CHINA DEVELOPMENT BANK versus DOHA BANK Q.P.S.C. & ORS.

Summary

The Supreme Court held that lenders to other Reliance Communications group companies were Financial Creditors of the Corporate Debtor because the Corporate Debtor, by the last part of clause 5(iii) of the Deeds of Hypothecation, undertook to pay any shortfall in the borrowers' liability after realisation of the hypothecated assets, which amounts to a guarantee under Section 126 of the Contract Act and a financial debt under Section 5(8)(i) of the IBC; the NCLAT's contrary judgment was set aside and the NCLT's order restored.

Issues

1. Whether lenders who advanced facilities to other group companies, and not to the Corporate Debtor, are Financial Creditors of the Corporate Debtor under Section 5(7) of the IBC by reason of the Deeds of Hypothecation executed by it.
2. Whether the clause in the Deeds of Hypothecation requiring each Chargor to pay on demand any shortfall after realisation of the hypothecated property constitutes a contract of guarantee.
3. Whether a financial debt and a claim exist under the IBC only upon occurrence of default.
4. Whether the moratorium under Section 14 of the IBC extinguished the contingent obligation to pay the shortfall.

Provisions considered

• Section 5(7) and 5(8)(i), Insolvency and Bankruptcy Code, 2016The amount of any liability in respect of a guarantee for money borrowed against interest is a financial debt under clause (i), and the creditor need not have disbursed money to the Corporate Debtor. As the Corporate Debtor guaranteed the borrowers' liability, the appellants were persons to whom financial debt was owed. (¶¶ 48, 49, 61)
• Section 3(6), 3(11) and 3(12), Insolvency and Bankruptcy Code, 2016A claim is a right to payment whether disputed, matured or not, and a liability in respect of a claim is a debt. Default under Section 3(12) is relevant only for initiating CIRP under Section 7(1); a claim exists even if the right cannot be enforced during moratorium. (¶¶ 47, 48, 62, 65)
• Sections 7(1) and 15, Insolvency and Bankruptcy Code, 2016Default is a precondition only for a Financial Creditor's application to initiate CIRP under Section 7(1); a person with a claim may submit it in response to the public announcement under Section 15 without any actual default. (¶ 62)
• Section 14(1), Insolvency and Bankruptcy Code, 2016The moratorium prohibits suits, transfers and enforcement of security against the Corporate Debtor but does not extinguish claims or liabilities; the Deeds of Hypothecation remained valid though nothing prohibited by Section 14 could be done under them. (¶¶ 63, 65)
• Section 126, Indian Contract Act, 1872A contract to perform the promise or discharge the liability of a third person on default is a guarantee. The Corporate Debtor's promise to pay the shortfall in the liability of the borrowers, who were third parties to it, satisfied this definition. (¶¶ 50, 58, 59)
• Section 127, Indian Contract Act, 1872Anything done or promised for the benefit of the principal debtor may be sufficient consideration for the surety's guarantee; noted in construing the Corporate Debtor's undertaking. (¶ 51)

Held

• The title of a document does not decide its nature; the document must be read as a whole and in a commercially sensible way. That a deed is called a deed of hypothecation does not exclude a guarantee within it. (¶¶ 52, 53)
• As the Security Trustee executed and accepted the Deeds of Hypothecation on behalf of the lenders under the Master Security Trustee Agreement, the deeds involved three parties: the lenders through the trustee, the borrowing group companies, and the Corporate Debtor, which was not their borrower. (¶¶ 40, 41, 42, 54, 56)
• The last part of clause 5(iii), by which each Chargor agreed to pay on demand any shortfall shown after sale of the hypothecated property, obliges the Corporate Debtor to discharge the borrowers' liability on their default and is a guarantee under Section 126 of the Contract Act. Phoenix ARC was distinguishable as the pledgor there never promised to discharge the borrower's liability; boilerplate formats in textbooks were irrelevant. (¶¶ 57, 58, 59, 60)
• The guarantee liability for money borrowed against interest is a financial debt under Section 5(8)(i), so the appellants are Financial Creditors though they disbursed nothing to the Corporate Debtor. (¶¶ 46, 47, 49, 58)
• Section 5(8) does not require default for a debt to be a financial debt; a person owed a financial debt is a Financial Creditor and may lodge a claim on the public announcement without any actual default. (¶¶ 61, 62)
• The moratorium under Section 14 bars enforcement but does not extinguish the claim or the underlying liability; otherwise no creditor could file a claim. The shortfall undertaking was also severable from the hypothecation under the deed's severability clause, and the claim existed whether or not the cause of action to invoke the guarantee had arisen. (¶¶ 63, 64, 65)
• The appellants' vote for the resolution plan did not defeat their status, since the NCLAT's final order of 19.01.2021 had approved the plan subject to the pending challenge to their status and contemplated reconsideration depending on its outcome. The alternative plea for treatment as secured creditors was not decided. (¶¶ 66, 67)

Result

Appeals allowed; NCLAT judgment dated 09.09.2022 set aside and the NCLT, Mumbai Bench order dated 02.03.2021 upholding the appellants' status as Financial Creditors restored.