How Should A Promoter/director Proceed To Participate In The Auction Of CD (MSME Unit) During The Liquidation Process ?

– Written by Arvind Mangla, Insolvency Consultant, Ex-Banker, and Author “Claims of Creditors” & “Offences & Penalties in IBC”. He has also launched open online IBC Case Law reference library, ibc-caselaw.blogspot.com

Query; How should a promoter/director proceed to participate in the auction of CD (MSME Unit) during the liquidation process ?

Facts of the Case

CD is a MSME UNIT.
Promoter/ Director is a guarantor for the credit facilities granted by SFC (Secured Financial Creditor).
Core Assets of the CD includes;
- i). Factory building, plant & machinery is owned by the CD and is mortgaged to SFC (Secured Financial Creditor).
- ii).Land. on which the factory is situated is owned by the promoter/director of CD & the same is also mortgaged with the SFC.
Liquidator has informed SCC (Stakeholder Consultation Committee) that SFC has relinquished the charge on the land (supra above) in favour of the Liquidator.
CoC while passing resolution for liquidation of the CD, directed to sell the CD in liquidation as a going concern as per the provisions of Regulation 39(c)(1), however provisions of Regulation 39(c)(2), for clubbing of liabilities with assets, were not invoked by CoC while passing resolution for liquidation of the CD.

Issues

Eligibility under section 29A.
Clubbing of Assets & Liabilities in going concern sale.
Auction of Guarantor’s property along with the property/assets of CD by the Liquidator.
SARFAESI Section 13(2) notice to Promoter/directors. Promoter/Guarantor should not participate in the auction of the assets of CD/Guarantor by SFC/ Liquidator under the provisions of SARFAESI, in view of the ruling of Hon’ble Supreme Court discussed in the following paragraphs.
Likely personal insolvency proceedings against Promoter/directors/guarantor, depending upon the limitation available to the SFC on the basis of documents which SFC might be holding. Promoter/directors/guarantor should not sign any communication to SFC, henceforth.

Keeping in view of the totality of the situation, it is not advisable for Promoter/ directors/ guarantor to directly participate/acquire the assets of CD/guarantor through auction in liquidation/SARFAESI proceedings.

For the purpose of acquiring the assets of CD/guarantor, a SPV (Special Purpose Vehicle – Company/Trust) may be formed by “unconnected persons”. [section 29A(j)]. Promoter/ directors/ guarantor may join SPV at a later date when the dust settles. (Personal Insolvency / DRT proceedings / SARFAESI proceedings)

Issue No. 1 – Eligibility under section 29A.

1. Provisions of the Code & Regulations

# Section 29A. Persons not eligible to be resolution applicant. –

A person shall not be eligible to submit a resolution plan, if such person, or any other person acting jointly or in concert with such person—

(a) is an undischarged insolvent;

(b) is a wilful defaulter in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949 (10 of 1949);

(c) at the time of submission of the resolution plan has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949 (10 of 1949) 3[or the guidelines of a financial sector regulator issued under any other law for the time being in force, and at least a period of one year has lapsed from the date of such classification till the date of commencement of the corporate insolvency resolution process of the corporate debtor:

Provided that the person shall be eligible to submit a resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to nonperforming

asset accounts before submission of resolution plan:

Provided further that nothing in this clause shall apply to a resolution applicant where such applicant is a financial entity and is not a related party to the corporate debtor.

Explanation I.- For the purposes of this proviso, the expression “related party” shall not include a financial entity, regulated by a financial sector regulator, if it is a financial creditor of the corporate debtor and is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares 1[or completion of such transactions as may be prescribed], prior to the insolvency commencement date.

Explanation II.— For the purposes of this clause, where a resolution applicant has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset and such account was acquired pursuant to a prior resolution plan approved under this Code, then, the provisions of this clause shall not apply to such resolution applicant for a period of three years from the date of approval of such resolution plan by the Adjudicating Authority under thisCode;

(d) has been convicted for any offence punishable with imprisonment –

(i) for two years or more under any Act specified under the Twelfth Schedule; or

(ii) for seven years or more under any law for the time being in force:

Provided that this clause shall not apply to a person after the expiry of a period of two years from the date of his release from imprisonment:

Provided further that this clause shall not apply in relation to a connected person referred to in clause(iii) of Explanation I];

(e) is disqualified to act as a director under the Companies Act, 2013 (18 of 2013):

Provided that this clause shall not apply in relation to a connected person referred to in clause (iii) of Explanation I;

(f) is prohibited by the Securities and Exchange Board of India from trading in securities or accessing the securities markets;

(g) has been a promoter or in the management or control of a corporate debtor in which a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place and in respect of which an order has been made by the Adjudicating Authority under this Code:

Provided that this clause shall not apply if a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place prior to the acquisition of the corporate debtor by the resolution applicant pursuant to a resolution plan approved under this Code or pursuant to a scheme or plan approved by a financial sector regulator or a court, and such resolution applicant has not otherwise contributed to the preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction;

(h) has executed a guarantee in favour of a creditor in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under this Code and such guarantee has been invoked by the creditor and remains unpaid in full or part;

(i) is subject to any disability, corresponding to clauses (a) to (h), under any law in a jurisdiction outside India; or

(j) has a connected person not eligible under clauses (a) to (i).

