2026 (3) TMI 93 - AT - IBC

Contract of guarantee arising from a covenant to pay converts a security into secured financial debt and creates personal liability.

Disbursement need not be made directly to the corporate debtor to qualify as financial debt under Section 5(8); funds advanced on behalf of or for the ... Financial debt - financial creditor - disbursement (requirement under Section 5(8)) - covenant to pay - contract of guarantee (Section 126, Indian Contract Act) - secured financial creditor vs other secured creditor - substance over form in security documentsFinancial debt - disbursement (requirement under Section 5(8)) - Direct disbursement to the corporate debtor is not a sine qua non for classification of a debt as a 'financial debt' under Section 5(8) of the Code. - HELD THAT: - The Tribunal examined the statutory language of Section 5(8) which requires a debt to be 'disbursed against the consideration for the time value of money' but does not expressly require that such disbursement be made directly to the corporate debtor. The Court analysed the concept of disbursement and concluded that while actual outflow of funds is an essential element of financial debt, the statute does not mandate exclusive or direct transfer to the corporate debtor's account. Money disbursed on behalf of, for the benefit of, or in connection with the corporate debtor may satisfy the disbursement requirement depending on the contractual and factual matrix. The Tribunal reviewed precedents distinguishing pure third party security from arrangements with payment undertakings, and cited a prior unchallenged decision of this Tribunal (Rajeev Kumar Jain v. Uno Minda Ltd.) holding that indirect disbursements can qualify as financial debt where the transaction carries consideration for the time value of money. On this basis the Adjudicating Authority's conclusion that disbursement must be directly to the corporate debtor was held to be erroneous. [Paras 53, 54, 56, 57]Direct disbursement to the corporate debtor is not an indispensable prerequisite for a debt to qualify as financial debt under Section 5(8).Covenant to pay - contract of guarantee (Section 126, Indian Contract Act) - secured financial creditor vs other secured creditor - The 'covenant to pay' in the supplemental mortgage deeds creates an enforceable guarantee (contract of guarantee) and, read with the Debenture Trust Deed and related finance documents, converts the Appellant's claim into a secured financial debt. - HELD THAT: - The Tribunal analysed the Debenture Trust Deed and the First and Second Supplemental Indentures of Mortgage, focusing on definitions of 'Secured Obligations', 'Security Interest', 'Security Providers' and the express Clause 2 (covenant to pay) in the supplemental mortgage deeds. Clause 2.1 records the mortgagor's undertaking to discharge the Secured Obligations and Clause 2.2, read together with 2.1, provides that the mortgagor shall ensure secured obligations do not fall into arrears and shall pay default interest, without prejudice to enforcement remedies. The Tribunal held that these provisions, taken in context with the DTD (including Clause 24 imposing joint and several liability of security providers), amount to an express, unconditional undertaking to discharge the secured obligations in consideration of the debenture subscription. Applying Section 126 of the Indian Contract Act and the reasoning in China Development Bank v. Doha Bank (where similar post enforcement shortfall undertakings were held to be guarantees), the Tribunal concluded that the covenant to pay constitutes a contract of guarantee rather than a mere limited security. Consequently, the Appellant's claim is founded on a guarantee-like obligation and falls within the inclusive definition of 'financial debt' under Section 5(8). The Tribunal rejected the contention that Clause 2.2 limits liability to default interest, observing that clauses 2.1 and 2.2 must be read jointly and that 2.2 does not negate the broader payment undertaking in 2.1. [Paras 86, 88, 90, 95, 96]The covenant to pay in the mortgage deeds creates an enforceable guarantee; the Appellant's claim is a secured financial debt and the Appellant qualifies as a financial creditor qua the Corporate Debtor.Secured financial creditor vs other secured creditor - substance over form in security documents - The classification of the Appellant's claim as an 'other secured creditor' was incorrect; on the facts and document language the Appellant is a 'secured financial creditor'. - HELD THAT: - Given the Tribunal's findings that indirect disbursement can satisfy Section 5(8) and that the supplemental mortgage deeds contain an express covenant to discharge Secured Obligations amounting to a guarantee, the Appellant's claim could not be confined to the status of an 'other secured creditor'. The Tribunal emphasised that substance of the transaction (express payment undertaking and joint and several liability of security providers) governs classification under the Code rather than mere nomenclature of documents. Consequently, the Adjudicating Authority's classification was set aside. [Paras 85, 96]The Adjudicating Authority was in error in treating the Appellant as an 'other secured creditor'; the Appellant is to be treated as a secured financial creditor.Remand for fresh consideration - The matter is remitted to the Adjudicating Authority for reconsideration and further proceedings in accordance with law. - HELD THAT: - After setting aside the Impugned Order, the Tribunal directed that the matter be remanded to the Adjudicating Authority to decide the claim and related issues in accordance with the legal principles articulated in the judgment. The Tribunal closed any interlocutory application and directed the parties to appear before the Adjudicating Authority on a specified date for further adjudication consistent with the findings recorded. [Paras 98]The Impugned Order is set aside and the case is remanded to the Adjudicating Authority to decide the matter in accordance with law.Final Conclusion: The appeal is allowed: direct disbursement to the corporate debtor is not a prerequisite for financial debt, the supplemental