Dissenting Secured Financial Creditors and Section 30(2) IBC: Unravelling the Challenges in Computation of Liquidation Value – By Hemang Mankar & Mohak Agarwal 

Dissenting Secured Financial Creditors and Section 30(2) IBC: Unravelling the Challenges in Computation of Liquidation Value

Hemang Mankar & Mohak Agarwal
Business Law (Hons.) Students at National Law University, Jodhpur


Secured creditors play a major role in the Indian Insolvency regime. The Bankruptcy Law Reforms Committee Report, 2015 [“BLRC Report”] recommended that secured creditors should have priority on realizations and the same was adopted under the Insolvency and Bankruptcy Code, 2016 [“the Code”]. Such high importance to secured creditors stems from the fact that the securities held by them form a significant part of the Corporate Insolvency Resolution Process [“CIRP”] as well as liquidation estate. If this priority is not vested in the secured creditor, it would seek to individually enforce the security, thus going against the idea of value-maximization, which forms a tenet of the Code.

In 2019, Section 30 of the Code was amended via the Insolvency & Bankruptcy (Amendment) Act 2019. There were two major changes:

  • Section 30(2) now required the Resolution Plan to provide at least an amount to the Dissenting Financial Creditors [“DFC”] “which shall not be less than the amount to be paid to such creditors in accordance with sub-section (1) of section 53 in the event of liquidation of the corporate debtor” [“liquidation value”].
  • Section 30(4) added a clause that the Resolution Plan must provide for “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”.

While there is no quarrel with the proposition that the use of the word ‘may’ in Section 30(4) makes the provision directory on the Committee of Creditors [“CoC”], Section 30(2) mandates the Resolution Plan to provide at least the liquidation value to the DFCs. There has been much litigation concerning the determination of this liquidation value. With this article, the author aims to analyse the approach of the Adjudicating Authority [“AA”] and the appellate forums in determining the minimum amount to be paid to the secured DFCs, the issues involved with their reasoning, and suggest an approach synchronous to the spirit of the Code.

India Resurgence Judgment: Jeopardization of Secured Creditors’ Rights?

In the case of India Resurgence ARC Private Limited v. Amit Metaliks Limited & Anr. (2021) ibclaw.in 87 SC [“India Resurgence case”], the appellant was a secured DFC who held security valued over INR 12 crores but was offered only a meagre value of INR 2.026 crores against his admitted claim of over INR 13.38 crores. While the Supreme Court rightly held that the manner of distribution as prescribed under Section 30(4) is merely a directory provision and the commercial wisdom of the CoC shall prevail, it failed to appreciate the mandatory provision of Section 30(2)(b) which required the Resolution plan to provide at least the amount the appellant would have received as per Section 53(1) in the event of liquidation.

The Court relied on Jaypee Kensington Boulevard Apartments Welfare Association and Ors. v. NBCC (India) Ltd. and Ors. (2021) ibclaw.in 63 SC, where the dispute was the manner of disbursement of the amount to the DFC, in an absurd fashion. In this case, the Supreme Court had held that the ‘entitlement’ of the DFC could be satisfied by either handing him over the quantum of money or allowing the recovery of money by enforcement of security interest. The Court upheld this stance and merely stated without any reason that the ‘entitlement’ of the appellant as per the Resolution Plan was INR 2.026 Crore, which was in similar proportion to what other secured creditors were supposed to receive and held it to be in compliance with Section 30(2).

The judgment fails on multiple counts. The Court failed to appreciate the fact that as per a plain reading of Section 30(2), it is required that the DFC must receive at least the liquidation value irrespective of what the other creditors are supposed to receive. Therefore, the ‘entitlement’ of the DFC is supposed to be the liquidation value and not the amount stipulated in the Resolution Plan. While the DFC is wholly entitled to claim similar treatment with respect to other similarly placed creditors in case it enables the DFC to secure an amount higher than the liquidation value, DFC cannot be compelled to settle for an amount lesser than the liquidation value just because the other Financial Creditors [“FCs”] have agreed to abide by the terms of the plan.        

Surprisingly enough, the Court even failed to fathom the liquidation value receivable by the DFC as per Section 53(1) of the Code had the Corporate Debtor [“CD”] gone into liquidation.

The judgment has, in effect, jeopardised the rights of a better-placed secured DFC, resulting in affirming a situation in which the other secured creditors could seek to benefit at the cost of the former’s security without the former even consenting to the plan. While this might seem like an attractive proposition to revive the Corporate Debtor, it has disastrous consequences both for the better-placed secured creditors as well as for the stakeholders located below secured creditors as we will see in the next section.