Explanation [I]. — For the purposes of this clause, the expression “connected person” means—

(i) any person who is the promoter or in the management or control of the resolution applicant; or

(ii) any person who shall be the promoter or in management or control of the business of the corporate debtor during the implementation of the resolution plan; or

(iii) the holding company, subsidiary company, associate company or related party of a person referred to in clauses (i) and (ii):

Provided that nothing in clause (iii) of Explanation I shall apply to a resolution applicant where such applicant is a financial entity and is not a related party of the corporate debtor:

Provided further that the expression “related party” shall not include a financial entity, regulated by a financial sector regulator, if it is a financial creditor of the corporate debtor and is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares 6[or completion of such transactions as may be prescribed], prior to the insolvency commencement date;

Explanation II—For the purposes of this section, “financial entity” shall mean the following entities which meet such criteria or conditions as the Central Government may, in consultation with the financial sector regulator, notify in this behalf, namely: —

(a) a scheduled bank;

(b) any entity regulated by a foreign central bank or a securities market regulator or other financial sector regulator of a jurisdiction outside India which jurisdiction is compliant with the Financial Action Task Force Standards and is a signatory to the International Organisation of Securities Commissions Multilateral Memorandum of Understanding;

(c) any investment vehicle, registered foreign institutional investor, registered foreign portfolio investor or a foreign venture capital investor, where the terms shall have the meaning assigned to them in regulation 2 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 made under the Foreign Exchange Management Act , 1999 (42 of 1999);

(d) an asset reconstruction company register with the Reserve Bank of India under section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002);

(e) an Alternate Investment Fund registered with Securities and Exchange Board of India;

(f) such categories of persons as may be notified by the Central Government .

2. Case Law on Section 29A;

NCLAT (04.07.2022) in Avantha Holdings Ltd. Vs. Mr. Abhilash Lal, RP for Jhabua Power Ltd. [Company Appeal (AT) (Insolvency) No. 304 of 2022] – [29A(c) – Date of declaration of NPA] [ Link – Synopsis ]
NCLT Chandigarh (24.05.2022) in Mr. Sumat Gupta RP, M/s Vallabh Textiles Company Ltd. Vs. M/s Aggarsain Spinners Ltd. [IA No.342 of 2021, IA No.456 of 2021, IA No.154 of 2022 In CP(IB) No.391/Chd/Pb/2018] – [29A(f)] [ Link – Synopsis ]
NCLAT (05.04.2022) in Sharavan Kumar Vishnoi & Anr. Vs. Upma Jaiswal & Ors. [Comp. App. (AT) (Ins.) No. 371 & 374 of 2022] – [29A – 30(2)(e)] [ Link – Synopsis ]
Supreme Court (18.01.2022)) in Bank of Baroda & Anr. Vs. MBL Infrastructures Ltd. & Ors. [Civil Appeal No. 8411 of 2019] – [29A(h)] [ Link – Synopsis ]
NCLAT (05.01.2022)) in Everest Organics Ltd. Vs. Leesa Lifesciences Pvt. Ltd. [Company Appeal (AT) (CH) (INS) No. 228 of 2021] – [29A(e)] [ Link – Synopsis ]
NCLAT (03.01.2022) in Canara Bank Vs. Mamta Binani, RP of Aristo Texcon Pvt. Ltd. [(Company Appeal(AT)(Insolvency) No. 1117 of 2019)] – [‘ex-facie’ opinion of RP] [ Link – Synopsis ]
NCLAT (21,09.2021) In Telangana State Trade Promotion Corporation Vs. A.P. Gems & Jewellery Park Pvt. Ltd. & Anr. [Company Appeal (AT)(CH) (Ins.) No.54 of 2021] – [29A(c) – 21(2) in praesenti] [ Link – Synopsis ]
NCLAT (04.06.2021) in Martin S.K.Golla & Anr. Vs Wig Associates Pvt. Ltd. & Ors. [Company Appeal (AT) (Ins) No.121 of 2019] – [ in praesenti 29A(c)] [ Link – Synopsis ]
NCLAT (01.06.2021) in Rakesh Kumar Agarwal & Ors. Vs Devendra P. Jain [Company Appeal (AT) (Insolvency) No. 1034 of 2020] – [29A – 240A] [ Link – Synopsis ]
SCI (15.03.2021) in Arun Kumar Jagatramka Vs. Jindal Steel and Power Ltd. & Anr. [Civil Appeal No. 9664 of 2019] – [29A – 35(1)(f) & 230 of CA] [ Link – Synopsis ]
NCLAT (17.02.2020) in JSW Steel Ltd. Vs. Mahender Kumar Khandelwal & Ors. [Company Appeal (AT) (Insolvency) No. 957 of 2019] – [Authorities empowered to decide in 29A] [ Link – Synopsis ]
Supreme Court of India (04.10.2018) in ArcelorMittal India Private Limited Vs. Satish Kumar Gupta and Ors.(Civil Appeal Nos. 9402 – 9405 of 2018) – [Role of RP, CoC & AA] [ Link – Synopsis ]

