Journal

EXPLORING APPROPRIATE APPROACH FOR

TREATMENT OF THE THIRD-PARTY SECURITY
HOLDERS UNDER THE IBC
DUSHYANT THAKUR
Introduction
The issue of the third-party security holders was recently considered by
National Company Law Tribunal (‘NCLT’), Allahabad Bench, in the case of IDBI
Bank Ltd. v Jaypee Infratech Ltd. (‘Jaypee Infratech case’).1 Third-party security is
the security provided by a person or persons other than the borrower.2 One of the
forms of the third-party security is the third-party mortgage, which was involved
in this case. Jaypee Infratech Ltd. (Corporate Debtor) mortgaged its immovable
properties with the ICICI Bank (Applicant) to provide for security in relation to
certain loan facilities provided to its holding company, Jayprakash Associates
Ltd. The type of mortgage created was English mortgage. One of the key issues
under consideration was whether the third party security holder/mortgagee, i.e.,
ICICI Bank, can be considered as a financial creditor. NCLT answered it in
negative. Financial creditor is the person to whom a financial debt is owed.3 A
financial debt is defined as a debt ‘which is disbursed against the consideration
for the time value of money’ and further includes certain types of debts specified
thereunder.4 NCLT observed that time value of money was not involved in the
instant case. Further, it also stated that the mortgage of immovable properties for
the financial assistance to its holding company would not come within the
purview of the specified types of debts. Accordingly, it was decided that the debt
is not a financial debt. Resultantly, ICICI Bank was held not to be a financial
creditor.
Implications on the rights and interests of the Third-Party Security Holders
The case was only in relation to the third-party mortgages. However, there is
no reason why the similar reasoning cannot be applied to other forms of the

1 IDBI Bank Ltd. v Jaypee Infratech Ltd., NCLT Allahabad, Company Appeal (AT) (Insolvency) No.
81/2018, Date of decision 9 May, 2018: (2019) 1 Comp LJ 207 (NCLT).
2 P Ramanatha Aiyar, The Major Law Lexicon (4th ed. 2015).
3 Section 5(7), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 6 (St.).
4 Section 5(8), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 6 (St.).
[J-49]
50 COMPANY LAW JOURNAL (2019) 1 Comp LJ

third-party securities, such as the third-party pledges. Thus, this ruling would
result in broader implications over the rights and interests of the third-party
security holders to recover their debt during the Corporate Insolvency Resolution
Process (‘CIRP’).
To begin with, only financial creditors and operational creditors may file an
application before NCLT to initiate CIRP under sections 7 and 9 of the Insolvency
and Bankruptcy Code, 2016 (‘IBC’) respectively. Considering that the third-party
security holders are not financial creditor, the first implication would be their
inability to initiate CIRP.
Upon admission of such application, a moratorium is declared under section
13 of the IBC.5 From the date of such declaration, any action to foreclose, recover
or enforce any security interest created by the corporate debtor in respect of its
property would be prohibited.6 Security interest has been defined in the IBC to
mean right, title or interest or a claim to property, created in favour of, or
provided for a secured creditor and includes mortgages or any arrangement to
secure payment or performance of an obligation of any person.7 Two phrases in
this definition must be considered. One, interest in a property is ‘provided for a
secured creditor’; and two, it includes ‘any arrangement to secure payment from
any person’. Accordingly, security interest is created in favour of the third-party
security holders. The second implication would result after declaration of
moratorium, after which, claim pertaining to security interest cannot be raised.
Further, only financial creditors form part of the committee of creditors.8 The
committee of creditors appoints the resolution professional.9 Thus, the third
implication would be their inability to form part of the committee of creditors.
Consequentially, they would not have any say in the appointment of the
resolution professional.
The resolution professional examines the resolution plan submitted by the
resolution applicant and submits the same before the committee of creditors for
its approval.10 It is the plan proposed for insolvency resolution of the corporate
debtor as a going concern.11 The resolution plan must be approved by the
committee of creditors by at least sixty-six per cent of votes.12 The fourth
implication would be their inability to play any role in approval of the resolution
plan.

