Supreme Court: Rents receivable can be assigned by a debtor to a creditor as actionable claim

The Supreme Court, vide its judgment dated October 19, 2023, in the matter of Infrastructure Leasing and Financial Services Limited v. HDFC Bank Limited and Another [Civil Appeal No(s). 4708 of 2022], has held that rents receivable can be assigned by a debtor to a creditor as actionable claim and dismissed an appeal assailing the impugned order dated May 13, 2022 (“Impugned Order”) passed by the National Company Law Appellate Tribunal, New Delhi (“NCLAT”).

Facts

Housing Development Finance Corporation Limited (“HDFC”) extended a credit facility of INR 400 Crores to Infrastructure Leasing and Financial Services Limited (“ILFS”/ “Appellant”) by way of a sanction letter dated June 22, 2018. Further, a Master Facility Agreement (“MFA”) was executed between HDFC and ILFS for securing the aforesaid credit facility. The MFA stipulated creation of an escrow account with HDFC Bank Limited (“Escrow Bank”/ “Respondent”). Further, an Assignment Agreement dated June 25, 2018 (“Assignment Agreement”) was executed between HDFC and ILFS. In terms of the Assignment Agreement, HDFC and ILFS had agreed that the authorized indebtedness of ILFS as per MFA, by way of the aforesaid credit facility together with the interest thereon was payable from the gross income and revenue to be derived from the operation of their business centre services agreements/ lease /leave and license agreement(s). It was further agreed that ‘all the receivables derived/ to be derived from the operation of the borrower’s contracts, a sufficient portion of which, to pay the principal and interest as and when the same shall become due’ in terms of the MFA was assigned and pledged and was ‘set aside for that purpose on the same day’. Power of Attorney was also executed between HDFC and ILFS (“POA”).

Further, pursuant to a petition filed on October 1, 2018 by the Union of India under Section 241 (Application to Tribunal for relief in cases of oppression, etc.) and Section 242 (Powers of Tribunal) of the Companies Act, 2013, the National Company Law Tribunal, Mumbai (“NCLT”) had ordered to supersede the existing board of directors of ILFS. Consequently, a new board of directors was constituted to take charge of the affairs of ILFS. However, by a subsequent order dated October 12, 2018, NCLT had declined to grant moratorium sought by the Union of India, similar to moratorium in terms of Section 14 (Moratorium) of the Insolvency and Bankruptcy Code, 2016 (“Code”). Thereafter, by order dated October 15, 2018 (“NCLAT Order”), NCLAT had granted appropriate reliefs in the nature of moratorium. Inter alia, the aforesaid order included stay on any action to foreclose, recover or enforce any security interest created over the assets of ILFS or those of its 348 group companies as well as stay on the acceleration, premature withdrawal or other withdrawal, invocation of any term loan, corporate loan, bridge loan, commercial paper, debentures, fixed deposits, guarantees, letter of support, commitment or comfort and other financial facilities or obligations availed by ILFS and its 348 group companies.

By e-mail dated October 16, 2018, ILFS informed the Escrow Bank about the NCLAT Order. On October 19, 2018, HDFC instructed the Escrow Bank to transfer monthly instalments from the escrow account to HDFC’s account. On October 23, 2018, ILFS informed HDFC about the NCLAT Order. Further, by letter dated October 27, 2018, ILFS called upon HDFC to reverse the debit of INR 6.24 Crores and credit the aforesaid amount back to ILFS. HDFC replied to the aforesaid letter addressed by ILFS, thereby stating that receivables (that is, rents) in respect of the secured property were assigned by ILFS in favour of HDFC and the asset ceased to belong to ILFS. Further, on January 4, 2019, ILFS called upon HDFC to reverse the amount debited by the Escrow Bank in the escrow account. Thereafter, by order dated February 4, 2019, NCLAT directed the Union of India and ILFS to approach Justice (Retired) Mr. D.K. Jain to seek supervision on the operation of the resolution process. Thereafter, pursuant to restrain orders being sought against banks and financial institutions from debiting accounts of ILFS and its group entities, on August 8, 2019, NCLAT passed an order to the effect that if any bank/ financial institution has debited any amount in violation of NCLAT Order, it will be open to Union of India and/or ILFS to apprise Justice Mr. D.K. Jain and seek appropriate reliefs.

