How Secured is Your Security? DBS Fights for Fair Share in Ruchi Soya Insolvency Saga | India
Anindita Roychowdhury and Vatsala Rai of AZB & Partners discuss the key takeaways from the recent judgment of the Supreme Court of India which examined the legal entitlement of dissenting financial creditors under the insolvency and bankruptcy regime in India. The authors would like to thank Sushrut Garg of AZB & Partners for his contribution to this article.
Introduction
Globally, the confidence of lenders while extending financial facilities is determined by the following considerations: (i) when collateral security is provided to secure such financial facilities; and (ii) such collateral security is not only high in terms of value, but the concerned jurisdiction’s insolvency laws provide for a method in which such security is protected in times of distress. Secured debt carries a lower interest rate compared to unsecured debt. Therefore, borrowers who may not have a proven track record or may have uncertain economic prospects in a competitive banking environment often offer their assets as collateral to lenders with the aim of securing cheap and accessible credit.
The Reserve Bank of India (RBI), as the banking sector regulator, prescribes “provisioning norms”; ie, the amount of capital that banks must set aside in respect of their loan accounts which are in default. Per RBI’s Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances (1 April 2023), depending on the ageing of the defaulting loan, on average, the amount of capital required to be set aside for secured loans is lower than that for unsecured loans. The economic rationale is that adequate provisioning is essential to maintain the health of the banking sector and achieve macroeconomic stability. The provisioning for secured debt is lower since banks can enforce the collateral offered by the borrower rather than relying on the borrower’s financial prospects.
Shortchanged!
While banks and financial institutions across the globe may be aware of the importance attached to negotiated financial lending with a high-value security underlying the transaction, this was curiously not the case when it came to DBS Bank, Singapore (DBS), which was a dissenting financial creditor in the corporate insolvency resolution process of Ruchi Soya Industries Limited (“Ruchi Soya”). Patanjali Ayurveda Limited was the Successful Resolution Applicant (SRA). DBS had exclusive charge on certain high-value assets of Ruchi Soya, which included immovable properties.
Once the SRA presented its resolution plan, the majority of the Committee of Creditors (CoC) of Ruchi Soya decided on a distribution mechanism that completely ignored the liquidation value assigned to DBS’s security. DBS received nearly INR100 crores less than the pre-assigned liquidation value for its security, even though all other creditors were assigned their respective amounts. It was clear that the majority of the CoC had taken a decision on the distribution of proceeds obtained from the SRA, which resulted in DBS being shortchanged and, in the process, the other lenders obtaining an unjust benefit by getting more than their respective share of the proceeds.
The Amendment
When DBS raised this issue before the National Company Law Tribunal (NCLT), it met with a dismissal order. The case then reached the National Company Law Appellate Tribunal (NCLAT). While DBS’s appeal was pending before the NCLAT, the Insolvency and Bankruptcy Code, 2016 (IBC) was amended and Section 30 of the IBC, post amendment, specifically provided for protection of rights of a dissenting financial creditor. The amendment essentially provided for a minimum liquidation value payout to a dissenting financial creditor under a resolution plan. The NCLAT, however, applied the amendments prospectively and the appeal was dismissed. It is also interesting that by the time the appeals were heard by the NCLAT, the judgment in Committee of Creditors of Essar Steel India Limited through Authorised Signatory v. Satish Kumar Gupta & Ors. (2020) 8 SCC 531) (“Essar Steel”), was pronounced by the Supreme Court and it upheld the amendments brought into Section 30 of the IBC and made various observations on the rights of a secured creditor.
The Escrow
DBS negotiated an escrow arrangement where the amount of approximately INR100 crores would be kept aside, and the assenting financial creditors agreed to the arrangement. This escrow arrangement took care of the following concerns: for the assenting financial creditors, the resolution plan could be implemented and proceeds other than the INR100 crores would be distributed; for the SRA it could take over the operations of Ruchi Soya; and for DBS, the amount was secured till the final outcome of the litigation. The glitch was that the escrow too needed the blessings of the Supreme Court.
Course Correction Despite Obstacles
When DBS appealed the NCLAT orders before the Supreme Court, it obtained the order to protect the escrow amount. While DBS’s appeals were pending, another bench of the Supreme Court heard and disposed of another case centred around the rights of a dissenting financial creditor regarding its security. This was in India Resurgence ARC Pvt. Ltd. v. Amit Metaliks Limited (2021 SCC Online SC 409) (“Amit Metaliks”). In a nutshell, the CoC in Ruchi Soya and the Supreme Court in Amit Metaliks took the view that a dissenting lender holding exclusive security interest will not be accorded the value of its particular security interest and may be forced to share recoveries on a pari passu basis with other assenting lenders.
Finally, when DBS’s appeals were heard by the Supreme Court and thereafter the judgment dated 3 January 2024 was passed, it sent a very clear message to all lenders. In brief, the Supreme Court did a deep dive into the interpretation of Section 30(2)(b)(ii) of the IBC (ie, rights of a dissenting financial creditor), read along with Section 53(1) of the IBC (ie, liquidation waterfall). Some key takeaways are outlined below.
- Section 30(2)(b)(ii) of the IBC recognises that all financial creditors may not be similarly situated. Secured creditors may have distinct sets of securities.
- The IBC provides for a minimum guaranteed payment to a dissenting financial creditor – the amount such creditor would have been paid in the event of liquidation. Therefore, a notional liquidation event is to be factored in for the payment of liquidation value.
- There is a need to ensure that the plan provides appropriate protection for the dissenting parties and that their rights are not unfairly affected, and the protection is echoed in Section 30(2)(b)(ii) of the IBC.
- Dissenting creditors are to receive the payment of the value of their security interest.
- There is a contradiction in the reasoning given in the judgment of the Supreme Court in Amit Metaliks, which is in discord with the ratio decidendi of the decisions of the three Judge Bench of Supreme Court in Essar Steel and Jaypee Kensington v. NBCC India, (2022) 1 SCC 401. While certain views are correct or partially correct in Amit Metaliks, it ought not to be read in a manner that denotes that a dissenting financial creditor would not be entitled to receive the liquidation value.
While the Supreme Court did a much-needed course correction on lender rights regarding their security, the concerned Supreme Court Bench, cautious due to its differing interpretation of Section 30(2)(b)(ii) of the IBC compared to the Amit Metaliks case, has referred the case to a larger bench of the Supreme Court. This has instilled renewed confidence amongst lenders, fostering hope for a legal guarantee of at least the liquidation value of their security interest.
The key insights are as follows:
- A lender need not always stall the implementation of a resolution plan. A lender may find ways to protect its rights (like an escrow in this case) whilst not obstructing monies coming back into the lending system.
- The IBC and the judgment dated 3 January 2024 protect the rights of a dissenting secured financial creditor and guarantee a minimum liquidation value of its security.
AZB & Partners