5 Section 13, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 14 (St.).
6 Section 14, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 14 (St.).
7 Section 3(31), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 5 (St.).
8 Section 21, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 18 (St.).
9 Section 22, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 19 (St.).
10 Section 30, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 24 (St.).
11 Section 5(26), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 5 (St.).
12 Section 30(4), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 24 (St.).
(JOURNAL) EXPLORING APPROPRIATE APPROACH FOR TREATMENT OF THIRD-PARTY 51

Once approved by the committee of creditors, the resolution plan is presented

before NCLT. After NCLT’s approval, it becomes binding on ‘the corporate
debtor and its employees, members, creditors, guarantors and other stakeholders’
involved in the resolution plan.13 ‘Other stakeholders’ may include third-party
security holders. The resolution plan may also involve part or complete sale of
assets subject to security interest14 or satisfaction or modification of any security
interest15. As already considered, security interest is created in favour of the
third-party security holders. Hence, the fifth implication would be that the
resolution plan may act in detriment to their rights.
With respect to liquidation of the company, rights of the third party security
holder would be affected only to the extent of deciding upon initiation of the
liquidation process. Apart from NCLT for the reasons specified and
contravention of the resolution plan by the corporate debtor, only the committee
of creditors has the power to initiate the liquidation process by at least sixty-six
per cent of the votes in its favour.16 Since security interest has been created in
their favour, they can be considered as secured creditors.17 The resultant rights of
the secured creditors provided in sections 52 and 53 of the IBC remains
unaffected by virtue of them not being considered as financial creditors.
Exploring an Appropriate Approach
The third-party securities are important to several forms of financing. Given
the severe implications of the case over the rights of the third-party security
holders, it is proposed in this article that they should have been considered as the
financial creditors. This could have been done by adopting either of the two
approaches described hereinafter. The first approach could have been treating the
third-party security as financial debt under section 5(8)(i) of the IBC. The second
approach is an alternative. It has been argued that the non-exhaustive definition
of financial debt could have been used to include third-party security within its
purview.
Treating the third-party security as financial debt under section 5(8)(i) of the IBC
Section 5(8) of the IBC through para (i) includes liability with respect to
guarantee for other listed financial assistance in the definition within the purview
of financial debt.18 This argument for treating the third-party security as financial
debt under section 5(8)(i) was also made in the Jaypee Infratech case. The argument

13 Section 31, Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 24 (St.).
14 Regulation 37(b), Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for
Corporate Persons) Regulations, 2016
15 Regulation 37(d), Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for
Corporate Persons) Regulations, 2016
16 Section 33(2), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 25 (St.).
17 Section 3(30), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 5 (St.).
18 Section 5(8)(i), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 6 (St.).
52 COMPANY LAW JOURNAL (2019) 1 Comp LJ

was rejected by NCLT on the sole ground that ‘consideration for the time value of
money’ is not involved, considering it to be a sine qua non for determining
financial debt. However, in view of the author, the observation of NCLT here
appears to be flawed. The definition of financial debt states that it ‘means’ the
debt along with interest, if any, which is disbursed against the consideration for
the time value of money and ‘further includes’ the specified list within its
purview. It is the established position that such definitions are extensive in
nature.19 Further, when ‘include’ is used in a definition after ‘mean’, the aim is to
further extend the exhaustive definition of the term.20 The items listed to include
within the meaning of financial debt form an illustrative list of what can be
covered within it. Thus, the presence of consideration for the time value of money
can be shown if the third-party mortgages can be covered within the purview of
section 5(8)(i).
For interpreting section 5(8)(i) to include the third-party security, the Indian
Contract Act, 1872, will have to be referred. A contract of guarantee has been
defined in section 126 of the Indian Contract Act, 1872 to mean a contract to
discharge liability of a third person in case of his default.21 The person who gives
the guarantee is the surety. Liability of a surety strictly depends on the terms of
the contract of guarantee22 and extends to the description contained in the
guarantee.23 In furtherance to this, liability of a person can even be fixed to the
extent of security interest created in a property. Accordingly, security interest
created by a person over his property for securing someone else a loan can be
termed as a contract of guarantee. In any case, the court is not confined to the
section 126 to determine surety in a contract of guarantee and equitable principles
can be applied, if not in contradiction to any provision of existing Indian law.24
The case of State Bank of India v Kusum Vallabhdas Thakkar25 can be taken into
consideration. In this case, the defendant wife mortgaged her property to the
bank in consideration of the advances made to her husband’s factory. The court
observed it to be a contract of guarantee and the wife as a surety. The court thus
held that:
‘Therefore, the liability of the defendant is as provided in the agreement and to that
extent of securing dues by a creation of mortgage, no personal liability is accepted by

