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Srei Infrastructure Finance Limited v. Sterling International Enterprises Limited Corporate Debtor.

National Company Law Tribunal
Mar 13, 2019
Smart Summary (Beta)

Tribunal Opinion — Structured Summary

Factual and Procedural Background

The Applicant is an Asset Reconstruction Company which seeks (a) quashing of the Resolution Professional's (RP) decision dated 11.10.2018 rejecting the Applicant's claim; (b) a direction to the RP to admit the Applicant as a Financial Creditor and include it in the Committee of Creditors (CoC); and (c) interim reliefs including stay of the RP's decision and a direction to permit the Applicant to participate in the resolution process. Costs were also claimed.

Sterling International Enterprises Limited (the Corporate Debtor) was admitted into the Corporate Insolvency Resolution Process (CIRP) by order dated 16.07.2018. The Applicant acquired the debt of Unique Proteins Private Limited (the principal borrower) from SICOM Limited by assignment on 22.03.2014. The Corporate Debtor had earlier mortgaged (equitable mortgage / deposit of title deeds) properties in favour of the Applicant on 22.09.2014 as additional security for the loan extended to Unique Proteins.

The Applicant issued a demand notice under SARFAESI on 28.02.2018 and took possession of mortgaged properties. After CIRP commenced, the Applicant submitted a claim to the RP and sought inclusion in the CoC. The RP rejected the claim by email dated 16.08.2018 (stating Sterling had only mortgaged properties and not given a corporate guarantee) and confirmed rejection by email dated 11.10.2018 (after consulting lawyers). Aggrieved, the Applicant filed this application under section 60(5) of the Code challenging the RP's rejection.

Legal Issues Presented

  1. Whether an entity that advanced loan to a third party but holds an equitable mortgage over properties of the Corporate Debtor (i.e., a mortgagee / secured creditor by way of deposit of title deeds) qualifies as a "Financial Creditor" of the Corporate Debtor under the Insolvency and Bankruptcy Code and thus is entitled to file a claim and be included in the Committee of Creditors during CIRP.
  2. Whether rejection of the Applicant's claim by the Resolution Professional on the ground that the Corporate Debtor did not give a corporate guarantee (only an equitable mortgage) was legally tenable and whether such rejection violates principles of natural justice or the statutory scheme governing CIRP.
  3. Whether the rights of a mortgagee/secured creditor who provided finance to a third party are limited to enforcement only in liquidation (relying on Section 52) or whether such mortgagee must be treated as a stakeholder during CIRP for purposes of the information memorandum, CoC participation and voting on resolution plans.

Arguments of the Parties

Applicant's Arguments

  • The RP erred in rejecting the claim on the basis that no corporate guarantee was given; a mortgage and a guarantee are distinct concepts and a mortgage can exist without a guarantee.
  • The RP's decision lacked justification and reasoning, contrary to principles of natural justice.
  • Creation of a mortgage alone creates a right for the lender to enforce the mortgage upon default; therefore there is a valid and subsisting claim against the Corporate Debtor.
  • The definition of "financial debt" includes mortgage claims and thus the transaction falls within the Code's scope.
  • Excluding the Applicant from the CIRP would frustrate the CIRP and cause future complications; the Applicant has rights to sue for sale and foreclosure in respect of the mortgaged property.
  • The RP failed to appreciate relevant provisions of the Transfer of Property Act and the Contract Act.

