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Creditor will be secured creditor and not 'Financial Creditor' by taking security of pledged shares

Supreme Court held on Wednesday that "a Creditor will be secured creditor, but not 'Financial Creditor' under the Insolvency and bankruptcy Code (IBC), if a corporate debtor has given security only by pledging shares, without undertaking to discharge borrower’s liability".

A three-Judge Bench comprising of Justices Ashok Bhushan, R. Subhas Reddy and M. R. Shah was hearing an appeal filed by Phoenix Arc Private Limited challenging the orders of NCLT and NCLAT which upheld the refusal of the interim resolution professional to allow its participation in the resolution process of a corporate debtor.

The Apex Court held that a person having only security interest over the assets of corporate debtor, even if falling within the description of 'secured creditor' by virtue of collateral security extended by the corporate debtor, would not be covered by the financial creditors as per definitions contained in sub-section (7) and (8) of Section 5 of the IBC.

The question before the top court was whether the appellant can be a 'financial creditor' solely on the basis of this pledge agreement.

In the present case the corporate debtor has only extended a security by pledging 40,160 shares of GEL to the Appellant. The appellant at best will be secured debtor qua above security but shall not be a financial creditor within the meaning of sub-sections (7) and (8) of Section 5 of the IBC.

The Bench observed, "The present is also a case where only security was created by the corporate debtor in 40,160 shares of GEL, there was no liability to repay the loan taken by the borrower on the corporate debtor in the present case. At best the Pledge Agreement and Agreement of undertaking executed on 10.01.2012, that is, subsequent to Facility Agreement, is security in favour of Lender-Assignor who at best will be secured creditor qua corporate debtor and not the financial creditor qua corporate debtor".

The Supreme Court Bench noted, "We may notice that the Appellate Tribunal has dealt with Section 5(8)(f) while rejecting the claim of the appellant as to be the financial creditor. It appears that the submission based on Section 5(8) (i) was not addressed before the Appellate Tribunal which has now been pressed before us. We, thus, uphold the decision of the Resolution Professional as approved by the NCLAT as correct. The appellant is not financial creditor of the corporate debtor. Hence, Miscellaneous Application was rightly rejected by the Adjudicating Authority".

Senior Advocate K.V. Vishwanathan, appearing for the Appellant, argued that the appellant will become a 'financial creditor' by virtue of Section 5(8)(i) of the IBC, which mentions liability arising out of 'guarantee or indemnity'.

Ms. Ami Jain, counsel appearing for the respondent (IRP), submitted that the appellant is not a creditor as it has no right of recovery of any debt from the corporate debtor and has a limited right of enforcing and realising the value of its security in the shape of the shares held by the corporate debtor in its subsidiary. The pledge is not, in any manner, a guarantee under the Contract Act, it was argued.


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