Pursuant thereto, ILFS made a representation before Justice Mr. D.K. Jain on August 28, 2019. Accordingly, Justice Mr. D.K. Jain issued show cause notices to HDFC as well as the Escrow Bank. In response to the show cause notice, the Escrow Bank stated that the receivables stood assigned in favour of HDFC and monies received were not the assets of ILFS. Thereafter, a personal hearing was granted to the parties, pursuant to which, on May 12, 2020, Justice Mr. D.K. Jain recommended the Escrow Bank and HDFC to maintain the status quo in the escrow account till a final view was taken on the application filed by ILFS. In view thereof, the Escrow Bank ceased to debit any amount from the escrow account. Thereafter, on July 3, 2020, Justice Mr. D.K. Jain passed a final order holding that the actions of HDFC and Escrow Bank in debiting the amount from the escrow account amounted to violation of the order passed by NCLAT and thus, HDFC and the Escrow Bank were directed to purge themselves within two weeks. In view of the aforesaid final order passed by Justice Mr. D.K. Jain, HDFC assailed the aforesaid order before NCLAT and sought the same be set aside. Whereas, ILFS sought direction from NCLAT that INR 112,79,18,348/- appropriated from its accounts towards debt service payments were in violation of the NCLAT Order as well as the final order passed by Justice Mr. D.K. Jain.

By the Impugned Order, NCLAT held that in so far as the amount of receivables deposited in the escrow account were sufficient to meet the principal and interest (payable by ILFS) assigned by the said borrower to HDFC, no proprietary interest continued with ILFS nor could it exercise any right over that part of the escrow account which was assigned. However, NCLAT did not accede to the contention raised by ILFS that there was no assignment of the receivables, but only the creation of security interest in the receivables. Further, NCLAT observed that since there was an express assignment of lease rental, sufficient to meet the principal and interest payments, the “assignment has to be accepted as assignment” in favour of HDFC and that pledge in the Assignment Agreement did not take away the nature of the transaction documents which was assignment. NCLAT further held that the NCLAT Order did not negate the Assignment Agreement nor did it take away the proprietary right of HDFC in the lease rental receivables. However, the right over receivables deposited in the escrow account to the extent they were in excess of principal and interest, was retained by ILFS and any amount in excess of the said principal and interest transferred to or debited in HDFC’s account needed to be reversed, after adjusting the shortfall in debiting any interest or principal of any earlier months.

Aggrieved by the Impugned Order, ILFS approached the Supreme Court challenging the same.

Issue

Whether the credit facility and other ancillary loan documents executed by ILFS, pursuant to which rents payable to ILFS stood passed over to HDFC, amounts to assignment and stands outside the purview of an “asset” owned by ILFS.

Arguments

Contentions of the Appellant:

It was contended by the Appellant that MFA and other agreements executed between parties clearly indicate that the credit facility advanced to ILFS was loan repayable within 96 months. The security interest was created by ILFS and the receivables were in the nature of security for repayment of the aforesaid credit facility. Further, escrow account was created in the Escrow Bank for the purpose of facilitating the repayment of principal and interest as per the repayment schedule. However, there was no transfer of title in the receivables from ILFS to HDFC. Further, the Appellant emphasized upon the order passed by Justice Mr. D. K. Jain and submitted that HDFC and Escrow Bank were obliged to return the amount debited to the tune of INR 112,79,18,348/-.

Further, the Appellant argued that the Lease Rental Discounting facility (“Lease Rental Discounting”) as relied upon by HDFC is a type of term loan offered with security of rental income. Further, none of the clauses from the relevant documents executed between parties contain any element or mention of the sale and purchase of the debt of ILFS. Hence, the aforesaid transaction is a loan transaction leading to creation of security interest and not a sale of debt at all.

Further, it was submitted that from the provisions of the Assignment Agreement and MFA, it is absolutely clear that receivables were charged in favour of HDFC only for securing the obligations of ILFS under MFA and for the purpose of facilitation of repayment and it did not amount to a transfer of the legal title over such receivables which continues to vest with ILFS.

