2022 (9) TMI 543 - AT - Insolvency and Bankruptcy

Tribunal: Deed of Hypothecation Not Financial Debt under Insolvency Law

The Tribunal held that the Deed of Hypothecation (DoH) did not constitute a financial debt under the Insolvency and Bankruptcy Code. It concluded that the ... Seeking recognition of R-2 to R-5 as Financial Creditors - the decision of the Resolution Professional of classifying the indirect lenders as the Financial Creditor of the Corporate Debtor is correct or not - considering the Respondents based on ‘Deed of Hypothecation’ (DOH) as Financial Creditor, is valid or not - HELD THAT:- What has come under appeal is that the Adjudicating Authority has considered the R- 2 to R- 5 as Financial Creditors of the Corporate Debtor. The basis of consideration is the ‘Deed of Hypothecation’only for considering the R-2 to R-5 as Financial Creditors of the Corporate Debtor. The Appellant No. 1 has critically sought that R-2 to R-5 should be derecognized/deleted as ‘Financial Creditors’ of the Corporate Debtor - It is an admitted position that the Corporate Debtor hypothecated its asset in favor of R-2 to R- 5 under the Deed of Hypothecation to secure the loans disbursed by them to the Reliance Communication Entities. It is also an admitted position that R-2 to R-5 have not disbursed money to Corporate Debtor. Section 5(8) of the Code is exhaustive and mere ‘Deed of Hypothecation’ does not fall within its ambit. RP has considered DOH as a ‘Deed of Guarantee’ which is a misconception of the obligations - The Security Interest created under the DOH shall be continuing security and shall remain enforce until all the obligations have been discharged by the borrowers under the respective facility documents. Hence, it can be construed that the clauses of DOH cannot be construed to be a ‘Covenant of Guarantee’ or ‘Contract of Guarantee’. Hypothecation Deed is a legal document and it establishes contractual relations between the parties where the lender agrees to grant a loan to the borrower in return for movable assets provided as security. Hypothecation of a moveable assets does not involve giving up ownership rights like title or possession. The Hypothecation Deed ensures that the parties are aware of their rights and liabilities and have a document which can be enforced in a court of law. It also grants the lender a right to cease the asset when the borrower fails to meet the terms of the Hypothecation Deed. The ‘Deed of Hypothecation’ is merely creation of security interest and a mere security of interest created by hypothecation or mortgage does not constitute a financial debt. From our commercial understanding ‘Deed of Hypothecation’ is not a ‘Deed of Guarantee’. The ‘Deed of Hypothecation’ discharges the liabilities of other borrowers upon their default and is limited to the realization value of those hypothecated assets and hence it cannot be construed as a contract of guarantee - ‘Deed of Hypothecation’ is a regular boilerplate clause in any standard draft of a ‘Deed of Hypothecation’. The instrument which covers hypothecation or guarantee is specifically specified in the initial part or object of the agreement or preamble and not somewhere some wordings are mentioned in the agreement. The ‘Deed of Hypothecation’ cannot be a basis to declare the parties as financial creditors as these Respondents are not even party to the DOH i.e. ‘Deed of Hypothecation’ - matter remanded back to the Adjudicating Authority for taking all consequential actions resulting from de-recognizing R-2 to R-5 as ‘Financial Creditors’. Petition disposed off. Issues Involved:1. Classification of indirect lenders as financial creditors.2. Validity of the Deed of Hypothecation as a basis for financial creditor status.3. Adjudicating Authority's reasoning and order.Issue-wise Detailed Analysis:1. Classification of Indirect Lenders as Financial Creditors:The main contention was whether the indirect lenders (Respondents 2 to 5) should be classified as financial creditors of the Corporate Debtor (Reliance Infratel Ltd.). The appellants argued that these respondents were not direct lenders to the Corporate Debtor and thus should not be classified as financial creditors. The Resolution Professional (RP) had included them based on the Deed of Hypothecation (DoH), which the appellants contested.2. Validity of the Deed of Hypothecation as a Basis for Financial Creditor Status:The appellants argued that the DoH does not constitute a financial debt under Section 5(8) of the Insolvency and Bankruptcy Code (IBC) and that it should not be considered a guarantee. They emphasized that the Corporate Debtor had not extended any corporate guarantee to the respondents and that the DoH only created a security interest, not a financial obligation. The respondents, however, claimed that the DoH included an obligation to pay any shortfall or deficiency, which they argued should be treated as a guarantee.3. Adjudicating Authority's Reasoning and Order:The Adjudicating Authority had dismissed the appellants' claims and upheld the RP's decision to classify the respondents as financial creditors. The Authority reasoned that the DoH included a covenant to pay any shortfall or deficiency, which it interpreted as a guarantee. The Authority also held that the mere existence of a debt was sufficient to file a claim, regardless of whether it was in default.Tribunal's Observations and Judgment:The Tribunal noted that the DoH is a legal document establishing a security interest but not a guarantee. It emphasized that the DoH's clauses did not amount to a contract of guarantee under Section 126 of the Indian Contract Act, 1872. The Tribunal found that the Adjudicating Authority had misconstrued the obligations under the DoH and that the DoH did not fall within the ambit of Section 5(8) of the IBC.The Tribunal concluded that the DoH is a standard security document and does not create a financial debt. It set aside the Adjudicating Authority's order and directed that the respondents be de-recognized as financial creditors. The case was remanded back to the Adjudicating Authority for all consequential actions resulting from this de-recognition. No order as to costs was made.