Calcutta High Court
G.K. Investments Limited vs Vistra Itcl (India) Limited on 28 November, 2018
Author: Soumen Sen
Bench: Soumen Sen
IN THE HIGH COURT AT CALCUTTA
Ordinary Original Civil Jurisdiction
ORIGINAL SIDE
BEFORE:
The Hon'ble JUSTICE SOUMEN SEN
G.A. 2182 OF 2018
C.S.162 of 2018
G.K. Investments Limited
Vs.
Vistra ITCL (India) Limited
For the Petitioner : Mr. S. K. Kapur, Sr. Adv.
Mr. Utpal Bose, Sr. Adv.
Mr. Paritosh Sinha, Adv.
Mr. Saubhik Chowdhury, Adv.
Mr. Dripto Majumdar, Adv.
For the Respondent : Mr. Rudraman Bhattacharyya, Adv.
Mr. Souvik Majumdar, Adv.
Mr. Suvrojit Dasgupta, Adv.
Hearing concluded on : 26th November, 2018. Judgment on : 28th November, 2018.
Soumen Sen, J.: The notice for invocation of pledge dated 27th July, 2018 by the defendant in its capacity as the security trustee is the subject matter of challenge in this interlocutory application.
On 3rd August, 2018 an interim order was passed by which the impugned notice was stayed initially for a period of one week and, thereafter, continued till 30st November, 2018 or until further order whichever is earlier.
The respondent no.1 initially did not appear despite notice, however, subsequently the said respondent appeared and after obtaining few extensions filed a comprehensive affidavit in opposition.
The defendant no. 25 was enjoying various credit facilities from different financial institutions of which the State Bank of India was the monitoring institution. There were events of default. It appears that the State Bank of India as the monitoring institution proposed a Master Restructuring Agreement (MRA) which was subsequently amended on 24th January, 2014. The said agreement was entered into between the borrowers, the lenders and the monitoring institution. Pursuant to such agreement, the Corporate Debt Restructuring Lenders (CDRL) have restructured the then existing credit facilities of the borrower and agreed to extend additional term loan and working capital facilities to the borrower aggregating to INR 10,304.25 crore.
In consideration of the lenders agreeing to grant such credit facilities the plaintiffs have pledged their shares under the pledge agreement dated 24th November, 2014. The recital of the said pledge agreement would show that the pledgor was aware of the Corporate Debt Restructuring (CDR) package and the MRA. The pledgor, as beneficial owner of the shares as mentioned in Schedule II of the said agreement, has created such securities for due payment of the facilities and applicable interest thereon and other moneys payable in respect thereof to the borrowers and lenders under the restructuring document.
The defaults by the principal debtors have occurred.
As a consequence thereof, SBI has initiated insolvency proceeding against the borrower under the Insolvency and Bankruptcy Code, 2016, which was admitted by the National Company Law Tribunal, Kolkata on 21st July, 2017. Thereafter the impugned notices were issued for sale of the pleged shares. The impugned notices stated that payment defaults and admission of insolvency proceedings constitute Events of Default as defined under sub-clauses (a), (b), (j) and (I) of Clause 7.1 of the Original Master Restructuring Agreement and, in view of the aforesaid, each CDR Lender has right to recall/accelerate the entire amount which shall forthwith become payable by the borrower. The notice invoking pledge refers to the earlier recall notice dated 25th February, 2018 which admittedly was issued during the pendency of the NCLT proceeding in which the lenders have exercised their right under the facility agreement and demanded payment of Rs. 12,396 crores. The security trustee has alleged that although reasonable notice was given to the borrower to pay the outstanding amount under the facility agreement, no such amount has been paid. In consequence of approved resolution plan of NCLT, Kolkata, part of the outstanding amount under the facility agreement has been received by the CDR Lenders and balance outstanding amount of the CDR Lenders under the facility agreement more particularly described in Schedule II have not been paid by the borrower till today.
The lenders have issued the impugned notices under Section 176 of the Indian Contract Act, 1872 exercising their right to sell the pledge shares. These notices are under challenge.
Mr. S.K. Kapur, learned Senior Counsel appearing on behalf of the petitioner has referred to Section 31 of the Insolvency and Bankruptcy Code, 2016 and a letter dated 4th June, 2018 from the borrower to the National Stock Exchange and other applicable stock exchanges to show that Vedanta Star Limited, a wholly owned subsidiary of Vedanta Limited (VSL), had completely discharged the debt of the debtors under the scheme approved by the NCLT and in view of discharge of such debts, the said invocation is illegal. It is submitted that the interests of the debtors were protected by Vedanta in making payment partly by cash and partly by issuing equity shares in favour of the consortium. It is submitted that the notices issued by the defendant no. 1 was issued mechanically without considering such facts that are relevant for the present purpose. Mr. Kapur has also referred to the reply given on behalf of the plaintiff on 2nd August, 2018 in which the plaintiff have reiterated that as against Rs.12,396 crores as stated in the recall notice dated 27th February, 2018, the lenders have received payment of about Rs.12,719 crores which is far exceeding the amount stated in the recall notice.
