06 May 2021

Distribution of assets in liquidation – No priority for first charge holders if security relinquished

The National Company Law Appellate Tribunal (NCLAT) has held that priorities amongst the secured creditors (first charge or second charge) will not prevail in distribution of assets in liquidation, in a case where the creditors had elected for relinquishment of security interest and for distribution of assets according to Section 53 of the Insolvency and Bankruptcy Code, 2016.

The Appellate Tribunal was of the view that first charge holder will have priority in realising its security interest if it elects to realize its security interest (under Section 52) and does not relinquish the same. However, once a secured creditor opts to relinquish its security interest, the distribution of assets would be governed by the provision engrafted in Section 53(1)(b)(ii) whereunder all secured creditors having relinquished security interest rank equally.

The NCLAT in the case Technology Development Board v. Anil Goel also noted that Section 53 had a non-obstante clause, thus having an overriding effect, and that the question as to whether the secured creditor holds first charge or second charge is material only if the secured creditor elects to realise its security interest.

Sub-classification amongst secured creditors when permissible

It may be noted that the Appellate Tribunal also observed that in the event of a secured creditor electing to realise its security interest but failing to realise the whole amount due to it would be entitled to distribution of assets under Section 53(1)(e)(ii) for any amount that remains unpaid following the enforcement of security interest.

It held that in such case, such secured creditor would be ranking lower in priority as compared to a secured creditor who has relinquished its security interest to the liquidation estate and is entitled to distribution of assets under Section 53(1)(b)(ii).

The Appellate Tribunal held that the two sets of secured creditors, one relinquishing the security interest and the other realising its security interest are to be hence treated differently.

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