Resolution Professional's Arguments

  • The Applicant is not a "financial creditor" and the debt is not a "financial debt" as defined under section 5(8) of the Code; therefore the claim is not admissible.
  • Relying on the Code's definitions (Sections 3(6), 3(8), 3(10), 3(11)), the RP argued that no financial or operational debt is owed by the Corporate Debtor to the Applicant because the money was not disbursed to Sterling (the Corporate Debtor) and liability arises from a principal borrower's obligation.
  • The RP contended there is no mechanism to value the mortgaged assets meaningfully as title to major mortgaged assets was under litigation and might have no substantial value.
  • The RP argued that enforcement rights under the mortgage deed arise in liquidation (citing Section 52) and that the Information Memorandum and classing of liabilities (Regulation 36) will protect the Applicant's rights without admitting the claim during CIRP.
  • On these bases the RP urged dismissal of the application as misconceived, frivolous and not maintainable, and sought exemplary costs.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Vijay Kumar Jain v. Standard Chartered Bank (Hon'ble Supreme Court) Interpreting Notes on Clauses and provisions of the Code concerning information provided to CoC, Regulation 36 (information memorandum), Regulation 37 (resolution plan content), Regulation 39(5) (sending approved/rejected plan to participants), Section 31(1), and the definition of "security interest" under Section 3(31). Emphasises that persons with security interests/guarantees are vitally interested in resolution plans and may be parties aggrieved under Section 61. The Tribunal relied on the reasoning in para 12 to treat security interests (including mortgage) as falling within the ambit of stakeholders whose rights are vitally affected by resolution plans. The decision supported the proposition that a mortgagee/holder of security interest should be considered a stakeholder for purposes of CIRP and CoC participation.
Export Import Bank of India v. Jekpl Ltd. (NCLAT), CA (AT) (Insolvency) No. 304 of 2017 (14.08.2018) Held that a guarantee given by a Corporate Debtor can render the guarantor a Financial Creditor under section 5(8)(h) of the Code; considered situations where the Corporate Debtor has not directly received loan/finance but is connected by guarantee/security. The Tribunal cited this NCLAT decision as analogous support for treating a mortgagee (who provided loan to a third party but holds security from the Corporate Debtor) as a Financial Creditor of the Corporate Debtor entitled to rights under the Code.

Court's Reasoning and Analysis

The Tribunal analysed the matter in a sequence that tracks the RP's position and the legal character of the mortgagee's rights.

  1. The Tribunal noted the RP's own admissions: (i) that the Applicant is a secured creditor for a loan given to a third party because Sterling created an equitable mortgage in favour of the Applicant; and (ii) that remedies under Section 52 exist for mortgagees in liquidation, although the RP argued that such rights cannot be exercised during CIRP.
  2. The Tribunal identified a practical and legal anomaly if the mortgagee is excluded from the CIRP process. Specifically, the CoC may approve or reject a resolution plan that vitally affects the rights attached to specific immovable properties in favour of the mortgagee; excluding the mortgagee would mean the CoC could decide without participation of an important stakeholder whose rights could be compromised, raising natural justice concerns and jeopardising the resolution plan's binding effect.
  3. Applying principles under the Transfer of Property Act, the Tribunal observed that an equitable mortgage by deposit of title deeds creates a debt and a vested interest in the property in favour of the mortgagee. The Tribunal concluded that surrender of title deeds and creation of equitable mortgage transferred rights such that the mortgagee has a vested right which entitles it to approach the RP on par with other financial creditors.
  4. The Tribunal relied on the Supreme Court's reasoning in Vijay Kumar Jain to show that security interests (including mortgages) are covered by the Code's concept of "security interest" (Section 3(31)), that persons with such interests are vitally affected by resolution plans, and thus warrant attention and participation in CIRP processes. The Tribunal treated that precedent as supporting inclusion of the mortgagee as a stakeholder.
  5. The Tribunal also referred to the NCLAT decision in Export Import Bank of India v. Jekpl Ltd. as persuasive authority that entities connected to debts by guarantees or security can be Financial Creditors even where the Corporate Debtor has not directly received the loan/finance.
  6. Weighing the statutory scheme, the Transfer of Property Act effects of an equitable mortgage, the RP's admissions and the cited precedents, the Tribunal concluded that the Applicant/Mortgagee should be recognised as a Financial Creditor and permitted to participate in the CoC; the RP was directed to collate the Applicant's claim as a Financial Creditor and include the Applicant in the CoC.
  7. The Tribunal rejected the RP's proposition that the mortgagee's rights are confined to liquidation and held that such a restrictive view would be inconsistent with the objectives of the Code and could lead to prejudicial outcomes for the CIRP process.

Holding and Implications

HOLDING: The application is allowed. The Applicant (mortgagee who advanced loan to a third party and holds equitable mortgage over properties of the Corporate Debtor) is to be treated as a Financial Creditor of the Corporate Debtor and is entitled to exercise voting rights under the Code; the Resolution Professional is directed to collate the Applicant's claim as a Financial Creditor and include the Applicant in the Committee of Creditors. No cost was awarded.