Mr. Kapur has submitted that under the pledge agreement it has been clearly stated that when the facilities and other dues have been repaid duly by the borrowers in part or totality, the pledged shares shall be forthwith released in part or in toto from the pledge. Since no portion of the debt has remained unpaid the security trustee who is holding the shares for the benefit of the lenders as a beneficial owner of the pledged shares is required to release the shares in favour of the pledgors. The said security trustee under the circumstances could not have issued the said notices in purported exercise of its right under the agreement for pledge of shares. It is submitted that the letter issued by Electro Steel dated 4th June, 2018 addressed to the National Stock Exchange and other applicable stock exchanges clearly mentions that the conversion of debt into equity share capital of the company is an integral part of the resolution plan inasmuch as the plan contemplates that an amount of INR 12719,13,20,550 due to the financial creditor shall be converted into INR 7399,13,20,550 fully paid up equity shares of INR 10 each of the company (New Equity Shares) which shall be issued to the financial creditors in proportion to their respective portion of the debt. The plan contemplates reduction of share capital and consolidation of the share capital. The respondent shall be issued and allotted 176,55,06,078 fully paid up equity shares of INR 10 each of the fully diluted share capital of the company and upon allotment of the aforesaid equity shares of the company, Vedanta Ltd. will hold 90% of the paid up share capital of the company. The remaining 10% of the company's share capital will be held by the company's existing shareholders and the financial creditors who receive share in exchange for the debt owed to them. The plan also contemplates simultaneously an upfront payment of INR 5320,00,00,000 that shall be remitted to the creditors from the Escrow Account which Vedanta Limited an wholly owned subsidy of Vedanta Limited had deposited on 4th June, 2018 in Escrow Account of the Company. The effective date under the resolution plan is 4th June, 2018. It is submitted that after the lenders have accepted the said resolution plan on the terms as contained therein no money remained unpaid and outstanding and, accordingly, the issuance of notice is ex facie illegal and arbitrary.
Mr. Kapur submits that when a creditor under a settlement agrees to convert a portion of the debt into shares it must be treated as an extinguishment of liability to pay such portion of the debt and in this regard the learned Senior Counsel has relied upon the judgment of Delhi High Court in Income Tax vs. Rathi Graphics Technologies Ltd. reported at 2015 SCC Online Del 10805.
Mr. R. Bhattacharjee, the learned Counsel for the defendants, on the other hand, has contended that the resolution plan does not absolve the pledgor from discharging their debt. It is submitted that by reason of reduction of capital the intrinsic value of each equity share of the defendant No. 25 has been drastically reduced and after such reduction the value of one fully paid equity share would be 0.20 paisa. In view thereof, the lenders are entitled to realize the balance amount for which the lenders have invoked the default clause of the facility agreement. The learned counsel has referred to the minutes of the 9th meeting of the Committee of Creditors of the defendant No.25 held on 29th March, 2018 and submits that such notice, inter alia, was served upon the plaintiff No.4. One of the agenda of the said meeting was to discuss and consider amended and restated resolution plan submitted on 29th March, 2018 by the resolution professional. Mr. Bhattacharjee submits that the members after taking into consideration the upfront amount required to be paid by Vedanta in terms of the resolution plan have unanimously resolved that the acceptance of the said restated resolution plan would be without prejudice to all the claims and rights of the Committee of Creditors against the guarantors of the No.25 and their respective assets and the relevant securities provided by such guarantors or any other person, over their relevant assets, if any under the relevant existing financial documents. Mr. Bhattacharjee has also referred to the amended and restated resolution plan dated 29th March, 2018 which, inter alia, has stated that the defendant No.25 shall stand discharged of any default or event of default under any loan of documents or other financing agreements or arrangements (including any side letter, letter of convert, letter of undertaking etc.) and all rights/remedies of the creditors shall stand permanently extinguished except any rights against any third party (including existing promoters) in relation to any portion of unsustainable debt secured or guaranteed by third parties. Mr. Bhattacharjee submits that amended and restated resolution plan contemplates conversion of unsustainable debt into company's equity share capital and on the basis thereof, the issued subscribed and paid up equity share capital of the defendant No.25 was reduced and the face value of the equity share becomes 20 paisa for each fully paid up equity share. The total issued subscribed and paid up equity share capital of the No.25 becomes Rs.10028.44 crore. The lenders have accepted the amended and restated resolution plan by fully reserving their rights to enforce their claim for the unrealized debt which had fallen due by reason reduction of the share capital of the defendant No.25.