3. # Section 240A. Application of this Code to micro, small and medium enterprises.

(1) Notwithstanding anything to the contrary contained in this Code, the provisions of clauses (c) and (h) of section 29A shall not apply to the resolution applicant in respect of corporate insolvency resolution process of any micro, small and medium enterprises.

4. # Section 35. Powers and duties of liquidator. –

(1) Subject to the directions of the Adjudicating Authority, the liquidator shall have the following powers and duties, namely: –

(f) subject to section 52, to sell the immovable and movable property and actionable claims of the corporate debtor in liquidation by public auction or private contract, with power to transfer such property to any person or body corporate, or to sell the same in parcels in such manner as may be specified:

Provided that the liquidator shall not sell the immovable and movable property or actionable claims of the corporate debtor in liquidation to any person who is not eligible to be a resolution applicant.

5. Case law on Section 35(1)(f)

NCLAT (14.12.2018) in State Bank of India Vs. Anuj Bajpai (Liquidator) [Company Appeal (AT) (Insolvency) No. 509 of 2019] held that;

# 9. …….. From the plain reading of the said provision, it is clear that the ‘Liquidator’ cannot sell the assets of the ‘Corporate Debtor’ to the persons who are ineligible in terms of Section 29A of the ‘I&B Code’.

# 15. Even if Section 52(4) is silent relating to sale of secured assets to one or other persons, the Explanation below Section 35(1)(f) makes it clear that the assets cannot be sold who are ineligible under Section 29A,
# 16. If during the liquidation process assets cannot be sold to a person who is ineligible under Section 29A, the said provision only applicable to the ‘Liquidator’ but also to the ‘secured creditor’, who opt out of Section 53 to realise the claim in terms of Section 52(1)(b) read with Section 52(4) of the ‘I&B Code’.

[ Link – Synopsis ]

Issue No. 2 – Clubbing of Assets & Liabilities in going concern sale.

CoC while passing resolution for liquidation of the CD, directed to sell the CD in liquidation as a going concern as per the provisions of Regulation 39(c)(1), however provisions of Regulation 39(c)(2), for clubbing of liabilities with assets, were not invoked by CoC while passing resolution for liquidation of the CD.

Promoter/ directors/ guarantor should resist/oppose the proposal of liquidator under Regulation 32A (c) of Liquidation Regulations, to club the liabilities with assets in a going concern sale in SCC (Stakeholders Consultation Committee meetings).

1. CIRP Regulations

# Regulation 39C. Assessment of sale as a going concern.

(1) While approving a resolution plan under section 30 or deciding to liquidate the corporate debtor under section 33, the committee may recommend that the liquidator may first explore sale of the corporate debtor as a going concern under clause (e) of regulation 32 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 or sale of the business of the corporate debtor as a going concern under clause (f) thereof, if an order for liquidation is passed under section 33.

(2) Where the committee recommends sale as a going concern, it shall identify and group the assets and liabilities, which according to its commercial considerations, ought to be sold as a going concern under clause (e) or clause (f) of regulation 32 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.

(3) The resolution professional shall submit the recommendation of the committee under sub regulations (1) and (2) to the Adjudicating Authority while filing the approval or decision of the committee under section 30 or 33, as the case may be.”.

2. Liquidation Regulations

32A. Sale as a going concern.

(1) Where the committee of creditors has recommended sale under clause (e) or (f) of regulation 32 or where the liquidator is of the opinion that sale under clause (e) or (f) of regulation 32 shall maximise the value of the corporate debtor, he shall endeavour to first sell under the said clauses.

(2) For the purpose of sale under sub-regulation (1), the group of assets and liabilities of the corporate debtor, as identified by the committee of creditors under sub-regulation (2) of regulation 39C of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 shall be sold as a going concern.

