In the earlier part of this article, "Third Party Security whether a fraudulent preference: Supreme Court decides", we summarised the findings of the Supreme Court in Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Etc.Etc. 1 in relation to whether certain third party mortgage transactions were to be avoided under Sections 43, 45 and 66 of the Insolvency and Bankruptcy Code, 2016 ("the Code"). In this concluding part, we examine the judgment in relation to the issue as whether the lenders of JAL could be recognized as financial creditors of the corporate debtor JIL on the basis of the mortgages created by JIL as collateral security for loans taken by its holding company JAL.


The Supreme Court has examined the term "financial debt" and "financial creditor" in great detail to clarify the meaning and role of a financial creditor in an insolvency resolution process.

Financial Creditor – as explained in Swiss Ribbons

The decision in the case of Essar Steel2 (decided on 15th November 2019) was based on the Apex Court's judgment in the case of Swiss Ribbons3 (decided on 25th January 2019). In the Swiss Ribbons case this court rejected the contentions that classification between financial creditors and operational creditors was discriminatory and violative of Article 14. Further, the Supreme Court has extensively discussed financial creditors and operational creditors and their roles under the insolvency resolution process. The most important feature is that a financial creditor is from the very beginning, involved in assessing the viability of the corporate debtor who can, and indeed, engage in restructuring of the loan as well as reorganization of the corporate debtor's business when there is financial stress. In short, a financial creditor is one whose stakes are intrinsically inter-woven with the well-being of the corporate debtor.

Financial Creditors – as explained in Pioneer Urban

This court while interpreting Section 5(8)(f) of the Code on the question as to whether an allottee under a real estate project, analysed the gamut of the terms 'disbursement', 'borrowing' and 'time value of money' being the root ingredients of 'financial debt' under the Code. The definition of 'financial debt' and 'financial creditor' in the Code have been defined with the words 'means' and 'includes' and in the present case the bench while interpreting such definitions clarified that the problem whether to read the definition in a restrictive sense or have an expanded meaning arrives because the definition includes both the terms 'means and includes'. This court decided not to go with either extremities, as laid down in the Pioneer Urban Case.

The Essentials of Financial Debt and Financial Creditor

The bench in the present case held that for a debt to be a financial debt for the purpose of Part II of the Code, the most essential element is that it should be a disbursal against the consideration for time value of money and for any person to be designated a financial creditor to the corporate debtor, it has to be shown that the corporate debtor owes a financial debt to such person.

The terms 'financial debt' and 'financial creditors' have been defined in Part II, however the term 'secured creditors' and 'security interests' have been mentioned in Part I of the Code and reading all the defining clauses harmoniously, it is evident that the legislature intended to differentiate between financial and secured creditors. The term 'secured creditor' being different from 'financial creditor' has been interpreted by the bench to distinguish the role of a financial creditor under CIRP. A secured creditor under the Code means a creditor in whose favour a security interest has been created. On the other hand, a financial creditor has been given the role of a guardian as such financial creditor has direct engagement in the functioning of the corporate debtor and would engage in restructuring of the loan as well as in reorganization of the corporate debtor's business when there is financial stress. Such financial creditors have been entrusted by the legislature with the role to ensure that the corporate debtor is rejuvenated and gets back to its wheels with reasonable capacity of repaying its debts and to attend on its other obligations.

In the present case, the bench held that if the secured creditors are added to the list of financial creditors and thereby allowed to have a say in the process, the growth and revival of the corporate debtor which has been the very objective of the Code, cannot be attained and thus such creditors having only security interest over the assets of the corporate debtor should stand outside the sect of financial creditors for the purpose of Part II of the Code.

On a contextual reading of the Essar Steel case and the Swiss Ribbons case, the bench was of the opinion that a secured creditor can only be subsumed in the definition of financial creditor if the such secured creditor was directly engaged in advancing credit to the corporate debtors and would not include indirect secured creditors who had extended any loan or facility to a third party but had taken a security from the corporate debtor. The contentions made by relying on the judgement in Smt. Kusum4, were also rejected by the bench in the present case stating that JAL Lenders while holding mortgages executed by the Corporate Debtor JIL, carrying a security interest could at best be understood as a secured creditor and not as a financial creditor, as JIL does not owe any financial debt to JAL Lenders.

To summarize the second issue of whether such JAL Lenders could be considered as financial creditors to the Corporate Debtor JIL, the bench decided that they may fall under the category of secured creditors, but such mortgage being neither towards any loan or facility towards JIL nor towards protecting any facility of JIL, essentially means that the corporate debtor JIL does not owe any financial debt to JAL Lenders and thus they cannot be considered to be financial creditors of JIL under Part II of the Code.

Effect on Part III?

The portion relating to partnership firms and individuals under Part III is yet to be notified (and is only partly in effect for personal guarantors) and even though the judgment relates to a specific tripartite agreement and time and again mentions its relevance only to Part II of the Code, whether the principles laid down in this judgment will affect third party securities created by individuals and partnership firms remains unclear. The mention of the term secured creditors might raise some questions as the bench remarked that JAL Lenders could be secured creditors by interpreting the literal meaning provided under Section 3(30) of the Code and the interpretation of such judgment in light of there being no mention of financial creditors under Part III might lead to a completely different outcome.


1 Civil Appeal Nos. 8512-8527 of 2019

2 Committee of Creditors of Essar Steel India Limited through Authorised Signatory v. Satish Kumar Gupta: 2019 SCC OnLine SC 1478

3 Swiss Ribbons Private Limited and Anr. v. Union of India and Ors.: (2019) 4 SCC 1726

4 State Bank of India v. Smt. Kusum Vallabhdas Thakkar: 1991 SCC Online Guj 14,

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