Asking the right question: How should the liquidation value be calculated?

Before delving into the manner followed by the AA and the appellate forums or the ideal method of calculation of liquidation value, it would be prudent to peruse the potential manner in which liquidation could take place as per Section 53 of the Code briefly. For the sake of understanding, the same could be divided into two scenarios: When the secured creditor has enforced his security interest as per Section 52 [A]; and when the secured creditor has relinquished security [B].

A. When the secured creditor has enforced his security interest as per Section 52

Case I

In such cases, the remaining debts post enforcement of security interest shall fall under Section 53(1)(e)(ii), pari passu with the dues to the government and below the debts owed to unsecured creditors.

In this case, liquidation value receivable under Section 53 = Liquidation value of the security + the amount receivable under Section 53(1)(e)(ii).

B. When the secured creditor has relinquished security

In such cases, there could be two possible scenarios, depending upon the interpretation of Section 53(1)(b)(ii) which provides for payments of ‘debts owed to secured creditor’ pari passu with workmen’s dues for twenty-four months preceding the liquidation commencement date and only below the CIRP and liquidation costs.

Case II

The entire debt of the secured creditor is considered under Section 53(1)(b)(ii) irrespective of the value of his security. To take an example, a secured creditor has an admitted claim of INR 200 crores and the value of his security is worth INR 5 crores. In this scenario, the secured creditor would be able to claim priority of payment over ‘employees other than workmen’ as well as the unsecured creditors for his entirety of debt, which is, INR 200 crores.

Here, the liquidation value = value receivable under Section 53(1)(b)(ii) for the entirety of the debt.

Case III

The creditor is considered to be secured only to the extent of the value of his security. For the rest of his dues, he shall be considered to be an unsecured creditor. Continuing the previous example, he shall fall under Section 53(1)(b)(ii) and claim priority over employees other than workmen and unsecured creditors but only to the extent of INR 5 crores, which is the value of his security. For his remaining debt of INR 195 crores, he shall be entitled to claim it as an unsecured creditor under Section 53(1)(d).  

Here, the liquidation value = value receivable for security under Section 53(1)(b)(ii) and value receivable for the rest of the debt under Section 53(1)(d).

Case II vs. Case III: Choosing a better option

Logically speaking, if CASE II is followed, it results in discrimination of (i)- better-placed secured creditors when compared to those whose value of security is negligible/minimal; (ii)- workmen; (iii)- employees other than workmen; and (iv)- unsecured creditors. This could be understood by taking another example:

Let’s say there are the following three secured FCs:

Name Debt (in crores) Security (in crores)
X 500 500
Y 500 10
Z 500 5

A total of INR 600 crores is left post-liquidation and post-payment of CIRP and liquidation costs. Assuming for the sake of simplicity that there are no workmen dues, if we follow CASE II, each of X, Y, and Z would gain an equal amount of INR 200 crores each. Neither the ‘employees other than workmen’ nor the unsecured FCs would get a single rupee. X would only get an amount of INR 200 crores despite having relinquished his security worth INR 500 crores into the liquidation estate. At the same time, when compared to unsecured creditors and a better-placed secured creditor (X), Y and Z seem to have unjustly benefitted. This is so because they were able to claim priority over the entirety of their debt of INR 500 crores for having a meagre security interest worth INR 10 crores and INR 5 crores respectively while the unsecured creditors received nothing.

If this approach is indeed followed, a better-placed secured creditor would never be willing to relinquish his security since he would seek to gain more by enforcing his security interests as per CASE I. This would result in a reduced value of liquidation estate and ultimately a reduced value post-liquidation.

This would also cast a burden on the unsecured FCs to vote in favour of the Resolution Plan, even if the same seems unviable, because of the inherently discriminatory manner of distribution if the CD is liquidated. 

On the other hand, if we consider CASE III, the distribution seems to be more just. Out of INR 600 crores, the secured creditors shall be paid as per the value of their security, and the remaining amount of INR 85 crores shall be distributed to the stakeholders ranking below in priority. Y and Z shall be entitled to claim their unsecured debt as an unsecured creditor under Section 53(1)(d). If followed, this method will encourage the secured creditors to relinquish their security and contribute to the liquidation estate, thus increasing the chances of getting a better value. Furthermore, it would also take into account the interests of the unsecured creditors, since the secured creditors would only be able to claim priority to the extent of their security.

Name Debt (in crores) Security (in crores) Amount paid (under Section 53(1)(b)(ii)
X 500 500 500
Y 500 10 10
Z 500 5 5

Y and Z shall be entitled to claim INR 490 and 495 crores respectively as an unsecured creditor under Section 53(1)(d).

