Evolution of Law for Protecting Secured Creditors Rights under IBC – Journey from Suit Proceedings to Corporate Insolvency Resolution Process

Introduction

The protection of secured creditors rights under IBC in India has undergone a remarkable transformation over the past three decades.. From the sluggish and ineffective civil litigation mechanisms of the early 1990s to the modern, time-bound insolvency resolution framework, this evolution reflects India’s commitment to strengthening its financial sector. This journey chronicles how India moved from a “defaulters’ paradise” to a creditor-driven insolvency regime that balances stakeholder interests while prioritizing economic recovery [1]. The story begins with the Narasimham Committee recommendations of 1991, which identified fundamental weaknesses in India’s debt recovery mechanisms. Prior to reforms, secured creditors faced enormous challenges in enforcing security interests as civil courts were overburdened, proceedings dragged on for years, and borrowers could easily obtain stay orders preventing meaningful recovery action [2].

The Pre-Reform Era: Civil Litigation and Its Limitations

Before specialized legislation, secured creditors in India relied primarily on civil litigation to recover dues through suits filed under the Transfer of Property Act, 1882, and the Code of Civil Procedure, 1908. This process was inherently lengthy, resource-intensive, and uncertain. Borrowers could exploit numerous procedural mechanisms to delay proceedings indefinitely, with appeals filed at multiple levels and interim orders frequently stalling enforcement actions. The average time for debt recovery through civil courts often exceeded ten years, by which time secured assets had typically depreciated significantly [1]. The delays posed existential threats to financial institutions as assets would deteriorate over time, making them less valuable or worthless. Borrowers in default could continue operating businesses or using assets without making payments, while creditors remained powerless to intervene. The absence of time limits and ease with which proceedings could be prolonged created a culture where defaulting on loans carried minimal consequences, discouraging lending and hampering economic development.

The RDDBFI Act, 1993: Establishing Debt Recovery Tribunals

Recognizing acute reform needs, Parliament enacted the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, following Narasimham Committee I recommendations [3]. This legislation represented the first significant departure from civil litigation by establishing specialized Debt Recovery Tribunals and Debt Recovery Appellate Tribunals to exclusively handle debt recovery matters involving banks and financial institutions, with the objective of expediting resolution. The RDDBFI Act conferred powers on DRTs mirroring those of civil courts under the Code of Civil Procedure, 1908, enabling them to summon witnesses, receive evidence, and pass recovery orders. The Act sought to create a streamlined alternative by limiting appeals and establishing time-bound procedures [3]. However, despite well-intentioned reforms, DRTs soon faced challenges. The volume of cases quickly overwhelmed tribunals, leading to significant backlogs. Jurisdictional limitations meant only certain creditor categories could approach DRTs, and threshold limits excluded many smaller claims. Moreover, DRTs still required court-like proceedings with full dispute adjudication, meaning the fundamental time-consuming nature of litigation persisted. While the RDDBFI Act marked an important step forward, it became clear that additional measures were necessary since the Act did not empower secured creditors to take possession of secured assets without tribunal intervention.

The SARFAESI Act, 2002: Empowering Secured Creditors Rights

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, commonly known as the SARFAESI Act, marked a paradigm shift in India’s approach to debt recovery. Enacted following Narasimham Committee II recommendations in 1998, the SARFAESI Act addressed the fundamental inadequacy of previous legislation by empowering secured creditors to enforce security interests without court or tribunal intervention [4]. This revolutionary provision allowed banks and financial institutions to take possession of secured assets, manage them, sell them, or transfer them to Asset Reconstruction Companies for recovery of dues. Under the SARFAESI Act, when a borrower’s account is classified as a non-performing asset, the secured creditor may issue a notice under Section 13(2) specifying the amount due and demanding payment within sixty days. If the borrower fails to discharge liability within this period, the creditor may exercise measures under Section 13(4), including taking possession of the secured asset, taking over management of the borrower’s business, appointing a manager, or requiring third parties to pay amounts due to the borrower [4].

The constitutional validity of the SARFAESI Act was challenged in the landmark case of Mardia Chemicals Ltd. v. Union of India (2004) 4 SCC 311 [5]. Petitioners contended that Sections 13, 15, 17, and 34 of the Act were arbitrary and violated fundamental rights guaranteed under Articles 14 and 19(1)(g) of the Constitution. They argued the Act conferred unchecked powers on banks without adequate judicial oversight, and that the requirement under Section 17(2) for borrowers to deposit seventy-five percent of the outstanding amount before filing an appeal was unconscionable and effectively denied access to justice. The Supreme Court, in a detailed judgment delivered on April 8, 2004, upheld the constitutional validity of most provisions of the SARFAESI Act. The Court emphasized Parliament’s supremacy in determining legislative necessity and rejected arguments that the SARFAESI Act was redundant given the RDDBFI Act’s existence. The Court noted the two statutes addressed different aspects of the recovery problem, with SARFAESI specifically targeting secured creditors and non-performing assets through a distinct mechanism [5]. However, the Supreme Court struck down Section 17(2), finding the seventy-five percent pre-deposit requirement unreasonable and arbitrary as it effectively denied borrowers the right to appeal by imposing an impossibly high threshold. This aspect demonstrated the Court’s commitment to balancing creditor rights with borrower protections. Following this decision, Parliament amended Section 17 to introduce a more reasonable graduated deposit structure, ensuring aggrieved borrowers retained meaningful access to appellate remedies before Debt Recovery Tribunals [5].