Mr. Bhattacharjee has referred to Section 39 (6) of the Insolvency and Banking Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 and submits that the said regulation makes it clear that any provision of resolution plan which would otherwise require the consent of the members or partners of the corporate debtor as the case may be under the terms of the constitutional documents of the corporate debtor, shareholders agreement, joint-ventures agreement or other documents of similar nature, shall take effect, notwithstanding, that such consent has not been obtained. It is submitted that the consent of the plaintiffs under the above circumstances is not required. In any event, the notice of the meeting, held on 25th March, 2018 would show that notice was sent to the plaintiff No. 4, however, the Plaintiff No.4 did not attend despite such notice. It is submitted that it is an admitted position that the petitioner No.4 was in control of the proforma defendant No.25 and was the promoter of the petitioner Nos. 1 to 3. He was all along aware that the face value of the shares had to be altered and had to be brought down because of the erosion of the net value of the assets. This should be evident from the minutes of the meeting dated 29th March, 2018, which was attended by the officers connected with the petitioner No.4. It would be evident from the minutes of the 9th meeting dated 29th March, 2018, that the petitioners are not absolved from discharging their liability either under the Deed of Guarantee or under the Deed of Pledge. In fact, the pledge agreements were executed to secure the due repayment of the entire dues of the No.25 to respondent Nos. 2 to 24 under the aforesaid Master Restructuring Agreement amended and supplemented by a Supplemental Master Restructuring Agreement. It is submitted that the plaintiff was also aware of the reduction of the share capital as would be evident from the letter dated 14th June, 2014 written by company Secretary of proforma Defendant No.25 who happens to be present and participated in the meeting held on 29th March, 2014. The said letter was written by the company Secretary prior to change of management to the National Stock Exchange for approval of the bid of Vedanta. Subsequently the proforma respondent no.25 through its company Secretary on 5th June, 2018 had written a letter to National Stock Exchange about reduction of price of shares. The reduction was done in pursuance of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. It is submitted that since it is the contention of the plaintiffs that the resolution plan is binding and since acts complained of are in pursuance of the resolution plan, the only available remedy of the plaintiffs is under Section 61 of the Insolvency and Bankruptcy Code, 2016.
Mr. Bhattacharjee has submitted that the recall notice was issued in accordance with the Reserve Bank scheme for sustainable structuring of stressed assets issued on 13th June, 2016 which gives a guideline of how a resolution plan can be formulated with regard to stressed assets. It is submitted that in the instant case it is an unsustainable debt and the lenders have never agreed to forgo their rights under the share pledge agreement.
In reply, Mr. Kapur has contended that there is a distinction between pledge and guarantee and the various provisions of IBC referred to by Mr. Bhattacharjee does not refer to pledge at all. Moreover, after insolvency proceeding has commenced and an interim resolution professional is appointed, under Section 16 of the Insolvency and Bankruptcy Code, 2016, the Management and Affairs of Corporate Debtor vests in the interim resolution professional and, accordingly, issuance of any notice to anyone of the directors of the defendant No.25 including the plaintiff No.4 is inconsequential. It is further submitted that no notice of meeting of CoC was given to the plaintiffs as pledges of the said shares. It is submitted that the Resolution Professional had sent notice of the 9th meeting to Sri Umang Kejriwal as member of the suspended Board of Directors of the proforma defendant NO. 25 and that too without copy of any resolution plan. The plaintiffs had no knowledge of the contents of the Resolution Plan on the date of the 9th meeting of CoC.
Mr. Kapur also submits that the use of the expressions "total sustainable debt" and "non-sustainable debt" are nomenclature adopted by the respondents and others who are involved in the proceedings before the NCLT and neither have any relevance in the present context nor are they binding or enforceable against any of the plaintiffs in any manner. Such nomenclatures are not terms of art or known in the law and have no legal basis. The manner of purported division or the mode of making financial projections conceived by Vedanta Limited and apparently used in the Insolvency Proceedings does not concern nor can be binding upon or meaningfully enforced against the plaintiffs or any of them. The fact of the matter is that the respondent no. 2 to 24 in lieu of their entire dues agreed to accept payment of sums partly in cash and partly by conversion of debt into equity. This method of liquidation of the dues of the said respondents was agreed to and accepted and implemented by them without the consent or concurrence of the plaintiffs. By reason of such dealings, the debt of the said respondents was fully liquidated and/or adjusted and/or satisfied and/or paid off in toto. It is submitted that any supposed bifurcation of the debt of the proforma respondent no. 25 into a "sustainable" portion of the debt or "unsustainable" portion of debt is irrelevant in as much as the entire debt of the respondents have been repaid by way of cash and equity. Such terms can have no bearing on the legal effect and meaning of the term "debt" as understood in law.
It is also submitted that the shares worth approximately Rs. 7399 crores were issued and allotted to the respondent no. 2 to 24 on 6th June, 2018 and the capital reduction was done on 14th June, 2018, which clearly establishes that the decrease in value of shares from INR 7399 crore (approx.) to the alleged INR 136 crore (approx.) is nothing but decrease in the value of the investments held by respondent no. 2 to 24 in proforma respondent no. 25, which was voluntarily agreed to by the CoC. Moreover, presently every share of face value of Rs. 10/- is quoted in the stock exchange at Rs. 53/-.
The moot point that needs to be decided in this application is whether the plaintiffs have made out a strong prima facie and an arguable case on merits with regard to its contention that the impugned notice is illegal and arbitrary.
