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2020 (2) TMI 1259 - SC - Insolvency and BankruptcyInitiation of CIRP - Scope of IBC - Preferential transaction u/s 43 - JIL had committed a default in repayment of its dues - who is the financial creditors of the corporate debtor - mortgage created by the corporate debtor as collateral security of the debt of its holding company JAL - whether the transactions in question deserve to be avoided as being preferential, undervalued and fraudulent, in terms of Sections 43, 45 and 66 of the Code? - HELD THAT - Looking to the legal fictions created by Section 43 and looking to the duties and responsibilities per Section 25, in our view, for the purpose of application of Section 43 of the Code in any insolvency resolution process, what a resolution professional is ordinarily required to do could be illustrated. (See para 28.1) On a motion made by the resolution professional after and in terms of the exercise aforesaid, the Adjudicating Authority, in its turn, shall have to examine if the referred transaction answers to all the descriptions noted above (para 28.1) and shall then decide as to what order is required to be passed, for avoidance of the impugned transaction or otherwise. Having found that the transactions in question cannot be countenanced, for being of preference during a relevant time to a related party; and having approved the order passed by NCLT in that regard, we do not consider it necessary to deal with the other length of arguments advanced by the learned counsel for parties on the questions as to whether the transactions are undervalued and/or fraudulent too. In the totality of circumstances, we would prefer leaving the said questions at that only, while also leaving all the related questions of law open; to be examined in an appropriate case. WHETHER LENDERS OF JAL COULD BE CATEGORISED AS FINANCIAL CREDITORS OF JIL - Held that - A person having only security interest over the assets of corporate debtor (like the instant third party securities), even if falling within the description of secured creditor by virtue of collateral security extended by the corporate debtor, would nevertheless stand outside the sect of financial creditors as per the definitions contained in subsections (7) and (8) of Section 5 of the Code. Differently put, if a corporate debtor has given its property in mortgage to secure the debts of a third party, it may lead to a mortgage debt and, therefore, it may fall within the definition of debt under Section 3(10) of the Code. However, it would remain a debt alone and cannot partake the character of a financial debt within the meaning of Section 5(8) of the Code - The respondent mortgagees are not the financial creditors of corporate debtor JIL. Indisputably, the debts in question are in the form of third party security; said to have been given by the corporate debtor JIL so as to secure the loans/advances/facilities obtained by JAL from the respondent-lenders. Such a debt is not and cannot be a financial debt within the meaning of Section 5(8) of the Code; and hence, the respondent-lenders, the mortgagees, are not the financial creditors of the corporate debtor JIL. Though several decisions have been cited on behalf of the respondent-lenders to contend that they do fall within the definition of financial creditor but for what has been discussed hereinabove, it does not appear necessary to dilate upon all of them. However, it would be appropriate to take note of the relevant decisions strongly relied upon by the respondents as infra - Much emphasis is laid on behalf of the respondents on the observations occurring in another three-Judge Bench decision of this Court in the case of Essar Steel 2019 (11) TMI 731 - SUPREME COURT and predominantly on the observation therein, that secured creditors as a class are subsumed in the class of financial creditors . Again, the decisions of the Court are required to be understood with reference to the context. In the case of Essar Steel, the questions before the Court related to the roles of resolution applicant, resolution professional and Committee of Creditors constituted under the Code and the jurisdiction of Adjudicating Authority as also the Appellate Tribunal in questioning the resolution plans. The constitutional validity of the Insolvency and Bankruptcy (Amendment) Act, 2019 was also under challenge. The problem arose essentially with the decision of NCLAT holding that in a resolution plan, there could be no difference amongst the creditors in that, a financial creditor and operational creditor deserve equal treatment under a resolution plan. It was in the setup of such background that in Essar Steel, this Court made the observations relied upon by the respondents. Whether the respondents (lender of JAL) could be recognized as financial creditors of the corporate debtor JIL on the strength of the mortgage created by the corporate debtor, as collateral security of the debt of its holding company JAL? - HELD THAT - Such lenders of JAL, on the strength of the mortgages in question, may fall in the category of secured creditors, but such mortgages being neither towards any loan, facility or advance to the corporate debtor nor towards protecting any facility or security of the corporate debtor, it cannot be said that the corporate debtor owes them any financial debt within the meaning of Section 5(8) of the Code; and hence, such lenders of JAL do not fall in the category of the financial creditors of the corporate debtor JIL. The impugned order dated 01.08.2019 as passed by NCLAT in the batch of appeals is reversed and is set aside.
