Participation In Corporate Debtor's Policy-Making Sufficient To Disqualify Financial Creditor From CoC: Supreme Court

The Supreme Court has held that a financial creditor need not exercise complete control over a corporate debtor to be treated as a related party under the Insolvency and Bankruptcy Code and excluded from its Committee of Creditors.

The Court clarified that participation in the corporate debtor's policy making process including a role in guiding its business interests, is sufficient to attract the related party disqualification under Section 5(24) of the Code.

“The rigour to find a financial creditor to be a related party under Section 21 read with the second proviso and sub-section (6A)(a), is a tad lesser than that required to find 'control' under Section 29A (c) and (g). The requirement would not be to the extent of being in the driving seat, but a role of navigation would suffice, in determining policy and channelising business interests.",  a division bench of Justices J.B. Pardiwala and K. Vinod Chandran observed.

The ruling arose from a dispute over the inclusion of ECL Finance Ltd and IDBI Trusteeship Services Ltd in the Committee of Creditors (CoC) of Palm Developers Pvt Ltd. ECL held debentures issued by Saha Infratech Pvt Ltd and had extended it a ₹90 crore revolving credit facility, with Palm Developers acting as corporate guarantor.

In June 2016, Saha Infratech proposed issuing non convertible debentures worth ₹160 crore, of which ₹110 crore was subscribed. ECL eventually held the entire debenture holding, while IDBI Trusteeship acted as trustee. In September 2017, ECL sanctioned the ₹90 crore facility, under which Palm Developers provided guarantees and other security.

After Palm Developers' insolvency commenced on January 27, 2020, IDBI Trusteeship and ECL submitted claims of approximately ₹131.17 crore and ₹139.02 crore, respectively. A homebuyer challenged their inclusion in the CoC. The NCLT excluded them on March 14, 2022, holding them to be related parties. The NCLAT New Delhi bench upheld the decision on July 12, 2022 which prompted appeals before the Supreme Court.

The Supreme Court first distinguished the test for control under Section 29A(c) and (g) of the IBC from the test for identifying a related party under Section 5(24)(m)(i), read with Section 21. It held that the latter did not require proactive control but an association through participation in policy making.

“We must immediately notice that a reading of Section 5(24) with the first proviso of sub-section (2) and sub-section (6A) of Section 21, does not indicate a requirement of a proactive control as would the rigour of the word 'control' in Section 29A (c) & (g) would bring forth. Sub-section (24) of Section 5, by sub-clause (m)(i), only requires an association with the CD by way of participation in policy making process of the CD,” the Court said.

The Court noted that the Articles of Association permitted the debenture holder or lender to appoint a nominee director upon default. In the event of a deadlock at board or shareholder meetings, the matter could be referred to the nominee director or lender for a final and binding decision.

The debenture arrangements also empowered the trustee or monitoring agent to approve quarterly construction budgets and require modifications. The Court held that these provisions gave ECL and the trustee an active role in steering the borrower's business and projects.

On the issue of ECL's powers to supervise the borrower's operations and finances, the Court noted that the facility agreement authorised the lender to appoint technical, management or consultancy professionals to inspect the borrower's working and examine its financial and cost-accounting systems, with the expenses borne by the borrower or obligor.

The Court held that ECL's powers went beyond mere restrictive or negative control and enabled overall supervision of policy implementation and project development. Since ECL was a related party, it could not participate in the CoC as a debenture holder or lender. IDBI Trusteeship, which represented ECL's interests as debenture trustee was also ineligible for inclusion.

The Court also rejected the subsequent assignment of ECL's rights, finding that it occurred after the insolvency process had commenced and was not a bona fide assignment. It appeared intended to circumvent the restriction on related party participation in the CoC.

Finding no question of law or perversity in the NCLAT's decision, the Supreme Court dismissed the appeals and closed the connected contempt petitions.

For the Appellants: Gaurav Mitra, Sr. Advocate, Abhishek Agarwal- 2107, AOR, Atul Sharma, Aditya Vashith, Advocates 

For the Respondents: Jayant Mehta, Arijit Prasad, Sr. Advocates, Raghavendra Mohan Bajaj, Garima Bajaj- 2433, AOR, Soumik Ghosal- 2373, AOR, Abhishek Agarwal- 2107, AOR, Megha Karnwal- 2805, AOR, Kumar Karan, Pankaj Pandey, Sahil Tagotra, AOR, Girish Tripathi, Digvijay Prasad, Ankita Singh, Deepak Kumar, Ashish Yadav, Shreya Kasera, Arjun Aggarwal, Alabhya Dhamija, AOR, Mahima Pandey, Jahnavi Verma, Megha Karnwal- 2805, AOR, Sahil Sethi, Samriddh Bindal, Vikash Kumar, Devika Tiwari, Swikriti Singhania- 2622, AOR, Soumik Ghosal, AOR, Ashutosh Chaturvedi