The Supreme Court, by a judgment pronounced on May 4, 2023, in the matter of Vistra ITCL (India) Limited and Others v. Mr. Dinkar Venkatasubramanian and Another [Civil Appeal No. 3606 of 2020], has held that by virtue of a security created by a corporate debtor in favor of a lender to secure the loan facility advanced to a third-party, even though the lender would be considered as a secured creditor of the corporate debtor, however the lender would not be considered as a financial creditor and would not form part of the Committee of Creditors (“CoC”) of the Corporate Debtor. Nonetheless, in the present case, the Supreme Court has directed that the Appellants will be entitled to retain the security interest in the pledged shares, in order to secure the ends of justice.

Facts

Amtek Auto Limited (“Corporate Debtor”) approached KKR India Financial Services Limited (“Appellant No. 2”) and L&T Finance Limited (“Appellant No. 3”) to extend a short-term loan facility of INR 500 Crores to its group companies namely, Brassco Engineering Limited (“Brassco”) and W.L.D. Investments Private Limited (“WLD”), for the ultimate end use of the Corporate Debtor. As per the Appellants, it was an understanding that the Corporate Debtor will create a first ranking exclusive security by way of pledge over 16,82,06,100 equity shares having face value of INR 2/- each of JMT Auto Limited (“JMT”) held by the Corporate Debtor.

A security trustee agreement was executed on December 28, 2015, between Vistra ITCL (India) Limited (“Appellant No. 1”) and WLD for an amount of INR 1,50,00,00,000/-. Further, a security trustee agreement was executed between Appellant No. 1 and Brassco for INR 1,50,00,00,000/-. Thereafter, another security trustee agreement was executed between Appellant No. 1 and Brassco for INR 2,00,00,00,000/-. Thereafter, an amended and re-instated pledge agreement was executed on July 05, 2016 (“Pledge Agreement”), between the Corporate Debtor, WLD, Brassco and Appellant No. 1, whereby the Corporate Debtor pledged 66.77% of its shareholding in JMT to secure the term loan facilities availed by WLD and Brassco from Appellant No. 2 and Appellant No. 3.

On July 24, 2017, Corporate Insolvency Resolution Process (“CIRP”) was initiated against the Corporate Debtor under the provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”) wherein Mr. Dinkar T. Venkatasubramanian (“Respondent No. 1”) was appointed as the interim resolution professional and he was subsequently confirmed as the resolution professional.

On November 2, 2017, Appellant No. 1 filed its claim as a secured financial creditor of the Corporate Debtor for a principal amount of INR 500 Crores. However, the aforesaid claim was rejected by the Respondent No. 1 in 2017 and such rejection was not challenged by the Appellants before the National Company Law Tribunal, Chandigarh (“Adjudicating Authority”).

Further, the Respondent No. 1 had received two resolution plans from entities namely, Liberty House Group Private Limited (“LHG”) and Deccan Value Investors (“DVI”) respectively. However, DVI withdrew its resolution plan and the revised resolution plan submitted by LHG was approved by the CoC of the Corporate Debtor on April 2, 2018, with majority voting shares of 94.20%. Thereafter, the aforesaid resolution plan submitted by LHG was approved by the Adjudicating Authority on July 25, 2018. However, thereafter, LHG failed to fulfil its obligations as committed in terms of the approved resolution plan and the Adjudicating Authority passed an order directing the CoC to reconsider the resolution plan of DVI.

Thereafter, the Appellants filed an application before the Adjudicating Authority claiming their right on the basis of pledged shares. However, the Adjudicating Authority dismissed the aforesaid application filed by the Appellants. Thereafter, upon approaching the National Company Law Appellate Tribunal, New Delhi (“Appellate Authority”), the Appellate Authority dismissed the appeal. While dismissing the appeal, the Appellate Authority observed that the claim form submitted by Appellant No. 1 as a secured financial creditor was rejected by Respondent No. 1 in 2017 and it was not challenged before the Adjudicating Authority at that time and therefore, the Appellants are not entitled to raise the same issue in 2020. Further, the Appellate Authority had also observed that the Appellant No. 1 has not lent any money to the Corporate Debtor and reiterated the view of the Adjudicating Authority that the Appellant would not come within the purview of financial creditor.

Aggrieved by the aforesaid decision of the Appellate Authority, the Appellants preferred a civil appeal before the Supreme Court.

Issue

Whether in case of third-party security created by a corporate debtor, the lender who is a secured creditor qua the corporate debtor but neither considered as financial nor operational creditor qua the corporate debtor, would be entitled to retain the security interest in the asset created by the corporate debtor.

Arguments

Contentions of the Appellants:

The Appellants contended that the observation made by the Appellate Authority, that the Appellant have challenged the rejection of claim by Respondent No. 1 after a delay of nearly three years, is erroneous since it is a case of continuing cause of action. It was further contended that no limitation is prescribed for challenging the categorization of the creditors in a wrongful category.

Further, the Appellants contended that they had challenged their non-inclusion in the CoC as secured financial creditor on February 11, 2020, which is nearly five months prior to the date of approval of resolution plan by the Adjudicating Authority (that is, July 09, 2020).

