2026 (3) TMI 94 - AT - IBC

Financial debt classification: indirect disbursement can suffice and a mortgage covenant with deficiency liability can operate as guarantee.

The text addresses three issues: (i) classification of financial debt under Section 5(8) - concluding direct disbursement to the corporate debtor is not ... Financial debt - disbursement - commercial effect of borrowing - covenant to pay - contract of guarantee - co extensive liability of surety - English mortgage - secured financial creditor - other secured creditorFinancial debt - disbursement - commercial effect of borrowing - Direct disbursement to the corporate debtor is not a sine qua non for a debt to qualify as a 'financial debt' under Section 5(8) of the Code. - HELD THAT: - The Tribunal held that Section 5(8) requires existence of a debt, disbursement against consideration for the time value of money and the commercial effect of borrowing, but does not expressly mandate that disbursement must be made directly to the corporate debtor. While direct disbursement is a significant factor in determining the nature of the transaction, funds disbursed for the benefit of the corporate debtor (even if routed to third parties) can satisfy the disbursement requirement. The Tribunal relied on statutory language and prior NCLAT precedent in Rajeev Kumar Jain to conclude that direct transfer to the corporate debtor is not indispensable and that the Adjudicating Authority erred in treating direct disbursement as a mandatory condition. [Paras 78, 79, 80, 81]Direct disbursement to the corporate debtor is not a mandatory prerequisite for classification of a debt as 'financial debt' under Section 5(8) of the Code.Covenant to pay - contract of guarantee - co extensive liability of surety - secured financial creditor - other secured creditor - A mortgage deed containing an explicit 'covenant to pay' and enforcement mechanism can operate as a contract of guarantee and convert the mortgage-holder into a secured financial creditor under Section 5(8). - HELD THAT: - Examining the Mortgage Deed clauses (including Clause 3 'Covenant to Pay' and Clause 25 'Liability for Deficiency') and applying recent Supreme Court authority (China Development Bank) and NCLAT precedents, the Tribunal concluded that where a security document contains an express promise by the mortgagor to repay and a right to recover any deficiency after enforcement, the arrangement assumes the character of a guarantee under Section 126 read with Section 128 of the Indian Contract Act. Such a covenant goes beyond mere security and establishes a personal liability of the mortgagor, thereby bringing the claim within Section 5(8) and qualifying the creditor as a secured financial creditor rather than an 'other secured creditor.' The Tribunal distinguished Anuj Jain to the extent that that case lacked an express covenant creating a guarantee. [Paras 67, 69, 70, 86, 87]The 'covenant to pay' in the Mortgage Deed creates an enforceable obligation akin to a guarantee and, together with the enforcement and deficiency clauses, renders the Appellant a secured financial creditor under the Code.English mortgage - mortgage - mortgage money - secured financial creditor - The Deed of Mortgage dated 12.05.2016 qualifies as an English mortgage under Section 58(e) of the Transfer of Property Act, and thereby entitles the mortgagee to sue the mortgagor personally for recovery of the mortgage money upon default. - HELD THAT: - The Tribunal noted the recital in the Deed expressly stating the parties' agreement that the mortgage is by way of a legal mortgage in English form and pointed to clauses (including re transfer/reassignment powers) that satisfy the essential features of an English mortgage. On that basis, and consistent with case law about the attributes required for an English mortgage, the Tribunal held that the mortgage grants the mortgagee a personal remedy against the mortgagor and supports classification of the claim as a secured financial debt. [Paras 67, 68, 88, 90, 92]The Mortgage Deed qualifies as an English mortgage and supports the Appellant's entitlement to recover mortgage money personally from the mortgagor, reinforcing its status as a secured financial creditor.Secured financial creditor - financial debt - The Appellant's claim arising from the Mortgage Deeds is to be treated as a secured financial debt and the Appellant is to be treated as a secured financial creditor. - HELD THAT: - Applying the conclusions that direct disbursement is not essential, that the Mortgage Deed contains an enforceable 'covenant to pay' amounting to a guarantee, and that the Deed qualifies as an English mortgage, the Tribunal concluded that the Appellant's claim falls within Sections 5(8)(f), (h) and (i) of the Code. The Tribunal also relied on facts showing the corporate debtor benefited commercially (development rights/saleable area) and on co extensive liability principles under Section 128 of the Indian Contract Act to reinforce the finding that the Appellant qualifies as a secured financial creditor. [Paras 69, 70, 71, 87, 92]The Appellant's claim based on the Mortgage Deeds is a secured financial debt