution of sale proceeds by the Official Liquidator in respect of a corporate debtor in liquidation.

The legal position vis-à-vis inter-se-priority of charges in the pre-IBC regime was discussed at length by the Hon’ble Supreme Court of India in the case of ICICI Bank vs Sidco Leathers Ltd. [Appeal (Civil) 2332 of 2006, decided on April 28, 2006]. In the said case, the Hon’ble Apex Court, while interpreting Sections 529 and 529A of the Companies Act, 1956, observed that even though workmen’s dues and secured creditors’ debts are treated pari passu, this does not negate inter se priorities between secured creditors. The Hon’ble Court stated that since the Companies Act of 1956 is a special statute which contains no provisions regarding inter se priority among secured creditors, the specific provisions set forth in the Transfer of Property Act, 1882 shall prevail. The Hon’ble Court further held that if Parliament, while amending the provisions of the Companies Act, 1956, intended to take away secured creditors’ entitlement to property, it would have stated so expressly. The Hon’ble Court, while deciding the issue, observed the following:

“Section 529A of the Companies Act does not ex facie contain a provision (on the aspect of priority) amongst the secured creditors and, hence, it would not be proper to read therein to things, which the Parliament did not comprehend. The subject of mortgage, apart from having been dealt with under the common law, is governed by the provisions of the Transfer of Property Act. It is also governed by the terms of the contract.”

“Merely because section 529 does not specifically provide for the rights of priorities over the mortgaged assets, that, in our opinion, would not mean that the provisions of section 48 of the Transfer of Property Act in relation to a company, which has undergone liquidation, shall stand obliterated.”

From the aforesaid, it is evident that the Hon’ble Apex Court upheld the validity of the Transfer of Property Act, 1882, which is a general law, over the provisions of the Companies Act, 1956, which is a special law and which did not recognise the concept of inter-se priority of charges.

 

Post-IBC Regime: Legal Position under the Code and the Report of the Insolvency Law Committee 2018

 

Report of the Insolvency Law Committee dated March 26, 2018

In the Report of the Insolvency Law Committee (ILC) dated March 26, 2018, it was noted that inter-creditor agreements should be respected. The ILC relied on the judgement of the Hon’ble Supreme Court in the case of ICICI Bank vs. Sidco Leathers Ltd. and came to the conclusion that the principles that emerged from the said case are also applicable to the issue under section 53 of the Code. The ILC in its report stated that Section 53(1)(b) of the Code only kept the workmen and secured creditors, on an equal pedestal and no observations were made on the inter-se priority agreements between the secured creditors and the same would therefore remain valid. The Report further clarified that the provision of Section 53(2) would come into effect only in cases where any contractual arrangement interferes with the pari passu arrangement between the workmen and secured creditors which means that contracts entered into between secured creditors would continue to remain valid.

 

Judicial Interpretation in recent times

Section 53 of the Code lays down the waterfall mechanism with respect to payment of debts to the creditors of the corporate debtor. The workmen’s dues and the debts of secured creditors rank pari passu under Section 53. However, the Code does not expressly provide for the preservation of inter-se-priorities between secured creditors at the time of distribution of sale proceeds realised by the liquidator by the sale of assets. The issue is to be understood and interpreted in the light of recent judicial decisions. Some of the recent judgments which have dealt with the issue are:

 

Technology Development Board vs Mr. Anil Goel & Ors. [I.A No. 514 of 2019 in CP(IB) No. 04 of 2017 decided on 27th February, 2020 by the Hon’ble NCLT, Ahmedabad]

In the instant case, the liquidator had distributed proceeds from the sale of assets to the first charge holders, in priority to the applicant who was a second charge holder without considering the claim of the applicant as a secured creditor that such distribution ought to have been made prorate among all secured creditors. It is pertinent to mention here that all the secured creditors had relinquished their security interests in the common pool of the liquidation estate. The Applicant was one of the secured financial creditors of the Corporate Debtor having a 14.54% voting share in the CoC of the Corporate Debtor.