The question that may be required to be decided in the suit is whether payment of the upfront amount of INR 5320.00 crore and conversion of an amount of INR 7399,13,20,550 due to the financial creditors into 739,91,32,055 fully paid up equity share of INR 10 each of the company to the financial creditors in proportion of the respective portion of the debt would discharge the liability of the plegor. There has been capital reduction and consolidation of capital as well. The amended and restated resolution plan, inter alia, stated that the company shall stand discharged of any default or event of default under any loan documents or other financing agreements or other agreements or arrangements and all rights/remedies of the creditors shall stand permanently extinguished except any rights against any third party (including existing promoters) in relation to any portion of unsustainable debt secured or guaranteed by third parties. It is further clarified that upon approval of the resolution plan by the NCLT, no further consent of any creditor shall be required to implement the Resolution Plan. Notwithstanding anything contained in the Resolution Plan, if any third party guarantor or security provider (including the Existing Promoters) who has guaranteed or secured any portion of debt availed by the Company prior to insolvency Commencement date, including the Existing Promoters who have created pledge over shares of Electrosteel Castings Limited or the Company, makes any claim against the company or Vedanta on account of any invocation/ enforcement of such guarantee or security provided, as the case may be (including the invocation of pledge over shares of Electrosteel Castings Limited or the Company) by the Financial Creditors of the Company in any circumstance (including on account of subrogation or equity), its claim shall be settled at NIL value at par with the Claims of Operational Creditors as set out in Section 3.4 II of this Resolution Plan. The restated resolution plan, therefore, has given a freehand to the lenders to enforce their right against any third party including the existing promoter in relation to any portion of unsustainable debt secured or guaranteed by third parties. This right given to the financial institutions, according to Mr. Kapur, is unilateral and not binding on the plaintiffs. In the meeting dated 29th March, 2018, the lenders have agreed to the amended and restated resolution plan subject to preservation of all their claims and rights against any person over the relevant assets, if any, provided by such persons as securities under the relevant existing Financing Documents.
Under Section 14 of the IBC once the moratorium is declared by the adjudicating authority no suit or proceeding against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal or arbitration panel or other authority can be instituted or continued. Unlike Section 22 of SICA, 1985 which is a precursor to the present legislation has not insulated a guarantor or any security furnished to the company. The lenders possibly proceeded on the basis that even if there is no bar to proceed against the securities of third parties of the corporate debtor but any proceeding or suit against the corporate debtor may potentially have a negative impact on the revival process, and enforcement of such rights against the securities may be seen as those covered under the moratorium provisions and accordingly did not take any immediate steps. That possibly could be the reason for the lenders not enforcing the pledge during the pendency of the proceeding. If the shares pledged have a bearing on the implementation of the plan and management of the corporate debtor of the company the lenders ordinarily would not be permitted to initiate such coercive proceeding. Had there be no such insolvency proceeding at all and the events of defaults had occurred the lenders could have automatically enforced the pledge agreement in addition to any other remedies that would be available to such lenders under law or contract. The moratorium under Section 14 refers only to debts due to corporate debtors, who are limited liability companies. In majority of the cases personal guarantees are given by promotees who are in management of the debtor companies. The object of the Code is not to allow such guarantors to escape from an independent and co- extensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them. In State Bank of India vs. V. Rama Krishnan & Ors. reported at AIR 2018 SC 3876 the Hon'ble Supreme Court has extensively referred to Insolvency Law Committee report in deciding whether Section 14 of the Insolvency & Bankruptcy Code 2016 would apply to a personal guarantor of a corporate debtor. It is stated:
"28. The Insolvency Law Committee, appointed by the Ministry of Corporate Affairs, by its Report dated 26.03.2018, made certain key recommendations, one of which was:
"(iv) to clear the confusion regarding treatment of assets of guarantors of the corporate debtor vis-à-vis the moratorium on the assets of the corporate debtor, it has been recommended to clarify by way of an explanation that all assets of such guarantors to the corporate debtor shall be outside scope of moratorium imposed under the Code;" The Committee insofar as the moratorium under Section 14 is concerned, went on to find:
"5.5 Section 14 provides for a moratorium or a stay on institution or continuation of proceeding, suits, etc. against the corporate debtor and its assets. There have been contradicting views on the scope of moratorium regarding its application to third parties affected by the debt of the corporate debtor, like guarantors or sureties. While some courts have taken the view that Section 14 may be interpreted literally to mean that it only restricts actions against the assets of the corporate debtor, a few others have taken an interpretation that the stay applies on enforcement of guarantee as well, if a CIRP is going on against the corporate debtor."
xxx xxx xxx "5.7 The Allahabad High Court subsequently took a differing view in Sanjeev Shriya v. State Bank of India, 2017 (9) ADJ 723, by applying moratorium to enforcement of guarantee against personal guarantor to the debt. The rationale being that if a CRIP is going on against the corporate debtor, then the debt owed by the corporate debtor is not final till the resolution plan is approved, and thus the liability of the surety would also be unclear. The Court took the view that until debt of the corporate debtor is crystallised, the guarantor's liability may not be triggered. The Committee deliberated and noted that this would meant that surety's liabilities are put on hold if a CIRP is going on against the corporate debtor, and such an interpretation may lead to the contracts of guarantee being infructuous, and not serving the purpose for which they have been entered into.
5.8 In State Bank of India v. V. Ramakrishnan and Veeson Energy Systems, NCLAT, New Delhi, Company Appeal (AT) (Insolvency) No. 213/2017 [Date of decision - 28 February, 2018], the NCLAT took a broad interpretation of Section 14 and held that it would bar proceedings or actions against sureties. While doing so, it did not refer to any of the above judgments but instead held that proceedings against guarantors would affect the CIRP and may thus be barred by moratorium. The Committee felt that such a broad interpretation of the moratorium may curtail significant rights of the creditor which are intrinsic to a contract of guarantee."
