SARFAESI Action Unaffected by Resolution Plan of Corporate Debtor
Table of Contents
The conflict between the Insolvency and Bankruptcy Code, 2016 (IBC) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) arises as IBC’s moratorium halts SARFAESI actions, yet secured creditors often continue SARFAESI enforcement. This is due to the IBC’s focus on corporate revival, sometimes excluding them, thus making SARFAESI a quicker recovery path for the asset itself. In Ashok Harry Pothen v. Indian Bank the Kerala High Court addressed whether a bank’s SARFAESI action against a personal guarantor’s property is barred by an approved IBC Resolution Plan of Corporate Debtor for that company, clarifying that SARFAESI rights for non-participating creditors remain.
Statutory Background
SARFAESI Act – Rights of Secured Creditors
The SARFAESI Act was enacted to empower secured creditors, such as banks and financial institutions, to recover non-performing assets (NPAs) efficiently by enabling enforcement of security interests without court intervention. Section 13(1) of this Act overrides provisions of the Transfer of Property Act, 1882, allowing secured creditors to enforce their rights directly under the Act. Under section 13(2), a secured creditor may issue a 60-day notice to a defaulting borrower to discharge their liability, provided the account is classified as an NPA, unless the borrower raised funds through debt securities. If the borrower fails to comply within the period, section 13(4) grants the secured creditor the right to take possession of secured assets, appoint a manager, take over management of the business, or sell the assets to realise the secured debt. This mechanism allows for the realization of secured assets without court intervention , promoting faster recovery and financial system stability.
IBC Framework on Resolution Plan of Corporate Debtor
The corporate insolvency resolution process (CIRP) under the IBC aims to resolve financial distress of corporate debtors within a time-bound framework by facilitating the revival of viable businesses as a going concern. A Resolution Plan of Corporate Debtor, proposed by a resolution applicant and approved by the Committee of Creditors (CoC) with at least 66% voting share, is submitted to the Adjudicating Authority, the National Company Law Tribunal (NCLT), for final approval under section 31(1). Once approved, the resolution plan becomes legally binding on the corporate debtor, its employees, members, creditors, guarantors, and statutory authorities. Secured creditors are entitled to recover their dues from the security interest they hold, and their claims are prioritized over unsecured creditors, with the resolution plan required to provide for the payment of debts in accordance with the law and the order of priority.
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Key Legal Issue Before the High Court
- Whether SARFAESI proceedings can continue after approval of a Resolution Plan of Corporate Debtor?
- Whether the secured creditor is bound by the plan if it has not relinquished its security interest?
Facts of the Case
The petitioner was involved in a joint development agreement with a corporate debtor, and the property in question was part of this agreement and also included in a resolution plan approved by the NCLT under the IBC. The Indian Bank initiated proceedings under the SARFAESI Act against the property mortgaged by the petitioner. The High Court held that the bar against claims outside the resolution plan under the ICB does not apply to a person like the petitioner who has a separate agreement with the corporate debtor, such as a joint development agreement.
High Court’s Observations
The court clarified that the bank’s right to proceed against the mortgaged property is not affected by the resolution plan, especially since the bank was not a party to the NCLT proceedings or the Resolution Plan of Corporate Debtor. It held that an approved resolution plan does not automatically bar SARFAESI action by a secured creditor, especially if the creditor was not involved in the NCLT process or the plan did not cover their specific security interest. The court reaffirmed that SARFAESI proceedings can continue to protect legitimate creditor rights outside the IBC framework, thus, balancing corporate revival with individual creditor justice.
Interaction Between IBC and SARFAESI
- Applicability of Section 238 of IBC: A resolution plan approved under the IBC does not automatically override ongoing SARFAESI proceedings. Instead, the moratorium under section 14 of the IBC stays SARFAESI actions once insolvency is admitted, but the SARFAESI Act remains applicable to secured assets unless explicitly superseded. The resolution plan binds only those creditors who participated in the process and are treated according to the plan’s terms, while the enforcement of security under SARFAESI continues for assets not fully resolved through the insolvency framework.
