On 26th February, 2020, the Supreme Court passed a judgment in Anuj Jain v. Axis Bank Ltd and others. In the judgment, the Apex Court held that lenders do not have authority to initiate a Corporate Insolvency Resolution Process (CIRP) as a financial creditor under the Insolvency and Bankruptcy Code, 2016 (the "Code"), against a third party, which has only created a security interest or mortgage in its properties, on behalf of the principal borrower.

Facts:

In this case, the Appellant, Mr. Anuj Jain was appointed as the Interim Resolution Professional (IRP) by the Allahabad Bench of National Company Law Tribunal (NCLT), in the CIRP of Jaypee Infratech Limited (JIL). This CIRP had been initiated by multiple banks and financial institutions (the "Lenders"), which had certain properties of the Corporate Debtor mortgaged as collateral securities against loans and advances made to its Holding Company, named Jaiprakash Associates Limited (JAL).

Judgment:

Based on submissions made by the IRP-Appellant, the NCLT refused to recognize such Lenders as financial creditors of the Corporate Debtor, JIL, under the Code, and further, directed the said Lenders to discharge the security interest in the said properties, and return the same to the JIL, free of all liabilities.

NCLT refused to recognize Lenders as financial creditors of the Debtor under the following grounds:

1. i) As the Corporate Debtor, JIL, carried out the said transaction of mortgage of properties to defraud its creditors, and/or for other fraudulent purpose.
2. ii) As the Lenders had lent money to its Holding Company, JAL, and not to JIL itself, thus, the Lenders of the JAL could not be considered as the financial creditors of the subsidiary company, i.e. JIL.

However, in appeal to the NCLAT (National Company Law Appellate Tribunal) by the Lenders, the Tribunal set aside the said NCLT Order, thereby holding that the aggrieved Lenders are entitled to exercise their rights under the Code and that the said transactions of JIL cannot be termed as fraudulent or undervalued under the Code.

Thereafter, aggrieved by the aforementioned NCLAT Order, the IRP-Appellant filed an appeal in the Supreme Court of India, wherein, the Apex Court made the following observations:

1- The NCLT has dealt with the nature of the transactions at length and further, held them to be preferential in nature. Thus, based on NCLT findings, the Supreme Court approved that the said transactions were preferential in nature and thus, have to be avoided.

2- That, although in most cases, where a borrower himself does not create a mortgage against the loan given by a lender, but a third party creates or promises to create a mortgage for the benefit of the principal borrower, the Court has accepted the same to be adequate consideration to the surety for giving a guarantee under the Indian Contract Act, 1872.

However, the Supreme Court refused to consider the same principle in matters related to mortgages that are created on behalf of the principal borrower, in favour of lenders, by a third party, under the Code, on the following grounds:

1. a) Under the Code, it is required that a financial creditor disburses a financial debt against consideration for time value of money. But in the present case, the significant element, i.e., disbursement of debt to the Holding Company, JAL, against consideration for time value of money, was missing, as the debt was given to JAL, but the security interest was created with respect to the properties of the Corporate Debtor, JIL. Thus, such Lenders cannot not be considered as ‘financial creditors’ of JIL under the Code.
2. b) Further, the mortgages made with the Lenders were neither towards any loan made to JIL, nor towards protecting any of JIL's securities. Thus, such a debt cannot be considered to be a ‘financial debt’ under the Code.

Therefore, the Apex Court upheld the NCLT Order on the above mentioned grounds, and restored the directions given to the said Lenders by the NCLT, that is, to discharge the security interest in the mortgaged properties, and return the same to JIL

With this judgment, the Supreme Court has laid down detailed principles for recognition of a preferential transaction, which could be made void under the Insolvency and Bankruptcy Code, 2016. The judgment is of significance to investors and lenders, as the approach of the SC in the case highlights the risk of a transaction being set aside and the conscience with which investors and lenders go forward.