Only Security Created Over Corporate Debtor's Assets Confers Secured Creditor Status: NCLT Kochi

The National Company Law Tribunal (NCLT) at Kochi has held that a creditor cannot claim the status of a secured financial creditor in a corporate insolvency resolution process merely because its debt is backed by the personal assets of promoters.

Such status can be claimed only where a security interest has been created over the assets of the corporate debtor.

“Under the insolvency process, only a security interest created over the assets of the Corporate Debtor can confer the status of a secured financial debt. Where no such security interest exists in favour of the creditor over the assets of the Corporate Debtor, the debt cannot be treated as a secured financial debt, notwithstanding the existence of security over the personal assets of the promoters.”, the court held

A coram of Judicial Member Vinay Goel and Technical Member Ravichandran Ramasamy delivered the ruling. The Bench allowed an application filed by the Resolution Professional of Roofco Trading Company Private Limited. It directed reclassification of Yes Bank's ₹4.92 crore claim from secured financial debt to unsecured financial debt.

The dispute arose from Yes Bank's claim of ₹13.92 crore in the corporate insolvency resolution process of Roofco Trading Company. The claim included ₹4.92 crore towards a loan extended to the company. The remaining ₹9 crore related to loans advanced to the promoters and backed by a corporate guarantee furnished by the company.

Based on the documents initially available, the Resolution Professional admitted the ₹4.92 crore component as secured financial debt. The ₹9 crore component was admitted as unsecured financial debt.

State Bank of India, a financial creditor and member of the Committee of Creditors (CoC), objected to the classification. It contended that the security relied upon by Yes Bank consisted of mortgages over the promoters' properties. According to SBI, no asset of the corporate debtor had been offered as security.

The Resolution Professional stated that he lacked adjudicatory powers to conclusively determine the dispute. He therefore approached the Tribunal and sought reclassification of the claim.

Yes Bank opposed the application. It argued that the facilities were supported by registered charges and mortgages created by promoters and guarantors. The bank further contended that a creditor's status as a secured financial creditor is determined by the existence of a validly created and enforceable security interest securing repayment of the debt.

The Tribunal examined the documents relied upon by the bank. It found that the memoranda of deposit of title deeds had been executed by Phoenix Cars India Pvt. Ltd. and certain individuals in their personal capacities. The documents had not been executed by Roofco Trading Company.

“Secured financial debt refers to a financial debt that is backed by a valid security interest over the assets of the Corporate Debtor, created through a mortgage, charge, hypothecation, pledge, or any other form of security interest executed by an agreement between the Corporate Debtor and the charge holder. In contrast, unsecured financial debt is not supported by any such security interest.”, It noted.

The bench observed that the distinction between secured and unsecured financial debt has limited relevance for voting rights in the CoC. Voting share is determined solely by the quantum of admitted debt. It is not dependent on the existence of a security interest.

The tribunal noted that the distinction between secured and unsecured financial debt becomes important during insolvency and, more particularly, at the liquidation stage. That distinction can directly affect the distribution of assets and recovery of dues. Since secured creditors enjoy certain statutory advantages by virtue of their security interests, an incorrect classification could have implications for the rights and recoveries of other creditors.

The bench then referred to the NCLAT's ruling in Bizloan Pvt. Ltd. v. Amit Chandrashekhar Poddar (Liquidator). Reiterating the principle laid down in that decision, it held that a debt can be treated as secured financial debt only where a security interest has been created over the assets of the corporate debtor.

Applying that principle, the Bench concluded that the security relied upon by Yes Bank had been created over the personal assets of the promoters. No security interest had been created over the assets of the corporate debtor. The debt, therefore, could not be treated as secured financial debt during the CIRP.

“Once it is evident that the Corporate Debtor never created a security interest in favour of the Respondent, the Respondent cannot claim itself to be a secured creditor qua the Corporate Debtor during the CIRP process.”

The Tribunal further observed:

“The assets of the Corporate Debtor are already secured in favour of other financial institutions, and therefore, such financial institutions, including State Bank of India, cannot be compelled to share their security interest and the benefits arising therefrom with the Respondent.”

The bench clarified that the ruling would not prevent Yes Bank from enforcing its rights against the mortgagors who had created security in its favour.

Accordingly, it directed reclassification of the ₹4.92 crore claim as unsecured financial debt. The tribunal also directed the Resolution Professional to reconstitute the Committee of Creditors if the reclassification results in any change in its constitution.

For Applicant: Krishnan Unni, PCS and Dileep K.P, Resolution Professional

For Respondent: Advocate Renjith R