The Supreme Court on 03.02. 2021(Wednesday), comprising of a bench of Justices Ashok Bhushan, R Subhash Reddy and MR Shah held that "A person having only security interest over the assets of corporate debtor even if falling within the description of 'secured creditor' by virtue of collateral security extended by the corporate debtor, would not be covered by the financial creditors as per definitions contained in Section 5(7) and (8)." [Phoenix Arc Pvt. Ltd. v. Ketulbhai Ramubhai Patel]
The Bench held, "If a corporate debtor has only offered security by pledging shares, without undertaking to discharge the borrower's liability, then the creditor in such a case will not become 'financial creditor' as defined under the Insolvency and Bankruptcy Code (IBC)."
Facts of the case
The Bank of Baroda had filed a Company Petition before the Adjudicating Authority under Section 7 of the Code to initiate the corporate insolvency resolution process in respect of the Doshion Veolia Water Solutions Private Limited (Corporate Debtor).
The Adjudicating Authority admitted the Company Petition and the corporate insolvency resolution process began. The respondent was appointed as the Interim Resolution Professional of the corporate debtor which was later confirmed as the Resolution Professional of the corporate debtor. Pursuant to the commencement of the corporate insolvency resolution process in respect of the corporate debtor, the appellant filed its claim for an amount of Rs.83,49,85,667/- with the respondent.
The respondent expressed an opinion that as per the Pledge Agreement submitted by the appellant, the corporate debtor’s liability was restricted to pledge of the shares only. The respondent sought further documents in respect of the appellant’s claim.
Although additional documents were submitted by the appellant, the respondent by email reiterated the earlier view.
The appellant filed the petition before the NCLT seeking a direction to the respondent to admit the claim of the appellant as a financial debt with all consequential benefits including voting rights in the Committee of creditors of the corporate debtor. The appellant stated that the pledge of the shares by the corporate debtor was in essence a guarantee for financial debt and, therefore, the appellant was a financial creditor of the corporate debtor.
The Resolution Professional vide email rejected the claim of the appellant as financial creditor of the corporate debtor on the ground that there was no separate Deed of Guarantee in favour of the Assignor. The respondent filed an affidavit in reply before the Adjudicating Authority.
After hearing the parties, the Adjudicating Authority passed an order rejecting the Miscellaneous Application filed by the appellant. The Adjudicating Authority held that the applicant’s status as financial creditor of the corporate debtor is not proved in the light of Section 5(8) of the Code.
Issue Before the Court.
Whether the appellant is a financial creditor within the meaning of Section 5(8) of the Code on the strength of pledge agreement and Deed of Undertaking entered into with L&T Infrastructure.
Contentions of the parties
The counsel appearing on behalf of the appellant, argued that the appellant will become a "financial creditor" by virtue of Section 5(8)(i) of the IBC, which mentions liability arising out of 'guarantee or indemnity'.
The counsel appearing on behalf of the respondent(IRP), submitted that the appellant is not a creditor as it has no right of recovery of any debt from the corporate debtor and has a limited right of enforcing and realising the value of its security in the shape of the shares held by the corporate debtor in its subsidiary. The pledge is not, in any manner, a guarantee under the Contract Act, it was argued.
Courts Observation & Judgment
The Court noted that the Pledge Agreement and undertaking given, entered between Assignor and corporate debtor cannot be termed as contract of guarantee within the meaning of Section 126 of the Contract Act, 1872, since it did not contain an undertaking by the corporate debtor to discharge the liability of the borrower.
"'The present is not a case where the corporate debtor has entered into a contract to perform the promise, or discharge the liability of borrower in case of his default. The Pledge Agreement is limited to pledge 40,160 shares as security. The corporate debtor has never promised to discharge the liability of borrower.
The Facility Agreement under which the borrower was bound by the terms and conditions and containing his obligation to repay the loan security for performance are all contained in the Facility Agreement.
A contract of guarantee contains a guarantee "to perform the promise or discharge the liability of third person in case of his default". Thus, key words in Section 126 are contract "to perform the promise", or "discharge the liability", of a third person.
Both the expressions"perform the promise" or "discharge the liability"relate to "a third person". The Pledge Agreement dated 10.01.2012 does not contain any contract that the promise which was made by the borrower in the Facility Agreement dated 12.05.2011 to discharge the liability of debt of Rs.40 crores is undertaken by the corporate debtor. It was the borrower who had promised to repay the loan of Rs.40 crores in Facility Agreement dated 12.05.2011 and it was borrower who had undertaken to discharge the liability towards lender. The Pledge Agreement dated10.01.2012 does not contain any contract that corporate debtor has contracted to perform the promise, or discharge the liability of the third person. The Pledge Agreement is limited to pledge of40,160 shares of GEL only".
The Court observed that the appellant can at best be termed a "secured creditor".
"The present is also a case where only security was created by the corporate debtor in 40,160 shares of GEL, there was no liability to repay the loan taken by the borrower on the corporate debtor in the present case. At best the Pledge Agreement and Agreement of undertaking executed on10.01.2012, that is, subsequent to Facility Agreement, is security in favour of Lender-Assignor who at best will be secured creditor qua corporate debtor and not the financial creditor qua corporate debtor"
"This Court held that a person having only security interest over the assets of corporate debtor, even if falling within the description of 'secured creditor' by virtue of collateral security extended by the corporate debtor, would not be covered by the financial creditors as per definitions contained in sub-section (7) and (8) of Section 5.What has been held by this Court as noted above is fully attracted in the present case where corporate debtor has only extended a security by pledging 40,160 shares of GEL. The appellant at best will be secured debtor qua above security but shall not be a financial creditor within the meaning of Section 5sub-sections (7) and (8)".
Though the Court held that the appellant was not a 'financial creditor' under IBC, it clarified that it was entitled to seek other remedies available under law to enforce the pledge agreement.
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