(3) Where the committee of creditors has not identified the assets and liabilities under subregulation (2) of regulation 39C of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, the liquidator shall identify and group the assets and liabilities to be sold as a going concern, in consultation with the consultation committee.

3. Case Law

i). NCLAT (11.01.2022) In Visisth Services Ltd. Vs. S. V. Ramani, Liquidator of United Chloro-Paraffins Pvt. Ltd. [Company Appeal (AT) (Insolvency) No.896 of 2020 ] held that;

It can be seen from the afore-noted discussion as well as Regulation 32 A of the IBBI (Liquidation Process) Regulations, 2016 that Sale as a ‘Going Concern’ means sale of assets as well as liabilities and not assets sans liabilities.

Paragraphs 3.2.1 and 4.2.1 of the afore-noted discussion paper amply specified that all assets and liabilities, which constitute an integral business of the Corporate Debtor Company would be transferred together and the consideration paid must be for the business of the Corporate Debtor.
We conclude that Sale of a Company as a ‘Going Concern’ means sale of both assets and liabilities, if it is stated on ‘as is where is basis’. [ Link Synopsis ]

ii). NCLAT (25.02.2022) in M/s Shiv Shakti Inter Globe Exports Pvt. Ltd. Vs. M/s KTC Foods Private Limited [Company Appeal (AT) (Insolvency) No. 650 of 2020] held that;

# 21. Adverting to the contention of the Learned Counsel for the Appellant that the Adjudicating Authority has erred in denying the sale of the ‘Corporate Debtor’ as a ‘going concern’ to the Appellant without including any contingent liabilities, we hold that it is a settled law that when the sale proceeds of a ‘Corporate Debtor’ are duly distributed in the Order of priority and in the manner prescribed under Section 53 of the Code, claims of any other Creditor cannot be entertained contrary to the provisions entailed under Section 53; subsequent to the distribution of sale proceeds under Section 53 no other entity including any Government entity can claim any past unpaid or outstanding dues against the Appellant who has purchased the ‘Corporate Debtor Company’ as a ‘going concern’.
It is significant to mention that the second Respondent/Liquidator has specifically submitted that even these claims by the Uttar Haryana Bijili Vitran Nigam were not submitted in the prescribed form either during the CIRP Process or at the Liquidation stage. We are of the considered view that at this stage subsequent to the sale of the ‘Corporate Debtor Company’ as a ‘going concern’, these claims cannot be foisted upon the Appellant. The scope and objective of the Code is to extinguish all claims specifically the ones which were not even made during the CIRP or in the Liquidation stage, to aid the purchaser of the Company as a ‘going concern’ to start on a ‘clean slate’.
The Hon’ble Supreme Court in ‘Ghanshyam Mishra & Sons Pvt. Ltd.’ Vs. ‘Edelweiss Asset Reconstruction Company Ltd. & Ors.’, Civil Appeal No. 8129 of 2019 and in ‘CoC of Essar Steel India Ltd.’ Vs. ‘Satish Gupta & Ors.’ (2020) 8 SCC 531 has laid down the proposition that the purchaser of the Company even in the Liquidation stage cannot be burdened with past liabilities when it is not mentioned in the ‘Sale Notice’.

[ Link – Synopsis ]

iii). NCLAT (26.05.2022) in Eastern Power Distribution Company of Andhra Pradesh Ltd. Vs. Maithan Alloys Ltd. [Company Appeal (AT) (Insolvency) No. 961 of 2021] held that;

That when the sale proceeds of a ‘Corporate Debtor’ are duly distributed in the Order of priority and in the manner prescribed under Section 53 of the Code, claims of any other Creditor cannot be entertained contrary to the provisions entailed under Section 53;

Subsequent to the distribution of sale proceeds under Section 53 no other entity including any Government entity can claim any past unpaid or outstanding dues against the Appellant who has purchased the ‘Corporate Debtor Company’ as a ‘going concern’

We are of the considered view that at this stage subsequent to the sale of the ‘Corporate Debtor Company’ as a ‘going concern’, these claims cannot be foisted upon the Appellant.

“The scope and objective of the Code is to extinguish all claims specifically the ones which were not even made during the CIRP or in the Liquidation stage, to aid the purchaser of the Company as a ‘going concern’ to start on a ‘clean slate’.

That the purchaser of the Company even in the Liquidation stage cannot be burdened with past liabilities when it is not mentioned in the ‘Sale Notice’.
The submission of the Appellant that they are entitled to recover the entire pre-CIRP and post-CIRP dues from the Successful Auction Purchaser i.e. Respondent No. 1 cannot be accepted. [ Link Synopsis ]

In my personal opinion, the clubbing of liabilities with assets in a going concern sale/auction is violative of the provisions of the Code on the following grounds.

