Third-Party security in insolvency cases: A case for limited participation
November 27, 2025
The IBC Amendment Bill must recognise non-voting participation rights for creditors holding third-party security
The Insolvency and Bankruptcy Code (Amendment) Bill, 2025, now before the Select Committee of Parliament and expected to feature in the forthcoming winter session, has attracted wide scrutiny. Its broad procedural reforms, such as accelerated timelines, stricter withdrawal, and creditor-led resolution has come in for much comment.
But here we focus on a narrower but consequential gap in the Bill: the legal position of creditors holding security over third-party assets, and their limited role during corporate insolvency.
Under current law, a lender who advances funds to one entity but takes security over another’s (not a guarantor) assets occupies an uncertain position when the latter enters insolvency. Despite holding valid security, such a creditor does not qualify as a “financial creditor” under Section 5(8) of the IBC.
SC rulings
The Supreme Court in Anuj Jain vs Axis Bank (2020) and Phoenix ARC vs Ketulbhai (2021) reaffirm that financial debt requires direct disbursal to the debtor. As a result, a creditor whose loan is secured by third-party assets remains outside the Committee of Creditors (CoC).
This has practical consequences. Exclusion from the CoC denies the creditor any role in decisions that affect the treatment and value of its collateral. The Supreme Court, in Vistra ITCL vs Dinkar Venkarasubramanian (2023), lamented that although the security interest subsists, exclusion from CoC deliberations effectively deprives such creditors of any influence over valuation and realisation of its security.
It noted that such exclusion does not sit well with the IBC’s spirit, which seeks to safeguards even those creditors situated outside the CoC. The Court thus fashioned a remedial approach by recognising the creditor’s entitlement to the full benefit of its security under Section 52 and 53 of the IBC.
Structural limitation
Yet this remedy reveals a deeper structural limitation. Being confined to Sections 52 and 53 offers little protection during resolution. Between exclusion from the CoC and the onset of liquidation lies a procedural vacuum. The creditor retains its security in form, but lacks any role in key decisions — valuation, treatment of the secured asset, and plan negotiations — that determine its security will ultimately retain value.
Worse, a resolution plan may extinguish the security altogether, leaving the creditor without collateral or recovery. This gap underscores why limited participation rights at the resolution stage are unnecessary.
The problem is sharper in group structures. The CoC often lacks full visibility into inter-company dependencies, shared assets, and intra-group guarantees. This can lead to undervaluation of cross-collateralised assets or mispricing of guarantees. Credit risk becomes harder to predict, as lenders cannot ascertain how collateral will be treated across related entities when intra-group arrangements blur asset boundaries. The result is distorted valuation and diminished predictability of recovery.
Clarification needed
A statutory clarification could address this asymmetry without disturbing the IBC’s scheme. One option is introducing a deeming provision, perhaps as Section 5(8A), treating third-party security linked to a financial transaction as “financial debt” for limited, non-voting purposes. Its placement would preserve definitional coherence and signal that participatory rights flow from, rather than depart from, the core concept of financial debt. This would not affect the waterfall or alter repayment priorities, but would allow such creditors to attend CoC meetings as observers in defined circumstances.
The concept of ‘observe participation’ already exists in practice wherein resolution professional may invite non-CoC stakeholders to attend meetings to assist deliberations, though without voting rights. Statutory recognition of this principle — limited to cases where (i) the secured asset forms a substantial part of the debtor’s estate; (ii) enforcement is stayed by moratorium under Section 14; or (iii) the creditor’s exposure is closely tied to group entities — would improve transparency without complicating decision-making.
Pending such legislative clarification, lenders can protect themselves contractually. Guarantees or indemnities can establish a direct financial obligation, bringing the claim within the existing definition of financial debt. Pre-insolvency enforcement under Section 13(9) of the SARFAESI Act may be explored before the moratorium attaches. Inter-creditor agreements within group entities can define priorities and mitigate disputes.
