The Supreme Court has upheld the exclusion of a debenture holder, its trustee and a subsequent debt assignee from the Committee of Creditors (CoC) of a real estate company, holding that participation in the corporate debtor’s policy-making processes can attract the related-party disqualification under the Insolvency and Bankruptcy Code, 2016 (IBC).
A Bench of Justice J.B. Pardiwala and Justice K. Vinod Chandran dismissed appeals challenging the exclusion of ECL Finance Limited and IDBI Trusteeship Services Limited from the CoC of Palm Developers Private Limited.
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The Court explained that establishing a related-party relationship through participation in policy-making under Section 5(24)(m)(i) does not require the same degree of proactive control examined for disqualification of resolution applicants under Section 29A.
The bench observed that the requirement need not extend to occupying the “driving seat”; a role in navigating policy and channelising business interests would suffice.
The dispute arose from financial arrangements entered into by Saha Infratech Private Limited, with Palm Developers acting as corporate guarantor and security provider.
Saha Infratech proposed issuing non-convertible debentures aggregating ₹160 crore in two tranches. Only the first tranche of ₹110 crore was subscribed, and the entire subscribed debenture holding subsequently came to be held by ECL Finance. IDBI Trusteeship Services acted as debenture trustee.
The debenture arrangement was secured through, among other things, an unconditional and irrevocable corporate guarantee from Palm Developers, a mortgage over the land and buildings of Project Encore, hypothecation of project receivables and an escrow mechanism for project revenues.
Separately, Saha Infratech entered into a facility agreement dated September 22, 2017, for a ₹90 crore revolving credit facility from ECL Finance. Palm Developers again acted as guarantor, with additional securities stipulated under the financing documents.
ECL therefore occupied two positions: a debenture holder and a lender, with Palm Developers guaranteeing obligations arising from both arrangements.
The corporate insolvency resolution process against Palm Developers commenced on January 27, 2020.
IDBI Trusteeship submitted a claim of approximately ₹131.17 crore in its capacity as debenture trustee, while ECL Finance submitted a claim of approximately ₹139.03 crore under the loan facility.
Both were initially treated as financial creditors and included in the CoC. An individual homebuyer challenged their inclusion, contending that they were related parties of the corporate debtor.
The National Company Law Tribunal accepted the challenge. It also held that the claims did not constitute financial debt because there had been no direct disbursement to Palm Developers.
The National Company Law Appellate Tribunal upheld their exclusion. The Supreme Court ultimately sustained that outcome while correcting aspects of the reasoning concerning financial debt and invocation of guarantees.
The Supreme Court rejected the view that Palm Developers’ status as a guarantor, rather than the principal borrower, prevented the obligations from constituting financial debt.
It held that the NCLT had misread Anuj Jain, Interim Resolution Professional for Jaypee Infratech Ltd. v. Axis Bank Limited. Section 5(8) expressly encompasses liabilities arising from guarantees or indemnities relating to the transactions specified in that provision.
Consequently, the absence of direct disbursement to the corporate guarantor did not, by itself, defeat the financial nature of the claims.
The Court also disagreed with the NCLAT’s adverse reasoning based on the corporate guarantee not having been invoked before commencement of insolvency proceedings.
Relying on China Development Bank v. Doha Bank Q.P.S.C., the Bench explained that the existence of financial debt and the occurrence of default are distinct questions. A person to whom financial debt is owed can qualify as a financial creditor even without a payment default.
Default assumes relevance when a creditor seeks to initiate insolvency proceedings under Section 7. The Court distinguished that requirement from submitting a financial-debt claim in an insolvency process already underway.
The Supreme Court also upheld the individual homebuyer’s standing to question the inclusion of the creditors.
The statutory arrangement for an authorised representative to attend CoC meetings and vote on behalf of homebuyers does not eliminate an individual homebuyer’s right to approach the adjudicating authority.
The Court referred to Phoenix ARC Private Limited v. Spade Financial Services Limited, which recognised the right of financial creditors to seek exclusion of related-party creditors from the CoC.
Accordingly, the fact that the challenge had been brought by an individual homebuyer, rather than the authorised representative of the homebuyers’ class, did not render it untenable.
The central issue was whether the financing arrangements brought the appellants within Section 5(24)(m)(i), which covers association with a corporate debtor through participation in its policy-making processes.
The Court examined the distinction between positive control and merely restrictive or negative rights discussed in Arcelor Mittal India Private Limited v. Satish Kumar Gupta.
That decision concerned eligibility to submit a resolution plan under Section 29A. In that context, the Court had distinguished the ability to drive management and policy decisions from a mere power to block particular actions.
The Bench clarified that the policy-making participation test under Section 5(24)(m)(i), read with the relevant CoC provisions, does not demand the same level of control.
The inquiry was whether ECL’s association with Palm Developers enabled participation in policy-making. It was unnecessary to establish control to the full extent contemplated in the Section 29A discussion.
On examining the transaction documents, the Court found rights extending well beyond ordinary restrictions intended to protect repayment.
The arrangements included powers concerning nominee-director appointments, resolution of board or shareholder deadlocks, approval and modification of quarterly construction budgets, and release of construction funds from escrow accounts.
The facility documents also restricted removal of managerial personnel without the lender’s consent. In specified circumstances, they required the borrower and obligors to appoint or change key technical, financial and executive staff to the lender’s satisfaction.
Further provisions enabled inspections, examination of financial and cost-accounting systems, appointment of real estate or distribution agents, and intervention in project-related activities.
A power of attorney conferred extensive authority concerning construction, statutory approvals, raw materials, labour, dealings with purchasers and completion of sales. The Court also noted provisions placing project revenues, including allottee payments, under ECL’s direct control.
Taken together, these arrangements established pervasive supervision over policy implementation and project development. The Court rejected the contention that the rights amounted only to restrictive or negative control, or that their asserted non-exercise removed the disqualification.
The Court held that ECL’s related-party status as the sole debenture holder also prevented its trustee from participating in the CoC on its behalf.
IDBI Trusteeship’s role was to protect the interests of the debenture holder. Since ECL held all the debentures and was disqualified from participation in that capacity, the trustee could not secure CoC representation for those interests.
On the facts of the case, ECL could not avoid the disqualification by relying on its separate position as a term-loan lender. The Court considered its dual capacities alongside the extensive rights arising from the financing documents.
The Supreme Court also considered ECL’s assignment of its rights under the facility agreement to the second appellant in its appeal.
Referring to Phoenix ARC, the Court acknowledged that a legitimate assignee of a related party’s debt is not automatically disqualified merely because of the assignor’s relationship with the corporate debtor.
However, a transfer made in bad faith or with fraudulent intent to undermine the insolvency process can result in the assignee being treated like a related-party financial creditor.
In this case, ECL had submitted the original claim, and the assignment occurred long after commencement of the insolvency process. The Court considered the transfer an attempt to overcome the statutory restriction on CoC participation.
It also referred to findings recorded in a forensic audit report and noticed by the Tribunal. Those findings concerned alleged diversion of funds through the corporate guarantor to promoter-controlled entities and the alleged misuse of the project to raise finance at the expense of homebuyers.
In that factual setting, the Bench held that the assignment failed the test of a bona fide transaction and that the assignee could not participate in the CoC.
The Supreme Court found no ground to interfere with the NCLAT’s conclusion that the appellants were related parties under Section 5(24).
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