The word “Liability” or “Liabilities” is nowhere defined in the Code, CIRP Regulations, Liquidation Regulations or The Companies Act.

Elaborate provisions have been provided in the Code to identify the assets & claims (liabilities) of the CD.

a). Section 36 – Identification of Assets.

b). Section 38 to 42 – Identification of claims on CD (Liabilities of CD).

Further Section 52 & 53 provides for disposal of assets & settlement of claims (liabilities).

As per the provisions of Section 53, after distribution of the proceeds of assets by the liquidator, all claims/liabilities stand satisfied/extinguished.

Now the question is how CoC can identify the liabilities (claims on CD) during insolvency process, even prior to public announcement of Liquidator calling for the claims on CD.

Liabilities, auctioned/sold along with assets in going concern auction/sale during liquidation, will thus get novated and will be satisfied in full in due course of time. Clubbing of liabilities (claims on CD) with assets will also tantamount to preferential treatment of such liabilities vis-a-viz liabilities/claims settled by liquidator under the provisions of Section 53.

Thus this will be the violation of Fundamental Rights of Equality enshrined under the Constitution of India.

The Constitution Of India
Article 14. Equality before law The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India Prohibition of discrimination on grounds of religion, race, caste, sex or place of birth.

Now the questions arise;

What are the criterias to be adopted by CoC [Regulation 39(c)] & liquidator [Regulation 32A] for identifying the liabilities for clubbing the same with assets in going concern sale during liquidation.
Whether these liabilities so identified (supra) will stand attached with the assets and constitute as part of Liquidation Estate (Section 36).
Whether the liquidator has powers to auction/sale any asset/liability, which are not part of Liquidation Estate.
Whether liquidator has to settle liabilities/creditors mandatorily as per the priority specified in section 53 or the priority of liabilities/creditors can be altered by RP/Liquidator by clubbing the liabilities with assets in consultation with CoC [CIRP Regulation 39(c)] / SCC [Liquidation Regulation 32A]
Whether the liabilities of CD can survive the liquidation process?
How will the compliance of Section 54 be taken care of?

iv). NCLT Mumbai-I (09.03.2021) in Gaurav Jain Vs. Sanjay Gupta, [IA No. 2264 of 2020 in C.P. (IB) No. 1239/MB/2018] held that;

The crux of the ‘going concern sale’ is that the equity shareholding of the Corporate Debtor is extinguished and the acquirer takes over the undertaking with the assets, licenses, entitlements etc.

The Corporate Debtor survives, only the ownership is transferred by the Liquidator to the purchaser. All the rights, titles and interest in the Corporate Debtor including the legal entity is transferred to the purchaser. After the sale as a ‘going concern’, the purchaser will be carrying on the business of the Corporate Debtor.

As far as the Liquidator is concerned, when the sale consideration is received from the bidder / purchaser, the same will be distributed to the Creditors in accordance with Section 53 of the Code. Since the amount is paid to the Creditors in terms of the Code, the liabilities of the Corporate Debtor towards the Creditors are treated as settled and the purchaser takes the assets free of any encumbrances or whatsoever.
In the normal parlance “going concern” sale is transfer of assets along with the liabilities. However, as far as the ‘going concern’ sale in liquidation is concerned, there is a clear difference that only assets are transferred and the liabilities of the Corporate Debtor has to be settled in accordance with Section 53 of the Code and hence the purchaser of this assets takes over the assets without any encumbrance or charge and free from the action of the Creditors. [ Link – Synopsis ]

Thus, there are contradictions in the various orders (supra), in respect of the following question;

Whether the auction purchaser during liquidation process under IBC takes over the assets without any encumbrance or charge and free from the action of the Creditors.

This position is negated when the assets & liabilities are clubbed together for auction/sale in going concern sale as per the existent regulations. Rather, provisions of going concern sale in liquidation are being used as a backdoor resolution process and reliefs, concessions & protections [Section 32A(1)] of the resolution process are being allowed in arbitrary manner, in absence of Rules & Regulations. Even in the resolution process, all liabilities stand extinguished, post approval of the resolution plan by the Adjudicating Authority. Thus clubbing of liabilities with assets in going concern sale during liquidation process is antithesis of the objectives of the Code.

Issue No. 3 – Auction of Guarantor’s property along with the property/assets of CD by the Liquidator.

In a recent development, NCLT/NCLAT permitted sale/auction of the assets of the guarantor alongwith the the assets of CD in a going concern sale.

