Read on to understand implications of moratorium on lenders who have taken certain forms of collateral/security interest, including security of assets of corporate debtor against whom insolvency proceedings have been initiated...A moratorium in general parlance refers to adelay or suspension of activity or law for acertain period of time. In the legal context, itmay refer to the...
Read on to understand
implications of moratorium
on lenders who have
taken certain forms of
collateral/security interest,
including security of
assets of corporate debtor
against whom insolvency
proceedings have been
initiated...
A moratorium in general parlance refers to a
delay or suspension of activity or law for a
certain period of time. In the legal context, it
may refer to the temporary suspension of a law
to allow a certain legal challenge or proceeding
to be carried out without any disruption on account of
interplay of overlapping legal processes.
Under the newly enacted Insolvency and Bankruptcy Code,
2016 ("the Code"), the National Company Law Tribunal ("the
Adjudicating Authority/NCLT") on the date of admission
of the application filed for initiating corporate insolvency
resolution process under Section 7 or Section 9 or Section
10 of the Code (called insolvency commencement date),
shall, by an order, declare a moratorium for prohibiting all
of the following, namely:
(a) institution of suits or continuation of
pending suits or proceedings against
the corporate debtor including
execution of any judgment, decree or
order in any court of law, tribunal,
arbitration panel or other authority;
(b) transferring, encumbering, alienating
or disposing of by the corporate
debtor any of its assets or any legal
right or beneficial interest therein;
(c) any action to foreclose, recover
or enforce any security interest
created by the corporate debtor in
respect of its property, including any
action under the Securitization and
Reconstruction of Financial Assets
and Enforcement of Security Interest
Act, 2002;
(d) recovery of any property by an
owner or lessor where such property
is occupied by or in the possession of the corporate
debtor1.
An exception to the abovementioned prohibition is the
supply of essential goods and services to the corporate
debtor, which shall not be interrupted by way of the
moratorium. Further, the Central Government is authorized
to notify non-applicability of the moratorium provisions
as the Government may deem fit in consultation with
the financial services regulator. Pursuant to the powers
vested with the Central Government under the Code, the
Department of Financial Services, Government of India
has addressed its letter dated May 1, 2017 to members of
the Indian Banks' Association, seeking suggestions on the
aforesaid exclusions from Section 14 of the Code, including
cases where SARFAESI action has been initiated under
Section 13(4) and Section 14 of the SARFAESI Act.
This article aims to analyze implications of the moratorium
on lenders who have taken certain forms of collateral/
security interest, including security of assets of the
corporate debtor against whom insolvency resolution
process has been initiated, pledge of shares pertaining
to the corporate debtor, guarantee from promoters of the
corporate debtor etc. This can be better understood by the
following illustration:
Company A is a promoter of Company B. Company B
has obtained a loan from Bank X against the following
security (a) Corporate Guarantee of Company A and
(b) Pledge of Shares held by Company A in Company
B ("the Pledged Shares"). Lenders of Company
A file an application under Section 7 of the Code against
Company A. The application has been
admitted by NCLT, the moratorium
has begun and interim resolution
professional (IRP) is appointed. In these
circumstances:
i. Can Company A or IRP stop invocation
of Pledged Shares by Bank X? Will
invocation of Pledged Shares be
impacted by the moratorium?
ii. Can Bank X invoke the Corporate
Guarantee?
iii. Can Company A refuse payment to
Bank X in the event of invocation of
Corporate Guarantee?
iv. Will the invocation of Corporate
Guarantee be impacted by the
moratorium?
Analysis - As per the Code, if the
application filed against Company A is
admitted by the NCLT, the following shall
occur:
(a) a moratorium shall be declared on any action to
foreclose, recover or enforce any security interest
created by the corporate debtor in respect to its property
under Section 14(1)(c) of the Code. This may lead to
the Bank X being barred from invoking the pledge over
the Pledged Shares till such time as the moratorium
continues;
(b) the interim resolution professional ("IRP") shall
take control and custody of any asset over which the
corporate debtor has ownership rights, including
securities it holds in its subsidiaries under Section
18(1)(f) of the Code i.e. the Pledged Shares as the same
would qualify as assets of the corporate debtor; and
(c) the Committee of Creditors ("CoC") established in
relation to Company A may instruct the IRP to create
additional security on the Pledged Shares in favor of such persons as instructed by the COC under Section
28(1)(b) of the Code.
