The Supreme Court of India, in China Development Bank v Doha Bank QPSC & Ors, held that the corporate debtor’s undertaking to discharge the liabilities of third parties under a deed of hypothecation (DoH) constitutes a guarantee under the Indian Contract Act, 1872 (ICA), and hence it can become a financial debt within the meaning of the Insolvency and Bankruptcy Code, 2016 (IBC).
In this case, the corporate insolvency resolution process (CIRP) had been commenced against Reliance Infratel. The appellants filed claims as financial creditors that were initially admitted, placing them on the committee of creditors (CoC). Respondent Doha Bank subsequently filed an application before the National Company Law Tribunal (NCLT) contesting this inclusion on the basis that the appellants’ claims were derived from various DoHs executed between the appellants and Reliance Communication Infrastructure, Reliance Communications, Reliance Telecom and the corporate debtor (RCom entities).
These DoHs stipulated, inter alia, the provision of assets as security and an undertaking to cover debt shortfalls among the RCom entities. Concurrently, a resolution plan was submitted and subsequently approved by the NCLT. An appeal against this approval was filed before the National Company Law Appellate Tribunal (NCLAT). The appellate body disposed of the appeal, observing that the NCLT may reconsider the resolution plan after deciding Doha Bank’s application, if necessary.
Subsequently, the NCLT dismissed Doha Bank’s application, prompting a further appeal to the NCLAT. The NCLAT allowed this appeal, holding that the DoH did not constitute a guarantee, thereby precluding the appellants’ classification as financial creditors. This matter was then taken to the top court.
CCE & Service Tax v Northern Operating Systems (P) Ltd was cited, and it was held that “the nomenclature of any contract or document is not decisive of its nature. An overall reading of the document and its effect is to be seen by the courts”. The court also held that a “contract becomes a guarantee when the contract is to perform the promise or discharge the liability of a third person in case of default. Thus, when a person enters into a contract to perform or discharge the liability of a third party, the contract becomes a contract of guarantee”.
Analysing the DoH, the court concluded that the corporate debtor’s undertaking to discharge the RCom entities’ liabilities constituted a guarantee.
The court also clarified that default is a prerequisite only for initiating the CIRP, and not for establishing a financial debt. Regarding a moratorium, the court held that it imposes an embargo on recovery proceedings and does not extinguish the claims of creditors. It was held that if such an argument were accepted, no creditor would be able to raise a claim after a moratorium was issued. Consequently, the impugned order was set aside, and the appellants were held to be financial creditors.
The dispute digest is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi & Mumbai. The authors can be contacted at support@numenlaw.com. Readers should not act on the basis of this information without seeking professional legal advice.