mortgage deeds' 'covenant to pay' amounts to an enforceable guarantee bringing the Appellant's claim within the scope of 'financial debt' and entitling the Appellant to be treated as a secured financial creditor; the Impugned Order is set aside and the matter is remitted to the Adjudicating Authority for further proceedings in accordance with this judgment. Issues: (i) Whether disbursement of debt to the corporate debtor is a prerequisite for classification as 'financial debt' under Section 5(8) of the Insolvency and Bankruptcy Code, 2016; (ii) Whether the appellant qualifies as a financial creditor under Section 5(7) read with Section 5(8) of the Code and whether the claim is a secured financial debt; (iii) Whether the 'covenant to pay' in the mortgage/deed creates an enforceable guarantee or merely secures the mortgage; (iv) Whether a covenant to pay for debt disbursed to a third party amounts to a contract of guarantee under Section 126 of the Indian Contract Act, 1872; (v) Whether the liability under the covenant to pay is limited only to the extent of the mortgaged property.Issue (i): Whether direct disbursement to the corporate debtor is mandatory for qualification as financial debt under Section 5(8) of the Code.Analysis: Section 5(8) defines financial debt as a debt disbursed against consideration for the time value of money and does not expressly require that disbursement be made 'to the corporate debtor.' Disbursement denotes outflow of funds in expectation of repayment, but statutory language is silent on the direction of transfer. Precedent establishes that absence of direct credit to the corporate debtor is a material factor in some cases, but subsequent authority allows disbursement made on behalf of or for benefit of the corporate debtor to qualify where consideration for time value of money and commercial effect of borrowing are present.Conclusion: Direct disbursement to the corporate debtor is not a sine qua non; disbursement on behalf of or for the benefit of the corporate debtor can satisfy Section 5(8) depending on transactional substance.Issue (ii): Whether the appellant qualifies as financial creditor and whether the claim is a secured financial debt.Analysis: The instruments (debenture trust deed and supplemental indentures) define 'secured obligations', 'security interest' and 'security providers' and record creation of mortgage and joint and several liability. The corporate debtor executed supplemental indentures containing covenantary obligations tied to the debenture trust deed and accepted binding obligations in the finance documents. The presence of an explicit covenant to discharge secured obligations, read with definitions and joint-and-several liability, transforms the nature of the obligation from mere security to a promise with financial character. Given that disbursement need not be directly to the corporate debtor, the contractual promise combined with commercial effect aligns the claim with financial debt under Section 5(8).Conclusion: The appellant qualifies as a financial creditor and the claim constitutes a secured financial debt.Issue (iii): Whether the covenant to pay creates an enforceable guarantee or merely secures the mortgage.Analysis: The covenant to pay in the supplemental indentures contains an unqualified undertaking to discharge the secured obligations in accordance with the finance documents and a covenant that secured obligations shall not be allowed to fall in arrears, together with acknowledgment of the debenture trust deed terms. These provisions, read conjunctively, create an obligation to meet shortfalls and enforce payment beyond mere proprietary remedies. Comparable authority treating similar clause as guarantee is applicable where the covenant imposes lender-protective personal liability.Conclusion: The covenant to pay creates an enforceable guarantee and is not limited to a simple security interest.Issue (iv): Whether the covenant to pay amounts to a contract of guarantee under Section 126 of the Indian Contract Act, 1872.Analysis: Section 126 requires a promise to discharge a third-party's liability on default. The supplemental indentures evidence a tripartite arrangement and an explicit promise by the corporate debtor to discharge secured obligations in consideration of debenture subscription. Clause language shows contingent and primary obligations to prevent arrears and to discharge shortfalls, satisfying the elements of a contract of guarantee.Conclusion: The covenant to pay amounts to a contract of guarantee within Section 126 of the Indian Contract Act, 1872.Issue (v): Whether liability under the covenant is limited only to the mortgaged property.Analysis: The indentures impose joint and several liability of security providers and contain covenantary obligations by the corporate debtor to discharge secured obligations, not merely to confine recovery to mortgaged assets. Clause language that secured obligations shall not be allowed to fall in arrears and that the mortgagor agrees to discharge secured obligations indicates personal liability beyond enforcement limited to the mortgaged property.Conclusion: Liability under the covenant is not confined solely to the mortgaged property; personal liability to discharge secured obligations is created.Final Conclusion: The appeal is allowed on the merits; the impugned order rejecting classification of the claim as secured financial debt is set aside and the matter is remanded to the Adjudicating Authority for further proceedings in accordance with law.Ratio Decidendi: Where a security document contains an explicit covenant by a security provider to discharge the secured obligations (a 'covenant to pay') in consideration of the underlying finance, that covenant-read with the finance documents and a joint-and-several liability clause-constitutes a contract of guarantee under Section 126 of the Indian Contract Act, 1872, and the resulting liability qualifies as 'financial debt' under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 even if disbursement was made to a third party, provided the transaction carries consideration for the time value of money and the commercial effect of borrowing.