Non-direct disbursement of debt to Corporate Debtor amounts to disqualification as ‘Financial Creditor’ under IBC: Questions left to Ponder

On February 26, 2020, the Hon’ble Supreme Court passed a judgment in the matter of Anuj Jain IRP for Jaypee Infratech Ltd. v. Axis Bank Limited & Ors. dealing with the resolution process of Jaypee Infratech Limited (JIL).

The Hon’ble Supreme Court was posed with an essential question that whether the lenders of Jaiprakash Associates Limited (JAL) could be recognized as ‘financial creditors’ of JIL on the strength of the mortgage created by JIL, as collateral security of the debts given by these lenders to its holding company JAL.

History of the Litigation

The factual matrix of the judgment is that JIL had mortgaged its properties as collateral securities for the loans and advances made by the lenders to Jaiprakash Associates Limited (‘JAL’) [the holding company of JIL]. Around 2016-17, mortgage deeds qua the properties of JIL were re-executed, to reflect the increase in the amount of facilities granted to JAL.

On August 9, 2017, the National Company Law Tribunal, Allahabad (NCLT) initiated the corporate insolvency resolution process (CIRP) of JIL. The lenders of JAL submitted a claim as a ‘financial creditor’ of JIL on the basis of the existence of the afore-referred mortgage deeds (Said Transaction).

The Resolution Professional (RP) not only rejected the claim of the lenders of JAL as ‘Financial Creditor’ of JIL; but, also filed an application seeking avoidance of Said Transactions as being preferential, undervalued and fraudulent. Aggrieved by the rejection, ICICI Bank Limited and Axis Bank Limited (Said Lenders) by way of separate applications questioned the decision of the RP rejecting their claims as financial creditors.

The Learned NCLT rejected the said applications vide its orders dated 09.05.2018 and 15.05.2018, respectively observing that the Said Lenders had not disbursed the debt (along with interest against the consideration for the time value of money) to JIL. Therefore, it was held that the Said Lenders could not be treated as Financial Creditors of JIL (on the premise of the mortgage created by JIL, as collateral security for the debt of JAL).

The Learned NCLT by its subsequent order dated 16.05.2018 accepted the application filed by the RP in part, holding that (i) the Said Transactions were executed within the look back period of two years and (ii) thus, identifying six of the Said Transactions to be preferential, undervalued and fraudulent within the meaning of Sections 43, 45 and 66 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’).

In appeal, the Hon’ble NCLAT, vide Final Common Order dated 01.08.2019; took an entirely opposite view of the matter and upturned the order dated 16.05.2018, while holding that the Said Transactions do not fall within the mischief of being preferential or undervalued or fraudulent.

Though, the aforesaid orders dated 09.05.2018 and 15.05.2018 were also questioned before the Hon’ble NCLAT by the Said Lenders of JAL by filing separate appeals. However, nothing was discussed by Hon’ble NCLAT in the Common Order on the aspect of rejection of claim as ‘Financial Creditor’; though, the outcome was that the appeal was allowed.

The Judgment

The Hon’ble Supreme Court in the Judgment observed that debts in question are in the form of a third party security; given by JIL so as to secure the loans/ advances/ facilities obtained by JAL from the Said Lenders. It has now been settled that such a ‘debt’ is not and cannot be a covered under the expression ‘financial debt’ [Section 5(8) of the IBC]; and hence, the Said Lenders (being the mortgagees) were not the ‘financial creditors’ of JIL.

The Hon’ble Court while construing the meaning of the words ‘mean’ and ‘include’ as provided under section 5(8) of the IBC held that:

1. the definition, by its very frame, cannot be read so expansive, rather infinitely wide; and

2. the root requirements of ‘disbursement’ against ‘the consideration for the time value of money’ could not be forsaken in the manner that any transaction could stand alone to become a financial debt.

