Treatment of Auto Loan charge by Loan Financers under the Insolvency Code – By Adv. Gaurav Mitra and Adv. Lavanya Pathak

Treatment of Auto Loan charge by Loan Financers under the Insolvency Code

Authored by:
Gaurav Mitra, Advocate (LLM, Cambridge University, BCL, University of Oxford)
Lavanya Pathak, Associate (LLM, Cambridge University)

Pending consideration by the Supreme Court of India, the decision in the case of Volkswagen Finance Pvt. Ltd. v. Sree Balaji Printopack Pvt. Ltd. (2020) 302 NCLAT will have a colossal effect on the auto loan industry of the country. The matter, currently being heard by a bench headed by Justice DY Chandrachud, shall be determinative of the legal position regarding the admissibility of a ‘claim’ before the liquidator, based on a hypothecation ‘charge’ over a vehicle where the charge is registered with the Regional Transport Office (“RTO”) under VAHAN, in accordance with Section 51 of the Motor Vehicle Act, 1988. While the NCLAT has answered the said question in the negative, stating that registration with the Registrar of Companies (“RoC”) under Section 77(3) of the Companies Act is necessary, the authors are of the view that the same is neither a legal requirement nor does it bode harmoniously with the scheme of applicable laws.

While dealing with the question of whether a holder of hypothecation charge over a vehicle will be a secured creditor or not, the Hon’ble NCLT and NCLAT placed reliance on an array of judgments to state that the registration under Motor Vehicle Act shall not be considered under the IBC. The Tribunals held that Section 77 (3) of the Companies Act read with the provisions of IBC, leave no doubt that the charge is liable to be registered under with the RoC. The tribunal further followed the rationale in Oil and Natural Gas Corporation Ltd. V/s. Official Liquidator of Ambica Mills Co. Ltd. and Ors., (2015) 5 SCC 300 to hold that in the absence of a registered ‘charge’, the appellant cannot be treated as a secured financial creditor.

However, a conjoint reading of the applicable laws clearly concludes that the registration accordance with the Motor Vehicle Act is liable to be considered by the liquidator of a corporate debtor as a ‘proof of charge’ under the IBC.

Section 52(3) of the IBC pertains to the existence of security and states that security ‘may be’ proved either by the ‘Records provided by the Information Utility’ or by ‘other means specified by the Board’. The Board has exercised this power vide Regulation 21 of the Liquidation Process Regulations, 2016. Regulation 21 further provides 3 ways in which the security ‘may be proved’. This includes under Regulation 21(a), ‘records available with the information utility’ and under Regulation 21(b), the RoC under section 77(3) of the Companies Act, 2013. Regulation 21(c) clearly mentions another way i.e., Proof of registration with the CERSAI.

It is pertinent to note that the provision separates the conditions by the use of the word ‘or’, thereby indicating them as disjunctive conditions. This rule of interpretation has been made amply clear by the Supreme Court in Hyderabad Asbestos Cement Products and anr. v. Union of India, (2000) 1 SCC 426 and Kamta Prasad Aggarwal v. Executive Engineer, (1994) 4 SCC 440. Consequently, registration with the RoC is merely one of the ways for proving security charge.

Furthermore, Proof of registration with CERSAI, by implication covers the charges registered with the RTO under VAHAN i.e., the registration authority under the Motor Vehicle Act by the application of a Mandatory Notification dated 03.05.2019, issued by the Government of India under Section 20A(2) of the SARFEASI Act. Pursuant to the notification, all charges registered with VAHAN stand integrated with CERSAI. In this regard, a clarification letter dated 04.10.2019 was also issued by the RBI, wherein they clearly stated that the financial institutions are liable to register hypothecation charge over vehicle with VAHAN only and not CERSAI, as both stand integrated. Thus, these notifications leave no iota of doubt that a valid hypothecation charge holder registered under the Motor Vehicle Act shall be treated as a secured creditor under the IBC. For ease of understanding, the aforesaid analysis has been illustrated as under:

At this point, it is necessary to clarify that the NCLAT judgment failed to note the Mandatory Notification dated 03.05.2019 and the Letter issued by RBI dated 04.10.2019. As such, following the law laid down by the Supreme Court in State of U.P. and Anr. v. Synthetics and Chemicals Ltd., the judgment is per incuriam these applicable guidelines that were not brought to the notice of the court.

Moreover, it is also important to note that non-recognition of this right will have two profound effects. Firstly, on the attempts to reconcile the systems of registration and secondly, on the terms of credit for granting an auto loan.

The BLRC Report that forms the genesis of the IBC, while dealing with the question of accessibility of information about secured assets, emphasized the importance of leveraging the existing Information Systems. In this regard, they clearly specified that as it becomes more comprehensive, CERSAI can be “an important part of the IUs for swifter liquidation under the Code.” The report of the Working Group on Information Utilities by the Ministry of Corporate affairs also noted that:

Several statutes require submission of credit information to repositories. For instance, the Companies Act requires that any charge upon a company’s assets be disclosed to the central government. The Credit Information Companies (CICs) Act requires financial institutions to periodically submit information about their loans to all CICs. The SARFAESI Act requires banks to report immovable securities to CERSAI. The WG discussed that to the extent possible, additional burdens should not be placed upon creditors and debtors to submit information to yet another entity, in this case, an IU. Instead, IUs should be able to import information from (and when possible, export information to) such repositories, as long as such import or export does not violate any law.

Thus, the intent of the drafters has always been to avoid duplication of information and to leverage existing records for the proof of security. This is also synonymous with the intent of Section 20A of the SARFEASI Act, to have a central base integrating various registered records under the Companies Act and the Motor Vehicle Act. It is also necessary to have a broad interpretation of Regulation 21 because the same is likely to have an effect on the rights of many charge holders that are registered under different authorities according to various applicable laws.

Coming to the second point, the Supreme Court in landmark cases of the IBC, have time and again clarified that one of the major objectives of the IBC is promoting the availability of credit. As such, any interpretation of the Code must consider the impact on the health of the credit market. In the Committee of Creditors of Essar Steel v. Satish Kumar Gupta [2019] 07 SC, the court while arriving at the decision, took the following consideration:

It was noted that generally all secured financial creditors are prudent entities which grant loans after exercising due-diligence and are presumed to be able to evaluate their interest and risks sufficiently. Moreover it may negatively impact the credit market and discourage banks and other financial creditors from granting large project loans which are more often than not granted against property or other valuable collateral.

Thus, not recognizing security interest will lead to higher interest on future loans. The BLRC Report also highlights that:

3. It is important for the Code to retain a sense of fairness in how the solutions in Liquidation should preserve the rights of all creditors, so that they are incentivised to continue providing credit to other entities. Thus, solutions in Liquidations must be evaluated on the long-term incentives of both secured creditors and non-secured creditors.

Thus, considering the clarity of the legal position on the question of law and the surrounding practical considerations, the Supreme Court must recognize the holders of a validly registered charge under the Motor Vehicle Act as secured financial creditors under the IBC. Furthermore, seeing that such a charge can only be registered with VAHAN, non-recognition under IBC will frustrate the purpose of the hypothecation.

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