Aggrieved by such distribution which recognised inter-se-priority among secured creditors, the Applicant moved the Hon’ble NCLT, Ahmedabad Bench.

The issue to be determined:

The primary issue that was to be decided by the Hon’ble NCLT was that once a secured creditor has not realised his security under Section 52 of the Code, and has relinquished the security to the liquidation estate, whether there remains no classification inter se i.e., by joining liquidation, all the secured creditors are ranked equal (pari passu), irrespective of the fact that they have inter-se-priority in security charge.

Observations of the Hon’ble NCLT

The Hon’ble NCLT while deciding the aforesaid issue held:

  • It is a settled position that when a charge is created on a property in respect of which there is already a charge, it cannot be said that the creation of the second charge on the property should have been objected to by the first charge holder as an existing and registered charge is deemed to be a public notice.
  • Emphasis was placed on Section 53(2) of the Code, which provides that any contractual arrangements between recipients under sub-section(1) with equal ranking, shall be disregarded by the liquidator if it disrupts the order of priority under that sub-section. In other words, if there are security interests of equal ranking, and the parties have entered into a contract in which one is supposed to be paid in priority to the other, such a contract will not be honoured in liquidation.
  • The whole stance in liquidation proceedings is to ensure parity and proportionality. However, the idea of proportionality is only as far as claims of similar ranking are concerned.

Decision:

The Hon’ble NCLT, relying on the judgement of the Hon’ble Supreme Court of India passed in ICICI Bank vs. Sidco Leathers Ltd., held that inter se priorities among creditors remain valid and prevail in the distribution of assets in liquidation.

 

Technology Development Board vs Mr. Anil Goel & Ors. [Company Appeal (AT) (Insolvency) No.731 of 2020 decided on 5th April, 2021 by the Hon’ble NCLAT, Principal Bench, New Delhi]

The issue to be determined:

Aggrieved by the aforesaid order dated 27th February 2020 passed by the Hon’ble NCLT, Ahmedabad, an appeal was preferred by the Applicant before the Hon’ble NCLAT wherein the issue raised for consideration was whether there could be no sub-classification among the secured creditors in the distribution mechanism adopted in a Resolution Plan of the Corporate Debtor as according to priority to the first charge holder would leave nothing to satisfy the claim of the Appellant who too is a secured creditor.

Observations of the Hon’ble NCLAT

The Hon’ble NCLT while deciding the issue took note of Sections 52 and 53 of the Code and held:

  • Section 52(2) of the Code stipulates that a secured creditor, in the event it chooses to realise its security interest, shall inform the liquidator of such security interest and identify the asset subject to such security interest to be realised. The liquidator’s duty is to verify such security interest and permit the secured creditor to realise only such security interest, the existence of which is proved in the prescribed manner. It is abundantly clear that there is a direct link between the realisation of a security interest and the asset subject to such security interest to be realised.
  • Section 53 deals with distribution of assets by providing that the proceeds from the sale of the liquidation assets shall be distributed in the order of priority laid down in the section. The provision engrafted in Section 53 has an overriding effect over all other laws in force.
  • The essential difference between the two provisions i.e Sections 52 and 53, lies with regard to the realisation of interest. While Section 52 provides an option to the secured creditor to either relinquish its security interest or realise the same, Section 53 is confined to the mode of distribution of proceeds from the sale of the liquidation assets.
  • Whether the secured creditor holds the first charge or the second charge is material only if the secured creditor elects to realise its security interest.
  • A secured creditor who once relinquishes its security interest ranks higher in the waterfall mechanism provided under Section 53 as compared to a secured creditor who enforces its security interest but fails to realise its claim in full and ranks lower in Section 53 for the unpaid part of the claim.
  • Section 52 incorporating the doctrine of election, read in juxtaposition with Section 53 providing for distribution of assets, treats a secured creditor relinquishing its security interest to the liquidation estate differently from a secured creditor who opts to realise its security interest, so far as any amount remains unpaid following enforcement of security interest to a secured creditor is concerned by relegating it to a position low in priority.
  • The non-obstante clause contained in Section 53 makes it clear that the distribution mechanism provided thereunder applies in disregard of any provision to the contrary contained in any Central or State law in force.
  • A first charge holder will have priority in realising its security interest provided it elects to realise and not relinquish the same. However, once a secured creditor opts to relinquish its security interest, the distribution would be in accordance with the Section 53(1)(b)(ii) wherein all secured creditors have relinquished their security interest.