Issues Involved:
1. Whether the transactions in question deserve to be avoided as being preferential, undervalued, and fraudulent, in terms of Sections 43, 45, and 66 of the Insolvency and Bankruptcy Code, 2016. 2. Whether the respondents (lenders of JAL) could be recognized as financial creditors of the corporate debtor JIL on the strength of the mortgage created by the corporate debtor, as collateral security of the debt of its holding company JAL. Analysis of the Judgment: Issue 1: Preferential, Undervalued, and Fraudulent Transactions Preferential Transactions: - Legal Framework: Section 43 of the Insolvency and Bankruptcy Code (IBC) deals with preferential transactions and relevant time. A corporate debtor is deemed to have given a preference if the transaction involves a transfer of property or an interest thereof for the benefit of a creditor, surety, or guarantor for or on account of an antecedent financial debt or operational debt, and the transfer puts such creditor, surety, or guarantor in a beneficial position than it would have been in the event of distribution of assets in accordance with Section 53. - Relevant Time: For related parties, the relevant time is two years preceding the insolvency commencement date, and for unrelated parties, it is one year preceding the insolvency commencement date. - Transactions in Question: The transactions in question involved mortgaging properties of JIL to secure loans for JAL. These transactions were found to be preferential as they were for the benefit of JAL, a related party, and were within the relevant time of two years before the insolvency commencement date. - Ordinary Course of Business: The transactions were not made in the ordinary course of business or financial affairs of JIL. The ordinary course of business or financial affairs of JIL did not include mortgaging its assets to secure the debts of its holding company JAL. - Conclusion: The transactions were preferential and fell within the mischief of Section 43 of the IBC. NCLT's order declaring these transactions as preferential was upheld. Undervalued and Fraudulent Transactions: - Undervalued Transactions: Section 45 of the IBC deals with undervalued transactions. A transaction is considered undervalued if it involves a transfer of one or more assets by the corporate debtor for a consideration significantly less than the value of the consideration provided by the corporate debtor. - Fraudulent Transactions: Section 66 of the IBC deals with fraudulent trading or wrongful trading. The transactions were alleged to be fraudulent as they were intended to defraud the creditors of JIL. - NCLT's Findings: NCLT found that the transactions were undervalued and fraudulent as they were made without any consideration to JIL and were intended to defraud the creditors of JIL. - Conclusion: The transactions were found to be undervalued and fraudulent. However, the court did not delve deeply into these aspects as the transactions were already held to be preferential. Issue 2: Financial Creditors Legal Framework: - Financial Creditor: As per Section 5(7) of the IBC, a financial creditor is a person to whom a financial debt is owed. - Financial Debt: Section 5(8) of the IBC defines financial debt as a debt along with interest, if any, which is disbursed against the consideration for the time value of money. Arguments: - Appellants' Argument: The lenders of JAL could not be considered financial creditors of JIL as the mortgages were not for any disbursement of debt to JIL but were for securing the debts of JAL. The transactions did not involve any consideration for the time value of money for JIL. - Respondents' Argument: The respondents argued that the creation of mortgages by JIL to secure the debts of JAL made them financial creditors of JIL as the transactions were akin to guarantees and created pecuniary liabilities on JIL. Court's Analysis: - Nature of Transactions: The transactions were third-party securities where JIL mortgaged its properties to secure the debts of JAL. These transactions did not involve any disbursement of debt to JIL. - Financial Debt: The transactions did not qualify as financial debt as they did not involve any disbursement against the consideration for the time value of money to JIL. - Conclusion: The lenders of JAL could not be categorized as financial creditors of JIL. The orders of NCLT rejecting the claims of the lenders of JAL to be recognized as financial creditors of JIL were upheld. Conclusion: 1. The transactions in question were preferential, undervalued, and fraudulent within the meaning of Sections 43, 45, and 66 of the IBC. The order of NCLT declaring these transactions as preferential was upheld. 2. The lenders of JAL could not be categorized as financial creditors of JIL as the transactions did not involve any disbursement of debt to JIL against the consideration for the time value of money. The orders of NCLT rejecting the claims of the lenders of JAL to be recognized as financial creditors of JIL were upheld.
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