Clearly, CASE III is a more logical and better manner of distribution of proceeds of liquidation. It also finds support in the Insolvency Law Committee Recommendations, 2020 [“ILC Report”], wherein the Committee opined that “this provision could not have been intended to provide secured creditors who relinquish their security interest, priority of repayment over their entire debt regardless of the extent of their security interest, as it would tantamount to respecting a right that has never existed. Further, if the “debts owed to a secured creditor” is not restricted to the extent of the security, there would be broad scope for misuse of the priority granted under Section 52(1)(b), as even creditors who are not secured to the full extent of their debt would rely on the mere fact of holding any form of security, to recover the entire amount of their unpaid dues in priority to all other stakeholders”. The Committee further opined that since the issue has been clarified, no further amendment is required in the Code. While this seems to clarify all the issues and grant priority towards payment of security interest if relinquished, and hence, a liquidation value close to and many a time even higher than that of the security interest, the AA and the Appellate courts have not accepted this proposition.

Computing liquidation value: No end for troubles in sight?

The AA and the appellate forums have, time and again, rejected the method of distribution stipulated under CASE III and gone on to embrace the method provided under CASE II. In the case of Jet Aircraft Maintenance Engineers Welfare Associate v. Aashish Chhawchharia, RP of Jet Airways (India) Ltd. & Ors. (2022) ibclaw.in 861 NCLAT, the National Company Law Appellate Tribunal [“NCLAT”] held that Section 53(1)(b)(ii) has to be given a plain and literal meaning. It concluded that interpreting Section 53(1)(b)(ii) to mean a distribution as per security interest would amount to adding the phrase ‘value of security interest of the secured creditors’ to the provision, which is impermissible. Furthermore, it held that the ILC Report could at best be a reason for making further amendment but could not be used to give a meaning other than the plain and literal meaning of the statute. The case was appealed against and is pending adjudication before the Supreme Court.

While arriving at this decision, NCLAT relied on the India Resurgence case where the court had rejected a distribution as per the value of security interest. This reliance is misplaced as the India Resurgence case dealt mainly with Section 30(4) and the manner of distribution in the Resolution Plan while the present case dealt with liquidation, an altogether different stage which commences once the CIRP fails.

The issue of distribution of proceeds as per Section 53(1) was taken up again in M/s. Dhankalash Distributors Pvt. Ltd. v Arena Superstructures Pvt. Ltd., the order for which was pronounced recently on 19 July, 2023. In this case, the National Company Law Tribunal [“NCLT”], Delhi sided with CASE I as the manner of distribution for computing liquidation value for the purposes of Section 30(2)(b). It held that the DFC would at best be entitled to the liquidation value commensurate with its security interest and could claim the unpaid amount under Section 53(1)(e)(ii), the priority for secured FCs who had enforced their security interest.

In arriving at this conclusion, the AA relied upon IDBI Bank Limited v. Jaypee Infratech Limited. (2019) ibclaw.in 47 NCLT. In this case, the NCLT Delhi held that the DFC has to be treated under Section 53(1)(b)(ii) of the Code but since no actual relinquishment has happened, he cannot sail in two boats and claim to be an unsecured creditor for his unpaid debts under Section 53(1)(d). The unpaid entitlement of the Secured FC shall only be considered in Section 53(1)(e)(ii).

Interestingly, this case created a hybrid between CASE I and CASE III and presumed relinquishment of security for secured claims and enforcement when it came to the remaining claims. This judgment has had the effect of causing further ambiguities about the acceptable method of computation of liquidation value.

The way forward

Looking at the way the AA and the appellate forums have approached the issue of computation of liquidation value, it could be fairly concluded that there is a great deal of perplexity in this regard. The implications of this perplexity are wide ranging on multiple stakeholders and are potent enough to affect the Indian economy as a whole. The implications are not only restricted to liquidation stage but also shed uncertainty in the CIRP stage owing to the deemed fiction of liquidation in Section 30(2). The present treatment of secured creditors is catastrophic for a large number of stakeholders and only seeks to unjustly benefit those secured creditors which carry marginal security. With this being said, it is imperative on the legislature to come up with an amendment along the lines of the ILC Report and provide for a distribution on the basis of security interest under Section 53(1)(b). Furthermore, it should also stipulate an appropriate and just method for the calculation of liquidation value for the purposes of Section 30(2) with an assumption of either relinquishment or enforcement. Lastly, the amendment should be brought after thorough deliberations in order to uphold the true spirit of the Code.  

[1] Authors can be reached at hemang.mankar@nlujodhpur.ac.in & mohak.agarwal@nlujodhpur.ac.in.



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