Non-registration of Charge under Section 77 of the Companies Act, 2013 is not a sufficient ground to classify a creditor as unsecured – Canara Bank v. Mr. S. Rajendran, Liquidator of Cape Engineers Private Limited – NCLAT, Chennai Bench

CORAM: Hon ble Justice M. Venugopal, Member (Judicial), Hon ble Justice Sharad Kumar Sharma, Member (Judicial) and Jatindranath Swain, Member (Technical)

INTRODUCTION

The case of Canara Bank v. Mr. S. Rajendran, Liquidator of M/s. Cape Engineers Private Limited [i] presented a complex legal question on whether a liquidator can classify a creditor as secured or unsecured based on registration of charge under Section 77 of the Companies Act, 2013 ( Companies Act ). The case is arising out of an appeal filed by Canara Bank ( Appellant ) against the order dated June 14, 2023 ( Impugned Order ), passed by the National Company Law Tribunal ( NCLT ) [ii] wherein, the NCLT had upheld the decision of Mr. S. Rajendran, the liquidator ( Respondent ) in classifying the Appellant as an unsecured creditor.

FACTS

The facts leading to the present case are as follows:

                The Appellant had extended credit facilities to the extent of INR 23,00,00,000 (Rupees TwentyThree Crores Only) to M/s. Sree Ganesh EPC Private Limited ( Borrower ) against collateral security of immovable property offered by M/s. Cape Engineers Private Limited ( Corporate Guarantor ) and execution of corporate guarantee agreement. A memorandum of deposit of title deedswas duly executed in this regard on July 7, 2015, and registered vide document no. 747/2015/SRO Thovalai in terms of Section 58(f) of the Transfer of Property Act, 1882 ( Transfer of Property Act ).

                The Borrower thereafter went into corporate insolvency resolution process and the Corporate Guarantor also preferred aninsolvency application under Section 10 of the Insolvency and Bankruptcy Code, 2016 ( IBC ). The NCLT vide order dated September 6, 2019, appointed Mr. J. Manivannan as interim resolution professional who was laterreplaced by the Respondent as the resolution professional.The Respondent was later appointed as a liquidator for the Corporate Guarantor vide order dated April 25, 2022. The Respondent had determined based on the loan documents, that the Appellant had 95.76% (ninety-five decimal seventy six percent) voting share in the Corporate Guarantor.

                Pursuant to the filing of public announcement form D on May 20, 2022, the Appellant had desired to stand outside the liquidation proceedings in accordance with Section 52 of IBC since there was huge difference in valuation of the secured interest. The Respondent had however, sent an email dated May 27, 2022, seeking documents from the Appellant to prove the existence of its security interestunder Regulation 21 of the Insolvency and Bankruptcy Board of India ( IBBI ) (Liquidation Process) Regulations, 2016 ( IBBIRegulations ). The Appellant, as evidence of the security interest,sharedthe registered memorandum of deposit to the Respondent on June 6, 2022.

                However, vide email dated July 1, 2022, the Respondent informed that since the charge created over the mortgaged property was not registered with the Registrar of Companies ( RoC ), the Appellant would be treated as unsecured financial creditor and such mortgaged property would form a part of the liquidation estate.

                Aggrieved by the same, the Appellant filed an application before the NCLT contending that the memorandum of depositcan be considered as a proof of security interest. The NCLT however, dismissed the application vide the Impugned Order. Aggrieved by the decision, the Appellant had preferred the present appeal before the National Company Law Appellate Tribunal ( NCLAT ), Chennai Bench.

ISSUES

The central issue addressed in the present case is whether a liquidator can classify a creditor as unsecured on the basis of non-registration of the charge on mortgaged property under Section 77 of the Companies Act.

SUBMISSIONS OF THE PARTIES

Submissions of the Appellant

                The Transfer of PropertyAct confers absolute rights on the Appellant with regard to the mortgage and the same cannot be rejectedby the Respondent merely on the ground of non-registration before the RoC.The Appellant had duly registered the charge before Central Registry of Securitisation Asset Reconstruction and Security Interest of India ( CERSAI ) on June 5, 2022, i.e., before the Respondent s communication on July 1, 2022.

                The Appellant holds 95.76% (ninety-five decimal seventy six percent) voting share and hence shall not be treated as an unsecured financial creditor. Additionally, the Appellant vide letter dated June 28, 2022, had informed the Respondent that they are continuing an action under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( SARFAESI Act ) against the mortgaged asset, under Regulation 37(7) of theIBBI Regulations. Since Regulation 37(7) of the IBBI Regulations specifically provides that the SARFAESI Act prevails over the IBBI Regulations, the Respondent cannot prevent the Appellant from enforcing its mortgage under the SARFAESI Act.

                Section 58(f) of the Transfer of PropertyAct shall be given preference over the IBC since the memorandum of deposit in the present case has been registered prior to the enforcement of IBC. The IBC in operation is prospective in nature and shall not derogate the ingredients of Section 58(f) of the Transfer of PropertyAct. Furthermore, the Appellant has acquired an unfettered and indefeasible right over the mortgaged asset.Further, the memorandum of depositcannot be brushed aside since the security was not registered under Section 77 of the Companies Act, being mandatory under IBC.

                The Appellant relied upon the case of ICICI Bank v. SIDCO Leathers Limited &Ors ., [iii] wherein, the Hon ble Supreme Court had observed that while enacting the Companies Act, the Parliament cannot be held to have deprived the first charge holder of its right to enforce security interest. Such a valuation right, therefore, must be held to have been kept preserved. .