and the Appellant is a secured financial creditor.Secured financial creditor - adjudicating authority - Remand to the Adjudicating Authority for fresh consideration in accordance with law of the claim and classification following the Tribunal's findings. - HELD THAT: - Having set aside the Impugned Order and held that the Appellant's claim qualifies as secured financial debt, the Tribunal remitted the matter to the Adjudicating Authority to decide the claim and attendant consequences in accordance with law and the conclusions reached by this Tribunal. The remand is for fresh consideration and verification by the Adjudicating Authority consistent with the legal findings articulated by the Tribunal. [Paras 93]Matter remanded to the Adjudicating Authority to decide the claim and classification in accordance with law and the Tribunal's findings.Final Conclusion: The Impugned Order is set aside; the Tribunal holds that direct disbursement to the corporate debtor is not a sine qua non for 'financial debt', that the Mortgage Deed contains an enforceable 'covenant to pay' rendering it equivalent to a guarantee and qualifying the Appellant as a secured financial creditor (the Deed being an English mortgage), and the matter is remanded to the Adjudicating Authority for fresh decision in accordance with law. Issues: (i) Whether disbursement of debt to the corporate debtor is a prerequisite for classification of a debt 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 Appellant's claim constitutes a secured financial debt; (iii) Whether the 'covenant to pay' in the Mortgage Deed creates an enforceable guarantee or merely secures the mortgage. Issue (i): Whether disbursement of debt to the corporate debtor is a prerequisite for classification 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 directly to the corporate debtor. Precedents and statutory text were examined to determine whether funds paid to third parties for the benefit of the corporate debtor can qualify. The tribunal considered prior decisions holding that indirect disbursement for the benefit of the corporate debtor may satisfy the commercial effect of borrowing and the requirement of consideration for time value of money. Conclusion: Direct disbursement to the corporate debtor is not a sine qua non for a debt to qualify as financial debt under Section 5(8) of the Code; disbursement on behalf of or for the benefit of the corporate debtor can satisfy the requirement. Issue (ii): Whether the Appellant qualifies as a financial creditor and whether its claim is a secured financial debt. Analysis: The Deed of Mortgage (12.05.2016), read with its clauses (including covenant to pay and liability for deficiency), was examined against Section 5(8) and related authorities. The mortgage deed expressly described the mortgage as an English mortgage and included rights of enforcement and a clause preserving mortgagor liability for any deficiency after realization. The Tribunal considered whether the mortgagor received direct benefit or commercial effect of borrowing through development arrangements and related-party connections, and whether the contractual terms created primary liability akin to a guarantee. Conclusion: The Appellant's claim under the Mortgage Deed constitutes a secured financial debt and the Appellant qualifies as a secured financial creditor in respect of that claim. Issue (iii): Whether the 'covenant to pay' in the Mortgage Deed creates an enforceable guarantee or merely secures the mortgage. Analysis: The content and operation of Clause 3 (covenant to pay), Clause 14 (failure to pay) and Clause 25 (liability for deficiency) were analysed with reference to Section 126 and Section 128 of the Indian Contract Act, 1872 and relevant Supreme Court precedents where covenants combined with enforcement and deficiency liability were held to be guarantees. The deed's express characterization as an English mortgage and clauses enabling recovery of shortfall from the mortgagor were treated as converting the security provider's undertaking into a promise to discharge shortfalls, thereby satisfying the elements of a guarantee in substance. Conclusion: The 'covenant to pay' in the Mortgage Deed, read with enforcement and deficiency clauses, operates as an enforceable undertaking akin to a contract of guarantee; it elevates the mortgage-based claim to financial debt rather than leaving it as a mere secured obligation. Final Conclusion: The appeal is allowed; the impugned order is set aside. The Appellant is to be treated as a secured financial creditor in respect of the mortgage-based claim and the matter is remanded to the Adjudicating Authority for further proceedings in accordance with law. Ratio Decidendi: Where a security document contains an express covenant to pay together with enforcement rights and express liability for any deficiency after realization, and the arrangement produces the commercial effect of borrowing for the corporate debtor, such an arrangement constitutes a contract of guarantee or financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 2016; direct disbursement to the corporate debtor is not an indispensable requirement.