Increasing Exclusiveness in the Financial Creditor Club: Legal Position of Judicial Reluctance

*Damini Chouhan & Vinisha Jain

The dilemma associated with the term ‘Financial Creditors’ seems to be a continuing tale of desolation for lenders. Supreme Court is leaving no stone unturned in confining the definition of Financial Creditor (“FC”) which is provided under Section 5(7) read with Section 5(8) of Insolvency and Bankruptcy Code, 2016 (“Code”). The former sub-section defines FC as a person to whom a ‘financial debt’ is owed and the latter sub-section provides a lengthy definition for the term ‘financial debt’. Applying the criteria under these provisions, the Committee of Creditors (“CoC”) constituted under Section 21(2) of the Code is an exclusive club of FCs. However, the rationale for exclusion of other categories of creditors is conspicuous by its absence. Further, to top it, courts have been continuously narrowing down the interpretation of these two provisions in determination who shall be considered an FC.

FORTRESSING CoC BY KEEPING CREDITORS AT BAY

In the most recent judgement of Phoenix Arc Pvt Ltd v. Ketulbhai Ramubhai Patel (“Phoenix 1”), it was observed by the Supreme Court that in a case where a corporate debtor only pledges shares to the creditor as security for the debt taken, such creditor shall not be considered an ‘FC’.  It is noteworthy that in the opinion of the Supreme Court the nature of the debt did fall under clause b of Section 5(8). However, as noted by both the National Company Law Appellate Tribunal (“NCLAT”) and the Supreme Court, the debt was not ‘disbursed against the consideration for the time value of money’. The reasoning as to why the debt was said not to be disbursed against the consideration for the time value of money, is absent in both the judgements. In 2017, in the case of Nikhil Mehta and Sons v. AMR Infrastructure Ltd., the phrase ‘time value of money’ was explained under Section 5(8) as the nature of debt wherein, in return for a sum of money advanced, the same has to be repaid along with the price for the time period after which it shall be returned. In other words, it was understood as when the principal amount has to be repaid after a period of time along with interest, which may or may not be in instalments. In the present case of Phoenix 1, the Facility Agreement as noted in the NCLAT’s judgement provided for repayment in 72 instalments along with interest. Applying the interpretation as made in the Nikhil Mehta case, the debt provided under this case stands disbursed against the consideration for the time value of money. Surprisingly, the NCLAT and the Supreme Court neither considered any authority for the interpretation of the phrase, nor provided any rationale in their judgement with respect to this phrase. They simply concluded that the debt was not ‘disbursed against the consideration for the ‘time value of money’ and accordingly did not consider the appellant as an FC. The Supreme Court referred to the case of Jaypee Infratech Ltd v. Axis Bank Ltd and ors, in this judgement wherein a thin line of difference was drawn between the service providers and borrowers. It observed that since service providers and borrowers are two distinct personalities, the lender will not be titled as FC. While pronouncing the judgment, the Supreme Court gave a strict interpretation to the term ‘financial debt’. Seemingly, on the other hand, the case also implies the importance of due diligence that lenders must carry out before they delve into financial transactions.

In another recent judgment of Phoenix Arc Private Ltd v. Spade Financial Services Ltd (“Phoenix 2”), the Supreme Court has propounded that FCs will be excluded from becoming members of CoC when they consciously remove the label of ‘related party’ with an intention to evade the bar placed by the first proviso to Section 21(2) of the Code. The rationale behind the judgment was to contain the admission of related party creditors who intentionally remove the label to dilute and influence the decisions of other creditors, which in turn would have an adverse effect on the resolution process. Although the judgment is well intended, proving the intention of the creditors is a tedious task which will make the process even more complex and burdensome.

In all of these cases, reliance has been placed on the landmark judgement of Swiss Ribbons Pvt Ltd v. Union of India,which elaborated upon the role and working of the FC. It observed that FC acts as a gatekeeper who proactively indulges himself in the affairs of the corporate debtor from the beginning. Furthermore, the role of the FC is not only limited to the realization of debt but also to revive and recuperate the Corporate Debtor.

ANALYSIS & CONCLUSION

It can be sufficiently inferred on comparing the varied interpretations given in these judgements, that the Supreme Court has given contradicting interpretations to the term FC. On the one hand, in the case of Phoenix 1, the claim of the creditor to be considered an FC was rejected on the basis of a very strict interpretation of the provisions and the meaning of financial debt. On the other hand, in some of the above-mentioned judgements, consideration has been placed on very abstract ideas of intention and care for the revival of the corporate debtor. Furthermore, in the case of Phoenix 1, despite the fulfilment of criteria, the creditor was considered only a secured creditor as its interest was considered to be confined to the pledged securities and the exclusion was on a purely technical basis. Yet in the case of Phoenix 2, the fulfilment of technicality was ignored considering it to be an intentional act of camouflage.

In conclusion, the CoC is already an exclusive club of FCs and further increasing the exclusivity by making such contradicting interpretations is like adding insult to injury. In these recent judgements of Phoenix 1 and Phoenix 2, the Supreme Court could subsume the creditors in the category of FCs through a liberal interpretation. However, it chose to make a rigid and compulsive interpretation of the provisions relating to FCs. The same is injudicious and unwise considering the ratio in the case of Binani Industries Limited v. Bank of Baroda & Anr., wherein the NCLAT held that ‘one form of credit must not be given preference over other forms’ in the light of the overriding objective of promoting overall credit availability. The Supreme Court’s reluctance to allow creditors to be considered as FCs is a discouragement for creditors and will adversely affect the objective of promoting credit availability. Furthermore, in the current scenario of an economic slowdown owing to the pandemic, leaving creditors high and dry is not something the regulators can afford.

*The authors are fourth-year students at the Institute of Law, Nirma University, Ahmedabad.