In my previous blog post, I commented on one aspect of the Supreme Court’s new judgement in the insolvency proceedings of Jaypee Infratech Limited (JIL), viz. its decision that JIL’s mortgages of its properties to secure the debts of its parent company Jaiprakash Associates Limited (JAL) amounted to a preference and deserved to be annulled. The other aspect of that case concerned a common plea taken by some banks that had lent to JAL against the mortgages given by JIL. The banks claimed to be financial creditors of JIL by virtue of the said mortgages.
Financial creditors occupy a very powerful position in the insolvency resolution process under the IBC, as they get to sit on the Committee of Creditors, the elite body that decides upon virtually every issue concerning the fate of the insolvent company.
The banks’ contention was as follows. Firstly, they were indisputably secured creditors of JIL. The very fact that they were secured creditors of JIL, it was argued, meant that they were financial creditors of JIL, notwithstanding the fact that they had not let any money to JIL, and had lent money to its parent JAL.
On this argument, it must be said that they were not wanting for ammunition. The recent decision of the Supreme Court in Essar Steel’s case reads like a paean to the rights of secured creditors, and contains the observation “secured creditors as a class are subsumed in the class of financial creditors”. Mercifully, the Supreme Court did not get taken in by what it had said earlier in a different context (and, crucially, through a different bench). It held, rightly in my opinion, that the mere fact that a creditor held a security of the corporate debtor did not make it a financial creditor, unless it satisfied the definition of that term under the IBC. The Court noticed that the definition did not include the word “mortgage”.
But the secured creditors had another good argument, which I think the Supreme Court failed to consider correctly. Relying on the Gujarat High Court’s judgment in a case called State Bank of India v. Smt. Kusum Vallabhdas Thakkar, the banks argued that if a person other than the borrower executes a mortgage to secure the debt of the borrower, such a person is treated by Indian law to be the guarantor of the loan taken by the borrower. As per the IBC, a financial debt includes not just a loan for interest, but also the amount of any liability in respect of a guarantee of such a loan. A financial creditor is a person to whom a financial debt is owed. For an otherwise detailed and well-reasoned judgement, the Supreme Court, in my opinion, was surprisingly flippant with the banks’ ‘guarantee’ argument.
The Court first said that it would be ‘stretching the ratio’ of Smt. Kusum’s case to apply it to the case at hand. For this it gave no reasons.
Further, the Court said that the definition of a financial debt did not include a mortgage and required disbursement against consideration for the time value of money. This, according to me, amounted to side-stepping the argument. It was almost like the Court did not want to take the ‘guarantee’ argument head-on. The Court was right that as per the definition, a financial debt requires disbursement against consideration for the time value of money, and there was no disbursement by the banks to JIL. But the last part of the definition includes even amounts guaranteed against such disbursement within the meaning of a financial debt. The Supreme Court paid no attention to this language. It completely failed to explain why the banks were not eligible to be financial creditors of JIL, if JIL was the guarantor of a loan given to JAL by the banks.
I think the ‘guarantee’ argument was a good one, and the Supreme Court got it wrong. The banks’ claim to being financial creditors of JIL was rejected, and I think they ought to have a genuine grievance with the Court’s judgement.