Contentions of the Respondent:

It was contended by the Respondent that a bare reading of the transaction documents makes it clear that the facility extended to ILFS is a Lease Rental Discounting, which is significantly different from a traditional loan transaction. It was further submitted that a Lease Rental Discounting involves the assignment/ sale of the rent receivables by the landlord to the financing entity at a discounted value in terms of the transaction documents. Hence, the assigned receivables are the property of HDFC and ILFS has no right/ title or interest in the monies/ receivables/ amount deposited in the escrow account. It was submitted that the transaction is not covered within the purview of NCLAT Order, as it was restricted to the assets of ILFS, whereas assigned receivables pursuant to Lease Rental Discounting belong to HDFC.

Observations of the Supreme Court

The Supreme Court observed that by virtue of POA executed by ILFS on June 25, 2018, ILFS had irrevocably nominated, constituted and appointed HDFC as its true and lawful attorney on its behalf and that the relevant clauses of the POA enabled HDFC to appropriate the proceeds received towards the discharge of the aforesaid facility and to receive all rents and all other sums in respect of such premises.

Further, the Supreme Court relied upon a plethora of judgments including Yellapu Uma Maheshwari v. Buddha Jagadheeswararao [(2015) 11 SCR 849] and Assam Small Scale Industries Development Corporation Limited v. J.D. Pharmaceuticals [2005 Supp (4) SCR 232] to conclude that in order to understand the nature of transactions entered into between parties, the same has to be determined on the basis interpretation of the transaction documents in its entirety and the substance therein and not merely on the nomenclature given in the transaction documents.

In particular, the Supreme Court observed that Lease Rental Discounting is a new kind of financial agreement by which a banker allows credit facilities to a commercial property owner, whereby it can be ensured that the asset owner is given access to credit. In such an arrangement, a substantial portion or the entire rent or receivables which the owner would be entitled to are made-sold or assigned, absolutely to the creditor bank with the intention that the borrower’s liabilities are discharged automatically from the proceeds payable in respect of the property. Considering that the owner is a debtor of the bank, the latter becomes the creditor of the tenant or the lessee as the case may be.

Further, the Supreme Court observed that the relevant clauses from the Assignment Agreement clearly set aside the rents payable to ILFS, in favour of the assignee, that is, HDFC. Further, relevant clause from the escrow agreement records that all receivables to which the borrower would be entitled would be deposited in the escrow account and further, that, the lessees or tenants of the properties owned by the borrower be instructed to pay such an amount in the escrow account itself. Furthermore, the escrow agreement authorizes only the lender (that is, HDFC) to instruct the Escrow Bank to transfer the amounts and permits the Escrow Bank to appropriate amounts towards adjustment arising out of the facility liability. Further, the POA categorically entitles HDFC to appropriate the proceeds deposited towards the discharge of the borrower’s liability under the aforesaid facility. Hence, the bank/ lender virtually steps into the shoes of the borrower and by the terms of the POA is also authorized to let out the premises in case due to an unforeseen situation an existing lessee or tenant vacates it or is unable to pay.

Hence, basis conjoint reading of all relevant transaction documents and ascertaining their interpretation in its entirety, the Supreme Court arrived at the conclusion that parties intended assignment of debt, that is, the rents payable.

Further, the Supreme Court considered it necessary to determine as to whether such amounts payable on a future date are to be considered property and, therefore, capable of transfer. In this regard, it was observed that as per Section 5 (“Transfer of property” defined) of the Transfer of Property Act, 1882, all manner of property is capable of transfer. Furthermore, Section 6 (What may be transferred) of the Transfer of Property Act, 1882 provides as to what kinds of properties or actions are not transferable, that is, personal claims in the nature of tortious claims and choices in action cannot be transferred.

Thereafter, the Supreme Court analyzed the definition of actionable claims as envisaged under the provisions of the Transfer of Property Act, 1882 as well as Sections 130 (Transfer of actionable claim), 131 (Notice to be in writing, signed) and 132 (Liability of transferee of actionable claim) of the Transfer of Property Act, 1882 which deal with transfer of actionable claims. Upon in-depth analysis, Supreme Court arrived at the conclusion that rents receivable can be assigned by a debtor to a creditor as actionable claim.