5.9 A contract of guarantee is between the creditor, the principal debtor and the surety, where under the creditor has a remedy in relation to his debt against both the principal debtor and the surety [National Project Construction Corporation Limited v. Sandhu and Co., AIR 1990 P & H 300]. The surety here may be a corporate or a natural person and the liability of such person goes as far the liability of the principal debtor. As per section 128 of the Indian Contract Act, 1872, the liability of the surety is co- extensive with that of the principal debtor and the creditor may go against either the principal debtor, or the surety, or both, in no particular sequence [Chokalinga Chettiar v. Dandayunthapani Chattiar, AIR 1928 Mad 1262].
Though this may be limited by the terms of the contract of guarantee, the general principle of such contracts is that the liability of the principal debtor and the surety is co-extensive and is joint and several [Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297]. The Committee noted that this characteristic of such contracts i.e. of having remedy against both the surety and the corporate debtor, without the obligation to exhaust the remedy against one of the parties before proceeding against the other, is of utmost important for the creditor and is the hallmark of a guarantee contract, and the availability of such remedy is in most cases the basis on which the loan may have been extended.
5.10 The Committee further noted that a literal interpretation of Section 14 is prudent, and a broader interpretation may not be necessary in the above context. The assets of the surety are separate from those of the corporate debtor, and proceedings against the corporate debtor may not be seriously impacted by the actions against assets of third parties like sureties. Additionally, enforcement of guarantee may not have a significant impact on the debt of the corporate debtor as the right of the creditor against the principal debtor is merely shifted to the surety, to the extent of payment by the surety. Thus, contractual principles of guarantee require being respected even during a moratorium and an alternate interpretation may not have been the intention of the Code, as is clear from a plain reading of Section 14.
5.11 Further, since many guarantees for loans of corporates are given by its promoters in the form of personal guarantees, if there is a stay on actions against their assets during a CIRP, such promoters (who are also corporate applicants) may file frivolous applications to merely take advantage of the stay and guard their assets. In the judgments analysed in this relation, many have been filed by the corporate applicant under Section 10 of the Code and this may corroborate the above apprehension of abuse of the moratorium provision. The Committee concluded that Section 14 does not intend to bar actions against assets of guarantors to the debts of the corporate debtor and recommended that an explanation to clarify this may be inserted in Section 14 of the Code. The scope of the moratorium may be restricted to the assets of the corporate debtor only."
It is observed that:
"29. The Report of the said Committee makes it clear that the object of the amendment was to clarify and set at rest what the Committee thought was an overbroad interpretation of Section 14."
Mr. Kapur has strenuously argued that the debt stands discharged as soon as the pledgors accepted the restated Resolution Plan. This Court, prima facie, is unable to accept the said submission in view of the rights reserved in favour of the respondent no. 2 to 24 under the restated plan and for the reasons recorded earlier.
If the plaintiffs contend that the liability could not be imposed upon them as they were not involved in the stated Plan by which the debt amount was substantially reduced and accordingly enforcement of the Share Pledge Agreement is unauthorized, illegal and unwarranted, then the plaintiff could be a person aggrieved under section 61 of the IBC. The plaintiffs, however, seem to have proceeded on the basis that the restated Plan discharges the plaintiffs and they are not the persons aggrieved and accordingly they are not required to file any appeal under section 61 of the IBC.
Mr. Kapur has drawn a distinction between guarantee and pledge. The said argument is advanced in view of the fact that the IBC Code, 2016 nowhere mentions about the pledgor but refers, inter alia, to guarantee. A guarantee as is commonly understood and also statutorily recognized is a promise to answer for the payment of some debt or the performance of some duty in case of the failure of another party, who is in the first instance, liable to such payment or performance. It is a contract to perform the promise or discharge the liability of a third party in case of his default. The pledge as defined under Section 172 of the Contract Act is a bailment of goods as security for payment of a debt. The extinguishment of debt, according to Mr. Kapur, has completely taken away the right of the lenders to enforce the pledge agreement. In a contract for guarantee unless a contrary intention appears from the agreement any variance made without the surety's consent, in the terms of the contract between the principal debtor and the creditor discharges the surety as to transactions subsequent to the variance. The surety like any other party cannot be bound to something for which he has not contracted. If the original parties have expressly agreed to vary a term of the original contract, unless, the surety has assented to the new terms there is nothing to which he can be bound, for the final obligation of the principal debtor will be something different from the obligation which the surety guaranteed; the parties having made it impossible for the guaranteed performance to take place. The surety is discharged forthwith on contract being altered without his consent. The surety is also discharged when a creditor compounds with, gives time to, or agrees not to sue, principal debtor unless the surety assents to such contract. In case of a pledge a pledgee is not entitled to sell the goods pledged to him before the amount of the loan becomes due. Where no time stipulated for payment of debt for which goods have been pledged the debtor is not in default until notice is given by the creditor that he requires payment on a certain day and that day has passed. If the pawner makes default in payment of the debt for which the goods were pledged the pawnee may bring a suit for sale of the thing pledged on giving the pawnor reasonable notice of the sale. However, the pawnee is not entitle to retain the goods pledged for any debt or promise other than the debt or promise for which they were pledged. It is on the happening of events of default that the debt became due and on the premise that the debt is not fully discharged the defendant no.1 had exercised its right under the facility agreement to sell the pledged shares for realization of a portion of the unsustainable debt after service of notice.