Further, the Appellants contended that there exists a creditor-debtor relationship between the appellants and the Corporate Debtor. It was submitted that debt arising out of pledge of shares amounts to financial debt by virtue of the definition of “security interest” envisaged under Section 3(31) of the IBC.

Contentions of the CoC:

CoC raised the issue of the Appellants challenging the rejection of claim by Respondent No. 1 by approaching the Adjudicating Authority after a delay of nearly three years and further submitted that even in the numerous correspondences addressed to Respondent No. 1, Appellant No. 1 never raised the aforesaid grievance, but merely requested to Respondent No. 1 to ensure that the pledged shares are not dealt with in any manner without the prior written consent of Appellant No. 1. CoC further submitted that the Appellants had filed the application before the Adjudicating Authority on February 11, 2020 not to challenge the claim rejection, but for seeking admission into the CoC.

Further, the CoC placed reliance on judgment delivered by the Supreme Court in the matter of Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited [(2020) 8 SCC 401] (“Anuj Jain Case”) and Phoenix ARC Private Limited v. Ketulbhai Ramubhai Patel [(2021) 2 SCC 799] (“Phoenix Case”) to substantiate its contention that the Appellants cannot be considered a financial creditors of the Corporate Debtor by virtue of a third-party security created by the Corporate Debtor in the form of pledged shares with respect to the amounts advanced by Appellant No. 2 and Appellant No. 3 to the group companies of the Corporate Debtor.

Observations of the Supreme Court

The Supreme Court observed that in Anuj Jain Case the court held that even though the lenders of Jaypee Associates Limited are secured creditors of Jaypee Infratech Limited (“JIL”) within the realms of IBC, they cannot be considered as financial creditors of JIL and would not form part of the CoC of JIL merely by virtue of third-party security creation. Further, relying upon its previous judgment in the matter of Anuj Jain Case, the Supreme Court in Phoenix Case held that Phoenix ARC Private Limited cannot be considered a financial creditor of Doshion Limited and Doshion Veolia Water Solutions Private Limited by virtue of third-party security creation. The Supreme Court observed that even in the present case, the liability to repay the financial facility was on the group companies of the Corporate Debtor who had availed the facility and not on the Corporate Debtor.

Thereafter, the Supreme Court examined whether the resolution plan can dilute, negate or override the Pledge Agreement because a resolution plan to such effect has been approved by the CoC. In this regard, Supreme Court observed that certain amendments were made in Section 30(2) of the IBC to secure the interests of operational creditors and dissenting financial creditors. However, in so far as creditors like Appellant No. 1, who are secured creditors but neither financial creditors nor operational creditors, a highly peculiar situation would arise wherein such creditors will be left remediless in terms of the amounts allocated to them upon implementation of an approved resolution plan since such creditors would neither avail the benefit available to the financial creditors nor the benefit available to the operational creditors. Hence, the Supreme Court observed that Appellant No. 1, not being a secured financial creditor is neither in a position to opt to realize its security interest in terms of Section 52(1)(b) (Secured creditor in liquidation proceeding) of the IBC nor it is in a position to receive sale proceeds at a relatively higher priority in the event of relinquishment of security interest to the liquidation estate.

In view of the above-mentioned issue, the Supreme Court considered two possible solutions. The first was to treat the secured creditor as a financial creditor of the Corporate Debtor to the extent of the estimated value of the pledged share on the date of commencement of the CIRP, which would make it a member of the CoC and give it voting rights equivalent to the estimated value of the pledged shares. However, this would lead to reconsideration of the earlier judgments in the matters of Anuj Jain Case and Phoenix Case and require reference to a larger bench of the Supreme Court. In view of the aforesaid reason, the Supreme Court observed that the first solution is not feasible.

Therefore, Supreme Court decided to treat Appellant No. 1 as a secured creditor in terms of Section 52 read with Section 53 of the IBC. The Supreme Court gave the option to DVI to treat Appellant No. 1 as a secured creditor, who will be entitled to retain the security interest in the pledged shares and would be entitled to retain the security proceeds on the sale of the said pledged shares under Section 52 of the IBC read with Rule 21A of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016. The Supreme Court further clarified that the aforesaid direction would not be a ground for DVI to withdraw the resolution plan which has already been approved by the Appellate Authority as well as the Supreme Court. The Supreme Court further observed that the aforesaid recourse would be equivalent in monetary terms for Appellant No. 1 and would be a fair and just solution in the interest of justice.

Decision of the Supreme Court

In view of the above-mentioned findings, the Supreme Court partly modified the impugned judgment of the Appellate Authority, holding that Appellant No. 1 would be entitled to all rights and obligations as applicable to a secured creditor in terms of Sections 52 and 53 of the IBC and in accordance with the Pledge Agreement. Accordingly, the Supreme Court disposed of the present appeal without any order as to costs.

VA View:

By way of the present judgment, the Supreme Court has settled a highly pertinent question of law. As such, lenders to group company having security over assets of corporate debtor are left remediless since such lenders would neither be able to avail the benefit available to the financial creditors nor the benefit available to the operational creditors.

In order to address this peculiar situation as evident from the facts of the present case, the Supreme Court directed that such lenders will be entitled to retain the security interest in the asset created by the corporate debtor. By providing an out of the box solution, the Supreme Court has endeavored to strike a fine balance to secure the ends of justice and equity.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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