Evolution Of Law For Protecting The Rights Of The Secured Lenders Journey From Suit Proceedings To Corporate Insolvency Resolution Process -…

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Prior to the advent of the Recovery of Debts Due to Banks andFinancial Institutions Act, 1993 (RDDB&FI Act), now known asRecovery of Debts and Bankruptcy Act (RDB Act'), theonly remedy available to a creditor was to approach a civil courtfor recovery of its dues and for enforcement of security. Suchcivil proceedings were either in the nature of an ordinary suit ora summary suit or a mortgage suit, as the case maybe. With an everincreasing burden of cases before the civil courts, a need was feltto introduce a law that would come to the rescue of Banks andFinancial Institutions to ensure disposal of lenders' casesexpeditiously by a Tribunal exclusively dealing with such matters.The Narasimham Committee deemed it essential to introduce andformulate specialized Tribunals for recoveries of debts due toBanks and Financial Institutions. The Committee recommended thatestablishment of specialized Tribunals is vital to the successfulimplementation of the financial sector reforms. The NarasimhamCommittee Report was further strengthened by the recommendationsmade by the Tiwari Committee Report, which also recommended theestablishment of specialized Tribunals. In view of theaforementioned reports, the RDDB&FI Act was promulgated in theyear 1993.

The RDDB&FI Act was introduced as a measure for expeditiousadjudication and recovery of debts due to Banks and FinancialInstitutions. With the introduction of the said Act, it wasbelieved that the huge pendency of the cases filed on behalf ofBanks and Financial Institutions will be tackled effectively. Itwas also assumed that secured creditors will be able to realizetheir debts by sale of assets charged by the Borrowers to the Banksand Financial Institutions. However, soon it was realized by thelaw-makers that the RDDB&FI Act did not prove to be very usefulfor the secured creditors in so far as taking over physicalpossession of a mortgaged asset and its sale, were not specificallyprovided for in the RDDB&FI Act. The procedure to be adoptedfor possession and sale of a secured asset related back to theprovisions of the Transfer of Property Act, 18821 (TPA')and thus, did not aid the cause of the secured creditors.

Accordingly, the Securitisation and Reconstruction of FinancialAssets and Enforcement of Security Interest Act, 2002(SARFAESI Act') came to be introduced. The SARFAESIAct aimed at providing measures to Banks and Financial Institutionsto take over the possession and management of a secured assetwithout intervention of a court of law. The provisions of theSARFAESI Act aimed at realizing long-term assets, manage problem ofliquidity, asset liability mismatches and to improve recovery byexercising powers to take possession of securities, sell the sameand to reduce non-performing assets by adopting measures forrecovery or reconstruction.

As the SARFAESI Act came for the direct benefit of the securedcreditor, the vires of the Act came to be challenged2 on thegrounds that the Act allows the Banks/ Financial Institutions toact in an arbitrary and unfair manner. However, the Hon'bleSupreme Court of India upheld the validity of the SARFAESI Act andexplained that the Act provides for issuance of a statutorynotice3 which provides for a time frame tothe borrower/ guarantor to respond and raise objections to themeasures proposed by the Bank/ Financial Institution. The SupremeCourt also observed that it is mandatory for a Bank/ FinancialInstitution to deal4 with the response/ objections ofthe borrower/ guarantor before proceeding ahead. Thus, a borrower/guarantor gets reasonable opportunity to raise objections. Further,Section 17 of the SARFAESI Act also empowers a borrower/ guarantor/any other aggrieved person to approach the concerned DRTchallenging the action of the Bank/ Financial Institution. Thus,there is no scope of arbitrariness. The Supreme Court also heldthat classification of an account as a non-performing asset is noton the whims and fancies of the Bank/ Financial Institution andthat there is a proper mechanism in place for the same.

In view of the aforementioned scenario and law, it becameabundantly clear that for a Bank/ Financial Institution there aretwo mechanisms - Firstly, by way of initiating proceedings foradjudication of debt and recovery of debt under the provisions ofthe RDDB&FI Act and secondly, by way of enforcing the securityinterest under the provisions of the SARFAESI Act. With theavailability of these two measures came another question, i.e.,whether a Bank/Financial Institution could take measures under theprovision of both the Acts simultaneously. The issue was answeredby the Hon'ble Supreme Court in the affirmative5. Thus,it can be easily stated that a secured creditor could initiateaction under both the Acts simultaneously if it deemednecessary.

With a change in circumstances and with surmounting debts byvarious companies and individuals, the need was again felt for alaw that could consolidate and amend the laws relating toreorganisation and insolvency resolution of corporate persons,partnership firms and individuals in a time bound manner formaximisation of asset values of such persons and to promoteentrepreneurship. Accordingly, the Insolvency and Bankruptcy Code,2016 (IBC) was introduced.