The pledgee can on events of defaults sue on the debt or promise but that does not extinguish the right to sell the pawn. The said right is recognised under Section 176 of the Indian Contract Act, 1872. The plaintiffs have raised the issue that the respondent no.1 having accepted payment partly in cash and partly by conversion of debt into company's equity shares in terms of the amended and restated resolution is not entitled to retain the goods pledged as the debt of the respondent no.25 stands discharged. Any compromise with the principal debtor may not automatically amount to discharge of a debt and conducts of the parties are relevant. The restated plan appears to have preserved rights of creditors against any third party (including the existing promoters) in relation to any portion of the unsustainable debt secured or guaranteed by third parties. If the plaintiffs have to fall back and rely on this plan as an excuse not to pay and claim return of the pledged shares they cannot ignore the other conditions imposed in the plan which is equally binding on all. The plaintiffs are the existing promoters. The plan is very much for continued existence of the respondent no.25. Although the plaintiff no.4 may have worn two hats but the plaintiffs are closely related to the defendant no.25 and were aware of the stand taken by the committee of creditors with regard to preservation of rights for realization of the balance amount through enforcement of the securities. The plaintiff no.4 had due notice of the meeting. If a compromise with a principal debtor does not discharge the pledgor then the consent of the pledgor would be immaterial. The resolution plan may provide for haircut, deferments and suspension of payments besides other measures and/or provisions prejudicial and/or disadvantageous to the interest of its employees, members, creditors, guarantors and other stake holders of the corporate debtor, however, such resolution plan would be binding on all such parties and stakeholders including the corporate debtor irrespective of their participation in the corporate insolvency resolution process. Moreover, a resolution plan once approved is binding, inter alia, upon the guarantors and other stake holders involved in the resolution plan. The existing promoters who have pledged their shares have stake in the defendant no.25. Moreover, it appears that the order under Section 31 is appealable under Section 32 and in any event any person aggrieved by the order of the adjudicating authority may prefer an appeal under Section 61 of the IBC, 2016. It is clear from a plain reading of the said section that filing of appeal is not restricted to creditors or the director or promoter of corporate debtor but it may include any person who is prejudicially affected by the order of the Tribunal namely, employee members, guarantor and other stake holders. The amended and restated resolution plan certainly affects the plaintiffs.
Section 31 of IBC has referred to "other stakeholders involved in the resolution plan". "Stake" means a deposit made to answer an event. In company finance, a "stakeholder" is a person or group that, because of its investment, has a direct interest in a company's performance (See Advanced Law Lexicon, compiled and edited by P. Ramanatha Aiyar, 3rd ed.). The existing promoters certainly have a stake in defendant no. 25 and would be liable to discharge the debt. The shares were pledged as security for payment of the debt. The said shares, inter alia, can be sold when there is a default in payment of the debt. In that sense, the plaintiffs are stakeholders. They were aware of the consequence of defaults. The stated resolution plan does not directly involve the present petitioners in their capacity as pledgors; but in a way it affects them as they were the existing promoters. On a strict literal interpretation of section 31(1) of the IBC, it appears that the plaintiffs are not bound by the stated resolution plan but the rider added to the said plan by which the rights of the pledgors to enforce their rights against "any third party (including the existing promoters) in relation to any portion of unsustainable debt secured or guaranteed by third parties"
undoubtedly insulates the rights of the pledges and adversely affect the rights of the pledgors. This clause needs to be read with the other clauses of the facility agreement and the MRA referred to in the Recall Notice dated 27th July, 2018.
The promoters of Electro Steel Castings Limited hold 53.02% of the shares in the defendant no. 25. The pledged shares constitute 10% of the total issued shares of the said company. Plaintiff no. 4 was promoter of Electrosteel Steels Ltd. and the plaintiff no. 1 and 2 are owned and controlled by the plaintiff no. 4, through various trusts controlled and/or managed by the plaintiff no. 4.
The Share Pledge Agreement (SPA) was entered into to secure repayment of entire dues of defendant no. 25 under Master Restructuring Agreement dated 21st December, 2013/20th January, 2014 modified and supplemented by Supplementary Master Restructuring Agreement dated 24th January, 2014 (hereinafter collectively referred to as the 'MRA').
The petitioners were aware of the resolution plan and the reduction of share capital would also be evident from the letter dated 23rd May, 2018 written by the Company Secretary of the defendant no. 25.
Although I am of the prima facie view that the stated plan does not absolve the liability of the plaintiffs for the outstanding amount under the facility agreement however, it is fairly admitted at the bar on behalf of the defendant that the notice for invocation of pledge dated 27th July, 2018 does not take into consideration the payment received by the defendant no.2 to 24 under the restated plan. Under such consideration the pledge invocation notices all dated 27th July, 2018 cannot be invoked and enforced.
The invocation of the share pledge agreement was for realization of a portion of unsustainable debt that is secured by pledge of shares. The plaintiff, however, has argued that there is no concept as sustainable debt and unsustainable debt and such nomenclature is unknown in law. The restated plan breathes life into the corporate debtor company but did not absolve the pledgors to pay for the remaining balance amount as approved under the plan by enforcement of securities.
