INITIATION OF CORPORATE INSOLVENCY PROCESS BASED ON RECOVERY CERTIFICATES

[Mr. M. GOVINDARAJAN]

Nonperforming assets

Non-Performing Assets (‘NPA’ for short) is the dealing of the accrued money in the form of principal or interest amount to the extent of a bank’s lendings. NPAs are referred to as the loans or advances that are arrears or defaults.  NPAs are categorized as sub standard assets, doubtful assets and loss assets.  NPA not only reduces the current profit of the bank but also endangers their future prospects. This lowers the profit causing low returns on investments affecting the current earnings of the bank.  Higher NPA also impacts the revenue strength of the banks.   High NPAs reduce the confidence level of the investor, significantly impacting the share price of the bank. Hence, banks stop payout of dividends to the shareholders.

Recovery certificate

The Recovery of Debts and Bankruptcy Act, 1993 (RDB Act) provides speedy redressal to lenders and borrowers through filing of Original Applications in Debts Recovery Tribunals (‘DRT’ for short) and appeals in Debts Recovery Appellate Tribunals.  The Securitization and Reconstruction of Financial Assets & Enforcement of Security Interest Act, 2002 (‘SARFAESI’ for short) provides access to banks and financial institutions covered under the Act for recovery of secured debts from the borrowers without the intervention of the Courts at the first stage. Securitization Appeals can be filed with the DRTs by those aggrieved against action taken by secured creditors under the SARFAESI Act.

On receipt of the application the DRT shall issue summons requiring the defendant to show cause within 30 days of the service of summons as to why the relief prayed for should not be granted.  The DRT after giving the applicant and the defendant an opportunity of being heard, pass such orders on the application as it thinks fit to meet the ends of justice.  The Presiding Officer shall issue a certificate under his signatures on the basis of the order of the Tribunal, to the Recovery Officer for recovery of the amount of debt specified in the certificate.

The Recovery Officer shall, on receipt of the copy of the certificate under sub-section (7) of section 19, proceed to recover the amount of debt specified in the certificate by one or more of the following modes-

• attachment and sale of the movable or immovable property of the defendant;
• arrest of the defendant and his detention in prison;
• appointing a receiver for the management of the movable or immovable properties of the defendant.

Issue

The issue to be discussed in this article whether the recovery certificate issued by DRT can be the base for initiating corporate insolvency resolution process (‘CIRP’ for short) by the recovery certificate holder under Section 7 of the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short) as yet another mode for recovery of the outstanding amount, with reference to decided case laws.

Financial debt

Section 7 of the Code provides that a financial creditor may initiate CIRP against the Corporate Debtor before the Adjudicating Authority when a default has occurred.  The section 7 includes the allottees under a real estate project as eligible to file the CIRP application against the corporate debtor.  There is no specific mention making eligible to the holder of recovery certificate holder to initiate CIRP.  Section 5(8) of the Code also does not include the dues under recovery certificate as ‘financial debt’.

Deemed decree

Section 19 (22A) of RDB Act [Inserted by Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 which came into effect from 04.11.2016 and notified vide No. No. S.O. 3395 (E), dated 04.11.2016, with effect from 04.11.2016 vide N. No. S.O. 3395(E) dated 04.11.2016].provides that any recovery certificate issued by the Presiding Officer under subsection (22) shall be deemed to be decree or order of the Court for the purposes of initiation of winding up proceedings against a company registered under the  Companies Act, 2013 or Limited Liability Partnership registered under the Limited Liability Partnership Act, 2008 or insolvency proceedings against any individual or partnership firm under any law for the time being in force, as the case may be.

The Supreme Court in the following cases held that the issuance of a certificate of recovery in favor of financial creditor would give rise to a fresh cause of action to the financial creditor, to initiate proceedings under Section 7 of the Code for initiation of the CIRP within 3 years from the date of issue of recovery certificate.  Even after 3 years the action may be initiated since the recovery certificate is deemed decree which has life for 12 years for execution. 