NCLAT (13.05.2022) in Ayan Mallick Vs. Pratim Bayal, Liquidator & Ors. [Company Appeal (AT) (Insolvency) No. 456 of 2022] held that;

13.05.2022: Heard learned counsel for the Appellant, Shri Ashish Makhija, learned counsel for the Liquidator and learned counsel appearing for the Bank. This Appeal has been field against the order dated 01.02.2022 by which the Adjudicating Authority (National Company Law Tribunal), Kolkata Bench, Kolkata has dismissed the I.A. No. 32/KB/2022 filed by the Applicant/Appellant. In the I.A. the prayer made by the Appellant who is Suspended Director of the Corporate Debtor was that e-auction sale notice dated 16.12.2021 for sale of the assets of the Corporate Debtor under liquidation and assets of the guarantor under SARFAESI Act be stayed until the disposal of the I.A.

# 2. The e-auction notice was issued for sale of factory and land. Apart from the assets of the Corporate Debtor, the land was owned by the Promoter/ Guarantor, hence, e-auction notice was for a joint sale of the assets. It was submitted before the Adjudicating Authority that joint sale will maximize the value of assets of the Corporate Debtor, hence the Court should permit the same. After hearing the learned counsel for the parties, the Adjudicating Authority rejected the application and observed that if there is maximization of the assets, selling it as a combined should not prejudice the applicant in any manner as it is going to get a better value for the corporate guarantor.

# 5. We have considered submissions of learned counsel for the parties and perused the record. When the Adjudicating Authority is satisfied that joint sale shall bring maximization of assets of the Corporate Debtor and the possession of the properties of the Guarantors have already been taken under SARFAESI and both land and factory need to be sold together to maximize the value of the assets, we fail to see that how the Appellant shall be prejudiced in any manner. We do not find any error in the order of the Adjudicating Authority rejecting the I.A. We dismiss the Appeal. We, however, observe that it shall be open to the Appellant to take such remedy under SARFAESI with regard to auction in accordance with law. [ Link – Synopsis ]

I personally do not subscribe to the above, and the following questions needs to be answered;

Whether Liquidator can include the property of guarantor in the Liquidation Estate.
Whether Liquidator can deal/auction any property outside the Liquidation Estate.
Whether Liquidator has powers to take into possession any property under the provisions of SARFAESI.
Whether a bank/financial institution can appoint Liquidator as its authorised officer to deal with the property (secured asset) under the provisions of SARFAESI.
Whether a Liquidator can work as representative of a stakeholder during the liquidation process.
In joint reserve price /joint auction notice how the money will be distributed of the realisation post auction.

Following are the provisions of the Code & regulations’

Quote.

# Section 36. Liquidation estate. –

(1) For the purposes of liquidation, the liquidator shall form an estate of the assets mentioned in sub-section (3), which will be called the liquidation estate in relation to the corporate debtor.

(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following: –

(a) any assets over which the corporate debtor has ownership rights, including all rights and interests therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;

(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation: –

(c) personal assets of any shareholder or partner of a corporate debtor as the case may be provided such assets are not held on account of avoidance transactions that may b avoided under this Chapter;

Unquote,

As per the provisions of the Code, personal assets of any shareholder can not be the part of the “Liquidation Estate” and can not be used for recovery in the liquidation process under the Code. However, a bank (SFC) can deal/realise mortgaged properties, other than those owned by CD , held by the bank as collateral security, outside the liquidation process as per existent laws.

Although, Liquidator, in his personal capacity, can accept assignment for disposal of properties mortgaged to the bank, (owned by shareholders) , as authorised agent/ representative of the bank, but the moment Liquidator, agrees to act as agent/representative of a stakeholder (bank), he renders himself ineligible to work as Liquidator & has to voluntarily vacate the office of Liquidator.

Quote;

Liquidation Regulations

# Regulation 3. Eligibility for appointment as liquidator.

(1) An insolvency professional shall be eligible to be appointed as a liquidator if he, and every partner or director of the insolvency professional entity of which he is a partner or director, is independent of the corporate debtor.

(3) An insolvency professional shall not continue as a liquidator if the insolvency professional entity of which he is a director or partner, or any other partner or director of such insolvency professional entity represents any other stakeholder in the same liquidation process.

Unquote,

In my opinion, the best way forward for the bank, in the present situation, is to enforce its security interest for the property of CD (Factory plant & machinery) under section 52(1)(b) and realise the same, as permitted under section 52(4) read with Liquidation Regulation 37(7) in SARFAESI, along with the guarantor’s property (Land) mortgaged with the bank, under section 13(8) of SARFAESI. This way SFC will be able to maximise the value of assets (Land, building, plant & machinery), without violating the provisions of either the Code (IBC.2016) or SARFAESI.

Lastly, following are some interesting provisions of the regulations for insolvency of Personal Guarantors.

