1. Dispute over classification of lenders as financial creditors under the IBC based on a covenant to pay shortfalls in a hypothecation deed for third-party debts. (Para 1 , 2 , 3 , 4 , 6 )
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2024 Supreme(SC) 1238
SUPREME COURT OF INDIA
Abhay S Oka, Pankaj Mithal, JJ.
China Development Bank – Appellant
Versus
Doha Bank Q.P.S.C. & Ors. – Respondents
Civil Appeal No. 7298 OF 2022 Civil Appeal No.7407 of 2022 Civil Appeal No.7615 of 2022 Civil Appeal No.7328 of 2022 and Civil Appeal No.7434 of 2023
Decided On : 20-12-2024
Advocates appeared:
For the Appellant(s) : Mr. Neeraj Kishan Kaul, Sr. Adv. Mr. Chetan Kapadia, Sr. Adv. Mr. Siddharth Ranade, Adv. Ms. Nishi Bhankharia, Adv. Mr. Ribhu Garg, Adv. Ms. Kaazvin Kapadia, Adv. Mr. Pushkar Deo, Adv. Mr. Deepak Joshi, Adv. Mr. Raghav Agarwal, Adv. Mr. Syed Jafar Alam, AOR
(Item Nos.1501.1 & 1501.3) : Mr. Darius Khambata, Sr. Adv. Mr. Rajendra Barot, Adv. Mr. Abhijnan Jha, Adv. Mr. Bharat Makkar, Adv. Mr. Pranav Tomar, Adv. Ms. Liz Mathew, AOR
For the Respondent(s): Mr. S. S. Shroff, AOR Mr. Saurav Panda, Adv. Mr. Vaijayant Paliwal, Adv. Ms. Charu Bansal, Adv. Ms. Mohana Nijhawan, Adv. Ms. Kirti Gupta, Adv. Mr. P. Chidambaram, Sr. Adv. Mr. Dhruv Malik, Adv. Ms. Jinal Shah, Adv. Ms. Palak Nenwani, Adv. Mr. Ronit Chopra, Adv. Mr. P Chidambaram, Sr. Adv. M/S. Juris Corp., AOR Mr. Abhijnan Jha, AOR Mr. Bharat Makkar, Adv. Mr. Pranav Tomar, Adv. Mr. Sanjay Kapur, AOR Mr. Devesh Dubey, Adv. Mr. Surya Prakash, Adv. Mr. Arjun Bhatia, Adv. Ms. Divya Singh Pundir, Adv. Ms. Mahima Kapur, Adv. Ms. Shubhra Kapur, Adv.
For the Appellant(s) : Mr. Neeraj Kishan Kaul, Sr. Adv. Mr. Chetan Kapadia, Sr. Adv. Mr. Siddharth Ranade, Adv. Ms. Nishi Bhankharia, Adv. Mr. Ribhu Garg, Adv. Ms. Kaazvin Kapadia, Adv. Mr. Pushkar Deo, Adv. Mr. Deepak Joshi, Adv. Mr. Raghav Agarwal, Adv. Mr. Syed Jafar Alam, AOR
(Item Nos.1501.1 & 1501.3) : Mr. Darius Khambata, Sr. Adv. Mr. Rajendra Barot, Adv. Mr. Abhijnan Jha, Adv. Mr. Bharat Makkar, Adv. Mr. Pranav Tomar, Adv. Ms. Liz Mathew, AOR
For the Respondent(s): Mr. S. S. Shroff, AOR Mr. Saurav Panda, Adv. Mr. Vaijayant Paliwal, Adv. Ms. Charu Bansal, Adv. Ms. Mohana Nijhawan, Adv. Ms. Kirti Gupta, Adv. Mr. P. Chidambaram, Sr. Adv. Mr. Dhruv Malik, Adv. Ms. Jinal Shah, Adv. Ms. Palak Nenwani, Adv. Mr. Ronit Chopra, Adv. Mr. P Chidambaram, Sr. Adv. M/S. Juris Corp., AOR Mr. Abhijnan Jha, AOR Mr. Bharat Makkar, Adv. Mr. Pranav Tomar, Adv. Mr. Sanjay Kapur, AOR Mr. Devesh Dubey, Adv. Mr. Surya Prakash, Adv. Mr. Arjun Bhatia, Adv. Ms. Divya Singh Pundir, Adv. Ms. Mahima Kapur, Adv. Ms. Shubhra Kapur, Adv.
