Continuing from the previous column discussion, we will proceed with analysing the issue from various perspectives, while tracing the position of law existing prior to the enactment of the IB Code.
A. Jurisprudence on status of creditors during liquidation prior to the IB Code
The distinction of statutory charge vis-à-vis a contractual charge does not seem to be a part of the previous liquidation process under the Companies Act, 1956. In K. Saradambal v. Jagannathan and Bros.,1 the corporate debtor had entrusted two machineries belonging to it to the creditor for carrying out certain repairs. The creditor, while carried out repairs by supplying certain spare parts, stood unpaid by the debtor. Subsequently, the debtor went into liquidation and the liquidator rejected the claim of the creditor on the ground that the charge was not registered in terms of Section 125 of the Companies Act, 1956. The creditor, in turn, specifically contended that it is entitled to a statutory lien on the machineries and is a secured creditor, and that appropriate directions should be given for the sale of the machineries for adjustment of the amount due to it and for deposit of the remaining balance.
Now a specific issue arose when the creditor claimed two sorts of rights, namely, (i) a lien in the capacity of being an unpaid vendor of the spare parts supplied for carrying out the repairs to the machinery. The same fell in the ambit of Section 462 of the Sale of Goods Act; and (ii) a lien in the capacity of repair charges. The same was claimed in the nature of “bailment” as defined under Section 148 of the Contract Act, 1872 and in terms of Section 1703 of the Contract Act, 1872, which pertains to the right of retention of the bailee on the goods over which it has provided service, till the bailee is paid.
Both the facts were not disputed, namely, that the creditor had sold spare parts and had made use of those spare parts in carrying out the repairs of the machinery as well as it had carried out repairs.
The major thrust of the liquidator was on the fact that the charge was not registered.
The High Court here opined that the provision of Section 125 of the Companies Act, 1956 required registration of only that charge which is created by a company and not to a charge arising by operation of law.4 The court, therefore, held that the fact that the lien claimed by the creditor is not registered would not disentitle it seeking its claim arising under the statutory lien.
Then, referring to Section 529 of the Companies Act, 1956, the High Court held that the holder of a statutory lien could stake claim of a secured creditor during the winding-up proceedings against insolvency corporate debtors. The court referred to the definition of “secured creditor” under Section 2(e) of the Provincial Insolvency Act, 1920 that defined a secured creditor as “a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor.”
Based on the same, the High Court concluded that Section 529 of the Companies Act, 1956 read with the relevant provisions of the insolvency law, the holder of a statutory lien or the holder of a lien created by contract and registered as required by Section 125 is a secured creditor in the matter of winding up of the insolvent company.
This position is to be contrasted with what Bharat Heavy Electricals Ltd. v. Anil Goel (BHEL – NCLT)5 did. The NCLT on a study of the terms “security interest”, “secured creditor” interpreted that there is a requirement of “creation” and on how these provisions seem to stipulate a specific mechanism with regards to what a security interest is and how such security interest can be created and/or provided for by the parties. It is crucial to understand that Section 3(31) defines a security interest in the following manner:
“security interest” means right, title or interest or a claim to 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 securing payment or performance of any obligation of any person.6
The definition while contains a definitive first part, also contains an “inclusive” definition in its second part when it stipulates that a security interest could include a “charge” and “any obligation of any person”. A statutory right certainly helps in securing performance of the obligation on the debtor.
Furthermore, Section 3(4) of the IB Code defines a charge as “an interest or lien created on the property or assets of any person or any of its undertakings or both, as the case may be, as security and includes a mortgage”.The same is much similar to the definition of a “secured creditor” as defined under Section 2(e) of the Provincial Insolvency Act, 1920 meaning “a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor”. The definition of “charge” under the IB Code is similar to the definition of the term “charge” as contained in the Companies Act, 20137.
The emphasis laid down by the NCLT on “creation” still does not answer why a statutory creation is not a creation of a legitimate right.
The legal jurisprudence on property law even goes so far to hold that on certain occasions, a statutory charge such as the charge held by a buyer under Section 55(6)(b) of the Transfer of Property Act, 1882 inherently contains a deeming provision where the notice of such charge is presumed even on any subsequent purchaser. In Abdul Hamid Khan,8 it was held that the charge under Section 55(6)(b)9 of the Transfer of Property Act for the prepaid purchase money comes into existence the moment the buyer pays part of the purchase money towards the sale transaction and that the same is available not only against the seller but also against the purchaser from the seller, irrespective of the question whether the said purchaser had or had not noticed a charge.
Such is the privilege leveled to a statutory charge as against a contractual charge.