In KOTAK MAHINDRA BANK LIMITED VERSUS A. BALAKRISHNAN & ANR. - 2022 (6) TMI 13 - SUPREME COURT, the Supreme Court held that once the claim fructifies into a final judgment and order/decree, upon adjudication, and a certificate of recovery is also issued authorizing the creditor to realize its decretal dues, a fresh right accrues to the creditor to recover the amount of the final judgment and/or order/decree and/or the amount specified in the recovery certificate. It has further been held that issuance of a certificate of recovery in favor of the financial creditor would give rise to a fresh cause of action to the financial creditor, to initiate proceedings under Section 7 of the Code for initiation of the CIRP, within three years from the date of the judgment and/or decree or within three years from the date of issuance of the certificate of recovery, if the dues of the corporate debtor to the financial debtor, under the judgment and/or decree and/or in terms of the certificate of recovery, or any part thereof remained unpaid.

The Supreme Court further that the prohibition under Section 14(1) of the Code to institution of suit or continuation of pending suits or proceedings including execution of decree would not mean that a decree holder is also prohibited from initiating CIRP, if he is otherwise entitled to in law.

The Supreme Court further held that a liability in respect of a claim arising out of a recovery certificate would be a ‘financial debt’ within the meaning of clause (8) of Section 5 Code and a holder of the recovery certificate would be a ‘financial creditor’ within the meaning of clause (7) of Section 5 of the Code and would be entitled to initiate CIRP within a period of 3 years from the date on which the recovery certificate is issued.

In TOTTEMPUDI SALALITH VERSUS STATE BANK OF INDIA & ORS. - 2023 (10) TMI 895 - SUPREME COURT, the appellant, in this case, is the Managing Director of Respondent No. 2, Totem Infrastructures Limited (Corporate Debtor).  Financial facilities were extended to the corporate debtor by various banks viz., Union Bank of India, IDBI, Oriental Bank of Commerce, Bank of Baroda, Karnataka Bank, Syndicate Bank, Punjab National Bank and various branches of State Bank of India in the form of loan and guarantees.  The total amount utilized by the Corporate Debtors is Rs.613.27 crores.  

A notice was issued to the Corporate Debtor under Section 13(2) of SARFAESI.  Recovery proceedings were initiated against the Corporate Debtor before the DRT.  Two applications were filed before DRT, Hyderabad and one application was filed before DRT, Bengaluru.  Two recovery certificates by the Hyderabad Tribunal were issued on 08.09.2015 and 17.10.2017 for a sum of Rs.14,50,06,349.23 and Rs.1408,03,14,857.40 respectively.  Another recovery certificate was issued by the Tribunal on 04.08.2017 for a sum of Rs.5,22,21,750/-

The State Bank of India initiated corporate insolvency resolution process against the Corporate Debtor under Section 7 of the Code before the Adjudicating Authority on 06.09.2019 founded on all the three recovery certificates.  The Adjudicating Authority admitted the application on 12.01.2021 and declared moratorium.  Interim Resolution Professional was also appointed by the Adjudicating Authority.  In its order the Adjudicating Authority observed that the corporate debtor issued a letter to the banks agreeing in principle to repay the dues to the financial creditors.  A request for one time settlement was also made.  The Adjudicating Authority treated this letter as to be an acknowledgment of debt.

The appellant, as the Managing Director of the Corporate Debtor and being aggrieved against the order of the Adjudicating Authority filed an appeal before the National Company Law Appellate Tribunal (‘NCLAT’ for short).  The appellant urged before NCLAT the ground of limitation.  The appellant further contended that the application has been initiated as per the directions of Reserve Bank of India (‘RBI’ for short) vide circular dated 12.02.2018 which was held to be ultra vires the provision of Section 35AA of the Banking Regulation Act, 1949 by the Supreme Court.  The said circular laid down norms for, inter alia, invoking the provisions of the Code in relation to stressed assets.  The appellant further contended that any acknowledgment beyond the period of limitation would not revive the right to sue. The NCLAT treated the letter of the corporate debtor which was issued on 29.01.2020 to be an acknowledgement of debt.  The NCLAT agreed with the decision of the Adjudicating Authority and dismissed the appeal filed by the appellant.