Implications:

  • Direct effect: The RP must admit/collate the Applicant's claim as a Financial Creditor and include the Applicant in the CoC for purposes of CIRP participation and voting on resolution plans. The Applicant obtains the procedural rights of a Financial Creditor in the ongoing CIRP.
  • Practical consequence: The decision prevents exclusion of a mortgagee who has a vested security interest from CIRP deliberations, preserving the stakeholder's ability to protect its security interest when resolution plans are proposed and approved.
  • Precedential note: The opinion relies on existing higher authority and NCLAT precedent to support its conclusion; the Tribunal did not indicate that it was establishing a novel legal principle beyond application of the cited authorities. Thus the decision's immediate effect is to resolve the parties' dispute and to require the RP to include the Applicant in the CoC.

This summary is strictly confined to the content and reasoning contained in the provided opinion and does not add or infer facts or legal holdings beyond that text.

Show all summary ...

V. Nallasenapathy, Member (Technical):— The Applicant, an Asset Reconstruction Company, filed this application praying for the following reliefs;

(a) That this Hon'ble Tribunal be pleased to allow Miscellaneous Application filed by the Applicant and accordingly quash and/or set aside the decision of the RP dated 11.10.2018;

(b) That this Hon'ble Tribunal be pleased to direct the Resolution Professional to incorporate the claim of the Applicant herein as a Financial Creditor, in accordance with the provisions of the Insolvency and Bankruptcy Code; Or in the alternative,

(c) Pending the hearing and final disposal of the present Miscellaneous Application, this Hon'ble Tribunal be pleased to stay the effect and operation of the decision dated 11.10.2018 and accordingly permit the Applicant to participate in the Resolution Process as a member of Committee of Creditors; Or in the alternative,

(d) This Hon'ble Tribunal be pleased to stay any further steps to be taken by Resolution Professional and by the Committee of Creditors in the absence of or without taking into consideration the vote of the present Application;

(e) Interim reliefs as prayed in prayer clause (b) to (d);

(f) Any other and further reliefs as this Hon'ble Tribunal may deem fit in the facts and circumstances of the present case;

(g) Costs of the application.

2. Sterling International Enterprises Limited, the Corporate Debtor herein, was put in Corporate Insolvency Resolution Process (CIRP) by an order of this adjudicating authority dated 16.07.2018 and the Respondent is the Resolution Professional (RP).

3. One M/s Unique Proteins Private Limited had availed a short term loan of Rs. 50 crores from M/s SICOM Limited and the Corporate Debtor mortgaged its assets as security towards the said loan in favor of SICOM Limited. The loan account of Unique Proteins Private Limited turned into non performing asset and SICOM Limited initiated SARFAESI proceedings by issuing notice dated 18.01.2013 demanding sum of Rs. 56,91,81,846/- from the Corporate Debtor. SICOM Ltd. took possession of the property of the Corporate Debtor under section 13(4) of the SARFAESI Act on 15.03.2013. On 22.03.2014, SICOM Ltd. assigned the debts of Unique Proteins Pvt. Ltd. along with all its rights and interest to the Applicant. Subsequently on 22.09.2014, the Corporate Debtor along with its other sister concerns further created charge over properties belonging to them by creation of equitable mortgage in favor of the Applicant. Further, on 22.09.2014 the Corporate Debtor along with their sister concerns made a declaration confirming the creation of Mortgage by deposit of title deeds of the additional properties in favor of the applicant.

4. On 28.02.2018, the applicant issued demand notice under the SARFAESI Act calling upon the principal debtor Unique Proteins Private Limited as well the Corporate Debtor to repay Rs. 57,21,13,945/- and in furtherance the applicant took possession of properties which were mortgaged as additional securities.

5. After the initiation of CIRP against the Corporate Debtor, the Applicant filed claim against the Corporate Debtor before RP and requested to include them in the committee of the Creditors of the Corporate Debtor. The Resolution Professional of the Corporate Debtor rejected the claim of the applicant on 16.08.2018 by an E-mail addressed to the Applicant stating as below:

“Dear Mr. Deo,

Your claim has been rejected.

