Supreme Court Quashes NCLAT’s Ruling, Upholds NCLT’s Verdict Over Financial Creditor Issue

Supreme Court Quashes NCLAT’s Ruling, Upholds NCLT’s Verdict Over Financial Creditor Issue

The matter involved the China Development Bank and the Doha Bank

The Supreme Court has held that the amount of liability on any guarantees for money borrowed against the payment of interest is a financial debt under Section 5(8) of the Insolvency and Bankruptcy Code (IBC).

The observation was made as part of its deliberation on whether the appellants, who acted as Secured Creditors, should be classified as Financial Creditors.

In the China Development Bank v. Doha Bank Q.P.S.C. & Ors case, the bench of Justice Abhay S. Oka and Justice Augustine George Masih said, “There is no requirement under Section 5(8) of the IBC that there can be a debt only when there is a default. When it is established that the financial debt is owed to any person, he/she becomes a Financial Creditor.”

The case stemmed from a dispute over the classification of appellants (China Development Bank), which provided security through a Deed of Hypothecation (DoH), but did not directly fund the corporate debtor, Reliance Infratel Ltd.

The appellants challenged the 9 September 2022 judgment of the National Company Law Appellate Tribunal (NCLAT), which addressed their classification as ‘Financial Creditors’.

Doha Bank, a direct lender to Reliance, contested the appellants' classification. It claimed they were not direct lenders, based on the DoH, which created charges over assets to secure repayment of the loans.

While initially, the National Company Law Tribunal (NCLT) admitted the appellants as Financial Creditors, after Doha Bank's objection, the matter reached the NCLAT.

The appellate tribunal reversed NCLT’s decision. It held that the DoH did not constitute a guarantee, thus the appellants were not guarantors.

The case was remanded to the NCLT for further proceedings. Additionally, the Civil Appeal No. 7434 of 2023 involved an appeal from a separate bank, not part of the NCLAT case, regarding its classification as a Financial Creditor.

The appellants argued that the Corporate Debtor, under the Master Security Trustee Agreement (MSTA) and DoH, guaranteed the repayment of loans taken by the Reliance Communications entities, including covering any shortfall in recovery.

They highlighted the obligations: paying the outstanding dues, creating a charge over assets for Secured Creditors and making good any shortfall in case of default. They said the guarantee qualified them as Financial Creditors.

The appellants maintained their participation in the Corporate Insolvency Resolution Process (CIRP) as Financial Creditors should not be overlooked. They disputed the claim that the moratorium under Section 14 extinguished their rights. It only prevents enforcement but did not invalidate their entitlement, they stated. If not considered Financial Creditors, they had a right to the value of their security interest in the Resolution Plan.

On the other hand, the respondents argued that the DoH did not qualify as a guarantee under Section 126 of the Contract Act. It involved hypothecation of assets in favor of the Security Trustee, not a promise to discharge the borrower’s debt. Clause 5(iii) of the DoH.

They added that it was a contingent contract dependent on asset sale prohibited by the moratorium under Section 14 of the IBC. The Corporate Debtor was not a guarantor and did not avail of loans from the appellants. The financial statements and CoC meeting minutes proved that.

They argued that the appellants approved the Resolution Plan, which extinguished their security. Once the CoC approved, the Resolution Plan could not be challenged. Asserting that the respondents’ appeals must be dismissed, the appellants said they were considered Financial Creditors, and their claim would not affect the CIRP or the Resolution Plan.

The judges analyzed the MSTA and the DoH and held, “The DoH has been executed by the Security Trustee acting on behalf of the appellants by the authority vested in it by MSTA. Clause 2.1 of the MSTA allows the Security Trustee to act on behalf of the appellants. Each Original Obligor appoints the Security Trustee who acts for the benefit of the secured parties."

Quoting Clause 5(iii) of the DoH, the bench ruled, "In the event that a default occurred, the Security Trustee shall take charge and/or possession of all or any part of the hypothecated property."

The bench referred to Section 126 of the Contract Act, which defines a guarantee as a contract to discharge a third party’s liability. It clarified that a person was a Financial Creditor as soon as the financial debt was owed, regardless of default.

Rejecting the argument that the claim under Clause 5(iii) was contingent upon default or the moratorium, the court emphasized the claim was valid despite the moratorium.

It confirmed the validity of the appellants’ claims despite the approval of the Resolution Plan by the NCLAT. The judges rejected the alternative contention regarding the appellants' status as Secured Creditors.

Justice Oka and Justice Masih held that the impugned judgment and order of the NCLAT was not sustainable. They upheld the 2 March 2021 order of the Mumbai bench of the NCLT and allowed the appeals.

The petitioner was represented by advocate Syed Jafar Alam and the respondents were guided by advocate Juris Corp and S. S. Shroff.