Decision

It was held by the Hon’ble NCLAT that the view taken by the Adjudicating Authority on the basis of the judgement passed by the Hon’ble Apex Court in ICICI Bank vs. Sidco Leathers Ltd. and ignoring the mandate of Section 53, which has an overriding effect and was enacted subsequent to the aforesaid judgment, is erroneous and cannot be supported. The Hon’ble NCLAT therefore held that the order of the Adjudicating Authority holding that the inter-se priorities amongst the secured creditors will remain valid and prevail in the distribution of assets in liquidation cannot be sustained and the liquidator was directed to treat the secured creditors relinquishing the security interest as one class ranking equally for distribution of assets under Section 53(1)(b)(ii) of the Code and distribute the proceeds in accordance therewith.

 

Kotak Mahindra Bank Limited vs Technology Development Board & Ors. [Civil Appeal Diary No(s). 11060/2021]

The aforesaid order passed by the Hon’ble NCLAT has been further challenged before the Hon’ble Supreme Court of India. The appeal is currently pending adjudication, but the Apex Court has stayed the operation of the impugned order dated 5th April passed by the Hon’ble NCLAT, by order dated 29th June, 2021 . The appeal has been last heard on April 29, 2022, wherein an order has been passed to list the matter after eight weeks. It would be interesting to see whether the Apex Court upholds the order of the Hon’ble NCLAT and disregards the inter se priority among creditors at the time of distribution of sale proceeds under Section 53 of the Code or upholds the validity of the same.

 

Oriental Bank of Commerce (now Punjab National Bank) vs Anil Anchalia & Anr. [Comp. App. (AT)(Ins) No. 547 of 2022 decided on 26th May, 2022 by the Hon’ble NCLAT]

  • In the instant case, the appellant, who was the first and exclusive charge holder with respect to the assets of the corporate debtor, had relinquished its security interest in the liquidation estate. The liquidator, however, distributed the sale proceeds on a pro rata basis under Section 53 of the Code. Being aggrieved by the said distribution, the Appellant filed an application [IA (IBC)/101(KB)2022] before the Hon’ble NCLT, Kolkata, which was rejected by an order dated March 4, 2022. Aggrieved by the same, the appellant preferred an appeal before the Hon’ble NCLAT.
  • One of the contentions raised by the Appellant in the instant case was that the order of the Hon’ble NCLAT in the case of Technology Development Board vs. Mr. Anil Goel & Ors. that secured creditors after having relinquished their security interest could not claim any amount realised from secured assets once they elected for relinquishment of security interest, and that they would be governed by the waterfall mechanism under Section 53 has been stayed by the Hon’ble Supreme Court of India and therefore the Appellant is entitled to receive the entire amount realised from its secured assets.
  • The Hon’ble NCLAT rejected the aforesaid contention and observed that in the light of the judgement passed by the Hon’ble Supreme Court in “India Resurgence ARC Private Limited vs. Amit Metaliks Limited and Anr. [2021 SC OnLine SC 409] and “Indian Bank vs. Charu Desai, Erstwhile Resolution Professional & Chairman of Monitoring Committee of GB Global Ltd. & Anr.[CA(AT)No. 644 of 2021] the issue is no more res integra. In the aforesaid two cases, a similar contention was raised by the Appellants that the dissenting financial creditors are entitled to receive payment as per their secured interest, wherein it was decided that “when the extent of value received by the creditors under Section 53 is given which is in the same proportion and percentage as provided to the other Financial Creditors, the challenge is to be repelled”.
  • Since the issue is no more res integra and has been decided in the case of India Resurgence ARC Private Limited vs. Amit Metaliks Limited and Anr. by the Hon’ble Apex Court by its judgment dated 13.05.2021, the instant appeal was also dismissed.