19 G.P. Singh, Principles of Statutory Interpretation (14th ed. 2016) [‘G.P. Singh’].
20 Jagir Singh and others v State of Bihar and another, AIR 1976 SC 997.
21 Section 126, Indian Contract Act, No. 9 of 1872.
22 Pioneer Bank Ltd v Mani Bhusan Malik AIR 1959 Cal 746; A Firma ‘Agencia Nacional Limitada’ v A Sociedade
‘Chowghule and Cia Limitada’ AIR 1967 Goa 88; Adamsab Usmansab Kanakya v Gurushinddayya Lingayya
AIR 1967 Mys 147.
23 Chandukutty Nambiar v Raman Nair AIR 1959 Ker 176.
24 A. Rajagopala Aiyar and others v S. Ramachandra Aiyar, (1942) 2 MLJ 406.
25 State Bank of India v Kusum Vallabhdas Thakkar, (1994) 1 GLR 655.
(JOURNAL) EXPLORING APPROPRIATE APPROACH FOR TREATMENT OF THIRD-PARTY 53

the surety. It is, therefore, fallacious to say that the defendant is not a debtor and,
therefore, the defendant could not have created a mortgage in favour of the creditor...
Just as the principal debtor can create a mortgage of his immoveable properties, a third
person can also agree to create a mortgage so as to secure the dues of the principal
debtor. In that manner, he becomes a surety to the extent of the security or the
mortgage.’
Another case which can be taken into consideration is K.T. Sulochana Nair v
Managing Director of Orissa State Financial Corporation.26 The case involved section
29 of the State Financial Corporations Act, 1951, which deals with rights of the
Corporation in case of default, and if it extends to property mortgaged with the
Corporation by surety or not. It was held that the property can be realized if the
industrial concern defaults in repayment of loan. Similar power of the bank to
proceed against the immovable properties mortgaged by the surety under section
13(11) of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 has been observed.27 Even for Mulla, it
appears to be a settled position that‘a person, who mortgages his property to
secure the debt of another, stands in the relation of surety towards the person
whose debt is thus secured’.28 Although the above mentioned cases mainly deal
with third-party mortgages, there is no reason why the principles derived cannot
be applied to other forms of the third-party securities. Therefore, third-party
securities can be treated as financial debt under section 5(8)(i).
Using non-exhaustive definition of financial debt to cover the third-party security
Financial debt has been defined to mean a debt alongwith interest, if any,
which is disbursed against the consideration for the time value of money. It
further illustrates certain kinds of financial debts from the points (a) to (i). Third-
party security, if not covered within the points (a) to (i), even then it will come
within the purview of financial debt.
As has already been stated, by the virtue of the kind of definition given to
financial debt, it is clear that the illustrative list is not exhaustive in its scope29 and
the definition as a whole is extensive in nature.30 Accordingly, it is possible that
other kinds of debts, although not present in the list, can be considered as
financial debts. For this it will be required to be shown that the ‘debt is disbursed

