On 3 February 2021, a three-judge bench of the Supreme Court of India passed a judgment in the matter of Phoenix ARC Private Limited v. Ketulbhai Ramubhai Patel (Judgement) holding that in the absence of an express obligation upon a pledgor to repay the loan amounts secured by the pledge, the beneficiary/holder of such pledge (Pledgee) will not be considered as a ‘financial creditor‘ of the pledgor under the Insolvency and Bankruptcy Code, 2016 (IBC).
The Supreme Court observed that the Pledgor was not a party to the Facility Agreement pursuant to which the facility was extended to the Borrower. Therefore, a direct obligation on the Pledgor to pay the facilities availed by the Borrower did not exist.
Section 5(7) of the IBC defines a financial creditor as any person to whom a ‘financial debt‘ is owed, legally transferred or assigned. In deciding the question before it, the Supreme Court examined the definition of financial debt under the IBC. Section 5(8) of the IBC defines what constitutes a financial debt and provides that the amount of liability under any guarantee or indemnity given in respect of specific items defined as constituting financial debt under Section 5(8) (such as money borrowed on interest, amounts raised under credit facilities, liabilities in respect of hire purchase contract etc.) would also be considered as a financial debt. Further, it observed that according to Sections 124 and 126 of the Contract Act, 1872, a contract of guarantee is a contract ‘to perform the promise, or discharge the liability, of a third person in case of his default’.Download PDF to read more
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