Your contentions only prove your debt claim on the principal borrower and not on Sterling International.

Sterling International has only mortgaged its properties but not given any corporate guarantee, so it is not a debtor and consequently your claim cannot be accepted.”

6. The Resolution Professional subsequently on 11.10.2018 sent another E-mail to the Applicant stating as below:

“Dear sirs,

I have reviewed your request and also consulted a few lawyers and even they are of the opinion that your claim is not admissible for the same reason I stated earlier. I am sorry to say but your claim is rejected.”

7. Aggrieved by the decision of the resolution professional, the applicant filed this application under section 60(5) of the Code for the reliefs cited supra.

8. The followings are the contentions of the applicant:

A. The resolution professional has arrived at an erroneous conclusion that though there is a mortgage created in favor of the applicant by the Corporate Debtor but since no corporate guarantee was executed, the claim of the applicant is not tenable in the CIRP of the Corporate Debtor and the decision of the RP in rejecting the claim is flawed.

B. The decision of the resolution professional is without any justification or without any reasoning, contrary to the principal of natural justice and not based on the sound principle of law.

C. The RP failed to appreciate the distinction between a mortgage or a guarantee and proceeded on the basis that there cannot be a mortgage without any guarantee. Any party can create a mortgage as a security without guaranteeing the repayment of debt. Creation of mortgage itself is sufficient to create a right in favour of the lender for enforcing the mortgage in case there is a default in repayment of the debt.

D. There is a valid and subsisting claim for the applicant as against the Corporate Debtor which the RP failed to appreciate. On default in repayment of the debt by Unique Proteins Ltd., the applicant has claimed and is entitled to recover its dues by enforcing the mortgage, therefore, there is a valid and subsisting claim.

E. Financial Debt also includes a mortgage claim and this includes the rights and obligations of any party which inter alia, will include the transaction of this nature.

F. The CIRP will be a futile exercise and may create future complications, if the legitimate claim of the applicant as a financial creditor is not admitted by the RP.

G. The RP failed to appreciate that the applicant is legally entitled to bring a suit for sale and foreclosure with regard to the mortgage property owned by the Corporate Debtor.

H. The decision of RP is contrary to the provisions of the Transfer of Property Act as well as Contract Act.

9. The contentions of the RP is below:

A. The Applicant is not a financial creditor and the debt is not a financial debt as defined under section 5(8) of the Code and hence the claim filed by the Applicant is rejected.

B. The Conjoint reading of the following sections of the Code:

i. Section 3(6) which defines claim as

a. A right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured;

b. Right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, immature, disputed, undisputed, secured or unsecured;

ii. Section 3(8) which defines Corporate Debtor as a corporate who owes a debt to any person;

iii. Section 3(10) which defines creditor as any person to whom a debt is owed and includes a Financial Creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree holder;

iv. Section 3(11) which defines debt as a liability or obligation in respect of a claim which is due from any person and includes a financial debt or an operational debt along with the Form C filed by the applicant;

- it is clear that neither any financial debt nor any operational debt is owed by the Corporate Debtor to the applicant and as such the applicant is precluded to file a proof of claim during the CIRP.

C. The RP further submits that a perusal of Form C submitted by the Applicant and even the present Application, it clearly appears that it is not the case where the money has been disbursed to the Corporate Debtor which is payable along with interest, therefore, the argument of the Applicant that the definition of financial debt does not envisage the disbursement of the debt has to be necessarily to the Corporate Debtor, is completely untenable. It is further submitted that the arguments of the applicant, that the scope of debt in the code is not limited to the liability or obligation owed directly by the principal borrower, but also includes liability or other liability of other parties in respect of the debt of the principal borrower is also untenable.

D. The RP further submits that the question of exercising the rights under the mortgage deed by the applicant can only arise during the liquidation as the same has been specifically provided for a secured creditor under Section 52 of the Code and therefore the rights of the applicant will remain intact and can be exercised after the CIRP period but not during the CIRP of the Corporate Debtor. Further Regulation 36 of the CIRP Regulations requires the Resolution Professional to place the liabilities of the Corporate Debtor in different classes while preparing the information memorandum of the Corporate Debtor in terms of section 29 of the Code. Hence no prejudice would be caused to the applicant in whatsoever nature as contended by the Applicant as all its rights are protected by the Code.

