Secured Creditor - Distribution of funds during Liquidation process

Secured Creditor - Distribution of funds during Liquidation process 2020-09-24

Query; What are the options/rights of a secured creditor in distribution of funds during the liquidation process.
Let’s look into the various provisions of the Code & Regulations framed thereunder.
# Section 30. Submission of resolution plan.
(4) The committee of creditors may approve a resolution plan by a vote of not less than sixty-six per cent. of voting share of the financial creditors, after considering its feasibility and viability, the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor and such other requirements as may be specified by the Board:
# Section 36. Liquidation estate. -
(1) For the purposes of liquidation, the liquidator shall form an estate of the assets mentioned in sub-section (3), which will be called the liquidation estate in relation to the corporate debtor.
(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following: -
  • (g) any asset of the corporate debtor in respect of which a secured creditor has relinquished security interest;
# Section 52. Secured creditor in liquidation proceedings.
(8) The amount of insolvency resolution process costs, due from secured creditors who realise their security interests in the manner provided in this section, shall be deducted from the proceeds of any realisation by such secured creditors, and they shall transfer such amounts to the liquidator to be included in the liquidation estate.
(9) Where the proceeds of the realisation of the secured assets are not adequate to repay debts owed to the secured creditor, the unpaid debts of such secured creditor shall be paid by the liquidator in the manner specified in clause (e) of sub-section (1) of section 53.
# Section 53 Distribution of assets. -
(1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period as may be specified, namely: -
(a) the insolvency resolution process costs and the liquidation costs paid in full;
(b) the following debts which shall rank equally between and among the following:
  • (i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
  • (ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;
(e) the following dues shall rank equally between and among the following: -
  • (i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
  • (ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;
Regulation 21A. Presumption of security interest.
(2) Where a secured creditor proceeds to realise its security interest, it shall pay -
(a) as much towards the amount payable under clause (a) and sub-clause (i) of clause (b) of sub-section (1) of section 53, as it would have shared in case it had relinquished the security interest, to the liquidator within ninety days from the liquidation commencement date; and
Regulation 31. List of stakeholders.
(1) The liquidator shall prepare a list of stakeholders, category-wise, on the basis of proofs of claims submitted and accepted under these Regulations, with-
  • (a) the amounts of claim admitted, if applicable,
  • (b) the extent to which the debts or dues are secured or unsecured, if applicable,
  • (c) the details of the stakeholders, and
  • (d) the proofs admitted or rejected in part, and the proofs wholly rejected.
Regulation 32. Sale of Assets, etc.
The liquidator may sell-
  • (a) an asset on a standalone basis;
  • (b) the assets in a slump sale;
  • (c) a set of assets collectively;
  • (d) the assets in parcels;
  • (e) the corporate debtor as a going concern; or
  • (f) the business(s) of the corporate debtor as a going concern:
Provided that where an asset is subject to security interest, it shall not be sold under any of the clauses (a) to (f) unless the security interest therein has been relinquished to the liquidation estate.

A secured creditor has the following options;

1. Secured creditor can exercise his right to enforce his security interest as per the provisions of section 52, but will have to share the proceeds of realisation of security interest. On sharing of the security interest provisions of the Code & Liquidation Regulations are in variance as follows;
  1. Section 52(8) of the Code provides that the amount of insolvency resolution process costs, due from secured creditors who realise their security interests in the manner provided in this section, shall be deducted from the proceeds of any realisation by such secured creditors,
  2. Liquidation regulation 21A(2) provides that where a secured creditor proceeds to realise its security interest, it shall pay - (a) as much towards the amount payable under clause (a) and sub-clause (i) of clause (b) of sub-section (1) of section 53, as it would have shared in case it had relinquished the security interest.
Author’s comments; It’s quite illogical that, when a property, which is not part of Liquidation Estate [Section 36(3)(g)], i.e. where secured creditor has enforced his security interest, secured creditor be asked to share the proceeds of enforcement of security interest for liquidation cost & workmen dues.

Disadvantages under this option is that where the proceeds of the realisation of the secured assets are not adequate to repay debts owed to the secured creditor, the priority of such unpaid debts of such secured creditor is lowered [Section 52(9)] in the waterfall under Section 53(1)(e).

2. Secured creditor can relinquish his security interest to the liquidation estate and stand second highest priority under the liquidation waterfall [Section 53(1)(b)]. This priority is given to “debts owed to a secured creditor in the event such secured creditor has relinquished security interest in favour of the liquidator”. This does not specify whether such debts owed are limited only to the value of the secured portion of the creditors’ debt,

Advantages are that Code does not specify whether such secured debts are limited to the value of the secured portion of the creditor’s debt only. This fact assumes greater significance in light of the wording of section 30(4) of Code for distribution of funds during insolvency proceedings;
  • Section 30 (4). The committee of creditors may approve a resolution plan by a vote of not less than sixty-six per cent. of voting share of the financial creditors, after considering its feasibility and viability, the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor and such other requirements as may be specified by the Board:
There is a significant absence of the term “value of the security interest “ in Section 53 of the Code. Thus the legislative intent of the Parliament is very clear that the amount of secured credit under section 53(1)(b) will not be limited to the extent of the underlying value of the security interest.