The previous position of law, prior to the IB Code, in the Companies Act, 1956 also offers a crucial insight into the issue.There again no such issue of contractual security interest vis-à-vis a statutory interest seems to be relevant. Rather, the court applied the statutory provisions of the Transfer of Property Act to decide who enjoyed the priority of claim. At the most, the discussion has been on whether inter-creditor agreements stand diluted considering the distribution arrangement suggested for the liquidation process under the Companies Act.
In ICICI Bank Ltd. v. SIDCO Leathers Ltd.,10the Supreme Court was dealing with the issue of inter se dispute between secured creditors and interpretation of Sections 529 and 529-A of the Companies Act, 1956 became the focal point. Admittedly, the respondent before the Supreme Court, namely, the Punjab National Bank held a second charge over the mortgaged asset, whereas the appellant had the first charge. However, issue arose regarding Section 529-A of the Companies Act, which the respondent PNB Bank argued to contain a non obstante clause, wherein no distinction has been made with regards to the priority over the claim amongst the secured creditors inter se. In other words, the respondent contended that the appellant could not claim a priority over the claim of the respondent.
The Supreme Court referred to Section 48 of the Transfer of Property Act, 1882 to opine that the rights of the first charge holder prevail over the interests of the second charge holder. The court then added that such a crucial right has to be understood to be in the knowledge of Parliament, when it enacted Section 529-A of the Companies Act, 1956. In other words, the court opined that while enacting the Companies Act, the Parliament could not be held to have intended to deprive the first charge holder of the said right.
With respect to the IB Code, the Insolvency Law Committee in its report dated March 2018 undertook a similar discussion. The Insolvency Law Committee was constituted by the Ministry of Corporate Affairs to conduct a detailed review of the Insolvency and Bankruptcy Code, 2016 in consultation with key stakeholders. Many of the recommendations were subsequently adopted by the legislature by way of amending the IB Code.11 Therefore, the views of the Committee on the issue of differential treatment on account of subordination agreements within the liquidation process under the IB Code is relevant.
Here, again no such issue seemed to arise on the contractual vis-à-vis statutory interest. The query before the Committee was raised that Section 53(1)(b)(ii) of the IB Code may be subjective to varied interpretation where inter-creditor or subordination agreements would lose meaning, once a creditor relinquished its security and came within the liquidation waterfall in Section 53. The aforesaid provision stipulates:
the following debts which shall rank equally between and among the following:
(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in Section 52;
The Committee herein reiterated that statutory provisions of Section 48 of the Transfer of Property Act, 1882 do not stand obliterated on account of the ranking provided for under Section 53(1)(b) of the IB Code.12
It is submitted that while the statutory rights regulated by the Transfer of Property Act, 1882 are intact, there seems to be unease with the insistence on contractual creation of security interests and the consequent overriding and exclusion of all statutory charges.
It is essential to note here that while the Sidco Leathers13 and the Report of the Insolvency Law Committee opine that the statutory provisions of Section 48 are applicable in liquidation under the Special Act of Companies Act and IB Code respectively, the same is done on account of the special provision in the general act of the Transfer of Property Act, 1881. On the other hand, in BHEL – NCLT14, the NCLT had directly held that the IB Code overrides the provisions of the Transfer of Property Act in defining the term “security interest”. As discussed, the NCLAT in Bharat Heavy Electricals Ltd. v. Anil Goel (BHEL – NCLAT)15 refrained from holding that any such conflict exists between the IB Code and the Transfer of Property Act or Sale of Goods Act, while upholding the ruling of the NCLT in BHEL – NCLT16 , adding that only a security interest which is “created” as such, is the valid security interest.
B. Inconsistency in judicial discourse vis-à-vis non-registration of a contractual charge
If the decision of the NCLAT in BHEL – NCLAT17 is to be taken into consideration, then an additional issue arises. If a contractual charge is sufficient to cloth a creditor with the status of a secured creditor, then whether non-registration of such a contractual charge should be a valid reason to exclude a creditor from the category of secured debt.
As noted earlier, Section 52(2) of the IB Code provides that in the event of the secured creditor choosing to realise the security interest, it shall inform the liquidator of such security interest and identify the asset subject to such security interest to be realised. It is the duty of the liquidator to verify such security interest and permit the secured creditor to realise only such security interest the existence of which is proved in the prescribed manner.18
Section 52(3) of the IB Code provides that the liquidator shall verify such security interest and permit the secured creditor to realise only such security interest, the existence of which may be proved either:
(a) by the records of such security interest maintained by an information utility; or
(b) by such other means as may be specified by the Board.
