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Collusive commercial arrangements between Creditors and CD wouldn't constitute a 'financial debt'—SC

The Supreme Court has held on Monday, that the commercial arrangements between creditors and Corporate Debtor were collusive in nature, they would not constitute a ‘financial debt’. Hence, Spade and AAA are not financial creditors of the Corporate Debtor.

A three-Judge Bench comprising of Justices Dr. D. Y. Chandrachud, Indu Malhotra and Indira Banerjee was hearing appeals challenging the orders of the NCLAT and the NCLT which excluded two entities AAA and Spade from the Committee of Creditors constituted for the insolvency resolution of a corporate debtor. The NCLT held that the both the entities were not 'financial creditors' as their transactions with the corporate debtor were collusive in nature and excluded them from the CoC. In appeal, the NCLAT reversed the finding and held that the entities were financial creditors but disqualified them from the CoC on the ground that they were 'related parties' of the corporate debtor.

The Supreme Court Bench, while considering the issue discussed the meaning of 'financial debt' and 'collusive transactions'. It observed that 'financial debt' means a debt along with interest, if any, which is disbursed against the consideration for the time value of money.

The Supreme Court has already interpreted the term 'disbursal' in the case of Pioneer Urban Land and Infrastructure Limited v. Union of India, (2019) 8 SCC 416 in the following terms:

The expression 'disbursed' refers to money which has been paid against consideration for the 'time value of money'. In short, the 'disbursal' must be money and must be against consideration for the 'time value of money', meaning thereby, the fact that such money is now no longer with the lender, but is with the borrower, who then utilises the money….”

The report of the Insolvency Law Committee dated 26 March 2018 has discussed the interpretation of the term “'Time value of money' and stated:

The words 'time value' have been interpreted to mean "compensation or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money, or factoring of a discount in the payment.”

The three-Judge Bench observed, “A transaction which is sham or collusive would only create an illusion that money has been disbursed to a borrower with the object of receiving consideration in the form of time value of money, when in fact the parties have entered into the transaction with a different or an ulterior motive. In other words, the real agreement between the parties is something other than advancing a financial debt.”

The Apex Court Bench noted that:

  1. The decision of the NCLAT, in as much as it referred to Spade and AAA as financial creditors, is set aside. Due to the collusive nature of their transactions alleged to be a financial debt under Section 5(8), Spade and AAA cannot be labelled as financial creditors under Section 5(7);

  2. The decision of the NCLAT, in as much as it referred to Spade and AAA as related parties of the Corporate Debtor under Section 5(24), is affirmed; and

  3. The decision of the NCLAT, in as much as it excluded Spade and AAA from the CoC in accordance with the first proviso of Section 21(2), is affirmed but for the reasons mentioned above.


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