Supreme Court’s Ruling on Contingent Claims and Financial Debt Under the Insolvency and Bankruptcy Code

Introduction:??

The Supreme Court of India on December 20, 2024 interpreted the Insolvency and Bankruptcy Code (IBC) concerning contingent claims arising from a deed of hypothecation (DoH), financial debt, and guarantees. The central issue in the case of China Development Bank vs Doha Bank OPSC and others revolved around whether the Corporate Debtor, Reliance Infratel Limited (RITL), could be considered a guarantor and whether its obligations under the DoH could qualify as "financial debt" under the IBC. The case involved secured lenders like China Development Bank, Asset Care and Reconstruction Enterprises Limited, Shubh Holdings Pte. Ltd., Export Import Bank of China, and Industrial Commercial Bank of China, who had provided financial facilities to the RCom entities, but not directly to the Corporate Debtor. The Court’s interpretation clarified important aspects of the IBC, particularly around contingent claims, financial debt, and the moratorium imposed during the Corporate Insolvency Resolution Process (CIRP).?

Background of the Case:?

The appellants, which were international financial institutions, had extended financial facilities to the RCom entities, specifically Reliance Communications (RCom) and Reliance Telecom (RTL). These facilities were secured against the assets of Reliance Infratel Limited (RITL), the Corporate Debtor. However, the primary borrowers—RCom and RTL—defaulted on their obligations, and the appellants sought to recover their dues by enforcing the guarantees and hypothecated assets under the DoH.?

The DoH in question included a clause (Clause 5(iii)) that dealt with contingent claims, specifically the liability arising from the shortfall in asset realization in the event of default. This clause stipulated that if the proceeds from the sale of hypothecated assets were insufficient to cover the liabilities, the Corporate Debtor (RITL) would be liable to make up the shortfall. In this context, the appellants argued that the imposition of a moratorium under Section 14(1) of the IBC had frustrated the enforcement of these contingent claims, as it prevented the sale of the hypothecated assets.

The core legal question was whether the moratorium under Section 14 of the IBC extinguished contingent claims under the DoH and whether such claims could still be filed during the CIRP.?

The Supreme Court’s Ruling:?

The Supreme Court ruled that the moratorium under Section 14 of the IBC does not extinguish contingent claims under a deed of hypothecation (DoH); rather, it temporarily bars their enforcement. The Court emphasized that a moratorium imposed under Section 14 of the IBC does not eliminate the underlying claims of creditors; it merely suspends their ability to take recovery actions. This important distinction clarifies that while creditors are prohibited from recovering their dues during the moratorium, the liability remains valid. The creditor’s right to claim remains active, and creditors retain the ability to file their claims for resolution under the IBC framework once the moratorium is lifted.?

Contingent Claims and the Moratorium?

One of the central issues in this case was whether the contingent claims arising from Clause 5(iii) of the DoH could be filed despite the moratorium. The appellants argued that the moratorium had effectively frustrated the enforcement of contingent claims because it blocked the sale of the hypothecated properties, which would result in a shortfall for which the Corporate Debtor would be liable.?

The Supreme Court dismissed this argument, explaining that while the moratorium temporarily halts the recovery actions, it does not invalidate the creditor’s claims. The liability under the DoH, which arises in the event of a shortfall from asset realization, remains intact, even though the sale of hypothecated assets is temporarily prohibited.?

Severability Clause in the DoH?

The Court also examined the severability clause in the DoH, which ensured that if any provision was deemed unenforceable due to the moratorium, the remainder of the agreement would continue to be valid and enforceable. Specifically, Clause 16(vi) of the DoH contained a severability clause that allowed for the enforcement of the remaining provisions of the agreement, even if some provisions were affected by the moratorium. This safeguard ensured that the enforceability of the Corporate Debtor’s obligation to cover shortfalls under the guarantee was unaffected by the moratorium.?

Financial Debt and the Role of the Corporate Debtor?

Another key aspect of the Supreme Court’s ruling was its interpretation of the term “financial debt” under the IBC. The appellants argued that their claims against the Corporate Debtor were based on guarantees given by the Corporate Debtor for loans taken by RCom and RTL. Under Section 5(8) of the IBC, a debt qualifies as "financial debt" if it arises from a liability related to a guarantee for the payment of money borrowed by another party.?

The Court examined the provisions of the IBC and the Indian Contract Act, particularly Section 126, which defines a “guarantee” as a contract where a person agrees to discharge the liability of a third party in case of default. The Court held that the Corporate Debtor’s liability under the DoH constituted a guarantee, as it had undertaken to discharge the liabilities of the primary borrowers (RCom and RTL) in the event of default. Thus, the Corporate Debtor’s obligations under the DoH could be classified as financial debt under Section 5(8) of the IBC, making the appellants Financial Creditors.?

This interpretation clarified that the appellants were not required to have directly lent money to the Corporate Debtor. Even though the appellants had not provided direct financial facilities to RITL, the guarantees extended by RITL for the loans taken by RCom and RTL created a financial debt that qualified them as Financial Creditors under the IBC.?

Contingent Claims and the Definition of “Claim”?

The Court further referenced the definition of “claim” under Section 3(6) of the IBC, which includes any right to payment or right to seek damages arising from a breach of contract, whether the right is disputed or undisputed. The appellants had argued that contingent claims could not be filed under the IBC because the cause of action had not yet arisen (i.e., the asset sale had not yet occurred, and the shortfall was not yet known).?

The Court rejected this argument, ruling that contingent claims, like the one at issue under the DoH, could still be filed even if the cause of action had not yet fully materialized. It held that the definition of “claim” under the IBC is broad enough to include contingent claims, which may arise in the future, once the conditions for their realization are met.?

Role of the Resolution Plan and CoC?

The Court also considered the implications of the approval of the resolution plan by the Committee of Creditors (CoC). The National Company Law Appellate Tribunal (NCLAT) had previously held that pending claims could not be asserted after the approval of a resolution plan. However, the Supreme Court clarified that the approval of the resolution plan did not negate the rights of creditors to file their claims.?

The Court referred to the NCLAT’s earlier observation that pending claims could still be addressed by the adjudicating authority if necessary. This reinforced the idea that the rights of creditors to assert their claims were not extinguished by the approval of the resolution plan, as long as those claims were valid under the IBC framework.?

Conclusion:??

Ultimately, the Supreme Court upheld the decision of the National Company Law Tribunal and quashed the NCLAT judgment, affirming that the contingent claims under the DoH remained valid despite the moratorium. The judgment clarified that the moratorium imposed during CIRP only temporarily suspends the enforcement of claims, but does not extinguish them.?

The Court’s ruling also reaffirmed the appellants’ status as Financial Creditors under the IBC due to the guarantees provided by the Corporate Debtor, Reliance Infratel Limited, for loans taken by RCom and RTL. The case provided important clarifications on the classification of contingent claims as financial debt, the application of the severability clause in a deed of hypothecation, and the interpretation of “claim” under the IBC.?