In our previous post, we discussed the La-Fin Judgments passed by the NCLAT (Pushpa Shah v. IL&FS Financial Services Limited) and NCLT, which had held that a put option holder may be treated as a ‘financial creditor’ under the Insolvency & Bankruptcy Code, 2016 (IBC). A three-judge bench of the Supreme Court set aside the La-Fin Judgments in Jignesh Shah vs Union of India primarily on the technical grounds of limitation without expressing a view on whether the NCLT and NCLAT were correct in treating a put option holder as a financial creditor.
This was followed by the landmark decision of Pioneer Urban and Infrastructure Limited vs Union of India (Pioneer Judgment) in which the Supreme Court interpreted the provisions of Section 5(8)(f) of the IBC in a manner similar to that done in the La-Fin Judgments, stating that the provision would subsume within it “amounts raised under transactions which are not necessarily loan transactions, so long as they have the commercial effect of a borrowing” and “done with profit as the main aim.”
In the backdrop of the La-Fin Judgments and the Pioneer Judgment, a reasonable view could be taken that put option holders would be able to successfully maintain an action under the IBC as ‘financial creditors’ to enforce their put option as expressed in our previous post.
However, the subsequent judgment of the Supreme Court in Anuj Jain v. Axis Bank Limited and the views expressed therein on the meaning and purport of ‘financial creditor’ have necessitated that this question be revisited and reassessed which the present post aims to do.
A brief recap of the La-Fin Judgments
In the La-Fin case a Letter of Undertaking had been provided by La-Fin Financial Services Pvt. Ltd. (La-Fin) to IL&FS Financial Services Ltd. (IFIN) at the time of IFIN’s investment in MCX Stock Exchange Limited (MCX-SX), a group company of La-Fin. The Letter of Undertaking was effectively in the nature of a put option. It stated that La-Fin or its appointed nominees would offer to purchase from IFIN its shares held in MCX-SX within a prescribed time and at a prescribed price, with a minimum of an internal rate of return of 15% to IFIN. The Letter of Undertaking was executed simultaneously with a share-purchase agreement by way of which IFIN agreed to purchase equity shares of MCX-SX. As such, the Letter of Undertaking can be said to be in the nature of third-party security provided by La-Fin to IFIN for the amount extended by IFIN to MCX-SX by way of its investment.
When La-Fin refused to honor its commitments under the Letter of Undertaking, IFIN sought relief by way of a winding-up petition and the NCLT and NCLAT examined the question of whether this would amount to ‘financial debt’ under Section 5(8) of the IBC. La-Fin contended that the Letter of Undertaking was a mere letter of comfort and there was no disbursement against consideration for time value of money made by IFIN to La-Fin. However, the NCLAT and the NCLT both rejected this, stating that the investment in MCX-SX had the commercial effect of a borrowing with an assured return within a guaranteed period and therefore amounted to ‘financial debt’ An amount had been raised with an objective of economic gain or commercial effect and as such could be treated as ‘financial debt’. It was not necessary for disbursement of money to have been made to the corporate debtor.
JAL and JIL went up the hill – third party security came tumbling after
In Anuj Jain v. Axis Bank Limited, third party security by way of a mortgage of its assets was provided by Jaypee Infratech Limited (JIL) to banks/financial institutions for loans advanced to its parent company, Jaiprakash Associates Limited (JAL). When JIL faced insolvency, the lenders (of JAL) in whose favour JIL had mortgaged its assets, sought recognition as financial creditors of JIL. The Supreme Court ultimately held the mortgages themselves to be invalid preferential transactions, thereby rendering the applications of the lenders moot. Despite this, the Supreme Court chose to examine the merits of the applications, analysing independently and comprehensively whether holders of third party security can be considered ‘financial creditors’ under the IBC. Therefore, while the Supreme Court’s observations on whether holders of third party security are ‘financial creditors’ under the IBC are obiter dicta, based on its examination and authoritative pronouncement on this question of law, the said pronouncement will be binding on the High Courts and the Tribunals.
In its analysis, the Supreme Court placed heavy reliance on the understanding of financial creditors laid out in Swiss Ribbons Pvt. Ltd. v. Union of India (Swiss Ribbons). In this case, the Supreme Court, while upholding the constitutionality of the IBC, had discussed the rationale behind the difference in treatment of financial creditors and operational creditors. It had rejected the contention that the classification between financial and operational creditors was discriminatory or in violation of Article 14 of the Constitution, stating:
“Most importantly, financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganisation of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.”
Extrapolating from this, the Supreme Court in Anuj Jain envisaged a “pivotal” role for the financial creditor, with “unique parental and nursing” duties towards the corporate debtor, with its own well-being interwoven with that of the corporate debtor. The Supreme Court states:
“in the scheme of the IBC, what is intended by the expression ‘financial creditor’ is a person who has direct engagement in the functioning of the corporate debtor; who is involved right from the beginning while assessing the viability of the corporate debtor; who would engage in restructuring of the loan as well as in reorganisation of the corporate debtor’s business when there is financial stress. In other words, the financial creditor, by its own direct involvement in a functional existence of corporate debtor, acquires unique position, who could be entrusted with the task of ensuring the sustenance and growth of the corporate debtor, akin to that of a guardian. In the context of insolvency resolution process, this class of stakeholders namely, financial creditors, is entrusted by the legislature with such a role that it would look forward to ensure that the corporate debtor is rejuvenated and gets back to its wheels with reasonable capacity of repaying its debts and to attend on its other obligations. Protection of the rights of all other stakeholders, including other creditors, would obviously be concomitant of such resurgence of the corporate debtor.”