 

Conclusion

 

Section 52 of the Code gives each secured creditor the option of relinquishing their right to the liquidation estate or realising their security interest on its own, subject to the Code’s requirements.

It can be possibly interpreted that once the secured creditor has relinquished its security interest in the liquidation estate, such a secured creditor exercises its option in favour of losing its priority rights over assets charged to it and joins the liquidation pool wherein the secured creditor is paid from the proceeds of the liquidation estate in accordance with Section 53 of the Code. The Code has provided the option to a secured creditor to enforce its first and exclusive charge by taking recourse to Section 52, whereby in the event it is unable to realise its entire dues, it would be ranked lower under Section 53 for realisation of the balance amount. A secured creditor cannot enjoy the fruits of both the provisions under Sections 52 and 53 of the Code at the same time. Once the secured creditor relinquishes its security interest to the common pool of the liquidation estate, it will be treated at par with all other creditors.

It can also be argued that the NCLAT has ignored the legislative intent clarified in the Insolvency Law Committee Report which after considering the decision of the Hon’ble Supreme Court in ICICI Bank vs Sidco Leathers Ltd. applied its principles to the issue under Section 53 of the Code and recommended that inter-se-priority among creditors was not disturbed by Section 53. Section 53 does not deal with inter-se-rights amongst creditors. It merely deals with the distribution of proceeds arising from the sale of assets to various stakeholders. The non-obstante clause in Section 53 would apply to scenarios where the provisions of the section are contrary to any law. Section 53(1)(b) merely mandates that workmen’s dues and debts owed to a secured creditor, in the event such secured creditor has relinquished security in the manner set out in Section 52, shall rank equally and nothing more. The said section does not deal with mortgages or inter-se-priorities amongst creditors/mortgagees. Mortgages are governed by the provisions of the Transfer of Property Act, 1882 and as such inter-se-priorities between mortgagees have been dealt with in that Act. Therefore, there may not be any justification for excluding the applicability of the provisions of the Transfer of Property Act, 1882 relating to mortgages for payment of dues to creditors under Section 53. The absurd result of not providing inter-se-priority to creditors at the time of distribution of sale proceeds under Section 53 would be that every secured creditor holding the first charge on assets would encourage liquidation and realise its dues by selling assets itself by opting to not relinquish the assets to the liquidation pool under Section 52. The chance of selling the corporate debtor as a going concern would then absolutely be eradicated, which would be contrary to the object and spirit of the Code.

It is expected that the Supreme Court will finally rest the issue while deciding the appeal in the case of Kotak Mahindra Bank Limited vs Technology Development Board & Ors. [Civil Appeal Diary No(s). 11060/2021 which is scheduled to appear for a hearing later this month.

Image Credits: Photo by Dennis Maliepaard on Unsplash

Section 53 does not deal with inter – se – rights amongst creditors. It merely deals with the distribution of proceeds arising out of sale of assets to various stakeholders. The non – obstante clause in Section 53 would apply to scenarios where the provisions of the section are contrary to any law. Section 53(1)(b) merely mandates that workmen’s dues and debts owed to a secured creditor, in the event such secured creditor has relinquished security in the manner set out in Section 52, shall rank equally and nothing more. The said section does not deal with mortgages or inter – se – priorities amongst creditors / mortgagees. Mortgages are governed by the provisions of the Transfer of Property Act, 1882 and as such inter – se – priorities between mortgagees has been dealt with in that Act.

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Voluntary Liquidation Process Under IBC: An Update

The Insolvency and Bankruptcy Code, 2016 read with, the Insolvency and Bankruptcy Board of India (Voluntary Liquidation Process) Regulations, 2020, establish a procedure for the voluntary liquidation of solvent corporate persons.