- Effect of Moratorium and Its Cessation: Secured creditors under the IBC retain the right to either enforce their security interest outside the liquidation estate in accordance with applicable laws such as the SARFAESI Act, or to relinquish their security interest and participate in the distribution of assets under section 53 of the iBC, with the choice of being protected by section 52. The approval of a resolution plan does not extinguish the right of a secured creditor to enforce its security through SARFAESI or other applicable laws, as the option to realise security independently remains valid even after plan contribution.
Distinction Between Participating and Non-Participating Secured Creditors
- Participating secured creditors, who vote for a resolution plan, may forfeit their right to enforce security if they choose to participate in the voting process, as their security interest is effectively surrendered for the benefit of all creditors. Non-participating secured creditors, who do not consent or are inadequately dealt with, retain their security rights unless they have expressly waived them or their security has been satisfied, and they may claim the liquidation value of their security interest if the plan does not provide adequate compensation.
- Secured creditors who vote for a resolution plan are treated as having relinquished their security interest, thereby becoming part of the general creditor pool and the subject to the distribution waterfall under action 53 of the IBC. In contrast, dissenting or non-consenting secured creditors are entitled to the liquidation value of their security interest, as affirmed by the Supreme Court in DBS Bank Limited v. Ruch Soya Industries Limited, which holds that such creditors should not be worse off than they would be in liquidation. The importance of an express waiver of satisfaction of security rights lies in ensuring that the relinquishment of security is clear and legally enforceable, preventing disputes over the extent of a creditor’s entitlement during the resolution or liquidation process.
Impact on Resolution Applicants
- Resolution applicants face heightened risk of parallel enforcement actions post-resolution if secured creditors assets are not clearly addressed, as the SARFAESI Act allows banks to initiate recovery proceedings even after resolution approval, though such actions are stayed once the IBC moratorium is in place.
- It is crucial to clearly identify and address secured assets in the resolution plan to prevent future disputes.
- Due diligence on pending SARFAESI proceedings is essential for resolution applicants to assess potential liabilities, ensure compliance with procedural requirements, and mitigate risks arising from unresolved enforcement actions.
Practical Implications for RPs and CoC
- Resolution professionals (RPs) and the CoC must proactively identify secured creditors’ enforcement intentions during the CIRP to ensure plan viability and compliance with section 52 of the IBC.
- Explicit treatment of assets subject to SARFAESI-secured interests in the Resolution Plan of Corporate Debtor is essential, particularly where such assets are already attached under penal laws.
- To avoid post-resolution litigation and asset disputes, RPs and CoC must conduct thorough due diligence on pre-existing attachments and ensure full disclosure of such encumbrances in the information memorandum and Resolution Plan of Corporate Debtor.
Key Legal Principles Emerging
- Approval of a Resolution Plan of Corporate Debtor does not automatically extinguish the liability of a guarantor, as their obligation remains co-extensive with that of the principal borrower, and the payment under the plan does not discharge the borrower’s full debt.
- Secured creditors retain their enforcement rights under the SARFAESI Act unless they have expressly relinquished such rights or opted to participate in the liquidation process under section 53 of the IBC.
- IBC and SARFAESI can operate in parallel post-CIRP only if the secured creditor chooses to enforce security interest outside the liquidation estate under section 52 of the IBC, but such enforcement is subject to the moratorium during CIRP period.
Conclusion
The High Court reaffirmed that SARFAESI enforcement survives Resolution Plan of Corporate Debtor unless clearly settled. The judgment emphasised that Resolution Plan of Corporate Debtor must comprehensively address the rights of secured creditors to ensure their interests are not inadvertently compromised. This ruling strengthens their interests without undue interference from insolvency processes. It also prevents the unintended waiver of security interests, ensuring that secured creditors retain their statutory rights under the SARFAESI Act.
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