Against the order of NCLAT the appellant filed the present appeal before the Supreme Court.  The appellant contended that the letter dated 29.01.2020 was a request to consider a onetime settlement. But again, in absence of averments or pleading, after initiation of insolvency proceeding, any promise made to pay the debt cannot be treated to have cured the fault of limitation in a preexisting action. A promise of this nature would constitute an independent cause of action.   The date of default should go back to the date on which the loan account of the corporate debtor was declared as nonperforming asset. Further the appellant contended that the banks having approached the DRT were barred under the doctrine of election from approaching the Adjudicating Authority for recovery of same set of debts.

The Supreme Court analyzed the facts of the case and the judgments relied on by the appellant.  The Supreme Court observed that NCLAT treated the letter of the corporate debtor which was issued on 29.01.2020 to be an acknowledgement of debt and on that basis proceeded to compute the limitation period.  In the opinion of the Supreme Court it was procedurally wrong.  If it is proceeded on the basis that the date of initial default, it  is the starting point of limitation, then lapse of 3 years from that date would have extinguished the bank’s right to initiate action under the Code.

The Supreme Court accepted the contention of the appellant that the letter was a request for one time settlement.  A promise of this nature would constitute an independent cause of action.  The recovery certificate arose out of a proceeding from the DRT. The enforcement mechanism for a recovery certificate is an independent course, which a financial creditor may opt for realization of its dues crystallized under the RDB Act, instead of chasing the mechanism under the RDB Act.  The Code is not a debt recovery mechanism.  It is a mechanism for revival of a company fallen in debt and it relates to ensuring recovery of debts in the process of applying such mechanism.  The question of election between the fora for enforcement of debt under the RDB Act and initiation of CIRP under the Code arises only after a recovery certificate is issued.

After the issue of recovery certificate, the financial creditor ought to have option for enforcing recovery through a new forum instead of sticking on to the mechanism through which recovery certificate was issued.  The Supreme Court held that the doctrine of election cannot be applied to prevent the financial creditors from approaching the Adjudicating Authority for initiation of CIRP.

The Supreme Court noticed that one recovery certificate was issued on 08.09.2015.   A question that arises now is as to whether the debts in connection with the recovery certificate issued in the year 2015 could form subject matter of an application under Section 7 of the Code filed on 06.09.2019.  The application filed before the Adjudicating Authority is a composite application based on the three recovery certificates.  One certificate was issued during 2015.   The application for this recovery certificate is more than three years.  In this regard the Supreme Court pointed out that a recovery certificate under the RDB Act is also clothed with the character of a deemed decree.  It will be difficult to accept that the legislature intended that such a recovery certificate could not be used for initiation of CIRP, which would enable the corporate debtor to continue as an ongoing concern and, at the same time, pay the dues of the creditors to the maximum.  In the event a financial creditor wants to pursue a recovery certificate as a deemed decree, he would get twelve years’ time for execution. This point has not been examined by NCLAT.

The Supreme Court observed that since the first two fora did not test the legality of the 2015 certificate as a deemed decree, the Supreme Court was of the opinion that this question also ought to be addressed by NCLAT.  The application with respect to the two recovery certificates issued in the year 2017 is maintainable.  In the event NCLAT is of opinion that the CIRP could not lie so far as the recovery certificate of 2015 is concerned, as the decree would be still alive, the claim based on the said recovery certificate could be segregated from the composite claim.  The Supreme Court directed that the  Committee of Creditors shall, in that event, treat the sum reflected in the said recovery certificate as part of the claims made in pursuance of the public announcement. The said directions were issued in exercising of jurisdiction of Supreme Court under Article 142 of the Constitution.  The Supreme Court dismissed the appeal.

Conclusion

The Supreme Court in the above said case laws confirmed the provisions of Section 19(22A) of RDB Act.  Since the recovery certificate is a deemed decree the same may be executed up to 12 years the CIRP may be initiated on the recovery certificate as per the above limitation.

References:

1. https://testbook.com/banking-awareness/npa-non-performing-assets-and-the-recovery#:~:text=As%20defined%20by%20the%20Reserve,Doubtful%20Assets%2C%20and%20Loss%20Assets.
2. https://drt.gov.in/#/aboutus.
3. https://www.dif.mp.gov.in/pdfs/RDDBFI-Act.pdf.