Decision of the Supreme Court

In view of the submissions made by parties and the above-mentioned observations, Supreme Court held that in the present case, the rents payable by the tenants, lessees and licensees are debts, which stood transferred to HDFC.

Therefore, Supreme Court held that rents receivable can be assigned by a debtor to a creditor as actionable claim. In view of the aforesaid decision, the present appeal filed by ILFS stood dismissed.

VA View:

The present judicial pronouncement rendered by the Supreme Court gives clarity on those issues which were unsettled and hence, are no more res integra.

More particularly, this judgment sets outs the precedent that when a borrower avails credit facilities and executes an assignment agreement by way of Lease Rental Discounting which is secured against the rent receivables from the property in question, would tantamount to transfer of right, title and interest in the rental amounts in favour of the lender and not merely creation of security interest. Therefore, Supreme Court has clarified that rents receivable can be assigned by a debtor to a creditor and the same shall come within the purview of actionable claim as per the provisions of the Transfer of Property Act, 1882.

For any query, please write to Mr. Bomi Daruwala at [email protected]

Gujarat HC: Purchaser of an asset in a liquidation process is not liable for payment of government dues which were not substantiated adequately during the CIRP and not lodged with the liquidator

The Gujarat High Court (“Gujarat HC”) has, by its judgment pronounced on September 22, 2023, in the matter of KRBL Limited v. State of Gujarat [C/SCA/19804/2022], held that the purchaser of an asset in a liquidation process of a corporate debtor is not responsible for payment of any government dues, if the claim was not adequately substantiated during the Corporate Insolvency Resolution Process (“CIRP”) and on failure to lodge the claim with the liquidator.

Facts

The Mumbai bench of National Company Law Tribunal (“NCLT”), vide its order dated January 17, 2020, admitted insolvency proceedings initiated against M/s. Gran Electronics Private Limited (“Corporate Debtor”) by Universal Digital Connect Limited. The claim of Sales Tax Department (“Respondent”) of an amount of INR 77,08,69,644 was rejected by the resolution professional on inadequacy of proof.

Thereafter, an application to liquidate the Corporate Debtor was admitted by NCLT on February 12, 2021. The Respondent failed to register its claim with the liquidator, despite a letter dated February 23, 2021 being issued by the liquidator to Assistant Commissioner of Tax. The liquidator initiated the sale of assets of Corporate Debtor by means of an e-auction. KRBL Limited (“Petitioner”) purchased a piece of land, which was a part of the liquidation corpus of the Corporate Debtor. The purchase was recorded vide sale deed dated December 17, 2021 containing an express stipulation thereunder that the Petitioner will not be responsible to pay any due amount to the government, since it will be dealt with in the manner specified in Section 53(1) of Insolvency and Bankruptcy Code, 2016 (“IBC”).

The Gram Panchayat of Varsamedi intimated the Corporate Debtor to pay outstanding property tax. The liquidator informed the Panchayat that any dues other than secured, unsecured or of the workman and employees, including the dues of Respondent, will fall under operational creditors. Vide notice dated January 10, 2022, the Respondent intimated attachment of the land in question. A pencil entry bearing no. 4454 was mutated in favor of the Petitioner. On a request made by the Petitioner on February 16, 2022, to certify the entry, the Talati-cum-Mantri refused to do so on the ground of existence of a charge of the Respondent. By the impugned order dated January 5, 2022, the Respondent demanded an amount of INR 56,01,79,095 towards outstanding GST dues and mutated entry no. 6295, inter alia, recording a charge on the property of the Respondent. Hence, the Petitioner approached the Gujarat HC with a writ petition under Article 226 of the Constitution of India to certify the entry no. 4454 in revenue record and to set aside order dated January 5, 2022 and further to set aside the consequential entry no. 6295 mutated in the revenue record petition.

Issue

Whether the purchaser of an asset in an auction is liable to pay the government dues which are not lodged with the liquidator at the time of liquidation process.

Arguments

Contentions of the Petitioner:

The Petitioner submitted that IBC is a complete code which deals with solutions on a holistic perspective concerning a company and all stakeholders, including the company, creditors, purchasers start with a ‘clean slate’. The Petitioner to strengthen its arguments, placed reliance on Ghanshayam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited [(2021)/ 9/ SCC/ 657], wherein the Supreme Court held that a successful resolution applicant cannot suddenly be faced with an undecided claim after a resolution plan submitted by him has been approved.