Flowing from the above, the Supreme Court held, a person having only a security interest over the assets of the corporate debtor would be interested only in realising the value of its security. It would not have any stake in the corporate debtor’s growth or equitable liquidation but would only seek to safeguard its own interests, which is not in-keeping with the object and purpose contemplated by the IBC. Therefore, while a third party security such as a mortgage debt may amount to debt, it would not comprise financial debt under Section 5(8) of the IBC, and the holder of such a security would not be a financial creditor. Further distinguishing the case from Committee of Creditors of Essar Steel India Limited through Authorised Signatory vs Satish Kumar Gupta, the Supreme Court held that Essar concluded that secured creditors would be financial creditors only in relation to direct secured creditors. On the other hand, the question in this case pertained to creditors secured indirectly, through third party security, and as such,
“it is absolutely clear that the class of secured creditors indicated by this Court in Essar Steel and Swiss Ribbons, as being subsumed in financial creditors, is only that of such secured creditors who are directly engaged in advancing credit to the corporate debtor and not the indirect creditors who had extended any loan or facility to a third party but had taken a security from the corporate debtor, whose resolution is under consideration.”
A case for put option holders?
On the face of it, the reasoning adopted in Anuj Jain appears to directly hit put option holders in the position of IFIN in the La-Fin scenario. A put option is purely a contractual obligation, undertaken frequently by related parties – often promoter companies – of the investee company such that an investor is provided with a sure-footed exit option. As such, it can be said that put option holders in many cases are in a position analogous to that of third party security holders whose interest in the assets of the put-option-giver (corporate debtor) is limited to the extent of the commercial value of shares/securities on which the put option is exercisable. Such put option holders are unlikely to be considered to be directly concerned or involved with the functional existence, sustenance and growth of the entity providing the put option. Viewed within the framework laid down in Swiss Ribbons and Anuj Jain, it is unlikely that such put option holders can be considered financial creditors under the IBC.
It is important to note that ‘financial debt’ is expressly defined in the IBC to include “any counter-indemnity obligation in respect of a guarantee, indemnity, documentary letter of credit or any other instrument issued by a bank or financial institution.” As discussed in our previous post, both the NCLT and the Bombay High Court have found put options to be clearly in the nature of a guarantee. In Anuj Jain as well, a contention was advanced that mortgage should be treated as a guarantee obligation and, therefore, be considered a financial debt under the IBC. This contention was rejected by the Supreme Court on the ground that mortgage debts did not carry the essential elements of “disbursement against consideration for time value of money”. As such, third party mortgage debt was excluded and distinguished from the heads / categories provided under the definition of financial debt in the IBC. However, unlike a mortgage, put options are ordinarily accompanied with a guaranteed price, period and rate of return, on which basis they were considered financial debt entailing “time value of money” in the La-Fin Judgments. Therefore, an argument could be made that put option obligations stand on a different footing when compared to mortgage obligations containing features, including those of a guarantee, which place them under the umbrella of financial debt.
As such, while Anuj Jain deals with mortgage debt and sets out broad principles on third party security that may incidentally apply to put option holders, the La-Fin Judgments specifically analysed the unique attributes and properties of put option holders and held them to be financial creditors. This reasoning was neither upheld nor displaced by the Supreme Court in appeal. While it is only the final judgment of the Supreme Court that carries binding value, the analysis contained in the La-Fin Judgments of the Tribunals remains cogent and persuasive, particularly when read with the expansive definition of financial debt adopted in the Pioneer Judgment. At the same time, the reasoning of the Supreme Court in Anuj Jain relies on Swiss Ribbons to posit a contrary stance on third party security holders. It remains to be seen how the Supreme Court will engage with these conflicting strands of jurisprudence when the lis of put option holders as financial creditors is taken up for consideration by it.
 Company Appeal (AT) (Insolvency) No. 521 of 2018
 CP 919/I&BC/NCLT/MB/MAH/2017
 WP (Civil) No. 455 of 2019
 WP (Civil) No. 43 of 2019
 Civil Appeal Nos. 8512-8527 of 2019
 Para 11.1, 11.2, 11.4, NCLT Judgement; Para 18, NCLAT Judgement
 Civil Appeal Nos. 8512-8527 of 2019
 Paragraph 51 of Swiss Ribbons
 Paragraph 39 of Anuj Jain
 Paragraph 47 of Anuj Jain
 Paragraph 47 of Anuj Jain
 2019 SCC OnLine SC 1478
 Paragraph 50.4 of Anuj Jain
 Union Bank of India v. Era Infra Engineering, CA No. 997(PB)/2018 in CP No. IB-190(PB)/2017 (NCLT Principal Bench, Order dated December 6, 2018).
 Vandana Global Limited v. IL&FS Financial Services Limited 2018 SCC OnLine Bom 337