Facts in Issue:
There is one company called Guntur Vegetables Oil Industries Ltd., which went into liquidation. The petitioner ( Rajah varu ) was one secured creditor of the company being the holder of 200 mortgage debentures (i.e. from Debentures bearing no. 101 to 300) and there is another company named East Asiatic Investment company who is the holder of 100 mortgage debentures (i.e. from Debentures bearing no. 1 to 100) which is issued under Debenture trust deed w.r.t. Rs. 1,50,000/-

Then the company borrowed Rs. 1, 30,000/- from government and executed mortgage deed with respect of the properties. Later on the company was ordered to be wound up in 1953, by the High Court of Judicature at Madras and a liquidator was appointed. Then after, high court of A.P. ordered liquidator to sell the properties.

Then after, R.R.J. K. R. Bahadur Varu filed a petition in the court under sec. 229 and 233 of the companies act & various provisions of Transfer of property to decide the question of priority between the debentures holders (1st Mortgagees) and the Government.

Identification of the Case:
Appellants: - State of Andhra Pradesh
Respondents:- Rajah Ram Janardhana Krishna Rangarao Bahadur Varu and others
Bench: Venkatesam J., Chandrasekhara Sastry J., Hierarchy of Court: - Andhra Pradesh High Court
Date of Judgment: - 07 April 1965 - Citation:- 1965 Indlaw AP 32, [1966] 36 Comp Cas 950

Procedural History:
The liquidation proceedings were transferred to the proceeds, to the District Judge, Guntur. Shri Rajah Ram Janardhana Krishna Rangarao Bahadur Varu ( the 1st respondent herein), filed I.A. No. 336/59 before the learned District Judge, Guntur, setting out these facts and requested the court to be decide the question of priority of claims between the first mortgage debenture- holders and the Government. The District court held that the debenture-holders are the first mortgagees of all the properties, present and future, and as the Government are the subsequent mortgages under the State Aid to Industries act, the Government are not entitled to claim priority over them This application was resisted by the Government as well as the liquidator.

Issue & Holding:
Whether debentures holders has any priority over than the Government as per facts of the case?
Yes, because the debenture-holders are the first mortgagees of all the properties, present and future, and as the Government is the subsequent mortgages under the State Aid to Industries act, the Government is not entitled to claim priority over them.

Reasoning:- (Dictum)
The bench expressed the dictum that before the mortgage was created between the company and government there is an already existing mortgage between company and debenture holders which created specific charge. Initially the court observed the Government contention, that there was no effective or valid mortgage created over the properties in favour of the debenture-holders under the debenture trust deed, and that even a floating charge was not created, and that the Government advanced Rs.1,30,000/- under the State Aid to Industries Act, and became a secured creditor taking precedence over the floating charge, if any, in favour of the debenture-holders. Thus, the Government contended that the land, buildings, plant and machinery and all other assets of the company were mortgaged to them for the claim of the debenture-holders.

That right was claimed both under the State Aid to Industries Act as well as under common law. Further, It was contended by the Government that no part of the machinery of the company including the boiler and tanks were permanently attached to the land and as such none of it constitutes immovable property. It was also contended that, in as much as the buildings or the machinery were not in existence on the date of debenture trust deed, no effective or valid mortgage was created in respect of those properties and that the floating charge, if any, created would not amount to a fixed charge. But court did not consider the above contention and analyzed the case on following grounds.

1. As per Sec. 48 of transfer of property act, the well established equitable maxim, qui prior est tempore potior est jure and lays down that the transferor cannot prejudice the rights of the transferee by any subsequent dealing with the property. In other words, if there are successive transfers of the same property, the later transfer is subject to the prior transfer. It follows that in the case of two successive mortgages, the later on created mortgage is subject to the prior mortgage.
    
2. In this case, there is an express clause to the effect that they constitute the mortgage security. There can, therefore, be no doubt that the debenture security has been created not merely on land, but also on the buildings and the plant and machinery erected or to be erected thereon at a later date. In order to get over this difficulty, the Government contentions that the indenture in question had not created a specific mortgage or a floating charge in respect of the property.
    
3. Further, There is no need to refer the case of State of Madras v Madras Electric Tramways[1], which says that "If any party entered into contracts with another then parties under contract are bound by all obligation of under its existing contract" because facts in that case are distinguishable from those in the case before us.
    