However, in practice, it can be observed that the majority of voluntary liquidation processes are getting delayed. As per the Discussion Paper released by IBBI, as on December 31st, 2021, 1105 voluntary liquidation processes have been initiated. Of which, the liquidators have submitted final reports to the Adjudicating Authority (AA) in 546 cases only. In other words, more than 50% (i.e., 559 cases) of the voluntary liquidation processes are still ongoing. On closer perusal of the ongoing cases, it is found that 293 cases (around 52%) of them have crossed the one-year time mark. In this background, the Voluntary Liquidation Process (Amendment) Regulations, 2022 have been introduced on April 5th 2022 by the IBBI.

Brief Analysis of the Voluntary Liquidation Process Amendments

The new changes seek to complete the voluntary liquidation process in a quick and efficient manner and ensure that the company does not lose value on its remaining assets since the asset value falls drastically with time. Further, the amendment seeks to clarify the date of the commencement of the liquidation process.  Now, the liquidator shall complete the liquidation process and ensure the submission of final reports within 270 days, 90 days earlier as compared to the statutory time period of 12 months. As per the Discussion Paper released by IBBI, Voluntary Liquidation, being non-adversarial in nature, can be completed in 270 days. Further, the liquidator is directed to distribute the proceeds from realization within 30 days from the receipt of the amount to the stakeholders, as compared to the earlier mandated time period of 6 months.

For the past few years, the government has been promoting several initiatives focusing on “ease of doing business” for corporates. However, it is essential to observe that “ease of doing business” does not only include ensuring a seamless start of a business but also includes a quick and easy structure for the exit.

In this backdrop, in the Union Budget 2022-2023, the Honourable Finance Minister announced that “Now the Centre for Processing Accelerated Corporate Exit (C-PACE) with process re-engineering, will be established to facilitate and speed up the voluntary winding-up of these companies from the currently required 2 years to less than 6 months[1].”

Further, in a Discussion Paper released in February 2022[2], IBBI identified the following problems plaguing the voluntary insolvency process:

  1. It was pointed out that the values of assets fall drastically, and hence a quick and efficient liquidation process is pertinent. However, the Code has failed to stipulate a time limit for such a voluntary liquidation process.
  2. It was also observed that more than 50% of the voluntary liquidation cases had been ongoing as per the data presented to the Board (as of December 31st, 2022). Further, 52% of the ongoing cases had crossed the one-year mark.

The relevant stakeholders also observed that one of the aspects that prolong the voluntary liquidation process is the practise of seeking a ‘No Objection Certificate’ (NOC) or ‘No Dues Certificate’ (NDC) from the Income Tax Department by liquidators during the process, even though the Code and the Voluntary Liquidation Regulations have not mandated the issuance of NOC/NDC. In this regard, the Board issued a Circular in November 2021, clarifying that “an insolvency professional handling a voluntary liquidation process is not required to seek any NOC/NDC from the Income Tax Department as part of compliance in the said process.”[3]

In alignment with the intention of the legislation, the Board has introduced the following amendments to optimize the voluntary insolvency process:

Section 10 (2) (r): Corporate Debtor shall be substituted by Corporate person

The amendment states that the liquidator shall maintain such other registers or books as may be necessary to account for transactions entered by the corporate debtor with the corporate person. This ensures holistic coverage of all financial transactions of the corporate debtor for the purpose of liquidation.

Section 30 (2): timeline for preparation of the list of stakeholders in case where no claims are received is reduced

 

Section 30 (2) requires the liquidator to compile a list of stakeholders within 45 days from the last date for receipt of claims. The amendment inserts the following provision; “Provided that where no claim from creditors has been received till the last date for receipt of claims, the liquidator shall prepare the list of stakeholders within fifteen days from the last date for receipt of claims.”

Previously, no differentiation between the timelines was prescribed in cases where there were no claims from creditors. This timeline was introduced because if no such claims were received till the last date, then it must not take much time for the preparation of a list of stakeholders as the list of shareholders/partners is available with the liquidator at the time of commencement.

Section 35: Timeline for distribution of the proceeds from realization reduced

The amendment reduces the period for distribution of proceeds from realisation to the relevant stakeholders to a period of thirty days from the receipt of the amount, from the earlier mandated six months.