Quote;

Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtor) Regulations, 2019,

# Regulation 4. Eligibility of resolution professional. (1) An insolvency professional shall be eligible to be appointed as a resolution professional for a resolution process, if

(a) he, the insolvency professional entity of which he is a partner or a director, and all the partners and directors of the said insolvency professional entity are independent of the guarantor;

(b) he is not subject to any ongoing disciplinary proceeding or a restraint order of the Board or of the insolvency professional agency of which he is a professional member; and

(c) the insolvency professional entity of which he is a partner or a director, or any other partner or director of such insolvency professional entity does not represent any party in the resolution process.

Explanation.- For the purposes of this sub-regulation, –

(i) a person shall be considered independent of the quarantor, if he

(a) is not an associate of the guarantor;
(b) is not a related party of the corporate debtor; and
(c) has not acted or is not acting as interim resolution professional, resolution professional or liquidator in respect of the corporate debtor;

(ii) the expression “related party” shall have the meaning assigned to it in sub-section (24) of section 5.

Unquote; Legislative intent of the above provision is clear that interim resolution professional, resolution professional or liquidator in respect of the corporate debtor should not be allowed to deal with the properties of the personal guarantor of the CD. In my opinion all the case laws mentioned (supra above) is “Per Incuriam“, being violative of the provisions of the Code & SARFAESI.

Issue No. 4 – Participation of Promoter/Director/guarantor in auction proceedings under SARFAESI by SFC/Liquidator.

The major takeaway from the following judgement of the Hon’ble Supreme Court is that unless the borrower is ready to settle the entire amount of loan outstanding, the borrower should not participate in the auction process initiated by a secured creditor under SARFAESI.

Case Law;

i). SCI (10.02.2022) in Bank of Baroda Vs. M/s Karwa Trading Company & Anr. [Civil Appeal No. 363 of 2022] held that;–

At this stage, it is required to be noted that even as per the Division Bench of the High Court the borrower made an offer to deposit/pay Rs.71 lakhs as a purchaser and not by way of redeeming the mortgaged property.

Therefore, the impugned judgment and order passed by the Division Bench of the High Court directing to release the mortgaged property/secured property and to handover the possession as well as the original title deeds to the borrower on payment of a total sum of Rs.65.65 lakhs only is contrary to Sub-section (8) of Section 13 of the SARFAESI Act.

By selling the mortgaged property/secured property it cannot be said that the borrower is discharged from the entire liability outstanding against him.

Unless and until the borrower was ready to deposit/pay the entire amount payable together with all costs and expenses with the secured creditor, the borrower cannot be discharged from the entire liability outstanding.

Therefore, as such no order could have been passed either by the DRT and/or by the Division Bench of the High Court to discharge the borrower from the entire liability outstanding and to discharge the mortgaged property and handover the possession along with original title deeds to the borrower.

It will be open for the appellant – bank to proceed further with the auction proceedings of the mortgaged property in auction i.e. residential house by inviting the bids afresh and whatever the amount is already paid by the borrower, may be in pursuance to the interim relief order passed by the DRT and/or the impugned judgment and order passed by the Division Bench of the High Court, the same may be adjusted against the dues/total liability of the borrower.

Issue No. 5 – Personal Guarantor to Corporate Debtor Insolvency Proceedings – Limitation Aspect.

In case of continuing guarantee, the limitation aspect gets delinked from the principal borrower after the invocation of the guarantee. In the present case the personal guarantee stands invoked [SARFAESI Section 13(2) notice]. However we do not know which documents, in the possession of the SFC, will extend the limitation. Promoter/ directors/ guarantor should not sign any communication to SFC henceforth.

The question here is whether the guarantor is liable for the actions of the principal borrower after the invocation of the continuing guarantee. On invocation of guarantee, the contract of guarantee attains the finality and the liabilities and obligations of the guarantor stands defined & fixed, as on the date of invocation of the continuing guarantee & the aspect of limitation to sue the principal borrower and / or the guarantor gets delinked & thus have to be viewed separately.

1. Supreme Court of India (10.04.2006) in Syndicate Bank vs Channaveerappa Beleri & Ors. [Appeal (civil) 6894 of 1997]

# 9. A guarantor’s liability depends upon the terms of his contract. A ‘continuing guarantee’ is different from an ordinary guarantee. There is also a difference between a guarantee which stipulates that the guarantor is liable to pay only on a demand by the creditor, and a guarantee which does not contain such a condition. Further, depending on the terms of guarantee, the liability of a guarantor may be limited to a particular sum, instead of the liability being to the same extent as that of the principal debtor.

The liability to pay may arise, on the principal debtor and guarantor, at the same time or at different points of time. A claim may be even time-barred against the principal debtor, but still enforceable against the guarantor. The parties may agree that the liability of a guarantor shall arise at a later point of time than that of the principal debtor. We have referred to these aspects only to underline the fact that the extent of liability under a guarantee as also the question as to when the liability of a guarantor will arise, would depend purely on the terms of the contract.

