Whether financial creditor of holding Co. considered as FC of subsidiary if subsidiary given loan security

Anuj Jain Interim Resolution Professional v. Axis Bank

• Civil Appeal Nos. 6777-6797 of 2019
• Civil Appeal no. 9357-77
• Date of Order: 26-02-2020

Sub

The case essentially deals with a third-party mortgage extended by the Corporate Debtor for a loan taken by its holding company, wherein the Corporate Debtor mortgaged its property for such borrowing.

The two questions that arose in the said case were

(i) Whether the given transaction would be a 'preferential Transaction' under section 43 of the Code?

(ii) Whether the creditors of the holding company will be treated as 'financial creditors' of the subsidiary on grounds of the securities provided for the facilities granted to the holding company?

THE SUPREME COURT OF INDIA

Regarding the first question, ( whether providing security for the facility enjoyed by Holding Company of the Corporate Debtor ) the Supreme Court, after analysing section 43 of the Code, stated that the intention of the parties is not important to determine whether the transaction is preferential.

For clarity in the categorization of a transaction as preferential, the Apex Court laid down the following steps-

(a) Determining "Relevant Time" concerning section 43:- Two years in case of related party and one year in case of unrelated parties (both to be calculated from insolvency commencement date);

(b) The next step would be to determine whether there has been a transfer of property or transfer of an interest of the corporate debtor;

(c) Then establishing the fact whether the beneficiary is a creditor or guarantor or surety in the capacity of the corporate debtor;

(d) Then to analyse whether the transaction is made on account of financial debt or an operational debt and whether the said transfer puts the transferee in a beneficial position than it would have been in the event of distribution of assets as per section 53 of the Code.

Based on the above discussion, the SC held the transaction between the Corporate Debtor and its holding as 'preferential' under the Code.

As regards the second question,(whether bank/ institution providing finance to holding company and secured by assets of Subsidiary company will be considered as Financial Creditor of Subsidiary) the instant question was determined in light of the fact that the Corporate Debtor had mortgaged its assets as security for loans taken by its holding company, i.e., there was no "direct nexus" between the Corporate Debtor and the lenders of the holding company. Whereas, the root requirement of a creditor to become a financial creditor for the purpose of the Code is the transaction vis-à-vis the corporate debtor.

The Hon'ble SC primarily held that in the given set-up, since the corporate debtor has given its property in mortgage to secure the debt of a third party (its holding company), the same may fall within the definition of 'debt' as per section 3 (10) of the Code but it cannot partake the character of 'financial debt' within the meaning of section 5 (8) of the Code. Hence, the financial creditor of the holding will only be considered as a secured creditor of the corporate debtor (and not financial) as there was no direct financial assistance given to the CD on the time value of money.

CONCLUSION

In the above case the the Apex Court has decided that the transaction securing of load of Holding Company by subsidiary through mortgaging its assets in favour of bank /institutions given loan to holding company is a " Preferential Transaction" and falls under provisions of Section 43 of the IBC,2016. Since there is no direct contact or direct nexus between the bank /financial institution providing loan to Holding Company and Subsidiary providing security and hence the bank /financial institution is not considered as " Financial Creditor" of Subsidiary in CIRP of Subsidiary Company. The debt due to Holding Company is consider as " Financial Debt", and hence Financial Creditors of Holding Company will be considered as Secured Creditor of the Subsidiary and not " Financial Creditor".

DISCLAIMER: The case law produced above is only for knowledge and information of the readers. The views expressed here are the persona views of the author , same should not be considered as professional advice. In case of necessity do consult with professionals for more understanding and clarity on the matter.

SECTION 3(10) provides that

"creditor" means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder.

SECTION 3(11) provides that

"debt" means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.

SECTION 5(8) provides that

"financial debt" means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

1. money borrowed against the payment of interest;
2. any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;
3. any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;
4. the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;
5. receivables sold or discounted other than any receivables sold on non- recourse basis;
6. any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;
7. any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;
8.  any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;
1. the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause;

SECTION 43 - PREFERENTIAL TRANSACTIONS

(1) Where the liquidator or the resolution professional, as the case may be, is of the opinion that the corporate debtor has at a relevant time given a preference in such transactions and in such manner as laid down in sub-section (2) to any persons as referred to in sub-section (4), he shall apply to the Adjudicating Authority for avoidance of preferential transactions and for, one or more of the orders referred to in section 44.

(2) A corporate debtor shall be deemed to have given a preference, if—

(a) there is a transfer of property or an interest thereof of the corporate debtor for the benefit of a creditor or a surety or a guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor; and

(b) the transfer under clause (a) has the effect of putting such creditor or a surety or a guarantor in a beneficial position than it would have been in the event of a distribution of assets being made in accordance with section 53.

(3) For the purposes of sub-section (2), a preference shall not include the following transfers—

(a) transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee;

(b) any transfer creating a security interest in property acquired by the corporate debtor to the extent that—

(i) such security interest secures new value and was given at the time of or after the signing of a security agreement that contains a description of such property as security interest and was used by corporate debtor to acquire such property; and

(ii) such transfer was registered with an information utility on or before thirty days after the corporate debtor receives possession of such property:

Provided that any transfer made in pursuance of the order of a court shall not, preclude such transfer to be deemed as giving of preference by the corporate debtor.

Explanation.For the purpose of sub-section (3) of this section, "new value" means money or its worth in goods, services, or new credit, or release by the transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the liquidator or the resolution professional under this Code, including proceeds of such property, but does not include a financial debt or operational debt substituted for existing financial debt or operational debt.

(4) A preference shall be deemed to be given at a relevant time, if—

(a) it is given to a related party (other than by reason only of being an employee), during the period of two years preceding the insolvency commencement date; or

(b) a preference is given to a person other than a related party during the period of one year preceding the insolvency commencement date.

SECTION 53 - DISTRIBUTION OF ASSETS

53. (1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely :

(a) the insolvency resolution process costs and the liquidation costs paid in full;

(b) the following debts which shall rank equally between and among the following :

(i) workmen's dues for the period of twenty-four months preceding the liquidation commencement date; and
(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;

(d) financial debts owed to unsecured creditors;

(e) the following dues shall rank equally between and among the following:

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;

(g) preference shareholders, if any; and

(h) equity shareholders or partners, as the case may be.

(2) Any contractual arrangements between recipients under sub-section (1) with equal ranking, if disrupting the order of priority under that sub-section shall be disregarded by the liquidator.

(3) The fees payable to the liquidator shall be deducted proportionately from the proceeds payable to each class of recipients under sub-section (1), and the proceeds to the relevant recipient shall be distributed after such deduction.

Explanation

For the purpose of this section—

(i) it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full; and

(ii) the term "workmen's dues" shall have the same meaning as assigned to it in section326 of the Companies Act,2013.