The Insolvency and Bankruptcy Code, 2016: A Unified Framework

Despite improvements brought by the SARFAESI Act, India’s insolvency landscape remained fragmented. Multiple overlapping laws governed insolvency and bankruptcy, including the Companies Act, 2013, and the Sick Industrial Companies (Special Provisions) Act, 1985. Different adjudicating authorities had overlapping jurisdictions, leading to conflicting decisions and procedural chaos. The lack of a unified framework meant creditors faced uncertainty about which forum to approach and which law would govern their claims [6]. In response, the Ministry of Finance constituted the Bankruptcy Law Reforms Committee in 2014 under T.K. Viswanathan’s chairmanship. The Committee examined international best practices and drafted comprehensive insolvency and bankruptcy legislation. After extensive consultations, the Committee submitted its report with a draft bill in November 2015, emphasizing the need for a creditor-driven process, time-bound resolution, and unified legal framework. Following refinements incorporating public comments, Finance Minister Arun Jaitley introduced the Insolvency and Bankruptcy Code, 2016, in the Lok Sabha. The Code received parliamentary approval and came into force as a watershed moment in Indian insolvency law [6].

The IBC established a completely new paradigm for handling corporate insolvency. When a corporate debtor defaults on obligations, a financial creditor, operational creditor, or the corporate debtor itself may initiate Corporate Insolvency Resolution Process by filing an application before the National Company Law Tribunal. The threshold for admission is deliberately low, requiring only proof of default without any insolvency test. Once admitted, the NCLT declares a moratorium, prohibiting all legal proceedings against the corporate debtor and preventing enforcement of security interests, including actions under the SARFAESI Act. This moratorium ensures the CIRP proceeds without external interference and all claims are consolidated under a single proceeding [6]. The NCLT appoints an Interim Resolution Professional who assumes control of the corporate debtor’s management, displacing existing promoters and directors. The Resolution Professional constitutes a Committee of Creditors comprising all financial creditors, which becomes the primary decision-making body during CIRP. The Committee of Creditors evaluates resolution plans submitted by prospective resolution applicants and votes to approve a plan that maximizes the value of the corporate debtor’s assets. The entire process must be completed within a maximum period of three hundred and thirty days, including any time spent in legal proceedings [6].

The constitutional validity of the IBC was challenged in Swiss Ribbons Pvt. Ltd. v. Union of India (2019) 4 SCC 17 [7]. Petitioners raised several constitutional questions, including whether the distinction between financial creditors and operational creditors violated Article 14 of the Constitution, whether operational creditors’ exclusion from voting rights in the Committee of Creditors was discriminatory, and whether various other provisions were arbitrary. The Supreme Court, in a judgment delivered on January 25, 2019, upheld the constitutional validity of the IBC, endorsing it as beneficial legislation designed to address the non-performing assets crisis. The Court rejected arguments that differential treatment of financial and operational creditors was discriminatory, reasoning that financial creditors have a fundamentally different relationship with corporate debtors compared to operational creditors. Financial creditors typically advance large sums as loans and maintain ongoing assessments of the corporate debtor’s financial health, making them better suited to evaluate resolution plans. The Court found this classification rationally connected to the objective of efficient insolvency resolution and therefore constitutionally valid [7].

The Waterfall Mechanism and Secured Creditors Rights under IBC

One of the most critical features of the IBC is the waterfall mechanism established under Section 53, which prescribes the order of priority for distribution of proceeds in liquidation. This mechanism is equally applicable during CIRP when evaluating whether a resolution plan provides fair treatment to different classes of creditors [8]. Under Section 53, the first priority is accorded to insolvency resolution process costs and liquidation costs, which must be paid in full before any distribution to other stakeholders. The second priority tier provides for workmen’s dues for the twenty-four months preceding the liquidation commencement date, and for debts owed to secured creditors, ensuring their rights under IBC. These two categories rank pari passu, meaning they share equally in the available proceeds at this level. The third priority is given to employees’ dues for the twelve months preceding liquidation commencement. Operational creditors rank at the sixth level, followed by government dues and statutory obligations at the seventh level. Any remaining debts to secured creditors who enforced their security interest but did not recover the full amount due are paid at the eighth level [8].