E. The RP further submits that even otherwise there is no modality to put a value to the assets mortgaged as the major mortgaged assets is under litigation for title and hence may have no substantial value.

F. With the above submissions the RP submits that the present application is misconceived, frivolous, untenable, not maintainable and is liable to be dismissed with the exemplary cost.

10. Discussion:

A. Even though RP submits that, the mortgagee's claim against the Corporate Debtor cannot be admitted during the CIRP, by quoting section 52 of the Code, RP fairly admits that the mortgagee is entitled to the remedies in liquidation, but rejected the claim saying that there is no remedy for the mortgagee under the CIRP. Further RP admits that, Applicant/Mortgagee is a secured creditor for the loan given to a third party, for which the Corporate Debtor created equitable mortgage of its properties.

B. It is an admitted fact that the mortgagee had provided loan to a third party by taking the property of the Corporate Debtor as security. During the CIRP, when an Information Memorandum is prepared by the RP, this fact has to be disclosed. Now, COC will decide on the Resolution Plan without the participation of the mortgagee of the Corporate Debtor as and when the Resolution Plan is submitted before it by RP, since the claim of the mortgagee was rejected by the RP. This creates an anomalous situation where the COC decides on a Resolution Plan completely ignoring a mortgagee who is also an important stakeholder. If the mortgagee, being a stakeholder in the mortgaged property, is left out of the process and nobody knows how the mortgagee will deal with the properties since the mortgagee has an interest transferred in specific immovable properties in its favor, which is also admitted by the RP. Hence, unless otherwise an opportunity is given to the mortgagee to have a seat in the Committee of Creditors and is made as a party to the process of approval or rejection of Resolution Plan, that will be a clear case of violation of natural justice. The main objective of the Code is resolution of the Corporate Debtor and this kind of selective exclusion of an important stakeholder may not auger well for the successful conduct of CIRP. By providing a narrow, conventional and restricted interpretation of the financial debt may lead to a situation which is diagonally opposite to the objective of the Code itself. Further, when no representation is given to the mortgagee in the Committee of Creditors the binding effect of the Resolution Plan may also end up in jeopardy when the mortgagee enters into litigation at the stage of approval of Resolution Plan or thereafter. Hence, the contention of the RP that the question of exercising the rights under the Mortgage Deed by the applicant can only arise during the liquidation and not in CIRP is not a sound proposition.

C. Under the Transfer of Property Act, 1882, the mortgagor binds himself to repay the mortgage money. Admittedly an equitable mortgage is created by the Corporate Debtor in favour of the Applicant. That means there is a debt, documents of title deeds are deposited as security and on payment of mortgage money only the title deeds are to be returned to the mortgager. It is clear that there is inherently an assurance to repay on the part of the Corporate Debtor to the Applicant/Mortgagee and hence the Mortgagee deserves to be treated as a Financial Creditor. Apart from that the Mortgagee has a vested interest in the property for the reason that the title in the property vest with the mortgagee until the loan is repaid to him. In this particular situation, the question whether the Corporate Debtor is bound to repay or not is not at all an issue to be discussed because the Corporate Debtor had already transferred the rights and the property in favor of the mortgagee, the day when he surrendered the Title Deeds with the Applicant. So in our opinion, the mortgagee always has a vested right to approach the RP on par with any Financial Creditor and claim the amounts and it is for the RP who is acting on behalf of the Corporate Debtor to forthwith admit the claim as per the law.

