Conundrum on concept of Subordinate charge in CIRP under IBC – By Mr. Divyanshu Dubey

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Mr. Divyanshu Dubey, B.Sc LLB (Hons.) National Law University Jodhpur

Conundrum on concept of Subordinate charge in CIRP under IBC

 Introduction

One of the significant modes of raising finances under Project Financing is through creating a Subordinate Charge to the existing charge holder. The second charge thus created, exists as subordinate to first charge and can only be realised once the debt of first charge holder has been satisfied as per the established laws. Such practise of creating charge is seen in general as Inter-creditor Agreements, that takes place between first charge holder and second charge holder.

The concept of Subordinate Charge has been recognized under the scheme of existing laws namely, Section 48 of Transfer of Property Act, 1882 and Section 529A of Companies Act recognized the concept of subordinate charges and in various judgments, Hon’ble Apex Court has also upheld, that first charge holder must be given priority over second charge holder. Further, it may be prudent to include the concept of subordinate charge, as these are commercial decisions taken by Financial Institutions at the time of lending of money through Intercreditor Agreements.

Introduction of Insolvency & Bankruptcy Code, 2016 (IBC) has diminished the concept of Subordinate Charge as Form H and Section 53 of Insolvency & Bankruptcy Code (“IBC”) recognizes only secured creditors. It is pertinent to note here that even the second charge holder has been identified as a secured creditor under the aegis of IBC, thereby, diminishing the line between first charge holder and second charge holder. In line of such non-clarity over subordinate charges under IBC the amount, under Resolution Plan, is being distributed without considering subordinate charges.

In this brief article, we would be going through the introduction of concept of charge, jurisprudence evolved with respect to Subordinate Charge, and why such concept should be clarified by Insolvency and Bankruptcy Board of India (“IBBI”).

Concept of Subordinate charges under various laws in India

Under Companies Act, Charge has been defined as an interest or lien created on the property or assets of a company, or any of its undertakings, or both, as security and includes a mortgage. [1]As per Transfer of Property Act, 1882, Charge is created where any immovable property of one person, by act of parties or operation of law, is made security for the payment of money to another, such transaction does not amount to mortgage and by virtue of the same, a charge is created towards repayment of loan as security.[2]

Section 48 of Transfer of Property Act determines priority of rights created by transfer and has introduced concept of Subordinate Charge. As per the said section, where a person create some rights in immovable property and such rights cannot all exist or be exercised together, then each latter right created in absence of any special contract shall be subjected to rights previously created.[3] This section clarifies that the first right over the said property is of first created charge, and in absence of any special contract, would hold preference over the latter charge created over the same immovable property.

Jurisprudence evolved with respect to subordinate charges

In the case of ICICI Bank Limited v. Sidco Leathers Limited & Others[4], Hon’ble Apex Court, while interpreting Section 48 of Transfer of Property Act, 1882, has held that claim of first charge holder will prevail over second charge holder and in case where debts are due to both, first charge holder shall be given priority for repayment. Further, on the issue of inter se priority between two sets of Secured Creditors, it also held that while enacting a statute, Parliament cannot be presumed to have taken away a right in property as it is a Constitutional right and right to recover money by enforcing a mortgage is also a right to enforce an interest in the property. [5]

In the case of State of Andhra Pradesh v. Rajah Ram Janardhana Krishna,[6] it was held that Specific Charge, which is created first in time, will take precedence over the charge created subsequently.  Much later, in the case of Jitendra Nath Singh v. Official Liquidator & Ors,[7] Hon’ble Supreme Court while interpreting Section 529A of the Companies Act, 1956 held that rights of secured and unsecured creditors of the company in winding up proceedings shall be similar to that of estate of persons adjudged as insolvent.

However, some contrary judgments have also been passed under IBC regarding subordinate charges. In Stressed Assets Stablization fund v. Bijay Murmuria,[8] question was raised regarding approval of resolution plan wherein the mandate, as prescribed under Section 48 of Transfer of Property Act, was ignored and preference of First Charge over Second Charge was not taken into consideration. Hon’ble NCLAT in the said case did not conform to the views of Appellant and held that the said issue does not arise in facts & law and that Appellant was not able to prove its first charge over assets of Company.[9]  However, in the Said case Appellant was not able to prove its first charge, thereby failed to make any ground under IBC, the question to give benefit to him, as first charge holder, does not arise.[10] Further, in the case of IREDA v. Bhuvnesh Maheshwari,[11] issue of priority of charges between first charge holder, as regards to distribution of proceeds of Resolution plan, was raised by IREDA. However Learned Appellate Tribunal, without going into details of applicability of principles of Subordinate Charge, held that the judgment of Hon’ble Supreme Court in Essar Steel[12] has upheld the commercial wisdom of Committee of Creditors and by virtue of Section 238 of IBC, IBC has overriding effect over any other laws.    

 Why should this concept be clarified by IBBI

  • Right to property is a constitutional right and Parliament cannot be presumed to take away such right, [13] unless explicitly mentioned in the Statute. Further, right to recover money by enforcing a mortgage is also covered under the ambit of Right to Property.[14] There is no mention of concept of Subordinate Charge in IBC, therefore, the said Code cannot take away the rights of Financial Creditors of getting priority over second charge holders.
  • As per Section 30(2)(e) of IBC, a Resolution Professional has to examine the Resolution Plan and has to confirm that such plan does not contravene any provisions of law for the time being in force and the substantive law which deals with the secured assets is Transfer of Property Act, 1882. As in the abovementioned matter of ICICI Bank v. Sidco Leathers Limited,[15] Hon’ble Apex Court has already examined Section 48 of Transfer of Property Act and has held that claim of first charge holder will prevail over second charge holder. Therefore, it can be interpreted that not giving first charge holder priority over second charge holder, for the proceeds under Resolution Plan and Section 53 of IBC, contravenes the provisions of law. Thus, Resolution Plans should be properly examined by Resolution Professionals and should not be approved by Hon’ble NCLTs.

Conclusion

Banks/ Financial Institutions (FIs) provide financial assistance on the basis of appraisal of loan recovery and strength of security available with them. The practise of giving Working Capital loans or any additional loans to be procured by the Corporates, is usually done through Subordinate Charges. Further, investments are done by Corporates on the basis of Financial Assistance given by Bank/ FIs as these loans are necessary to run the business.

Conclusively, it would be correct to mention that, Banks/FIs would be reluctant to allow the Corporates to take further loans as necessary to run the business by ceding second charge, as they would be wary of their value of first charge being at par with second charge lender under IBC.

IBC is a mechanism devised to rehabilitate a Stressed Corporate. Thus, intention of law makers will be undone if First charge holder would be reluctant to rehabilitate by going under IBC and would explore other recovery forums. Therefore, it is the need of the hour that a clarification regarding the concept of Subordinate Charge be made by the Insolvency & Bankruptcy Board of India, so that Banks/FIs can come at informed decision while lending Financial Assistance to the Corporates, which in turn would help them in enforcing the securities for Recovery.

Reference

[1] Section 2 (16) of Companies Act 2013.

[2] Section 100 of Transfer of Property Act, 1882.

[3] Section 48 of Transfer of Property Act, 1882.

[4] 10 SCC 452 (2006).

[5] Id.

[6] 36 Comp Cas 950 (1966).

[7] 1 SCC 462 (2013).

[8] (2019) ibclaw.in 460 NCLAT

[9] Id.

[10] Id.

[11] Company Appeal (AT) No.971 of 2020.

[12]  [2019] ibclaw.in 07 SC

[13] Id.

[14]Id.

[15] Supra Note 4.

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