4. Therefore, the dictum of the bench is that:
   cannot be any doubt that these buildings, plant and machinery brought thereon also constitute the security created under the debenture trust deed. That being so, even though they have also been mortgaged to the Government, we cannot hold that the Government acquired any right of priority over the debenture-holders.

Evaluation:
This is a classic case to understand the priority concept while distributing the company’s property during winding up or after liquidation process. As per current scenario, Section 326, 327 of Companies Act, 2013 has been amended where dues of workmen and the secured creditors are in priority to all other dues.

Earlier, the dues of secured creditor were to rank pari passu in terms of proviso to sub Section 1 of Section 325. Now the secured creditor who has realized a secured asset is also entitled to priority towards the balance of his dues. The distribution and preferential payment under Companies Act and IBC are different and Section 326 shall not be applicable in the event of liquidation under IBC, 2016. If the liquidation proceedings happens with respect to IBC then sec. 53 of IBC comes into picture.

The Companies Act does not define a creditor and a secured creditor and hence, we have to refer to the Insolvency Act for the definitions of these two words. Section 2(1)(a) and Section 2(1)(e) of the Insolvency Act[2] define the words creditor and unsecured creditor and are extracted here in below which states the following definition:
2(1)(a) creditor includes a decree-holder, debt includes a judgment-debt, and debtor includes a judgment-debtor.

2(1)(e) secured creditor means a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor.
Initially, Under the Companies act 1956 act, Section 529A has overriding effect upon the above noted preferential payments. Section 530 is subject to the provisions of section 529A. This section provides for equal ranking priority of workmen’s dues and those of secured creditors. Therefore, only’ if there is any balance left after satisfying the claims under section 529A will the State or other creditors get any share[3].

Also in the case of Official Liquidator v. Canara Bank[4], The Kerala High Court again held that only if any balance or surplus after satisfying the claims of the secured creditor, i.e., the mortgagee bank in this case is available, the State or other creditors would be entitled to any share over the proceeds of the sale.

Synthesis:
Finally, by observing the court verdict under s. 230 of the Companies Act, 1913 we can say that the Government can claim priority against the debenture-holders only in respect of revenues, taxes, cesses and rates. But now the position has changed. The loan under the State Aid to Industries Act does not answer that description and we hold that the Government cannot claim any preferential payment u/s. 230(1)(a) of the Act. But,

The Government must work out its rights only on the basis that the debenture-holders are the first mortgagees and the Government is the second mortgages. That being so, the mortgage debenture-holders are entitled to the priority and be paid in full before the Government are entitled to claim any portion of the sale proceeds in the hands of the official liquidator. So, we can say that appeal was rightly dismissed.

Recent cases:
In Girish Lalwani S/o Govind Ram and another v Punjab National Bank, Jaipur Through Manager Rita Bumblani and others[5], while deciding the third party rights the tribunal upheld and relied on these lines:
Thus, the foregoing discussion makes it clear that where a specific charge Is created on immoveable property, an equitable charge or a floating charge if any, created cannot have priority.

Even If there be any other specific charge created on the same property, the specific charge which is the first in point of time taken priority over the second. In a case where buildings are constructed or machinery is fixed to the earth for its beneficial use after mortgaging the land, the buildings and the machinery or plant would constitute immoveable property as an accession to the land, and form part of mortgagee's security. So that, the mortgagee can claim security not merely in respect of the land mortgaged but also the buildings and the machinery fixed to the earth subsequently."

End-Notes:

1. 1956 Indlaw MAD 118
2. Inserted definitions of creditor and unsecured creditor in the Insolvency Act,1920
3. Govanola Binny Brinton & Co. (Engineers), In re (1990) 1 Comp U 102, 106, 107: (1990) 67 Corn Cases 441 (Ker).
4. (1990) 1 Ker UT 160 (Ker)
5. 2011 Indlaw DRAT 18, See also: Mithilesh Goel and others v Punjab National Bank, New Delhi and others, 2010 Indlaw DRAT 191, State Bank of Bikaner and Jaipur v Rajiv Mathur, 2010 Indlaw DRAT 168, Satish Kumar Behl v State Bank of India and others, 2010 Indlaw DRAT 188

Written by Kadimisetty Sai Sreenadh, BA., LLB (Hons.)