# 11. But in the case on hand, the guarantee deeds specifically state that the guarantors agree to pay and satisfy the bank on demand and interest will be payable by the guarantors only from the date of demand. In a case where the guarantee is payable on demand, as held in the case of Bradford (supra) and Hartland (supra), the limitation begins to run when the demand is made and the guarantor commits breach by not complying with the demand.

# 13. What then is the meaning of the said words used in the guarantee bonds in question? The guarantee bond states that the guarantors agree to pay and satisfy the Bank ‘on demand’. It specifically provides that the liability to pay interest would arise upon the guarantor only from the date of demand by the Bank for payment. It also provides that the guarantee shall be a continuing guarantee for payment of the ultimate balance to become due to the Bank by the borrower. The terms of guarantee, thus, make it clear that the liability to pay would arise on the guarantors only when a demand is made. Article 55 provides that the time will begin to run when the contract is ‘broken’.

Even if Article 113 is to be applied, the time begins to run only when the right to sue accrues. In this case, the contract was broken and the right to sue accrued only when a demand for payment was made by the Bank and it was refused by the guarantors. When a demand is made requiring payment within a stipulated period, say 15 days, the breach occurs or right to sue accrues, if payment is not made or is refused within 15 days. If while making the demand for payment, no period is stipulated within which the payment should be made, the breach occurs or right to sue accrues, when the demand is served on the guarantor.

# 14. We have to, however, enter a caveat here. When the demand is made by the creditor on the guarantor, under a guarantee which requires a demand, as a condition precedent for the liability of the guarantor, such demand should be for payment of a sum which is legally due and recoverable from the principal debtor. If the debt had already become time-barred against the principal debtor, the question of creditor demanding payment thereafter, for the first time, against the guarantor would not arise. When the demand is made against the guarantor, if the claim is a live claim (that is, a claim which is not barred) against the principal debtor, limitation in respect of the guarantor will run from the date of such demand and refusal/non compliance.

Where guarantor becomes liable in pursuance of a demand validly made in time, the creditor can sue the guarantor within three years, even if the claim against the principal debtor gets subsequently time-barred. To clarify the above, the following illustration may be useful :

Let us say that a creditor makes some advances to a borrower between 10.4.1991 and 1.6.1991 and the repayment thereof is guaranteed by the guarantor undertaking to pay on demand by the creditor, under a continuing guarantee dated 1.4.1991. Let us further say a demand is made by the creditor against the guarantor for payment on 1.3.1993. Though the limitation against the principal debtor may expire on 1.6.1994, as the demand was made on 1.3.1993 when the claim was ‘live’ against the principal debtor, the limitation as against the guarantor would be 3 years from 1.3.1993. On the other hand, if the creditor does not make a demand at all against the guarantor till 1.6.1994 when the claims against the principal debtor get time-barred, any demand against the guarantor made thereafter say on 15.9.1994 would not be valid or enforceable.

Be that as it may. [ Link – Synopsis ]

Query; How should a promoter/director proceed to participate in the auction of CD (MSME Unit) during the liquidation process ?

Facts of the Case

CD is a MSME UNIT.
Promoter/ Director is a guarantor for the credit facilities granted by SFC (Secured Financial Creditor).
Core Assets of the CD includes;
- i). Factory building, plant & machinery is owned by the CD and is mortgaged to SFC (Secured Financial Creditor).
- ii).Land. on which the factory is situated is owned by the promoter/director of CD & the same is also mortgaged with the SFC.
Liquidator has informed SCC (Stakeholder Consultation Committee) that SFC has relinquished the charge on the land (supra above) in favour of the Liquidator.
CoC while passing resolution for liquidation of the CD, directed to sell the CD in liquidation as a going concern as per the provisions of Regulation 39(c)(1), however provisions of Regulation 39(c)(2), for clubbing of liabilities with assets, were not invoked by CoC while passing resolution for liquidation of the CD.

Issues

Eligibility under section 29A.
Clubbing of Assets & Liabilities in going concern sale.
Auction of Guarantor’s property along with the property/assets of CD by the Liquidator.
SARFAESI Section 13(2) notice to Promoter/directors. Promoter/Guarantor should not participate in the auction of the assets of CD/Guarantor by SFC/ Liquidator under the provisions of SARFAESI, in view of the ruling of Hon’ble Supreme Court discussed in the following paragraphs.
Likely personal insolvency proceedings against Promoter/directors/guarantor, depending upon the limitation available to the SFC on the basis of documents which SFC might be holding. Promoter/directors/guarantor should not sign any communication to SFC, henceforth.