NCLAT Clarifies Scope of ‘Financial Debt’, Restores Secured Creditor Status in Debenture Guarantee Dispute

NCLAT Clarifies Scope of ‘Financial Debt’, Restores Secured Creditor Status in Debenture Guarantee Dispute

Introduction

The National Company Law Appellate Tribunal (NCLAT) has held that direct disbursement of funds to a corporate debtor is not mandatory for a claim to qualify as a “financial debt” under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (IBC). A Bench comprising Justice Mohammad Faiz Alam Khan (Judicial Member) and Naresh Salecha (Technical Member) clarified that the statutory definition does not require that the money be disbursed “to the Corporate Debtor,” but only that there be disbursement against consideration for the time value of money and having the commercial effect of borrowing.

Factual Background

The appeal was filed by Vistra ITCL (India) Ltd. against an order of the National Company Law Tribunal in the corporate insolvency resolution process (CIRP) of Radius Estate Projects Pvt. Ltd. Vistra was acting as debenture trustee for debenture holders who had subscribed to optionally convertible debentures worth ₹395 crore issued by Aaditri Constructions Pvt. Ltd.. To secure the debenture obligations, supplemental indentures of mortgage were executed in 2019, under which the corporate debtor agreed to discharge all “secured obligations” arising under the Debenture Trust Deed.

Following default, Vistra filed a claim of ₹874 crore in the CIRP of Radius Estate Projects Pvt. Ltd., asserting that the mortgage deeds contained an express and unconditional “covenant to pay,” which in substance amounted to a guarantee. The resolution professional, however, classified Vistra as an “other secured creditor” instead of a secured financial creditor on the ground that no funds had been directly disbursed to the corporate debtor.

Procedural Background

Aggrieved by the classification of its claim, Vistra challenged the order of the NCLT Mumbai before the NCLAT. Before the Appellate Tribunal, the resolution professional and other respondents contended that the corporate debtor had neither borrowed the funds nor received the debenture proceeds. They argued that merely offering assets as security, without receipt of loan amounts, would not satisfy the definition of “financial debt” under Section 5(8) of the IBC.

The NCLAT proceeded to examine whether direct disbursement to the corporate debtor was an essential requirement under the statute and whether the “covenant to pay” in the mortgage deeds constituted a guarantee.

Issues

1. Whether direct disbursement of funds to the corporate debtor is mandatory for a claim to qualify as a financial debt under Section 5(8) of the IBC.

2. Whether the “covenant to pay” contained in the mortgage deeds amounted to a contract of guarantee.

3. Whether Vistra was entitled to be classified as a secured financial creditor in the CIRP.

Contentions of the Parties

Vistra contended that Section 5(8) of the IBC does not expressly require that funds be disbursed directly to the corporate debtor. It argued that what is essential is the existence of a debt disbursed against consideration for the time value of money and having the commercial effect of borrowing.

It further submitted that the mortgage deeds executed by the corporate debtor contained an express and unconditional covenant to pay the secured obligations, which in substance amounted to a guarantee. This undertaking created an enforceable liability and was not merely a security over property.

The resolution professional and other respondents argued that the corporate debtor neither borrowed the funds nor received the debenture proceeds. According to them, the absence of direct disbursement to the corporate debtor was fatal to the claim being treated as a financial debt. They contended that merely creating a mortgage over assets did not convert the obligation into a financial debt under the IBC.

Reasoning and Analysis

The NCLAT examined the language of Section 5(8) and observed that the provision does not use the words “to the Corporate Debtor” after the term “disbursed.” The essential ingredients of financial debt, the Bench held, are: existence of a debt, disbursement of money, consideration for time value of money, and commercial effect of borrowing.

The Tribunal clarified that the statute does not mandate that funds must be transferred di    rectly into the corporate debtor’s account. What is required is disbursement against consideration for time value of money. Relying on its earlier decision in Rajeev Kumar Jain v. Uno Minda Ltd., the Tribunal reiterated that direct disbursement to the corporate debtor is not an indispensable condition.

On the issue of the “covenant to pay,” the Tribunal held that the corporate debtor’s undertaking to discharge the secured obligations amounted, in substance, to a contract of guarantee under Section 126 of the Indian Contract Act. This was not a mere mortgage securing someone else’s debt but an enforceable promise forming part of the overall borrowing arrangement.

Accordingly, the Appellate Tribunal concluded that Vistra’s claim could not be downgraded solely on the ground that the funds were not directly disbursed to the corporate debtor.

Decision

The NCLAT set aside the order of the NCLT Mumbai and remanded the matter for fresh consideration in light of its findings. It held that direct disbursement to the corporate debtor is not mandatory for a debt to qualify as a financial debt under Section 5(8) of the IBC and that the “covenant to pay” may constitute a guarantee creating financial liability.

In this case the appellant was represented by Senior Advocate Sunil Fernandes with Dharav Shah, Suyash Goverdhan, Pranaya Goyal, Nanki Geewal, Manasi Joguekar & Srishti Agarwal.