The reason for the reduction of this timeline is that the liquidator remains in close contact with the corporate person and hence should be able to distribute the proceeds quickly.

Further, in cases where there are creditors, since the resolution regarding the commencement of the process is approved by the creditors representing two-thirds of the value of the debt of the corporate person, distribution to the creditors should also take much less time than is currently stipulated.

Section 5(2): Timeline for intimation of appointment as liquidator to the Board enhanced.

5(2) provides that an insolvency professional shall notify the Board about his appointment as liquidator within 3 days of such appointment.  As per the amendment, the regulation has changed the timeline for the intimation from 3 days to 7 days.

Section 37: Timeline to complete the liquidation process reduced.  

The amended provides that if the creditors approve the resolution, the liquidator shall complete the liquidation process and submit the final report to the registrar, board, and adjudicating authority within 270 days from the date of the commencement of the liquidation and within 90 days from the liquidation commencement date in all other cases (where there are no creditors for the company). Previously, the time period for completion of liquidation was one year and no such bifurcation of the time period for completion of liquidation on the basis of the presence or absence of creditors was enumerated. The reason for this reduction in the timeline for completion is that the liquidation estate of the corporate person undergoing the voluntary liquidation process is non-adversarial and also generally straightforward both in terms of the size and heterogeneity of the assets involved. Therefore, the realisation of the assets involved during the voluntary liquidation process takes less time as compared to the liquidation process.

Section 38(3): Final Report and Compliance certificate shall be submitted in Form-H.

Section 38 directs the liquidator to submit the final report to the adjudicating authority along with the application. The amendment has specified Form H for submission of the final report. Such specifications were not provided previously. A compliance certificate provides a summary of actions taken by the liquidator during the voluntary liquidation process. It will assist the Adjudicating Authority in expediting the adjudication of dissolution applications.

Section 39(3): Form H substitutes Form I

As per the amended Rules, Section 39 (3), the stakeholder claiming entitlement to any amount deposited into the Corporate Voluntary Liquidation Account, may apply for an order for withdrawal of the amount to the Board on Form H and not Form I.

Date of Commencement of Liquidation

The amendment clarified that for the corporate person who has creditors representing two-thirds of the debt of the corporate person, the date of liquidation commencement is the date on which such creditors approve the declaration passed for the initiation of the liquidation.

Note: In order to curb delays in liquidation, the Board had recently issued a circular clarifying that an Insolvency Professional handling a voluntary liquidation process is not required to seek any NOC/NDC from the Income Tax Department as part of compliance in the said process.

Conclusion

The amendments effectually fall in line with the Board’s intention to substantiate a streamlined and quick voluntary insolvency procedure, which certainly can be perceived as an initiative in the right direction. The proposed amendments by curtailing the unwarranted time spent on various activities (such as obtaining a No-Objection Certificate from the Income Tax office) may ensure the early completion of the voluntary liquidation process, thereby, providing a quicker exit for the corporate person. Further, the proposed reduction in the time taken for distribution of proceeds would result in an early distribution to the stakeholders and thereby, promote entrepreneurship and the availability of credit. It will assist the Adjudicating Authority in expediting the adjudication of dissolution applications.

References: 

[1] https://www.timesnownews.com/business-economy/budget-proposed-c-pace-for-accelerated-corporate-exit-process-article-89283883

[2] https://ibbi.gov.in/webfront/Discussion-Paper-on-Voluntary-Liquidation-process-Jan-2022.pdf

[3] https://www.ibbi.gov.in/uploads/legalframwork/cc881169aad7ee239aea7954505a76ab.pdf

 

Image Credits: Photo by Melinda Gimpel on Unsplash

The amendments effectually fall in alignment with the Board’s intention to substantiate a streamlined and quick voluntary insolvency procedure, which certainly can be perceived an initiative in the right direction.  The proposed amendments by curtailing the unwarranted time spent on various activities (such as obtaining No-Objection Certificate from the Income Tax office) may ensure early completion of the voluntary liquidation process, thereby, providing a quicker exit for the corporate person.

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