Supreme Court Clarifies Rights of Secured Creditors in Insolvency: Vistra ITCL vs. Dinkar Venkatasubramanian (2023)

Introduction

Date of the Judgment: May 4, 2023

Citation: (2023) INSC 428

Judges: M. R. Shah, J. and Sanjiv Khanna, J.

What happens to a company’s assets when it goes through insolvency? The Supreme Court of India recently addressed this question, specifically focusing on the rights of secured creditors who hold pledged shares. This judgment clarifies the position of these creditors under the Insolvency and Bankruptcy Code, 2016 (IBC). The court examined whether a secured creditor, who is not a financial or operational creditor, can still enforce their security interest during the corporate insolvency resolution process (CIRP).

Case Background

Amtek Auto Limited (Corporate Debtor) sought a short-term loan of INR 500 crores through its group companies, Brassco Engineers Ltd. and WLD Investments Pvt. Ltd. The understanding was that Amtek would provide a first-ranking exclusive security by pledging 16,82,06,100 equity shares of JMT Auto Ltd.

A Security Trustee Agreement was executed between Vistra ITCL (India) Ltd (Appellant no. 1) and WLD for INR 150 crores on December 28, 2015. Amtek’s board also passed resolutions to create security over the JMT Auto Ltd. shares. IDBI Bank issued a No Objection Certificate (NOC) stating that proceeds from the sale of assets could be used to settle dues under the Security Trustee Agreement up to INR 450 crores.

Further agreements were made, including an amended and reinstated pledge agreement on July 5, 2016, where Amtek pledged 66.77% of its shareholding in JMT Auto Limited to secure loans taken by WLD and Brassco from KKR and L&T. Subsequently, an application under Section 7 of the IBC was admitted against Amtek on July 24, 2017, and Mr. Dinkar T. Venkatasubramanian was appointed as the resolution professional.

Vistra ITCL filed a claim as a secured creditor for INR 500 crores on November 2, 2017, which was rejected by the Resolution Professional. This rejection was not challenged by Vistra. After some resolution plans failed, Vistra filed another application under Section 60(5) of the IBC, claiming rights based on the pledged shares. This application was dismissed by the Adjudicating Authority, which was upheld by the NCLAT.

Timeline

Legal Framework

The case revolves around the interpretation of key provisions of the Insolvency and Bankruptcy Code, 2016 (IBC), specifically:

• Section 3(31) of the IBC: Defines “security interest” as a right, title, or claim to property created to secure payment or performance of an obligation. It includes mortgages, charges, and pledges.
• Section 5(7) of the IBC: Defines “financial creditor” as a person to whom a financial debt is owed.
• Section 5(8) of the IBC: Defines “financial debt” as a debt along with interest, if any, which is disbursed against the consideration for the time value of money.
• Section 30(2) of the IBC: Lays down the requirements for a resolution plan, ensuring payment of insolvency resolution costs, operational creditor debts, and financial creditor debts. It also states that the plan should not contravene any law.
• Section 31 of the IBC: Mandates that the Adjudicating Authority should approve a resolution plan only if it meets the requirements of Section 30(2).
• Section 52 of the IBC: Deals with the rights of a secured creditor in liquidation proceedings, allowing them to relinquish their security interest or realize it.
• Section 53 of the IBC: Specifies the order of priority for distribution of assets in liquidation.

Arguments

Appellants’ Arguments:

• The appellants argued that their claim as a secured financial creditor was not belated, as it was a continuing cause of action. They contended that the Resolution Professional, CoC, Resolution Applicant, and Adjudicating Authority must consider the correct categorization of claimants.
• They submitted that there was a creditor-debtor relationship between them and Amtek, as the loans to WLD and Brassco were for the ultimate benefit of Amtek. They relied on board resolutions and NOCs from IDBI Bank to support this claim.
• The appellants argued that the pledge of shares constituted a financial debt under the IBC, as it was a security interest under Section 3(31).
• They distinguished the case from previous judgments like Anuj Jain and Phoenix ARC, arguing that those cases did not involve a direct benefit to the corporate debtor.

Respondents’ Arguments:

• The respondents argued that Vistra’s claim was rejected in 2017 and was never challenged. They contended that Vistra’s application in 2020 was belated and not a challenge to the rejection, but an attempt to gain admission into the CoC.
• They submitted that Vistra did not qualify as a financial creditor of Amtek, as there was only a third-party security given in the form of pledged shares. They relied on the judgments in Anuj Jain and Phoenix ARC.
• They argued that the pledge agreement was limited to the shares and did not promise to discharge the liability of the borrower.

Issues Framed by the Supreme Court

The Supreme Court considered the following issues:

1. Whether the lenders of Jaypee Associates Limited (JAL), the holding company of Jaypee Infratech Limited (JIL), the Corporate Debtor, hold the status of ‘financial creditors’ of JIL within the meaning of Section 5(7) of the Insolvency and Bankruptcy Code, 2016 read with the expression ‘financial debt’ as defined in Section 5(8) of the Code.
2. Whether the resolution plan can dilute, negate, or override the pledge agreement because a resolution plan to this effect has been approved by the CoC.

Treatment of the Issue by the Court

Authorities

The Supreme Court relied on the following authorities:

Judgment

How each authority was viewed by the Court?

• The Court followed the ratio laid down in Anuj Jain [ (2020) 8 SCC 401 ] and Phoenix ARC [ (2021) 2 SCC 799 ], holding that a person having only a security interest over the assets of the corporate debtor, even if falling within the description of “secured creditor” by virtue of collateral security extended by the corporate debtor, would not be covered by the definition of financial creditors as per Section 5(7) and 5(8) of the IBC.
• The Court relied on PTC India Financial Services Limited v. Venkateswarlu Kari and Another [(2022) 9 SCC 704] to explain the concept of ‘pledge’ under the Indian Contract Act, 1872.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the need to balance the rights of secured creditors with the objectives of the IBC. The court recognized that while Vistra ITCL was not a financial creditor, its security interest in the pledged shares could not be extinguished by the resolution plan. The court emphasized the importance of protecting the rights of secured creditors, even those who do not fall under the categories of financial or operational creditors.

Logical Reasoning

Key Takeaways

✓ A secured creditor holding pledged shares is not considered a financial creditor under the IBC.

✓ A resolution plan cannot extinguish the rights of a secured creditor.

✓ Secured creditors are entitled to retain their security interest and realize it as per Sections 52 and 53 of the IBC.

Directions

The Supreme Court directed that the successful resolution applicant, DVI, should treat Vistra ITCL as a secured creditor. Vistra would be entitled to retain the security interest in the pledged shares and receive proceeds from their sale, as per Sections 52 and 53 of the IBC.

Development of Law

The Supreme Court’s judgment clarifies that while a pledge of shares does not make one a financial creditor, it does not diminish the rights of a secured creditor. This decision ensures that secured creditors holding pledged assets are not left remediless in the CIRP. The ratio decidendi of the case is that a secured creditor, even if not a financial or operational creditor, is entitled to the rights and obligations as applicable to a secured creditor under Sections 52 and 53 of the IBC. There is no change in the previous position of law, however, it has been clarified that the rights of secured creditors cannot be overridden by a resolution plan.

Conclusion

The Supreme Court’s ruling in M/S VISTRA ITCL (INDIA) LTD & ORS. vs. MR. DINKAR VENKATASUBRAMANIAN & ANR. clarifies the rights of secured creditors holding pledged shares during insolvency proceedings. While such creditors are not classified as financial creditors, their security interests are protected, and they are entitled to realize their assets as per the IBC. This judgment ensures a balance between the objectives of the IBC and the rights of secured creditors.