On plain reading of the abovementioned sections of Code,
it appears that security created in the form of pledge
over Pledged Shares cannot be enforced till expiry of the
moratorium period. Though the IRP can theoretically take
control of Pledged Shares, under the existing depository
system established under the Depositories Act, 1996 read
along with the bye-laws issued by the National Securities
Depository Limited (NSDL)3, there is no provision for any
third party to take charge or control of the already Pledged
Shares. Unless, Bank X consents to the release of the pledge
on Pledged Shares, neither IRP will be able to take control
or deal with in any manner, or create additional pledge over
Pledged Shares nor COC can instruct creation of additional
pledge over Pledged Shares in favor of lenders of Company
A. The Code does not give any power to either the IRP or
COC to invalidate or cancel the pledge validly created in
favor of Bank X on Pledged Shares in terms of the procedure
prescribed under the Depositories Act, 1996. Therefore, the
pledge created in favor of Bank X will not be impacted
except that during the moratorium period, Bank X may not
be able to invoke and sell Pledged Shares. After expiry of
the moratorium period, Bank X will have no restriction for
invoking or selling Pledged Shares.
theoretically take control of
Pledged Shares, under the
existing depository system
established under the
Depositories Act, 1996, there
is no provision for any third
party to take charge or control
of the already Pledged Shares
As regards the Corporate Guarantee, Bank X may not be
able to invoke it during the moratorium period, however,
there would be no restriction on sending demand notice
to the Company A, asking it to make payment under the
Corporate Guarantee. Further, upon non-payment by
Company A under the said Guarantee, Bank X will be at
liberty to initiate appropriate legal proceedings against
Company A before Debt Recovery Tribunals and/or under
the Code, in its capacity as a financial creditor of Company
A in terms of the Code.
Now let's reverse the above illustration:
Company A is a promoter of Company B. Company B
has obtained a loan from Bank X against the following
security (a) Corporate Guarantee of Company A and (b)
Pledge of Shares held by Company A in Company B ("the
Pledged Shares"). Some other lenders of Company B file an
application under Section 7 of the Code against Company B.
The application has been admitted by NCLT, the moratorium
has begun, and IP is appointed. In these circumstances:
i.
Can Company A or IRP stop invocation of Pledged
Shares by Bank X? Will invocation of Pledged Shares be
impacted by the moratorium?
ii.
Can Bank X invoke Corporate Guarantee?
iii.
Can Company A refuse payment to Bank X in the event
of invocation of Corporate Guarantee?
iv.
Will invocation of Corporate Guarantee be impacted by
the moratorium?
In this case, neither invocation of Corporate Guarantee
nor Pledged Shares shall be impacted by declaration of
moratorium. The COC can even, as part of the resolution
plan, decide on invocation of Corporate Guarantee and
Pledged Shares.
It may thus be noted that it is important that moratorium
provisions are interpreted to be restricted to the assets of
the corporate debtor and must not be used as a tool by
third-party security providers to evade their liability under
security documents executed with the lenders.
The recent judgment given by NCLT, Mumbai, in case of
M/s Schweitzer Systematic India Private Limited vs.
Phoenix ARC Limited2, is an illustrative judgment on this
aspect, where the tribunal ruled that '
moratorium has no
application on properties beyond the ownership of the
corporate debtor
.'
It was further ruled that (a) moratorium shall commence on
the corporate debtor; (b) property not owned by corporate
debtor does not fall within the ambit of moratorium; (c)
order of CMM directing the court commissioner to take over
possession of properties shall not fall into the clutches of
moratorium; (d) further clarified that any action under
SARFAESI Act shall come within the ambit of moratorium if
an action is to foreclose or recover or create any interest in
respect of the property belonged to or owned by a corporate
debtor, otherwise not.
Footnote:
1. Section 14 of the Insolvency and Bankruptcy Code, 2016.
2. Order dated July 3, 2013 in TCP No. 1059/I&BP/NCLT/MB/MAH.
3. In terms of the Depositories Act, 1996 read along with the Bye-Law 9.9.9 issued by NSDL (as
amended till June, 2017); the entry of pledge or hypothecation made in respect of any securities shall be cancelled by the Depository Participant when the Client
redeems the pledge or hypothecation and makes a request, with the concurrence of the pledgee.
Disclaimer
– The views expressed in this article are the personal views of the author and are purely informative in nature.