From Waterfall to Whirlwind: SC’s NSEL Jolt to Secured Creditors

CCL NLUO
Jul 1
6 min read

Fourth year law student at Gujarat National Law University, Gandhinagar

I. Introduction

In its recent ruling in National Spot Exchange Ltd. v. Union of India, the Supreme Court ("SC") has clarified the legal position of secured creditors vis-à-vis assets attached under the Prevention of Money Laundering Act, 2002 (PMLA) and the Maharashtra Protection of Interest of Depositors (in Financial Establishments) Act, 1999 ("MPID"). The Court held that when assets are attached under these special statutes, secured creditors cannot assert priority over them, and when such fraudulent assets are attached prior to the imposition of a moratorium under the Insolvency and Bankruptcy Code, 2016 ("IBC"), they escape its shielding effect. This marks a significant departure from the conventional understanding of secured creditors' rights under the IBC, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ("SARFAESI") and Recovery of Debts and Bankruptcy Act, 1993 ("RDB"). In this post, the author analyses the evolving jurisprudence on the treatment of secured creditors and critiques the implications of the NSEL judgment in the broader insolvency framework.

II. The (In)Consistent Treatment of Secured Creditors

Historically, Indian insolvency and debt recovery law has offered a somewhat fluctuating path for secured creditors. Prior to the IBC, section 326(1)(b) of the Companies Act, 2013 supported secured creditors in debt recovery. With the advent of the paradigm-shifting IBC, section 53(1) incorporated their claims within the liquidation waterfall, placing them on par with workmen’s dues. Furthermore, section 52 of the IBC, read with Regulation 37 of the Liquidation Process Regulations, 2016, grants secured creditors the option to either enforce their security interests independently or relinquish them to the liquidation estate. In Technology Development Board v. Anil Goel, the National Company Law Appellate Tribunal ("NCLAT") confirmed that secured creditors could choose between enforcing their security outside liquidation or participating within it by allowing it to form a part of liquidation estate. However, the SC stayed this decision in Kotak Mahindra Bank Ltd. v. Technology Development Board, plunging the issue back into uncertainty. Later, in Vistra ITCL (India) Ltd. v. Dinkar Venkatasubramanian, the SC affirmed that secured creditors retain their rights under sections 52 and 53 even during the Corporate Insolvency Resolution Process ("CIRP"), thus allowing them to enforce or realise proceeds from the sale of secured assets.

Nonetheless, ambiguity persists concerning inter se distribution among secured creditors. The primary tension lies between upholding equitable treatment of all creditors and discouraging strategic dissent from secured creditors seeking enhanced payouts. The Court’s contrasting approaches in India Resurgence ARC Pvt. Ltd. v. Amit Metaliks Ltd. and DBS Bank Ltd. Singapore v. Ruchi Soya Industries Ltd. forms the melting pot of such conundrum. In Amit Metaliks, the SC emphasised on the supremacy of the Committee of Creditors’ (CoC) commercial wisdom and held that dissenting secured creditors are only entitled to the minimum liquidation value, precluding any claim based on the full value of their security. The SC categorically held that secured creditors claiming greater payouts than prescribed under section 53 based on security interest value is impermissible. This position was later reaffirmed in Beacon Trusteeship Ltd. v. Jayesh Sanghrajka. However, in DBS Bank, the Court allowed dissenting secured creditors to claim liquidation value based on the actual value of their security interest. The court ascertained the object of section 30(2)(b) to be defending the dissenting financial creditors’ rights and observed that such secured creditors are qualified to receive the value of concerned security which would have been alternatively available to the creditor pertaining to liquidation of the corporate debtor. Such view safeguards the financial interests of minority creditors and aligns with global standards such as the UNCITRAL Model Law on Cross-Border Insolvency. However, given the diametrically opposite interpretations by coordinate benches, this issue now awaits resolution by a larger bench.

III. NSEL Verdict- Boon for Depositors; Bane for Secured Creditors

In NSEL v. UOI, the SC was gripped with a factual matrix surrounding defaulter’s properties priorly attached by the Enforcement Directorate ("ED") under PMLA and Maharashtra Government under MPID Act, whereby, the Court had previously invoked Article 142 of the Constitution to set up a Single Member Committee for sale of attached properties and distribution of proceeds. The court was tasked with deciding upon the standing of secured creditors’ priority of interest over such assets attached under PMLA and MPID provisions, in context of prevailing provisions under SARFAESI and RDB Acts, and whether the moratorium imposed under IBC finds application against such attached properties.

