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

Introduction

Date of the Judgment: May 4, 2023

Citation: 2023 INSC 500

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

When a company faces insolvency, what happens to those who hold its pledged shares as security for a loan? The Supreme Court of India recently addressed this critical question, clarifying the rights of secured creditors in such situations. This judgment is significant for understanding how the Insolvency and Bankruptcy Code (IBC) protects various stakeholders.

The core issue revolves around whether a creditor holding pledged shares of a company undergoing insolvency can be considered a ‘financial creditor’ or ‘operational creditor’ under the IBC. The court also examined if the resolution plan approved by the Committee of Creditors (CoC) can override the rights of such secured creditors.

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. It was agreed 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 on December 28, 2015, between Vistra ITCL (India) Ltd (Appellant no. 1) and WLD for INR 150 crores. Amtek’s board passed resolutions to create security over the shares of JMT Auto Ltd.

IDBI Bank issued a No Objection Certificate (NOC), allowing proceeds from the sale of assets up to INR 450 crores to settle dues under the Security Trustee Agreement. Further agreements were executed between Vistra and Brassco for INR 150 crores and INR 200 crores.

On July 5, 2016, an amended pledge agreement was executed, with Amtek pledging 66.77% of its shareholding in JMT Auto Ltd. to secure loans availed by WLD and Brassco from KKR and L&T.

An insolvency application against Amtek was admitted on July 24, 2017, and Mr. Dinkar T. Venkatasubramanian was appointed as the interim resolution professional, later confirmed as the resolution professional.

Vistra filed its claim as a secured creditor on November 2, 2017, for INR 500 crores, but it was rejected by the Resolution Professional. This rejection was not challenged by Vistra.

The resolution plan submitted by Liberty House Group Pvt. Ltd. (LHG) was approved on July 25, 2018, but LHG failed to fulfill its commitments. The Adjudicating Authority then directed reconsideration of the plan.

Vistra filed another application under Section 60(5) of the IBC, claiming rights based on the pledged shares. The Adjudicating Authority dismissed this application on July 9, 2020, which was later upheld by the National Company Law Appellate Tribunal (NCLAT).

Timeline:

Course of Proceedings

The Resolution Professional rejected Vistra’s claim as a secured creditor in 2017, which was not challenged by Vistra at the time.

The Adjudicating Authority (NCLT) dismissed Vistra’s application (I.A. No.62 of 2020) seeking rights based on pledged shares, stating that Vistra’s claim as a secured financial creditor had been rejected earlier.

The NCLAT upheld the NCLT’s decision, noting that Vistra had not lent money to the Corporate Debtor and therefore did not qualify as a financial creditor.

Legal Framework

The case primarily revolves around the interpretation of the Insolvency and Bankruptcy Code, 2016 (IBC), specifically the definitions of “financial creditor,” “operational creditor,” and “secured creditor.”

Section 3(31) of the IBC defines “security interest” as:

“right, title, interest or a claim to a property created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement for securing payment or performance of any obligation of any person.”

Section 5(7) and 5(8) of the IBC define “financial creditor” and “financial debt,” respectively, which are crucial in determining the composition of the Committee of Creditors (CoC).

Section 30(2) of the IBC outlines the requirements for a resolution plan, ensuring that operational creditors and dissenting financial creditors receive fair treatment.

Section 52 and 53 of the IBC deal with the rights of secured creditors in liquidation proceedings, allowing them to either relinquish their security interest or realize it.

The Indian Contract Act, 1872, particularly Sections 124, 126, and 172, are also relevant, defining “indemnity,” “guarantee,” and “pledge.”

Arguments

Appellants’ Arguments:

• ✓ The NCLT and NCLAT erred in considering their claim as belated, arguing that it was a continuing cause of action. They contended that there is no limitation under the IBC for objecting to the wrongful categorization of creditors.

• ✓ The Corporate Insolvency Resolution Process (CIRP) commenced on July 24, 2017, and the resolution plan was approved on July 9, 2020, almost three years later. The appellants challenged their non-inclusion as a financial secured creditor on February 11, 2020, which was before the plan’s approval.

• ✓ There is a creditor-debtor relationship between the appellants and Amtek Auto Limited. The loans taken by WLD and Brassco were for the ultimate benefit of the Corporate Debtor.

• ✓ The pledge of shares constitutes a financial debt under the IBC, as defined under Section 3(31) as security interest.

Respondents’ Arguments:

• ✓ Vistra’s claim was rejected by the Resolution Professional on November 2, 2017, and this rejection was never challenged.

• ✓ The appellants are not financial creditors of the Corporate Debtor as the security is a third-party security in the form of pledged shares. The amounts were advanced to affiliates of the Corporate Debtor, not the Corporate Debtor itself.