26 K.T. Sulochana Nair v Managing Director of Orissa State Financial Corporation, AIR 1992 Ori 157.
27 S.K. Agarwal v Oriental Bank of Commerce and others, (2005) 128 Comp Cas 926 (Uttaranchal).
28 II Pollock and Sir Dinshaw Fardunji Mulla, The Indian Contract and Specific Relief Acts 1474 (Nilima
Bhadbhade ed., LexisNexis Butterworths 2014) (1905).
29 B.V.S. Lakshmi v Geometrix Laser Solutions Private Limited, NCLAT New Delhi, Company Appeal (AT)
(Insolvency) No. 38/2017, Date of decision – 27 December, 2017 [‘B.V.S. Lakshmi case’].
30 Insolvency Law Committee, Report of the Insolvency Law Committee 16 (2018) [‘ILR Report’]; G.P.
Singh, supra note 19.
54 COMPANY LAW JOURNAL (2019) 1 Comp LJ

against the consideration for the time value of money’.31 For convenience, the
requirements through this statement can be divided into three parts.
Firstly, emphasizing the term ‘debt’ used in the definition of financial debt, it
has been defined in the IBC to mean a liability or obligation in respect of a claim
which is due from any person.32 Reading the definition of debt, it can be
determined that a debt can be due from any person. Consequently, there is no
limitation upon a third-party security holder, to whom debt can be owed by the
third-party providing security.
The second part involves dealing with ‘disbursement of debt’. It is possible that
the debt was disbursed to the person other than the Corporate Debtor.33 Further,
such disbursement can be made through any instrument.34 This instrument, in
view of the author, can also be in lieu of the third-party security. Thus, this part
does not constraint the third-party security holder to be a financial creditor.
The third part involves determining the presence of disbursement against the
consideration for the time value of money. This part requires that the
disbursement of debt must be necessarily against ‘consideration for time value of
money’. This phrase has been interpreted to mean compensation or the price paid
for the length of time for which the money has been disbursed.35 This can also be
in the form of payment of interest on the money disbursed.36 For considering the
third-party security holders as financial creditors, a lot would depend on content
of the contract through which the third-party security is provided and what
could be covered using the security in case the principal borrower defaults in
paying back the debt. Example can be taken of a situation when only the security
can be used for covering the original debt and not interest on the debt. Such
interest, being considered as consideration for time value of money, is absent in
this example. Thus, this example does not involve financial debt. On the other
hand, if the security also covers consideration for time value of money, it would
be considered as a financial debt.
Conclusion
The IBC has resulted in a major financial sector reforms by providing creditors
a robust way to enforce their rights. However, the IBC has created classes among
different kinds of creditors. Rights of a creditor to enforce his right would depend

31 Nikhil Mehta v AMR Infrastructure, NCLAT, New Delhi, Company Appeal (AT) (Insolvency) No.
07/2017, Date of decision – 21 July, 2017 [‘Nikhil Mehta case’].
32 Section 3(11), Insolvency and Bankruptcy Code, Act No. 31 of 2016: (2016) 3 Comp LJ 1, 3 (St.).
33 B.V.S. Lakshmi case, supra note 29.
34 Ibid; Rajesh Kumar Himatsingka v Himatsingka Resorts Private Limited, (2018) 95 taxmann.com 177 (NCLT
- Guwahati).
35 ILR Report, supra note 30.
36 Nikhil Mehta case, supra note 31.
(JOURNAL) EXPLORING APPROPRIATE APPROACH FOR TREATMENT OF THIRD-PARTY 55

on the class he belongs to. Against this backdrop, it should also be understood
that providing finance or debt to a company would also be depend upon the
category the creditor would belong to, if the company goes into a CIRP.
Accordingly, interpretation of the IBC in relation to determining is a creditor
belongs to the category of financial creditor or not would have profound effect
over financing of a company.
The NCLT’s order would have detriment effect over financing of the company
of the basis of the third-party security. Therefore, considering the importance of
the third-party securities, an appropriate approach would involve doing a
balancing act by treating the third-party security holders as financial creditors in
either of the manners proposed.

__________________

“The sole objective of the Insolvency and Bankruptcy Code 2016 is to find
solutions for stressed assets arisen out of non-performing assets with best of intent as
so many things are involved in the process and liquidation perforce would be the last
way out which the tribunal would avoid optimally”
—Shri M.M. Kumar, President, National Company Law Tribunal (NCLT)
@moneycontrol.com