The Petitioner also emphasized, while relying on the Paschimanchal Vidhyut Vitran Nigam Limited v. Raman Ispat Private Limited and others [Civil Appeal No. 7976 of 212] (“Paschimanchal Case”), that Sections 52 (Secured Creditor in liquidation proceedings) and 53 (Distribution of assets) are complete and comprehensive and all rights even of secured creditors in the secured assets stands diluted and compromised. Once a property is sold by the liquidator in the public auction and on “as is where is basis,” a secured creditor cannot be allowed to assert an entry for the asset once sold.

The Petitioner further submitted that even as per Section 100 (Charges) of Transfer of Property Act, 1882 (“TPA”), a charge created by operation of law or otherwise is not mortgage, and a charge cannot be enforced against any property in the hands of the person to whom such property has been transferred for consideration and without any notice of charge. The Petitioner had no notice of pending government dues, and as such is not liable to pay the government dues.

Contentions of the Respondent:

The Respondent submitted that Section 31 (Approval of Resolution Plan) of IBC is not applicable to the facts of the present case. Since the insolvency proceedings did not materialize, the rights of the Respondent did not extinguish. The rights of the Respondent are restored, since there was a failure of insolvency resolution process.

The Respondent further submitted that since the asset was sold on “as is where is basis”, the rights of the Respondent stood secured. They do not stand relinquished even if the distribution is done after following Section 53 (Distribution of assets) of IBC. The Respondent emphasized that since the asset was sold on an “as is where is basis”, ratio laid down in Paschimanchal Case, should not be applied to present case.

Observations of the Gujarat HC

Gujarat HC analyzed the facts of the case that CIRP was undertaken and claims were invited and the Respondent failed to substantiate it and at the stage of liquidation did not lodge its claim. Gujarat HC placing reliance on judgments pronounced by Supreme Court observed that the debt of the Respondent did not form part of the resolution plan and therefore stood extinguished.

Gujarat HC examined Sections 52 and 53 of IBC and asserted that the Respondent as an operational creditor would have to fall in line as per the “waterfall mechanism”.

Gujarat HC relied upon judgments pronounced in the matter of Ghanshayam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited [(2021)/9/SCC/657] and Paschimanchal Case and reiterated that once having relinquished its interest under Section 52, the Respondent cannot continue the insistence of maintaining the charge in the revenue records and its claim will have to stand in priority.

Thereafter, Gujarat HC discussed that the dissenting argument of the Respondent, that since the asset was sold on “as is where is basis” and the charge of the Respondent was rightly recorded, is misconceived as the sale deed already records that the purchaser shall not be liable for payment of any outstanding dues of the government.

Gujarat HC also deduced Section 100 of TPA in a manner that a charge cannot be enforced against any person who has bought the property for consideration and has no notice of such charge.

Decision of the Gujarat HC

Gujarat HC held that the Petitioner was entitled to a ‘clean slate’. The Court set aside the order dated January 5, 2022, passed by the Respondent and mutated entry no. 6295 in the revenue records. It further directed the Talati-cum-Mantri to certify entry No. 4454 in the revenue records pursuant to the sale of land in question by registered sale deed dated December 17, 2021.

VA View:

The present judgment of Gujarat HC is a significant judicial pronouncement in the realm of insolvency law.

Gujarat HC has protected the rights of the purchaser of an asset in the liquidation process against claims that are not substantially proved during the CIRP and are not lodged with the liquidator at the time of liquidation process. This decision strengthens the enforcement mechanism of IBC. Gujarat HC has clarified the position of law that the purchaser of an asset under IBC is not liable to pay any dues to any government authority, since all dues, claims and debts will be dealt as per the “waterfall mechanism”. The government authorities cannot insist on the payment of dues, if the claim has not been lodged with the liquidator within the stipulated time. Gujarat HC also clarified the law under TPA that charge cannot be enforced against any person who has bought the property for consideration and has no notice of such charge.

For any query, please write to Mr. Bomi Daruwala at [email protected]