This waterfall structure assigns significant priority to secured creditors, recognizing their role in providing credit to the economy. However, in recent years, judicial interpretations have introduced complexity. In State Tax Officer v. Rainbow Papers Ltd. (2023) 9 SCC 545, the Supreme Court held that government authorities holding a statutory charge over assets qualify as secured creditors under the IBC. This decision created significant concern among financial institutions and creditors, as it appeared to dilute the priority afforded to secured lenders. In response, the Ministry of Corporate Affairs issued a consultation paper in January 2023 proposing amendments to clarify that government dues should be treated as secured only if the security interest arose from a transaction with the corporate debtor, rather than from a statutory charge created by operation of law [8].

Interaction Between SARFAESI and IBC

The relationship between the SARFAESI Act and the IBC has been a subject of considerable judicial interpretation. Section 238 of the IBC provides that the Code shall have overriding effect over all other laws. During Corporate Insolvency Resolution Process, Section 14 of the IBC imposes a moratorium that specifically prohibits any action to foreclose, recover, or enforce any security interest created by the corporate debtor, including actions under the SARFAESI Act [9]. However, the interplay becomes more nuanced in the context of liquidation. Under Section 52 of the IBC, secured creditors have the option to either relinquish their security interest to the liquidation estate, in which case they participate in the waterfall mechanism at the second priority level, or they may choose to realize their security interest by enforcing it outside the liquidation estate. This dual option provides flexibility to secured creditors while ensuring that the insolvency process remains creditor-driven and value-maximizing [9].

Conclusion

The evolution of laws protecting secured creditors rights under IBC in India represents one of the most significant legal and economic reforms of the past three decades. From the inefficient civil litigation system of the pre-reform era, through the establishment of Debt Recovery Tribunals, the revolutionary SARFAESI Act, and finally the comprehensive Insolvency and Bankruptcy Code, India has progressively strengthened its framework for debt recovery and insolvency resolution. This journey reflects a fundamental shift from a debtor-friendly regime to a creditor-driven system that balances the interests of all stakeholders while prioritizing economic value maximization. The SARFAESI Act empowered secured creditors to enforce their security interests without court intervention, dramatically reducing the time and cost of recovery. The IBC further refined this approach by creating a time-bound, collective resolution mechanism that seeks to rescue viable businesses while ensuring fair treatment for creditors. Landmark judgments such as Mardia Chemicals and Swiss Ribbons have upheld the constitutional validity of these legislative reforms while ensuring that borrower protections and fundamental rights are not compromised. Today, India’s insolvency and bankruptcy framework is recognized internationally as a significant achievement, with the country having risen substantially in the World Bank’s Ease of Doing Business rankings, particularly in the resolving insolvency metric.

References

[1] ClearTax. “SARFAESI Act, 2002 – Applicability, Objectives, Process, Documentation.” Available at: https://cleartax.in/s/sarfaesi-act-2002 

[2] Metalegal. “A Bank’s Comrade: An Overview of the SARFAESI Act.” May 12, 2025. Available at: https://www.metalegal.in/post/a-bank-s-comrade-an-overview-of-the-sarfaesi-act 

[3] IJLSSS. “History And Evolution Of The IBC.” June 21, 2025. Available at: https://ijlsss.com/history-and-evolution-of-the-ibc/ 

[4] Taxmann. “Overview of the SARFAESI Act – Background | Provisions.” March 22, 2025. Available at: https://www.taxmann.com/post/blog/overview-of-the-sarfaesi-act 

[5] Lawful Legal. “Mardia Chemicals Ltd. v. Union of India (2004): A Landmark Judgment on SARFAESI Act.” March 4, 2025. Available at: https://lawfullegal.in/mardia-chemicals-ltd-v-union-of-india-2004-a-landmark-judgment-on-sarfaesi-act-2/ 

[6] Vajira Mandravi IAS Academy. “SARFAESI Act 2002, History, Objectives, Provisions, Challenges.” October 10, 2025. Available at: https://vajiramandravi.com/current-affairs/sarfaesi-act-2002/ 

[7] IBC Laws. “Swiss Ribbons Pvt. Ltd. V. Union of India: The Constitutionality of IBC Upheld.” Available at: https://ibclaw.in/swiss-ribbons-pvt-ltd-v-union-of-india-the-constitutionality-of-ibc-upheld-understanding-the-procedural-aspect-and-the-after-effects-by-ms-manisha-arora-and-mr-pranav-ashutosh/ 

[8] IBC Laws. “Waterfall Mechanism: Basic structure of the Insolvency and Bankruptcy Code, 2016.” Available at: https://ibclaw.in/waterfall-mechanism-basic-structure-of-the-insolvency-and-bankruptcy-code-2016-by-harshit-gupta/ 

[9] IBC Laws. “Rights of Secured Creditors under the Insolvency and Bankruptcy Code, 2016.” Available at: https://ibclaw.in/rights-of-secured-creditors-under-the-insolvency-and-bankruptcy-code-2016-by-advocate-sabhay-choudhary/