D. It is to be noted that the Hon'ble Supreme Court in the case of “Vijay Kumar Jain v. Standard Chartered Bank” at para 12 stated as below:

“12. There is no doubt whatsoever that Notes on Clauses are an important aid to the construction of Sections of the Code as they show what the Drafting Committee had in mind when such provisions were drafted. However, a closer look at the Notes on Clause 24 makes it clear that the third sentence of the Notes on Clause 24 is itself problematic. First and foremost, it speaks of the resolution professional seeking information. The resolution professional does not seek information at a meeting of the committee of creditors, which is what Section 24 is all about. The resolution professional only seeks information from the erstwhile Board of Directors under Section 29 before preparing an information memorandum, which then includes the financial position of the Corporate Debtor and information relating to disputes by or against the Corporate Debtor etc. All this has nothing to do with Section 24 of the Code which deals with meetings of the committee of creditors. Secondly, the resolution professional does not prepare a resolution plan as is mentioned in the Notes on Clause 24; he only prepares an information memorandum which is to be given to the resolution applicants who then submit their resolution plans under Section 30 of the Code. The committee of creditors, in turn, gets information so that they can assess the financial position of the Corporate Debtor from various sources before they meet. It is, therefore, difficult to understand the Notes on Clause 24. Even assuming that the Notes on Clause 24 may be read as being a one-way street by which erstwhile members of the Board of Directors are only to provide information, we find that Section 31(1) of the Code would make it clear that such members of the erstwhile Board of Directors, who are often guarantors, are vitally interested in a resolution plan as such resolution plan then binds them. Such plan may scale down the debt of the principal debtor, resulting in scaling down the debt of the guarantor as well, or it may not. The resolution plan may also scale down certain debts and not others, leaving guarantors of the latter kind of debts exposed for the entire amount of the debt. The Regulations also make it clear that these persons are vitally interested in resolution plans as they affect them. Thus, under Regulation 36 of the CIRP Regulations, the information memorandum that is given to each member of the CoC and to any potential resolution applicant, will contain details of guarantees that have been given in relation to the debts of the Corporate Debtor (see Regulation 36(2)(f) of the CIRP Regulations). Also, under Regulation 37(d) of the CIRP Regulations, a resolution plan may provide for satisfaction or modification of any security interest. Security interest is defined by Section 3(31) of the Code as follows:

3. Definitions.—In this Code, unless the context otherwise requires,—

(31) “security interest” means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:

Provided that security interest shall not include a performance guarantee;”

This would certainly include a guarantor who may be a member of the erstwhile Board of Directors. Further, under Regulation 37(1)(f), a resolution plan may provide for reduction in the amount payable to the creditors, which again vitally impacts the rights of a guarantor. Last but not least, a resolution plan which has been approved or rejected by an order of the Adjudicating Authority, has to be sent to “participants” which would include members of the erstwhile Board of Directors - vide Regulation 39(5) of the CIRP Regulations.

Obviously, such copy can only be sent to participants because they are vitally interested in the outcome of such resolution plan, and may, as persons aggrieved, file an appeal from the Adjudicating Authority's order to the Appellate Tribunal under Section 61 of the Code. Quite apart from this, Section 60(5)(c) is also very wide, and a member of the erstwhile Board of Directors also has an independent right to approach the Adjudicating Authority, which must then hear such person before it is satisfied that such resolution plan can pass muster under Section 31 of the Code”.

E. The mortgage executed by the Corporate Debtor in favor of the applicant is also a security interest as provided u/s 3(31) of the Code and the applicant/mortgagee is also a stakeholder whose rights will be affected vitally. In view of this situation, this Bench is of the considered view that the Applicant/Mortgagee shall be given the status of Financial Creditor.

F. It is also worth mentioning the judgment of the Hon'ble NCLAT in the case of Export Import Bank Of India v. Jekpl Ltd., in CA (AT) (Insolvency) No. 304 of 2017 dated 14.08.2018, wherein it was held that guarantee given by a Corporate Debtor is a Financial Creditor of the Corporate Debtor as provided u/s 5(8)(h) of the Code. It is to be noted that the Corporate Debtor has not received any loan/finance/facilities but the recipient of the loan is only the Principal Borrower, as in the case on hand.

G. In view of the above discussion, it is held that the Applicant/Mortgagee of properties of the Corporate Debtor, who had advanced loan to a third party, is a Financial Creditor of the Corporate Debtor, who is also entitled to exercise voting rights under the Code for enabling the successful implementation of CIRP. Accordingly the Resolution Professional is directed to collate the claim received from the Applicant as a Financial Creditor and include the Applicant in the CoC.

H. Accordingly this application is allowed. No cost.