In face of section 26E of SARFAESI Act and section 31B of RDB Act, which mandate prioritised payment of debt dues to secured creditors notwithstanding any other existing law, the Court employed the pith and substance doctrine and emphasised on the federal structure of the Constitution to hold that secured creditors are not entitled to claim priority of interest as against fraudulent assets attached under the provisions of PMLA and MPID Act. Despite the non-obstante clauses in both these provisions, which explicitly afford overriding priority to secured creditors’ claims, the SC held that such rights do not extend to pre-existing attachments made under PMLA or MPID Act. Further, the SC declared that properties attached under MPID Act antecedent to imposition of moratorium under section 14 of IBC, circumvent the effect of such moratorium. This interpretation effectively subjugates priority accorded to secured creditors under SARFAESI and RDB Act, subordinate to penal attachments made prior in time under other special legislations. Notably, the Court’s reasoning rests on the premise that properties attached under penal statutes do not constitute “debt” under section 4 of the MPID Act. However, this view appears to be in conflict with the procedural framework under section 5(1) of the MPID Act, which authorises the state government to attach and control such properties for the benefit of depositors; effectively creating a form of constructive trust that serves debt-like obligations.

IV. Stark Divergence from Existing Jurisprudence

The Supreme Court’s decision in NSEL has granted protection to depositors’ interests as effectively it has been prioritised over secured creditors’ claims in an event of clash between depositor-preservation and banking security enforcement. However, it is argued that the SC’s interpretation of section 26E of SARFAESI Act and section 31B of RDB Act places a judicial limitation on the provisions, which runs contrary to the well-established principle of according greater vigour and supremacy in application to notwithstanding provisions. The SC, in Orient Paper and Industries Ltd. v. State of Orissa, observed the effect of such provisions being “engulfing all rules having the force of law, whichever be the source from which they emanate- statutory, judicial or customary... notwithstanding any judicial decision recognising any right or interest or grant inconsistency with or contrary to the provision...”. The NSEL verdict seems to retreat from this robust interpretation. Further, in Jalgaon Janta Sahakari Bank Ltd. v. Joint Commissioner, the Bombay High Court ("HC") explicitly upheld that secured creditors’ dues take precedence “over all other dues” including statutory claims, while interpreting section 26E of SARFAESI Act and section 31B of RDB Act. Similarly, in Indian Bank v. CTO, Ambattur Assessment Circle, the Madras HC ruled that section 26E overrides the Tamil Nadu General Sales Tax Act, reaffirming its dominance over state statutes. In the context of PMLA, the Appellate Tribunal in Bank of India v. Deputy Director, ED also held that SARFAESI and IBC proceedings enjoy precedence over PMLA attachments, with secured creditors’ claims ranking above those of government authorities, including central, state and local. The NSEL judgment effectively overturns this chain of reasoning by judicially reading down the scope of SARFAESI and RDB Act priorities, despite their clear and unambiguous statutory wordings.

V. Conclusion and Way Forward

The SC’s attempt to preserve the interests of defrauded depositors is undoubtedly a commendable objective. However, the judgment in NSEL introduces greater uncertainty into the legal position of secured creditors, particularly financial institutions that rely on statutory recovery mechanisms like SARFAESI and RDB. Despite being favourably placed by the legislature in IBC’s distribution waterfall, and by virtue of non-obstante provisions added to SARFAESI and RDB Act, the judiciary has created a patchwork of exceptions that could deter secured financing and complicate the predictability of debt enforcement.

In practical terms, secured creditors now face the risk of losing enforcement rights over properties classified as “proceeds of crime” even if their claims were bona fide and predate such classification. This judicial override dilutes the legislative intent behind the non-obstante clauses in SARFAESI and RDB Acts, undermining creditor confidence. A potential legislative solution lies in the enactment of a harmonising statute that clarifies the interaction between economic recovery laws and penal statutes. Alternatively, a statutory amendment could ensure that bona fide secured creditors are protected from ex post facto penal attachments. Ultimately, as banks and financial institutions form the backbone of credit markets, a coherent and predictable framework for secured debt recovery is essential for maintaining trust in India’s ever-growing insolvency ecosystem.

Note: This article has been reviewed by Mr. Anish Jaipuriar (Partner, Burgeon Law), at the Tier II Stage.