The provision was a subject-matter of discussion in Volkswagen Finance (P) Ltd. v. Shree Balaji Printopack (P) Ltd.,19 where the appellant car financier of the corporate debtor claimed that it should be treated as a secured creditor, since it held a charge by way of hypothecation, entered in the registration certificate under the terms of Section 51 of the Motor Vehicles Act, 1988. The liquidator rejected this contention on the ground that the claim of the car financier was not registered under Section 77 of the Companies Act, 2013 and the car financier was unable to furnish proof in terms of Regulation 21 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (Liquidation Regulations). The NCLAT held that the liquidator rightly rejected the claim as Regulation 21 of Liquidation Regulations was not complied with.
Regulation 21 of the Liquidation Regulations stipulate that the existence of a security interest may be proved by a secured creditor based on:
(a) the records available in an information utility, if any;
(b) certificate of registration of charge issued by the Registrar of Companies; or
(c) proof of registration of charge with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.
Noting that neither the charge was registered with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI), nor with the Registrar of Companies (RoC) or the information utility (IU), the NCLAT rejected the claim. As a result, it was held that the appellant could not be termed as secured creditor.
However, the appeal is currently pending before the Supreme Court.20
It must be noted here that the word used is “may” in Regulation 21 of the Liquidation Regulations and the same was also a subject of discussion in BHEL – NCLT21 decision. While the NCLT specifically adjudicated this issue, the NCLAT ruling is silent on the same.
The NCLT therein had opined that the provision under Regulation 21 is directory and discretionary, since the same pertains to only providing for various modes of proving a security interest. The NCLT reasoned that a claimant could also rely on other modes (not mentioned in Regulation 21) to prove its security interest. It, however, added that the stage of proving a security interest could only arise once the status of the creditor is already ascertained to be one that of a secured creditor. The NCLT noted that while the definition of a “charge” is same in both the Companies Act, 2013 as well as the IB Code, however, unlike Section 77 of the Companies Act, 2013, there is no compulsion under the IB Code requiring mandatory registration. The NCLT had specifically rejected the argument of the liquidator wherein it was pleaded that unless a charge is registered under Section 77 of the Companies Act, 2013, the liquidator will not entertain such a claim into consideration. The NCLT held that the IB Code attains precedence over the Companies Act, 2013 and even if a charge could be proved by other modes (other than certificate of registration of charge issued by the Registrar of Companies), the liquidator could still adjudicate on the issue of security interest.
However, the NCLAT in Indiabulls Housing Finance Ltd. v. Samir Kumar Bhattacharya22 had also declined the claim of a creditor to be a secured creditor on account of the contractual charge being not registered in terms of Section 7723 of the Companies Act, 2013. The appellant staked claim on account of having given loan to the corporate debtor sometime in 2012 and against which received the title deed of premises belonging to the corporate debtor and thereby creating a right of an equitable mortgage.
Section 77(1) speaks of the duty on the company on which the charge is created to get the same registered with the Registrar of Companies (RoC). Section 77(2) entails that a copy of the registered charge will be given to the person in whose favour the charge is created. 77(3) stipulates that the liquidator or any creditor shall consider no charge, if the same is not registered. Section 125 of the Companies Act, 1956 also stipulated that a charge will be void against a liquidator and any creditor of the company, unless registered in terms of the Act.
Since there was no charge registered in terms of the Companies Act, 2013, the NCLAT held that the creditor could not claim to be a secured creditor. Furthermore, the NCLAT held that since the charge was registered post the approval of a resolution plan, the same would not allow the appellant creditor to stake claim of being a secured creditor.24
Therefore, while the NCLAT in other cases insists on the registration of a charge, the same sits in contrast with its approval of the reasoning in BHEL – NCLT25 which only requires that a charge be “created” consciously and/or explicitly by the parties.
The law postulated under the IB Code has received overwhelming support from every corner of the legal ecosystem. The legislature and the courts have worked in tandem in ironing out several of the issues that crop up during the implementation of the framework laid down under the IB Code. The judicial interpretation has been generally on those issues where any gap is witnessed in the provisions of the IB Code. For instance, in Innoventive Industries Ltd. v. ICICI Bank,26the National Company Law Tribunal emphasised the need for the compliance of the principles of natural justice and issuance of notice by the NCLT to the corporate debtor before admitting any application for insolvency against it. The ruling in BHEL – NCLT27, however, constitutes a major re-reading of the statutory provision. It is even more startling that the NCLAT in BHEL – NCLAT28 reiterated the findings of the NCLT but without upholding the premise over which the decision of the NCLT was based upon in interpretation. A secured creditor, if could only claim a security interest, if the same is contractually or consciously created, then the statutory mandate of Transfer of Property Act, 1882 and Sale of Goods (amendment) Act, 1963 are rendered nugatory and otiose. This becomes even more astonishing when the NCLAT itself in several other cases such as Indiabulls Housing Finance29, Volkswagen Finance30 (as discussed earlier) has consistently held that a contractual charge, if not statutorily registered, would not constitute a valid security interest for the purposes of Sections 52 and 53 of the IB Code. Certainly, the issue requires a more in-depth analysis from the Supreme Court and the National Company Law Appellate Tribunal, as the present understanding on this issue may result in an intended creation of conflict between two statutory laws, one in which only a creditor holding a security interest stands to lose.
† Advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is also a visiting faculty at the National Law University, Mumbai and NUJS Kolkata and the author of the commentary Insolvency and Bankruptcy Code — Law and Practice.
“Unpaid seller’s rights. — (1) Subject to the provisions of this Act and of any law for the time being in force, notwithstanding that the property in the goods may have passed to the buyer, the unpaid seller of goods, as such, has by implication of law—
(a) a lien on the goods for the price while he is in possession of them;
(b) in case of the insolvency of the buyer a right of stopping the goods in transit after he has parted with the possession of them;
(c) a right of resale as limited by this Act.
(2) Where the property in goods has not passed to the buyer, the unpaid seller has, in addition to his other remedies, a right of withholding delivery similar to and co-extensive with his rights of lien and stoppage in transit where the property has passed to the buyer.”
“170. Bailee’s particular lien.—
Where the bailee has, in accordance with the purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the goods bailed, he has, in the absence of a contract to the contrary, a right to retain such goods until he receives due remuneration for the services, he has rendered in respect of them.”
4. The High Court here in K. Saradambal, 1971 SCC OnLine Mad 273 : (1972) 42 Comp Cas 359 noted the ruling in Oudh High Court in Hukmichand v. Pioneer Mills Ltd., 1926 SCC OnLine Oudh CC 66 where it was held that S. 109 of the Companies Act, 1913 was applicable only to a charge created by the company by contract and not to a charge arising by operation of law. The same principle was applied in the context of S. 125 of the Companies Act, 1956, by the High Court.
6. IB Code, S. 3(31). (emphasis added)
8. Abdul Hamid Khan Mubin Khan v. Mohd. Ali Humayun, 1951 SCC OnLine Bom 20. See C.M.V. Krishnamachari v. M.D. Dhanalakshmi Ammal, 1965 SCC OnLine Mad 95 referring to the ruling in Abdul Hamid Khan case.
“55. Rights and liabilities of buyer and seller. —
In the absence of a contract to the contrary, the buyer and the seller of immoveable property respectively are subject to the liabilities, and have the rights mentioned in the rules next following, or such of them as are applicable to the property sold:
(1) – (5) …
(6) The buyer is entitled –
(a) where the ownership of the property has passed to him, to the benefit of any improvement in, or increase in value of, the property, and to the rents and profits thereof;
(b) unless he has improperly declined to accept delivery of the property, to a charge on the property, as against the seller and all persons claiming under him, to the extent of the seller’s interest in the property, for the amount of any purchase-money properly paid by the buyer in anticipation of the delivery and for interest on such amount; and, when he properly declines to accept the delivery, also for the earnest (if any) and for the costs (if any) awarded to him of a suit to compel specific performance of the contract or to obtain a decree for its rescission. An omission to make such disclosures as are mentioned in this section, para (1), clause (a), and para (5), clause (a), is fraudulent.”
11. For instance, see amendments to Ss. 8, 9, 10, 12 amongst several others by the legislature by way of Act No. 26 of 2018, (w.e.f. 6-6-2018).
“77. Duty to register charges, etc.—
(1) It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India, to register the particulars of the charge signed by the company and the charge-holder together with the instruments, if any, creating such charge in such form, on payment of such fees and in such manner as may be prescribed, with the Registrar within thirty days of its creation:
(2) Where a charge is registered with the Registrar under sub-section (1), he shall issue a certificate of registration of such charge in such form and in such manner as may be prescribed to the company and, as the case may be, to the person in whose favour the charge is created.
(3) Notwithstanding anything contained in any other law for the time being in force, no charge created by a company shall be taken into account by the liquidator appointed under this Act or the Insolvency and Bankruptcy Code, 2016, as the case may be, or any other creditor unless it is duly registered under sub-section (1) and a certificate of registration of such charge is given by the Registrar under sub-section (2).
(4) Nothing in sub-section (3) shall prejudice any contract or obligation for the repayment of the money secured by a charge.”