The court affirmed the classification of appellants as Financial Creditors under the IBC, establishing that obligations in the Deeds of Hypothecation constituted guarantees.
Headnote:(A) Insolvency and Bankruptcy Code, 2016 - Section 5(7) and 5(8) - Financial Creditors - Classification of appellants as Financial Creditors upheld - The NCLAT's order setting aside the NCLT's classification of appellants as Financial Creditors quashed - The Corporate Debtor's obligation to discharge liabilities of third parties established under the Deeds of Hypothecation. (Paras 68)
(B) Contract Act, 1872 - Section 126 - Definition of guarantee - The Corporate Debtor's undertaking to pay shortfall in liabilities of RCom and RTL amounts to a guarantee under the Contract Act. (Paras 58)
Facts of the case:
The appellants claimed classification as Financial Creditors based on Deeds of Hypothecation executed by RCom entities, which included an obligation to cover shortfalls in liabilities. The NCLT initially upheld this classification, which was challenged by the 1st Respondent-Doha Bank.
Findings of Court:
The court found that the NCLAT's decision to set aside the NCLT's classification was incorrect, reaffirming the appellants' status as Financial Creditors. The Corporate Debtor's obligations under the Deeds of Hypothecation were clarified as guarantees.
Issues: The main issues were the classification of the appellants as Financial Creditors and the interpretation of the Deeds of Hypothecation regarding guarantees.
Ratio Decidendi: The court ruled that the obligations under the Deeds of Hypothecation constituted guarantees, thus affirming the appellants' status as Financial Creditors under the IBC. The NCLAT's order was quashed, restoring the NCLT's classification.
Result: The appeals are, accordingly, allowed.
Judgement Key Points
Key Points: - The DoH clause 5(iii) can create a guarantee under Section 126 of the Contract Act, making Corporate Debtor a guarantor for shortfall obligations. (!) (!) (!) - Whether the appellants are Financial Creditors under IBC depends on treating the DoH as a guarantee and the applicability of Sections 5(7), 5(8), and 3(6)/(11) to define "financial debt" and "claim." (!) (!) (!) (!) (!) - The NCLAT's reversal of NCLT's classification of appellants as Financial Creditors was quashed; the appellants are to be classified as Financial Creditors, with the DoH recognized as guaranteeing obligations. (!) (!)
Question 1?
Question 2?
Question 3?
Legal Category Hierarchy
- insolvency and bankruptcy law
- contract law
Table of Contents
2. Whether a covenant to pay shortfalls in a hypothecation deed constitutes a guarantee under the Contract Act, thereby qualifying lenders as financial creditors under the IBC. (Para 9 , 11 , 12 , 13 , 19 , 26 , 27 , 28 , 30 , 31 )
3. The court analyzed the hypothecation deed and found the obligation to pay shortfalls for third-party borrowers constitutes a guarantee, creating a financial debt under the IBC. (Para 40 , 41 , 42 , 44 , 45 , 53 , 54 , 55 , 56 , 57 , 58 , 59 , 61 , 62 , 63 , 64 , 65 )
4. A covenant to discharge the liability of a third party by paying shortfalls in recovery from secured assets constitutes a guarantee and a financial debt under IBC. (Para 58 , 59 )
5. The appellate tribunal's order was set aside and the adjudicating authority's order upholding the status of the lenders as financial creditors was restored. (Para 68 )
6. Does the title or nomenclature of a document determine its legal nature?
No, the nomenclature of a contract or document is not decisive. The real nature of the transaction must be determined by an overall reading of all terms, clauses, and the resulting rights and effects. (Para 53 )
7. Does a covenant to pay a shortfall in a hypothecation deed constitute a guarantee?
Yes, if a party who is not the borrower undertakes to pay any shortfall or deficiency in the recovery of debts owed by third parties after the sale of hypothecated assets, it constitutes a contract of guarantee under Section 126 of the Contract Act. (Para 58 , 59 )
8. Is an actual default necessary to be classified as a Financial Creditor under the IBC?
No. While default is necessary to initiate CIRP under Section 7, it is not a requirement for a debt to be financial debt under Section 5(8) or for a person to be a Financial Creditor under Section 5(7). (Para 61 , 62 )
9. Does the moratorium under Section 14 of the IBC extinguish a creditor's claim?
No, the moratorium prohibits the institution of suits or enforcement of security interests, but it does not extinguish the underlying liability or the right to file a claim during the resolution process. (Para 63 , 65 )
JUDGMENT :
ABHAY S. OKA, J.