So Parliament can consider a formal clarification recognising non-voting participation rights for creditors holding third-party security, wherever decision of the CoC directly affect the value of their collateral. This modest reform would strengthen commercial certainty without altering the IBC’s foundational balance.
The writer is an advocate at the Delhi High Court
Published on November 27, 2025
But here we focus on a narrower but consequential gap in the Bill: the legal position of creditors holding security over third-party assets, and their limited role during corporate insolvency.
Under current law, a lender who advances funds to one entity but takes security over another’s (not a guarantor) assets occupies an uncertain position when the latter enters insolvency. Despite holding valid security, such a creditor does not qualify as a “financial creditor” under Section 5(8) of the IBC.
SC rulings
The Supreme Court in Anuj Jain vs Axis Bank (2020) and Phoenix ARC vs Ketulbhai (2021) reaffirm that financial debt requires direct disbursal to the debtor. As a result, a creditor whose loan is secured by third-party assets remains outside the Committee of Creditors (CoC).
This has practical consequences. Exclusion from the CoC denies the creditor any role in decisions that affect the treatment and value of its collateral. The Supreme Court, in Vistra ITCL vs Dinkar Venkarasubramanian (2023), lamented that although the security interest subsists, exclusion from CoC deliberations effectively deprives such creditors of any influence over valuation and realisation of its security.
It noted that such exclusion does not sit well with the IBC’s spirit, which seeks to safeguards even those creditors situated outside the CoC. The Court thus fashioned a remedial approach by recognising the creditor’s entitlement to the full benefit of its security under Section 52 and 53 of the IBC.
Structural limitation
Yet this remedy reveals a deeper structural limitation. Being confined to Sections 52 and 53 offers little protection during resolution. Between exclusion from the CoC and the onset of liquidation lies a procedural vacuum. The creditor retains its security in form, but lacks any role in key decisions — valuation, treatment of the secured asset, and plan negotiations — that determine its security will ultimately retain value.
Worse, a resolution plan may extinguish the security altogether, leaving the creditor without collateral or recovery. This gap underscores why limited participation rights at the resolution stage are unnecessary.
The problem is sharper in group structures. The CoC often lacks full visibility into inter-company dependencies, shared assets, and intra-group guarantees. This can lead to undervaluation of cross-collateralised assets or mispricing of guarantees. Credit risk becomes harder to predict, as lenders cannot ascertain how collateral will be treated across related entities when intra-group arrangements blur asset boundaries. The result is distorted valuation and diminished predictability of recovery.
Clarification needed
A statutory clarification could address this asymmetry without disturbing the IBC’s scheme. One option is introducing a deeming provision, perhaps as Section 5(8A), treating third-party security linked to a financial transaction as “financial debt” for limited, non-voting purposes. Its placement would preserve definitional coherence and signal that participatory rights flow from, rather than depart from, the core concept of financial debt. This would not affect the waterfall or alter repayment priorities, but would allow such creditors to attend CoC meetings as observers in defined circumstances.
The concept of ‘observe participation’ already exists in practice wherein resolution professional may invite non-CoC stakeholders to attend meetings to assist deliberations, though without voting rights. Statutory recognition of this principle — limited to cases where (i) the secured asset forms a substantial part of the debtor’s estate; (ii) enforcement is stayed by moratorium under Section 14; or (iii) the creditor’s exposure is closely tied to group entities — would improve transparency without complicating decision-making.
Pending such legislative clarification, lenders can protect themselves contractually. Guarantees or indemnities can establish a direct financial obligation, bringing the claim within the existing definition of financial debt. Pre-insolvency enforcement under Section 13(9) of the SARFAESI Act may be explored before the moratorium attaches. Inter-creditor agreements within group entities can define priorities and mitigate disputes.
So Parliament can consider a formal clarification recognising non-voting participation rights for creditors holding third-party security, wherever decision of the CoC directly affect the value of their collateral. This modest reform would strengthen commercial certainty without altering the IBC’s foundational balance.
The writer is an advocate at the Delhi High Court
Published on November 27, 2025