                If the IBC had not come into force, the Appellant could have easily enforced the security interest as per Section 58(f) of the Transfer of PropertyAct and Rule 8 of the Security Interest (Enforcement) Rules, 2002 ( SARFAESI Rules ). Further, Section 35 of the SARFAESI Act clearly states that the provisions of the SARFAESI Act would prevail in case of any inconsistency with any other law in force. In this regard, the Appellant relied upon the case of SICOM Limited V. Sundaresh Bhat, the Liquidator of ABG Shipyard Ltd. [iv] wherein, it was held that non-registration of mortgage under Section 77 of the Companies Act cannot be a valid ground to hold the mortgagee as unsecured creditor.

                In light of the above submissions, the Appellant prayed for setting aside the Impugned Order.

Submissions of the Respondent

                The Appellant s claim has not satisfied any requirements under Regulation 21 of the IBBI Regulations for establishing existence of security interest since they failed to furnish the documents sought by the Liquidator. Further, the fixed deposit in the name of the Borrower, as lying with the Appellant, is a mutual credit and was not adjusted in the claim sum.

                The Appellant had registered the charge with CERSAI on June 5, 2022, although the same was mandated since 2020, indicating that the registration of charge was an after-thought.In this regard, the Respondent relied upon the case of Volkswagen Finance Limited v. Shree Balaji Printpack Private Limited [v] wherein it was held that if the charge is not registered under Section 77(1) of the Companies and with CERSAI then, the creditor cannot be treated as secured creditor.

                The Respondent also relied upon UCO Bank v. G. Ramachandran, Liquidator of Sai Regency Power Corporation Private Limited [vi] wherein the security interest created by the creditor was upheld on the basis of claim form.

                The Appellant has also failed to fulfil the requirements of Section 52 of IBC r/w. Regulation 21 of the IBBI Regulations in establishing the existence of security interest to the Respondent. Furthermore, the Transfer of PropertyAct would not be applicable since the Appellant is an unsecured financial creditor.

                With respect to initiation of proceedings under the SARFAESI Act, the Respondent contended that Section 33(5) of IBC prevents initiation of any suit or proceedings when a liquidation order is passed against the corporate debtor. The Appellant in the instant case has failed to establish the security interest as per IBC and hence cannot initiate an action under SARFAESI on asset that forms part of the liquidation estate.

                In light of the above submissions, the Respondent prayed for dismissal of the appeal.

ANALYSIS AND JUDGEMENT

The secured creditor has the option to enforce its security to realise its debt or to stand entirely outside the winding up proceedings. [vii] It may also prefer a winding up petition after securing a decree from the debt recovery tribunal and a recovery certificate. [viii] Further, a secured creditor may choose another method of adjudication in case the earlier option is not viable. [ix] It is the adjudicating authority s duty to consider the rights of the secured creditor to realise the security interest and sit out of liquidation by virtue of Section 52 of IBC. [x]

Upon a reading of Section 52 and 53 of IBC, it may be understood that the intent of the legislature was to give an option to the secured creditor to choose either to enforce security interest against the asset out of the liquidation estate or to relinquish the same and claim as a secured creditor under Section 53(1)(b) of IBC and rank equal to other secured creditors.

A first charge holder would be prioritised in realising its security interest if it has not relinquished the same. However, in case of relinquishment of security interest, the distribution of assets shall be as per Section 53(1)(b)(ii) of IBC.

The liquidator shall not ask for directions to relinquish the secured interest over the assets of the secured creditor. The liquidator s role is to verify the existence of security interest and permit those creditors to exercise their rights under Section 52 of IBC who has a valid security interest over the assets. Further, since IBC prevails over SARFAESI Act, the liquidator shall not prefer a petition based on SARFAESI Act.

TheNCLAT held that the right to recover the money lent by enforcing a mortgage is a right to enforce an interest in the property. Furthermore, since the claim of the first charge holder prevails over the second charge holder, the Appellant by virtue of Section 58(f) of the Transfer of PropertyAct and Rule 8 of the SARFAESI Rules has the power to enforce the security interest. The NCLAT also observed that the NCLT has erred in upholding the decision of the Respondent in classifying the Appellant as an unsecured creditor.

Non-registration of mortgage under Section 77 of the Companies Act is not an adequate ground to declare the Appellant as unsecured creditor. Furthermore, the mortgagee s rights under the Transfer of PropertyAct and the SARFAESI Act shall not be diluted through Regulation 21 of the IBBI Regulations. With respect to the CERSAI registration, the NCLAT held that the same became mandatory in February 2020, which is much after the creation of the mortgage and hence the registration of the mortgage in the office of S.R.O. is valid in nature.

In light of the aforesaid reasons, the NCLAT had setaside the Impugned Order.

CONCLUSION

The NCLAT s decision in the present caseunderscores the importance of upholding the rights of secured creditors and their autonomy in recovering debts secured by a valid mortgage. The NCLAT has categorically explained the rights of a secured creditor and the ambit of Section 52 of IBC, thereby reaffirming the present position.Further, by settingaside the decision of the NCLT, the NCLAT has preserved the sanctity of security interest in insolvency proceedings. The case shall serve as a significant legal precedent, safeguarding the interests of secured creditors and maintaining fairness and equity in the resolution process.