The statement of objects and reasons of the Insolvency and Bankruptcy Code, 2016 has, inter alia, stated that the existing framework for insolvency and bankruptcy is inadequate, ineffective and results in undue delays in resolution, therefore, the proposed legislation.
The objective of the Insolvency and Bankruptcy Code, 2015 is to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time- bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the priority of payment of government dues and to establish an Insolvency and Bankruptcy Fund, and matters connected therewith or incidental thereto. An effective legal framework for timely resolution of insolvency and bankruptcy would support development of credit markets and encourage entrepreneurship. It would also improve Ease of Doing Business, and facilitate more investments leading to higher economic growth and development.
During the Parliamentary debate, learned Finance Minister Shri Arun Jaitley has, inter alia, stated on the floor of the House that the object behind SICA was revival of sick companies. But not too many revivals took place. But what happened in the process was that a protective wall was created under SICA that once you enter the BIFR, nobody can recover money from you. so, that non- performing investment became more non-performing because the companies were not being revived and the banks were also unable to pursue any demand as far as those sick companies were concerned, and therefore, SICA runs contrary to this whole concept of exit that if a particular management is not in a position to run a company, then instead of the company closing down under this management, a more liquid and a professional management must come and then save this company. That is the whole object. And if nobody can save it, rather than allowing it to be squandered, the assets must be distributed - as the Joint Committee has decided - in accordance with the waterfall mechanism which they have created. (emphasis supplied) The report of the Bankruptcy Law Reforms Committee of 2015 has observed that when creditors know they have weak rights resulting in a low recovery rate, they are averse to lend. The Report has stated: "Hence, lending in India is concentrated in a few large companies that have a low probability of failure. Further, secured credit dominates, as creditors' rights are partially present only in this case. Lenders have an emphasis on secured credit. In this case, credit analysis is relatively easy: it only requires taking a view on the market value of the collateral. As a consequence, credit analysis as a sophisticated analysis of the business prospects of a firm has shriveled.
Both these phenomena are unsatisfactory. In many settings, debt is an efficient tool for corporate finance; there needs to be much more debt in the financing of Indian firms. E.g., long-date corporate bonds are essential for most infrastructure projects. The lack of lending without collateral, and the lack of lending based on the prospects of the firm, has emphasized debt financing of asset-heavy industries. However, some of the most important industries for India's rapid growth are those which are more labour intensive. These industries have been starved of credit.
"When a firm (referred to as the corporate debtor in the draft law) defaults, the question arises about what is to be done. Many possibilities can be envisioned. One possibility is to take the firm into liquidation. Another possibility is to negotiate a debt restructuring, where the creditors accept a reduction of debt on an NPV basis, and hope that the negotiated value exceeds the liquidation value. Another possibility is to sell the firm as a going concern and use the proceeds to pay creditors. Many hybrid structures of these broad categories can be envisioned.
The Committee believes that there is only one correct forum for evaluating such possibilities, and making a decision: a creditors committee, where all financial creditors have votes in proportion to the magnitude of debt that they hold. In the past, laws in India have brought arms of the Government (legislature, executive or judiciary) into this question. This has been strictly avoided by the Committee. The appropriate disposition of a defaulting firm is a business decision, and only the creditors should make it."
The report also highlighted the role that Insolvency and Bankruptcy plays in debt financing. It is stated: "The creditors put money into debt investments today in return for the promise of fixed future cash flows. But the returns expected on these investments are still uncertain because at the time of repayment, the seller (debtor) may make repayments as promised, or he may default and does not make the payment. When this happens, the debtor is considered insolvent. Other than cases of outright fraud, the debtor may be insolvent because of
(i) Financial failure - a persistent mismatch between payments by the enterprise and receivables into the enterprise, even though the business model is generating revenues, or
(ii) Business failure - which is a breakdown in the business model of the enterprise, and it is unable to generate sufficient revenues to meet payments.
Often, an enterprise may be a successful business model while still failing to repay its creditors. A sound bankruptcy process is one that helps creditors and debtors realize and agree on whether the entity is facing financial failure and business failure. This is important to allow both parties to realize the maximum value of the business in the insolvency.
Control of a company is not divine right. - When a firm defaults on its debt, control of the company should shift to the creditors. In the absence of swift and decisive mechanisms for achieving this, management teams and shareholders retain control after default. Bankruptcy law must address this."
The committee indicated various principles to design the new insolvency and bankruptcy resolution framework which, inter alia, include:-
"The Code will ensure a time-bound process to better preserve economic value.
The law must ensure that time value of money is preserved, and that delaying tactics in these negotiations will not extend the time set for negotiations at the start.
The Code will ensure a collective process.
The law must ensure that all key stakeholders will participate to collectively asses viability. The law must ensure that all creditors who have the capability and the willingness to restructure their liabilities must be part of the negotiation process. The liabilities of all creditors who are not part of the negotiation process must also be met in any negotiated solution.
The Code will respect the rights of all creditors equally. The law must be impartial to the type of creditor in counting their weight in the vote on the final solution in resolving insolvency.