FACTUAL ASPECTS
1. These appeals take exception to the judgment dated 9th September 2022 of the National Company Law Appellate Tribunal, Principal Bench, New Delhi (for short, ‘the NCLAT’). The appellants in this batch of appeals (for short, ‘appellants’), except the appellant in Civil Appeal No.7434 of 2023, were parties to the appeals preferred by 1st to 4th respondents in Civil Appeal No. 7298 of 2022.
2. The issue involved in these appeals is whether the appellants can be classified as ‘Financial Creditors’ within the meaning of sub-section (7) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (for short, ‘the IBC’). Another issue may arise in the event it is held that the appellants are not ‘Financial Creditors’. The issue will be whether the appellants can be classified as ‘Secured Creditors’ and paid commensurate to their security interest.
3. 1st respondent-Doha Bank claims to be a direct lender and secured Financial Creditor of Reliance Infratel Limited (for short, ‘RITL’ or ‘the Corporate Debtor’). A Corporate Insolvency Resolution Process (CIRP) was initiated by the adjudicating authority (NCLT) in respect of RITL-Corporate Debtor at the instance of Ericsson India Private Limited, and the Interim Resolution Professional (IRP) was appointed. We are concerned in this case with Reliance Communications Infrastructure Ltd. (for short, ‘RCIL’), Reliance Communications Ltd. (for short, ‘RCom’), Reliance Telecom Ltd. (for short, ‘RTL’) and RITL. These companies are hereinafter collectively referred to as “RCom entities”.
4. Public announcements were made under Section 15 of the IBC inviting claims from creditors. The appellants submitted their claims as Financial Creditors of the Corporate Debtor. While admitting the claim of the appellants, the Resolution Professional classified the appellants as Financial Creditors. Accordingly, the appellants were included in the Committee of Creditors (for short, ‘the COC’). The 1st Respondent-Doha Bank, made applications before the NCLT to challenge the admission of the claims of the appellants (except the appellant in Civil Appeal No.7434 of 2023) as Financial Creditors. The contention of the 1st respondent-Doha Bank was that the said appellants were not direct lenders of the Corporate Debtor, and it was impermissible to admit them as Financial Creditors on the basis of various terms of the Deeds of Hypothecation.
5. During the pendency of 1st respondent-Doha Bank’s Application, a Resolution Applicant submitted a Resolution Plan for the Corporate Debtor, which the CoC approved in its meeting held on 2nd March 2020. After that, the 5th respondent-RP filed an application for grant of approval to the Resolution Plan. By order dated 3rd December 2020, the NCLT approved the Resolution Plan. The approval was granted without deciding the pending application made by the 1st respondent-Doha Bank, filed for objecting to the status of the appellants as Financial Creditors. The 6th Respondent preferred an appeal before the NCLAT to challenge the approval of the Resolution Plan. By the order dated 19th January 2021, the NCLAT directed the NCLT to decide the application of the 1st Respondent-Doha Bank. The NCLAT disposed of the appeal by observing that depending on the outcome of the application of the 1st Respondent, the order approving the Resolution Plan could be reconsidered.
6. The appellants have relied upon the Deeds of Hypothecation dated 4th March 2011, 9th March 2011, 12th February 2012 and 15th September 2018 (collectively referred to as “the DoH”). The DoH were executed jointly by each of the Rcom entities (described therein as Chargors), including the Corporate Debtor (RCIL), to create a charge over their property for securing the repayment of the facilities advanced by the appellants. The RCom entities agreed to provide their assets as security and further undertook to pay any shortfall of debts owed by each of the RCom entities. All the RCom entities pooled