It was observed that it may partake in any form of transaction as envisaged under section 5(8) of the IBC. But, it was held that in order to qualify as a ‘financial creditor’ a basic element of disbursal to the corporate debtor, of amount against the consideration of time value of money, needs to be found in the genesis of any debt being claimed as ‘financial debt’ before it could be treated so under Section 5(8) of the IBC.

The Hon’ble Court also considered the definitions of ‘debt’ [Section 3(11)] ‘secured creditor’ [Section 3(30)] and ‘security interest’ [Section 3(31)] and held that the legislature had maintained a distinction amongst the expressions ‘financial creditor’ and ‘operational creditor’ and ‘secured creditor’ and ‘unsecured creditor’. Therefore, it was held by the Hon’ble Supreme Court that every secured creditor would be a creditor and every financial creditor would also be a creditor; but, every secured creditor may not be a financial creditor.

The Hon’ble Court also considered the celebrated judgments of Swiss Ribbons Private Limited v. Union of India and Pioneer Urban Pioneer Urban Land and Infrastructure Limited & Anr. v. Union of India and Ors. and held that what is intended by the expression ‘financial creditor’ is a person who has direct engagement in the functioning of the corporate debtor and therefore, would be involved right from the beginning while assessing the viability of the corporate debtor and who would engage in restructuring of the loan as well as in reorganisation of the corporate debtor’s business, when there is financial stress. Therefore, it was held that the financial creditor, by its own direct involvement in a functional existence of corporate debtor, acquires unique position, who could be entrusted with the task of ensuring the sustenance and growth of the corporate debtor, akin to that of a guardian.

On the basis of the above finding, the Hon’ble Court ultimately held that the creditors of JAL cannot be included under the class of ‘Financial Creditors’ of JIL; merely on the basis of the execution of mortgage deeds.

Questions Remained Unanswered and Difficulties Posed By The Judgment

The above finding poses a question that whether the invocation of a guarantee provided by the Corporate Debtor to discharge the debt of another company (being the principal borrower) would qualify the creditor invoking the guarantee to fall under the class of ‘financial creditor’?

The Hon’ble Court in the Judgment has not traversed specifically in answering the said question and not interpreted section 5(8) in this context (as the same did not arise in the said matter). But having said that, the reading the ratio decidendi of the Judgment would suggest that the answer to this question would be a clear ‘no’, as there has been no disbursal to the Corporate Debtor against the consideration of time value of money by the said creditor. The obvious upshot of the same is that though the liability of the guarantor may be co-existent with that of the principal borrower; but, that would make the creditor invoking the guarantee as only a ‘creditor’ of the Corporate Debtor and not the ‘financial creditor’ under the IBC.

Therefore, the natural corollary of this interpretation is that neither such creditor having the security interest nor the creditors invoking guarantee can invoke the provisions of Section 7 of the IBC. Such creditors cannot also then become a part of Committee of Creditors (‘CoC’) constituted under Section 21 of the IBC. This implies that they will have no right on the decision making involved during the CIRP and shall stand completely excluded. Furthermore, the nature of treatment to be given by a resolution applicant, while submitting the Resolution Plan, to claims submitted by such creditors, also has thus become an issue of debate.

The said interpretation by the Hon’ble Court may seem to be obvious and plain; but, the consequences it carries are massive. There are many cases where the CIRP was initiated at the behest of the creditors only having security interest in the assets of the corporate debtor or upon invocation of the guarantee issued by the said corporate debtor. Furthermore, all such creditors have been a part of the CoC and have been deciding the fate of the Corporate Debtor during the CIRP. Many such companies have already gone into liquidation on the basis of the decision making by such secured creditors.

It thus creates a conundrum where if such secured creditors didn’t fall under the definition of ‘Financial Creditor’, then all such actions taken by them could be construed to be illegal and non-est. Hence, in the wake of the Judgment, we may see a new round of litigation where the actions of such creditors [having been taken as a consequence of them being treated as the ‘financial creditor’] may be challenged. It would be interesting to see how such gaping questions are dealt by the concerned Tribunals/Courts, as and when they are faced with the same.