THE PROS AND CONS OF ALLOWING RESOLUTION PLANS TO EXTINGUISH INTERESTS OF SECURED CREDITORS
ARGUMENTS IN FAVOR: PROMOTING RECOVERY AND STABILITY
Allowing a resolution plan to extinguish the security interest of a secured creditor, even without their consent, can be crucial for the overall stability of a distressed company. By enabling the restructuring of debt and assets, the resolution process can facilitate a quicker turnaround for the business, preserving jobs and ensuring that the enterprise can continue to operate. This approach fosters an environment where creditors can recover more in the long term, as the revitalized company may ultimately provide better returns than liquidating its assets. Hence, prioritizing the collective benefit of stakeholders can outweigh the individual rights of secured creditors in certain scenarios.
Facilitating business restructuring
The primary goal of IBC is to promote the revival of distressed companies rather than liquidating them. Allowing resolution plans to extinguish secured creditors’ interests can enable more effective restructuring. The case of State Bank of India vs. V. Ramakrishnan (2018) highlights the aforementioned principle, wherein the Hon’ble Supreme Court upheld the resolution plan that restructured the debts of the corporate debtor, emphasizing the importance of protecting the interests of employees and the larger business ecosystem.By allowing resolution plans to extinguish secured creditors’ interests, the process becomes swifter, enabling businesses to restructure their debts efficiently. The case of State Bank of India vs. Anil Ambani (2020) emphasises the importance of timely resolution to avoid asset deterioration, effectively arguing that speed can trump individual creditor rights when broader stability is at stake.
Preserving employment
By enabling companies to restructure their debts and continue operations, the IBC indirectly supports job preservation. In re K. S. P. S. A. vs. Indian Overseas Bank (2019), the National Company Law Appellate Tribunal (NCLAT) recognized that a successful resolution plan not only benefits creditors but also safeguards the livelihoods of employees. Allowing for the extinguishment of secured interests can lead to better overall outcomes for all stakeholders involved. In the Jaypee Infratech case (2019), the resolution plan was designed to allow the company to continue operations, thereby preserving jobs and maintaining economic activity. This illustrates how a revitalized business can ultimately provide better returns for creditors compared to the often minimal recoveries seen through asset liquidation.
Long-term outcomes for Creditors`
While extinguishing security interests may seem detrimental in the short term, it can lead to better long-term outcomes for creditors. The case of Essar Steel India Ltd. vs. Satish Kumar Gupta (2019) underscored that a viable business could provide higher returns for creditors over time compared to immediate liquidation. This indicates that a resolution plan that allowed for the restructuring of debts, reinforcing the notion that revitalized businesses are more likely to repay creditors in the future.
Collective benefit of stakeholders
The IBC emphasizes the collective interest of all stakeholders. In re Binani Industries Ltd. vs. Bank of Baroda (2018), the Hon’ble Supreme Court noted that the resolution process should prioritize the broader interests of stakeholders, sometimes at the expense of individual creditor rights. This perspective fosters an environment where collaborative solutions can emerge.
When the resolution process prioritizes collective benefit of stakeholders, it encourages collaboration rather than confrontation. The Committee of Creditors (CoC) in the Essar Steel case(2020) demonstrated that a focus on collective interests could lead to innovative resolution plans that catered to multiple parties, including employees and unsecured creditors, ultimately resulting in a more sustainable business model.
ARGUMENT AGAINST: PROTECTING CREDITOR RIGHTS
Allowing the extinguishment of a secured creditor’s interest without their consent undermines the foundational principles of secured lending and may deter future investment. Creditors enter agreements with the understanding that their security interests will be protected, as this reduces their risk. If secured interests can be disregarded in resolution plans, it may lead to increased risk premiums and a reluctance from lenders to provide financing to businesses, especially those perceived as high-risk. This erosion of trust in the security of lending could ultimately harm the overall economy by constraining access to capital for businesses in need of support.
Erosion of Creditor confidence
Allowing the extinguishment of secured creditors’ interests without their consent raises concerns about the sanctity of secured lending. Creditors rely on the protection of their security interests to mitigate risks. The case of Jaypee Infratech Ltd. vs. Axis Bank (2021) illustrated these concerns, where the NCLAT ruled against a resolution plan that unfairly compromised the rights of secured creditors, emphasizing the need to uphold creditor rights.One of the strongest arguments against extinguishing secured creditors’ interests is the fundamental erosion of their rights. In re Ruchi Soya Industries Ltd.(2020), the Hon’ble Supreme Court ruled that creditors’ rights must be safeguarded, reinforcing the idea that lending is predicated on secured interests being honoured. Ignoring these rights can lead to a slippery slope where creditors lose confidence in the security of their investments.
Investment deterrence
Disregarding secured interests in resolution plans may deter future investments, as lenders could perceive increased risks.The case of M/s. Innoventive Industries Ltd. vs. ICICI Bank (2018) highlighted this issue when the Hon’ble Supreme Court stressed the need to balance the rights of creditors with the resolution objectives, cautioning against creating an environment where creditors feel insecure about their investments.
The willingness of creditors to lend is significantly influenced by their perception of risk. If secured interests can be easily overridden, future investment could dwindle. The case of Cyrus Mistry vs. Tata Sons (2019) highlights concerns over corporate governance and creditor rights, showing that uncertainty regarding the treatment of secured creditors can deter potential investors from engaging with distressed entities.
Potential for misuse
There is a risk that allowing resolution plans to bypass secured creditors’ consent could be abused by companies attempting to escape their obligations. The case of Ravinder Kumar Gupta vs. State Bank of India (2021) demonstrated this concern, wherein the NCLT expressed reservations about resolutions that unfairly disadvantaged secured creditors, reinforcing the need for robust safeguards against misuse.
Allowing the extinguishment of secured interests without consent opens the door for potential misuse. Companies may leverage this power to side-step their obligations, leading to a culture of irresponsibility. The Bhushan Steel case(2019) exemplified concerns where some stakeholders argued that the resolution plan lacked adequate safeguards for creditor interests, raising questions about ethical conduct in distress situations.
Economic implications
The broader economic impact of undermining secured creditor rights could be detrimental. A perception of increased risk in lending could lead to higher interest rates and reduced availability of credit, affecting businesses across sectors. This point was underscored in the case of Vishal Fabrics Ltd. vs. Bank of India (2020), wherein the NCLAT warned against creating an unstable lending environment.
The potential for undermining the credibility of secured lending has broader economic implications. As seen in the aftermath of various insolvency proceedings, a loss of confidence can lead to higher risk premiums, restricting access to credit for businesses that genuinely need support. If the legal framework appears to favour the quick resolution over creditor rights, lenders might withdraw from the market altogether, stunting economic growth.
CONCLUSION
The debate over allowing resolution plans to extinguish the security interests of secured creditors in India is complex and multifaceted. While IBC aims to facilitate business recovery and protect the collective interests of stakeholders, the rights of secured creditors cannot be overlooked. As India continues to navigate the intricacies of corporate insolvency, policymakers must strike a careful balance between promoting recovery and safeguarding creditor rights. Only through thoughtful consideration of these factors the country can foster a stable and conducive environment for both businesses and creditors alike. While the potential for enhanced business recovery and the preservation of jobs cannot be ignored, the risks associated with undermining creditor rights and deterring future investments pose significant threats to the financial ecosystem.
Authored by
Adv. Somesh Pandey,
SUO Law Offices
