Recently, the Supreme Court passed a Judgment dated 26-02-2020 in Anuj Jain v. Axis Bank Ltd and others, wherein the Apex Court held that lenders cannot initiate corporate insolvency resolution process as a financial creditor under the Insolvency and Bankruptcy Code 2016 as amended thereof (the Code) against a third party, which has only created a security interest or mortgage in its properties, on behalf of the principal borrower.
In this case,Mr. Anuj Jain was appointed as the Interim Resolution Professional (IRP) by National Company Law Tribunal (NCLT), Allahabad Bench, in the Corporate Insolvency Resolution Process (CIRP) of Jaypee Infratech Limited (the Corporate Debtor). The CIRP was initiated by various banks and financial institutions (the Lenders), which had certain properties of the Corporate Debtor mortgaged as collateral securities against loans and advances made to its Holding Company, namely, Jaiprakash Associates Limited (the Holding Company).
The NCLT, based on the submission of the IRP, refused to recognize such Lenders as financial creditors of the Corporate Debtor under the Code, on the following grounds, and further, directed the said Lenders to discharge the security interest in the said properties, and return the same to the Corporate Debtor, free of all encumbrances.:
i) As the Corporate Debtor carried out the said transaction of mortgage of properties to defraud its creditors, and/or for other fraudulent purpose.
ii) As the Lenders had lent money to its Holding Company and not to the Corporate Debtor itself, thus, the Lenders of the Holding Company could not be considered as the financial creditors of the subsidiary company, i.e. the Corporate Debtor.
But in appeal by the Lenders, the National Company Law Appellate Tribunal (NCLAT) set aside the said NCLT Order, thereby holding that the aggrieved Lenders are entitled to exercise their rights under the Code and that the said transactions of the Corporate Debtor cannot be termed as fraudulent or undervalued under the Code.
Thereafter, aggrieved by the said NCLAT Order, the IRP filed an appeal in the Supreme Court of India, wherein, the Apex Court made the following observations:
1- That the NCLT has dealt at length the nature of the transactions and further, held them to be preferential in nature. Thus, based on NCLT findings, the Apex Court approved that the said transactions were preferential in nature and thus, have to be avoided.
2- That although in general cases, where a borrower himself does not create a mortgage against the loan given by a lender, but a third party creates or promises to create a mortgage for the benefit of the principal borrower, the Court has accepted the same to be sufficient consideration to the surety for giving a guarantee under the Indian Contract Act 1872 as amended thereof.
But the Apex Court refused to consider the same principle in matters pertaining to mortgages created by a third party on behalf of the principal borrower in favour of lenders under the Code, on the following grounds:
a) The Code requires a financial creditor to have disbursed a financial debt against consideration for time value of money. But in this case, the significant element of disbursement of debt to the Holding Company against consideration for time value of money was missing, as the debt was given to the Holding Company but the security interest was created with respect to the Corporate Debtor’s properties. Thus, such Lenders would not be considered as ‘financial creditors’ of the Corporate Debtor under the Code.
b) Further, the mortgages made with the Lenders were neither towards any loan made to the Corporate Debtor nor towards protecting any security of the Corporate Debtor. Thus, such a debt cannot be termed as ‘financial debt’ under the Code.
Thus, the Apex Court upheld the NCLT Order on the aforesaid grounds and restored the NCLT directions to the said Lenders to discharge the security interest in the mortgaged properties, and return the same to the Corporate Debtor.
Senior Legal Associate
The Indian Lawyer