Outstretching section 29A to realisations by secured creditors: Will it work?

-Sikha Bansal (resolution@vinodkothari.com)

Freedom is not worth having if it does not include the freedom to make mistakes.

                                                                                                                                                                    Mahatma Gandhi

If one collates all the discussion going on around section 29A of the Insolvency and Bankruptcy Code, 2016 (‘Code’), the concept has been outstretched so far that the idea of Mahatma, at least when applied to entrepreneurial traits, seems to be a distant dream.

In a recent ruling, State Bank of India v. Anuj Bajpai (Liquidator)[1], Hon’ble National Company Law Appellate Tribunal (‘NCLAT’) held that a secured creditor realising assets outside of liquidation under the Code cannot sell the assets to persons ineligible under section 29A.

As understood, the rationale quoted was – (i) public interest such that ineligible persons remain ousted from the management or ownership of assets, (ii) possibility of a ‘cartel’ between defaulters and financial creditors, which can defeat the objective of maximization of value of assets.

​With this ruling, section 29A has assumed the role of an impregnable fort, and applies to all scenarios – resolution, liquidation, going concern sale in liquidation, schemes of arrangement in liquidation, and now even to sale by secured creditors outside liquidation.

With all humility and due respect to the decision of the Appellate Authority, it is opined that the conclusion arrived might not be entirely in consonance with the law, whether the Code or otherwise. The perspective is for the reasons as discussed below.

Rights of secured creditors under the Code

The ruling seems to indicate that a secured creditor needs to have the permission of the liquidator under section 52; and that the liquidator can impose conditions on the secured creditor other than those imposed by law.

However, the terms of section 52 are unequivocal, as there is clearly a right vested in the secured creditor to choose between realization and relinquishment. Of course, the decision has to be taken within a time frame. The section uses words like “may”, “inform the liquidator”, etc. – only pre-condition is that the secured creditor can be ‘permitted’ by the liquidator to realize only such security interest, the existence of which is proven by the secured creditor.

The conventional right given to the secured creditor is attributed to the fundamental principle of respecting commercial bargains even during insolvency proceedings. A secured creditor can stand outside winding up and enforce his security[2]. It is an established rule that such rights should not be tampered with, except where there are higher societal considerations (for instance, cutting out a portion of such realisations for workmen).

Therefore, as per section 52, the secured creditor may enforce, realize, settle, compromise or deal with the secured assets in accordance with such law as applicable to the security interest being realized and to the secured creditor. The ruling, at one place, even while referring to the above, mentions:

“In terms of ‘I&B Code’ the secured assets and the interest of the secured creditor to recover the proceeds of debts due to it has not been specifically prescribed, it does not make that the procedure prescribed under the ‘SARFAESI Act, 2002’ will be applicable to secured creditor to sale the proceeds.”

The observation seems to be counter-intuitive, as the Code itself entitles the secured creditor to apply the proceeds of sale to recover the debt due to it, and the creditor shall be guided by the law applicable to the security interest – more often than not, the law applicable would be SARFAESI Act, 2002.

There is nothing in the Code or the SARFAESI Act or even any other law, which specifies who cannot be a buyer, when a secured creditor realizes security. Making any such stipulation puts a fetter on the commercial rights of the secured creditor, to such extent that, effectively, there remains no distinction between realization and relinquishment.

Collective vs. individual action

Understandably, proceedings under the Code are collective proceedings, as assets form a part of the common pool, wherefrom creditors are paid in accordance with their priority in the waterfall. Even a scheme of arrangement is a collective remedy. The core idea is to revive the business and/or maximize the value with the hope that the going concern/slump value would be more than the value of scattered assets.  Ousting erstwhile management will ensure that the business/assets do not go into the same hands, which could not act (or say, produce results) in the best interests of the collective body of creditors.

However, enforcement action by secured creditors is either individual or at the most, a class remedy. The secured creditor seeks to settle its dues by realizing the security interest. Fairly enough, the secured creditor remains accountable for any surplus arising out of realization; however, it has first claim on the secured asset which it created by contract prior to the debtor going into insolvency. While possibility of a secured creditor forming a cartel with the erstwhile management cannot be ruled out; yet putting a blanket ban arises out of a conclusive presumption, which may or may not exist.

Overdoing section 29A and the other side of the coin

The introduction of section 29A was to strengthen the insolvency resolution process such that certain persons are prohibited from submitting resolution plans who, on account of their antecedents, may adversely impact the credibility of the processes under the Code.

Although the Apex Court has already upheld the validity of the provision, irrespective of whether the default was an act of malfeasance not; the lawmakers as well as the judiciary might need to relook the entire scenario from a different perspective. Even the Bankruptcy Law Review Committee took note of the fact that “some business plans will always go wrong”, and “above all, bankruptcy law must give honest debtors a second chance, and penalize those who act with mala fide intentions in default”.

This is apart from the fact that the edifice of corporate existence is separateness of identities – failure of a business does not necessarily mean that the management is not capable of undertaking any business activity or the manager, even in his individual capacity, should be disqualified to buy the asset.  If a person’s venture of selling homes did not go well, that does not mean he should be disqualified to buy a home.

Disregarding this separateness and applying section 29A universally will have a two-way distress –

(i) it adds to the element of uncertainty to debtor-creditor agreements, as in at the time of entering into the lending arrangement, the secured creditor has to take into account the fact that several classes of persons would be disqualified to buy assets on which it is relying – this might affect credit affordability for corporates, and rather become counter-productive to the objective of the Code (promoting availability of credit);  and

(ii) it reduces the risk-appetite of the entrepreneurs, and the entrepreneurs will be incapacitated to acquire assets even in their personal capacities.

Also, as the rights of the secured creditors would be curbed; the Code might not remain a preference for such creditors. The same applies to corporate debtors – provisions for self-filing will become redundant as the shareholders and the management would apprehend being ousted now and forever, even when the default is genuine and is not a result of mala fide acts.

Hence, probably, what we need is a balanced interpretation and implementation of section 29A, failing which it might be difficult to adhere to the objectives of the Code.

[Note: The views are personal to the author and do not necessarily represent the views of the organization.]

[1] Company Appeal (AT) (Insolvency) No. 509 of 2019; Order dated 18.11.2019

[2] See Allahabad Bank v. Canara Bank, [2004] 4 SCC 406, wherein the Supreme Court extensively discussed the rights of secured creditors vis-à-vis winding up proceedings.