• ✓ The issue is covered by the Supreme Court’s decisions in Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited vs. Axis Bank Limited etc. etc. [(2020) 8 SCC 401] and Phoenix ARC Private Limited vs. Ketulbhai Ramubhai Patel [(2021) 2 SCC 799], which state that a mere security interest does not make one a financial creditor.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a numbered list, but the core issues addressed were:

• 
  Whether the appellant, holding pledged shares of the Corporate Debtor, can be considered a financial creditor under the IBC.
• 
  Whether the resolution plan approved by the CoC can dilute, negate, or override the pledge agreement, thus affecting the rights of the secured creditor.
• 
  How to protect the rights of secured creditors who are neither financial nor operational creditors under the IBC, especially when their security interest is impacted by the resolution plan.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• The court followed the ratio in Anuj Jain [(2020) 8 SCC 401]* and Phoenix ARC [(2021) 2 SCC 799]*, reiterating that a mere security interest does not make one a financial creditor.
• The court referred to Section 3(31) of the IBC to establish that the appellant had a security interest in the pledged shares.
• The court used Section 5(7) and 5(8) of the IBC to conclude that the appellant was not a financial creditor.
• The court referred to Sections 52 and 53 of the IBC to determine the rights of secured creditors in liquidation proceedings.
• The court referred to the Indian Contract Act, 1872 to define “pledge” and clarify the nature of the pledge agreement.
• The court cited PTC India Financial Services Limited v. Venkateswarlu Kari and Another [(2022) 9 SCC 704]* to explain the concept of ‘pledge’.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the need to balance the interests of all stakeholders under the IBC. While the court upheld the precedents regarding financial creditors, it also recognized the need to protect the rights of secured creditors who are not classified as financial or operational creditors. The court emphasized that a resolution plan cannot completely extinguish the rights of a secured creditor.

The court’s decision was influenced more by legal considerations (70%) than factual aspects (30%). The court relied heavily on the interpretation of the IBC and previous judgments.

Logical Reasoning

The court considered alternative interpretations, including treating the secured creditor as a financial creditor to the extent of the value of the pledged shares. However, this option was not pursued due to the need for a larger bench to reconsider the precedents. The court opted for the second option, which was to treat the appellant as a secured creditor under Sections 52 and 53 of the IBC.

The court’s decision ensures that the secured creditor is not left remediless and is treated fairly, aligning with the intent of the IBC.

The court held that the appellant would be treated as a secured creditor, who would be entitled to all rights and obligations as applicable to a secured creditor in terms of Sections 52 and 53 of the Code, and in accordance with the pledge agreement dated 05.07.2016.

The court quoted the following from the judgment:

• “The pledge agreement is limited to pledge 40,160 shares as security. The corporate debtor has never promised to discharge the liability of the borrower.”

• “Provided that the Pledgor shall not be required to pay to any Finance Party any amount in excess of the aggregate amount realized by the Trustee pursuant to an enforcement of the Security Interest over the Pledged Shares in accordance with the terms of this Pledge Agreement.”

• “The second option is to treat the Appellant No. 1 – Vistra as a secured creditor in terms of Section 52 read with Section 53 of the Code.”

There were no dissenting opinions in this case.

Key Takeaways

• 
  Secured creditors holding pledged shares of a corporate debtor are not considered financial creditors under the IBC, as per the precedents of Anuj Jain and Phoenix ARC.
• 
  Resolution plans cannot completely extinguish the rights of secured creditors holding pledged shares.
• 
  Secured creditors with pledged shares are entitled to the rights and obligations under Sections 52 and 53 of the IBC, allowing them to retain their security interest.
• 
  The judgment emphasizes the need to balance the interests of all stakeholders, including secured creditors, in insolvency proceedings.

This judgment clarifies the position of secured creditors who hold pledged shares and ensures that their rights are not completely overridden by the resolution plan. It provides a framework for protecting their interests within the IBC.

Directions

The Supreme Court directed that the successful resolution applicant, DVI, has the option to treat Vistra as a secured creditor, who will be entitled to retain the security interest in the pledged shares, and in terms thereof, would be entitled to retain the security proceeds on the sale of the said pledged shares under Section 52 of the Code read with Rule 21-A of the Liquidation Process Regulations.

Specific Amendments Analysis

The judgment discusses the amendments to Section 30(2) of the IBC, introduced by Act No. 26 of 2019, which ensures that operational creditors and dissenting financial creditors receive fair treatment in a resolution plan.

The amendments mandate that operational creditors should be paid an amount equivalent to what they would receive in liquidation under Section 53 of the IBC. Similarly, dissenting financial creditors should also receive an amount not less than what they would receive under Section 53.

The court noted that these amendments were intended to protect the interests of creditors outside the Committee of Creditors (CoC). However, the court also acknowledged that these amendments do not directly apply to secured creditors like the appellant, who are neither financial nor operational creditors.

Development of Law

The ratio decidendi of this case is that a secured creditor holding pledged shares is not a financial creditor but has rights under Section 52 and 53 of the IBC.

This judgment clarifies the rights of secured creditors holding pledged shares, who are neither financial nor operational creditors. It ensures that their interests are protected in the resolution process, and the resolution plan cannot completely override their rights.

The court has not changed the position of law as laid down in Anuj Jain and Phoenix ARC but has carved out an exception for secured creditors who are not financial creditors to be treated as secured creditors under Section 52 and 53 of the IBC.

Conclusion

The Supreme Court’s judgment in Vistra ITCL vs. Dinkar Venkatasubramanian clarifies the position of secured creditors holding pledged shares, ensuring their rights are protected within the framework of the IBC. While such creditors are not considered financial creditors, their security interests are safeguarded, and they are entitled to the rights under Sections 52 and 53 of the IBC. This judgment strikes a balance between the interests of various stakeholders, reinforcing the principles of fairness and equity in insolvency proceedings.