Disadvantages under the option is that the value of security interest realized by the liquidator will be shared towards;
  1. Insolvency Resolution Process Cost.
  2. Liquidation cost.
  3. Workmen’s dues.
Apparently, the advantages under the second option are more significant, which may vary from case to case. Maybe this is to promote sale of CD as a going concern, to maximise the asset realization & relinquishment of security interest by the secured creditors is the precondition of sale of CD as a going concern.

# Regulation 32A. Sale as a going concern.
(1) Where the committee of creditors has recommended sale under clause (e) or (f) of regulation 32 or where the liquidator is of the opinion that sale under clause (e) or (f) of regulation 32 shall maximise the value of the corporate debtor, he shall endeavour to first sell under the said clauses.

Some important judgements;
i). NCLT Mumbai (08.04.2019) in SBI Global Factors Ltd. V/s. Sanaa Syntex Private Limited (MA 1123/2018 in CP No. 172/IBC/NCLT/MB/MAH/2017) held that a secured creditor is not required to share proceeds of realization of security interest with workmen:-
“# 5. On perusal of the prayers made in this application, three pertinent questions come up for consideration of this Bench:
i. Whether SBI, the Financial Creditor is legally entitled to stay out of liquidation?
ii. Whether there is any bar on the Secured Creditor to sell the assets to erstwhile promoters/directors of the Corporate Debtor, if the secured creditor opts out of liquidation ……….… Or …....... Whether S. 29A is applicable to liquidation proceedings in a situation when the Secured creditor realises the security interest on its own?
iii. Whether the Secured Creditor exercising his right U/s 52(1)(b) of the Code has to make payment of workmen’s dues out of the amount realised from the sale of such secured assets as the EPF/workmen’s dues, which do not form part of the liquidation estate?
  • # 11. Therefore, it is an undisputed assertion that the secured creditor’s rights have to be protected and respected. They must have the choice of taking their collateral and selling it on their own. Hence, the first question with respect to the secured creditor opting out of the liquidation estate, stands answered in the affirmative.
  • # 15. Hence, this prayer of the applicant/Liquidator, that the secured creditor availing its option U/s 52 of the Code should not sell the assets to the erstwhile promoters/directors, is hereby accepted. The answer to question No. (ii) is in affirmative.
  • # 17…..Although the applicant/Liquidator has placed reliance on the judgement dated 12.09.2018 in the matter of Precision Fasteners V. EPF, passed by NCLT Mumbai in MA 576&752 of 2018 in CP No.1339/2017, wherein it was held that “All sums due to any workman or employee from the provident fund, pension fund and gratuity fund, shall not be a part of the liquidation estate and shall not be used for recovery in liquidation”. But this decision is in context of the rights of the employees and not in the context of the restriction imposed U/s 53(1)(b)(ii). This judgement is therefore, not applicable in the present context because of a common understanding that the EPF dues are not being treated as the assets to be covered in the liquidation estate, however, the same are the liability of the Corporate Debtor which has to be paid by the liquidator as per S. 53 of the Code, and not by the secured creditor out of the proceeds from the sale of secured assets if exercised their option U/s 52(1)(b) of the Code. Hence, this prayer of the applicant is rejected on above findings. Question (iii) is answered in negative.”
ii). NCLT Allahabad (24.07.2018) in J.R. Agro Industries P Limited V/s. Swadisht Oils P Ltd. [CA 59 of 2018 in CP 13/ALD/2017] held as under:-
  • (Page 33/50) “Notably, distinction under section 53 is a two-fold distinction – (i) secured / unsecured, and (ii) operational/financial. As regards secured creditors, it does not matter whether the creditor is financial or operational, since section 53(1)(b) uses the expression “secured,” and there is no indication as to the nature of debt (financial/operational) owed to such secured creditor. However, when it comes to unsecured creditors, unsecured financial creditors appear in the 4th rank; but unsecured operational creditors come in the 6th rank.”
Here it will not be out place to mention that Board does not have mandate to frame regulations for the provisions of Section 52(8) as per section 240(2)(zh, zi, zj & zk) read with Section 3(32), Section 196(t) & Section 238. As such the Board is requested to drop the Regulation 21A(2) of Liquidation Regulations providing sharing of proceeds of realization of security interest for liquidation cost and workmen dues.

Similar is the situation with Regulation 31(1)(b) of Liquidation Regulations, which is in variance with the provisions of Section 53(1)(b).

Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog

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Arvind Mangla
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