In Phoenix ARC Pvt. Ltd. v. Ketulbhai Ramubhai Patel1, an appeal came up before the Supreme Court under Section 62 of the Insolvency and Bankruptcy Code, 2016 (“Code”). The appellant therein challenged the decision of the National Company Law Appellate Tribunal (“NCLAT”), New Delhi dated 09.04.2019 whereby the NCLAT dismissed the Company Appeal filed by the Appellant. The Company Appeal was filed by the appellant against order dated 22.02.2019 of National Company Law Tribunal (“NCLT”), Mumbai Bench rejecting the Miscellaneous Application filed by the appellant under Section 60(5)(c) of the Code holding that the appellant is not the financial creditor of Doshion Veolia Water Solutions Private Limited (the corporate debtor).
- L & T Infrastructure Finance Company Limited (the lender) advanced a financial facility to Doshion Limited (the borrower) and entered into a Facility Agreement dated 12.05.2011. The lender advanced to the borrower a financial facility of Rs.40 crores repayable in 72 structured monthly instalments.
- The Board of Directors of Doshion Veolia Water Solutions Private Limited (the corporate debtor) passed a Resolution on 26.07.2011 to give Non-Disposal Undertaking in favour of L & T Infrastructure Finance Company Limited whereby Board was authorised to provide an undertaking to the effect that 100% of its shareholding in Gondwana Engineers Limited (GEL) shall not be disposed of so long as any amounts were due and payable and outstanding under the financial assistance proposed to be provided by L&T Infra to the borrower.
- On 10.01.2012 a Pledge Agreement was executed between the corporate debtor and the lender by which agreement 40,160 shares of GEL were pledged as a security and a deed of undertaking was also executed by the corporate debtor in favour of the lender.
- By an agreement dated 30.12.2013 L&T Infrastructure assigned all rights, title and interest in the financial facility including any security, interest therein in favour of Phoenix ARC Pvt. Ltd.
- The borrower failed to repay as per agreed terms dated 12.05.2011.
- On 31.08.2018, Bank of Baroda filed Company Petition No. CP (IB)1752/MB/2017 before the Adjudicating Authority under Section 7 of the Code to initiate the CIRP in respect of the corporate debtor. By order dated 31.08.2018, the Adjudicating Authority admitted the Company Petition and the CIRP began.
- The appellant filed its claim for an amount of Rs.83,49,85,667/- with the respondent/ resolution professional. The resolution professional vide email dated 20.09.2018 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 appellant thereafter filed M.A.No.1514 of 2018 before the NCLT, Bench at Mumbai in Company Petition No.CP(IB)1752/MB/2017 seeking a direction to the respondent/ resolution professional to admit the claim of the appellant as a financial debt with all consequential benefits including voting rights in the Committee of creditors (“CoC”) of the corporate debtor.
- The appellant submitted that pledge of the shares by the corporate debtor was in essence a guarantee for financial debt and, therefore, appellant was a financial creditor of the corporate debtor.
- The NCLT passed an order dated 22.02.2019 rejecting the Miscellaneous Application filed by the appellant. The NCLT 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. On appeal, the NCLAT held that pledge of shares in question do not amount to “disbursement of any amount against the consideration for the time value of money” and it does not fall within sub-clause (f) of sub-section (8) of Section 5.
The question to be considered before the Supreme Court was whether the appellant would come within the purview of “financial creditor” within the meaning of Section 5(8) of the Code on the strength of pledge agreement dated 10.01.2012 and Deed of Undertaking dated 10.01.2012 entered into with L&T Infrastructure.
The Supreme Court, inter alia, observed and held:
- The Facility Agreement dated 12.05.2011 was executed between the Doshian Ltd. and the L&T Infrastructure Finance Company Ltd. The corporate debtor was not a party to the Facility Agreement. It was Doshion Ltd., the borrower who was to repay the loan of Rs.40 crores.
- The definition of ‘financial debt' as contained in Section 5(8) contains the expressions “means” and “includes”. The definition begins with the words “financial debt” means 'a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money and includes'...The main part of the definition, thus, provides that financial debt means a debt “which is disbursed against the consideration for the time value of money”. The definition in the second part gives instances which also includes financial debt. As clear from the definition a contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. 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.
- A contract of guarantee contains a guarantee “to perform the promise or discharge the liability of third person in case of his default”. The key words in Section 126 of the Indian Contract Act, 1872 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 dated 10.01.2012 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 of 40,160 shares of GEL only.
- 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.
- In Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited Axis Bank Limited and others, (2020) 8 SCC 401, it was 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 in Jaypee Infratech Limited (Supra) 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 5 sub-sections (7) and (8).
- 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 on 10.01.2012, 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.
The case iterates the understanding of the term ‘financial debt' to mean a debt which is disbursed against the consideration for the time value of money. It clearly makes a distinction between a person who gives guarantee to the lender to discharge the liability of the borrower to pay the loan and a person who merely pledges its shares without any such undertaking to repay the outstanding dues of the borrower. In the absence of such an undertaking, the pawnee would not become a financial creditor of the Corporate Debtor (pawnor).
1 Civil Appeal No. 5146 of 2019, decided on February 3, 2021.
Originally Published by VGC Law Firm, February 2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.