The Code must ensure clarity of priority, and that the rights of all stakeholders are upheld in resolving bankruptcy.
The law must clearly lay out the priority of distributions in bankruptcy to all stakeholders. The priority must be designed so as to incentivize all stakeholders to participate in the cycle of building enterprises with confidence.
While the law must incentivize collective action resolving bankruptcy, there must be a greater flexibility to allow individual action in resolution and recovery during bankruptcy compared with the phase of insolvency resolution."
A financial creditor has been defined under Section 5(7) as a person to whom a financial debt is owed and financial debt is defined under Section 5 (8) to mean a debt which is disbursed against consideration for the time value of many as opposed to this an operation creditor means a person to whom an operational debt is owed and an operational debt under section 5 (21) means to claim in respect of provision of goods or services.
The salient features of IBC, 2016 was discussed at length in Innovative Industries Ltd. (supra). In the instant case, we are concerned and financial creditors. Section 7 becomes relevant when it comes to a financial creditor triggering the process. In the case of a corporate debtor who commits a default of a financial debt, the adjudicating authority has merely to see the records of the information, utility or other evidence produced by the financial creditor to satisfy itself that a default has occurred. As soon as the application is admitted a moratorium in terms of section 14 of the Code is to be declared by the adjudicating authority land a public announcement is made stating, inter alia, the last date of submission of claim and the details of the interim resolution professional who shall be vested with the management of the corporate debtor and the responsible for receiving claims. Under Section 17, the erstwhile management of the corporate debtor vested in an interim resolution professional who is a trained and qualified person registered under Chapter IV of the Code.
This interim resolution professional is now to manage the operations of the corporate debtor as a going concern under the directions of a committee of creditors appointed under Section 21 of the Act. Decisions by this committee are to be taken by a vote of not less than 75% of the voting share of the financial creditors. Under Section 28, a resolution professional, who is none other than an interim resolution professional who is appointed to carry out the resolution process, is then given wide powers to raise finances, create security interests, etc. subject to prior approval of the committee of creditors.
Under Section 30 any person who is interested in putting the corporate body back on its feet may submit a resolution plan to the resolution professional, which is prepared on the basis of an information memorandum.
This plan must provide for payment of insolvency resolution process costs, management of the affairs of the corporate debtor after approval of the plan, and implementation and supervision of the plan. It is only when such plan is approved by a vote of not less than 75% of the voting share of the financial creditors and the adjudicating authority is satisfied that the plan, as approved, meets the statutory requirements mentioned in Section 30, that it ultimately approves such plan, which is then binding on the corporate debtor as well as its employees, members, creditors, guarantors and other stakeholders. Importantly, and this is a major departure from previous legislation on the subject, the moment the adjudicating authority approves the resolution plan, the moratorium order passed by the authority under Section 14 shall cease to have effect. The scheme of the Code, therefore, is to make an attempt, by divesting the erstwhile management of its powers and vesting it in a professional agency, to continue the business of the corporate body as a going concern until a resolution plan is drawn up, in which event the management is handed over under the plan so that the corporate body is able to pay back its debt and get back on its feet. All this is to be done within a period of 6 months with a maximum extension of another 90 days or else the chopper comes down and the liquidation process begins. (See. Innoventive Industries Ltd.) (supra) An unsustainable debt according to me would be a debt where the assets are classified as stressed assets, that is to say, there has been a significant diminution in the intrinsic value of such assets in comparison to the liabilities of the company. It essentially occurs when there is a gross mismatch between the assets and the liabilities and raises a red herring that all is not well with the corporate debtor and there is a threat from creditors to proceed against the assets of the corporate debtor which might not only affect the debtor company but all other stakeholders. The triggering of the process may ultimately result in a plan by which corporate body is able to survive and get back on its feet. In such proceeding the creditors may give up some of their claims with or without conditions in an expectation that such concessions and rearrangement would be beneficial for the continued existence of the corporate debtor. The creditors in doing so may not in all situations give up their right to enforce other securities so as to recover the deficit which has been done in the instant case and reflected in the reinstated plan but in no case can realize more that it had agreed. Once the debt is crystallized to the extent the unsustainable portion of the debt has remained unrealized the secured creditors may realize such sums after giving adjustment of all sums received under the plan. Keeping in view the object of the Code and the terms of the restated plan it prima facie appears that the creditors have not given up the right to cover the differential amount that has resulted due to the reduction in the value of shares. The object and purpose of the plan needs to be read, understood and considered in that context. On such considerations, I am unable to accept that the restated plan has extinguished the liability of the pledgors. The said view is, however, prima facie and not conclusive. The issue is not finally decided as is not necessary at this stage to decide it finally as the notices are otherwise liable to be quashed for the reasons stated below. However, it would only be a pyrrhic victory for the financial institutions as it has been fairly conceeded and admitted at the bar that the notices of invocation of pledge does not reflect the correct amount as the amounts realized under the plan partly by cash and partly by conversion of debt into equity have not been accounted for. On such considerations the pledge invocation notices all dated 27th July, 2018 are set aside.
G.A. 2182 of 2018 is accordingly stands disposed of. However, there shall be no order as to costs.
Urgent Photostat certified copy of this judgment, if applied for, be given to the parties on usual undertaking.
(Soumen Sen, J.)