The IBC is based on the premise that any creditor6 towhom a debt is due by a Corporate Person can initiate a CorporateInsolvency Resolution Process (CIRP') against suchDebtor by filing an appropriate Application/ Petition. In thepresent article we will be dealing with the provisions of IBC thatrelate to the Corporate Debtor alone as certain provisions relatingto personal insolvency are yet to be notified. A secured creditorhas been defined7 to include a creditor in favour ofwhom a security interest is created. A question that may come toone's mind is that what would be a right of a securedcreditor in case of initiation of a CIRP.

Firstly, it is imperative to point out that on initiation ofCIRP, an Interim Resolution Professional (IRP') takesover the management and control over the assets of the CorporateDebtor. Subsequently, with the consent of the Committee ofCreditors (CoC'), IRP may be appointed as a ResolutionProfessional (RP'). Now it becomes the duty of RP tomanage the affairs of a Corporate Debtor as a going concern. The RPis duty bound to call for Resolution Plans which get approved aftera consensus of not less than 66 percent of the CoC members. If aResolution Plan gets approved (firstly by CoC and thereafter by theAdjudicating Authority), the terms of the said Plan will beimplemented. The secured creditor or any other creditor will bepaid only as per the approved terms of the Resolution Plan asprovided under Section 53 of IBC. However, in case no ResolutionPlan gets approved, the ultimate result is liquidation.

During the process of liquidation of a Corporate Debtor, it isthe right of a secured creditor to either relinquish its rightstowards the security interest or to realise its security interestin a manner prescribed.8 In the event, a secured creditorrelinquishes its security interest, the said asset would form partof the Liquidation Estate and the proceeds thereof will bedistributed as per law. However, if a secured creditor retains itsright to realize its security interest, it will be incumbent on thesecured creditor to prove to the satisfaction of the liquidator itssecurity interest and only that portion will be allowed to be soldon which the secured creditor proves its claim.9 In case, a securedcreditor does not inform the liquidator about its intention torealize the security interest within a period of 30 days from theliquidation commencement date, the assets covered under thesecurity interest shall be presumed to be part of the liquidationestate10. Further, the secured creditorwould also be required to pay to the liquidator within 90 days theamount of its share for the Insolvency Resolution Process Cost andliquidation cost11

It is also the duty of the secured creditor who has proceeded toenforce its security interest to pay to the liquidator the amountsreceived in excess of its admitted claim12 within 180 daysfrom the liquidation commencement date.13 It is alsopertinent to point out here that IBC provides for enforcement ofsecurity interest by only one secured creditor over the asset.After enforcement of right by one secured creditor, no othersecured creditor can enforce its rights subsequently forrealization of the amount for the same secured assets, as theexcess amount is deposited with the liquidator14. Thus, from theaforementioned, it is amply clear that a special recognition isaccorded to a secured creditor under the provisions of IBC andopportunity (in case of liquidation) is afforded to the securedcreditor to enforce its security interest. However, the same is notwithout fetters.

Having explained the rights of a secured creditor under theprovisions of IBC, it would also not be impertinent to mention thatthe process provided under IBC is not for recovery of debt or forenforcement of security interest but for resolution of insolvency.However, it would also not be out of place to mention that lawsincluding IBC recognize the importance of a security interest andthus, efforts have been made by the legislature to give recognitionto the rights of a secured creditor to enforce a security interest,whether the same is done under the provisions of the SARFAESI Actor under IBC.

Footnotes

1.Chapter IV, Transfer of Property Act, 1882

2.Mardia Chemicals Ltd v. Union of India,AIR 2004 SC2371

3.Section 13(2) of the SARFAESI Act.

4.Section 13(3-A) of the SARFAESI Act.

5.AIR2007SC712

6.Section 3(10) of IBC defines creditors to include both securedcreditors and unsecured creditors.

7.Section 3(30) of IBC

8.Section 52 of IBC

9.Supra

10.Regulation 21 A (1) of Insolvency and Bankruptcy Board Of India(Liquidation Process) Regulations, 20161 Amended Upto24-04-2020.

11.Section 21A(2) (a) of Insolvency and Bankruptcy Board Of India(Liquidation Process) Regulations, 20161 Amended Upto24-04-2020.

12.JM Financial Asset Reconstruction Company Ltd v.Finquest Financial Solutions Pvt. Ltd & OrsCompany Appeal (AT) (Insolvency) No.593 of 2019 decided on11.12.2019

13.Section 21A(2) (b) of Insolvency and Bankruptcy Board Of India(Liquidation Process) Regulations, 20161 Amended Upto24-04-2020.

14.Supra Note 12

This article is for information purpose only. It is notintended to constitute, and should not be taken as legal advice, ora communication intended to solicit or establish commercial motiveswith any. The firm shall not have any obligations or liabilitiestowards any acts or omission of any reader(s) consequent to anyinformation contained herein. The readers are advised to consultcompetent professionals in their own judgment before acting on thebasis of any information provided hereby.