The Hon’ble Supreme Court of India in a recent judgement in China Development Bank v. Doha Bank Q.P.S.C. & Ors. Civil Appeal Nos. 7298 of 2022 has held that the Corporate Debtor’s undertaking to discharge the liabilities of third parties under a Deed of Hypothecation (“DoH”) constitutes a guarantee under Section 126 of the Indian Contract Act, 1872 (“ICA”) and hence it can become a financial debt within the meaning of Section 5(8) of Insolvency and Bankruptcy Code, 2016 (“IBC”). Corporate Insolvency Resolution Proceedings (“CIRP”) commenced against Reliance Infratel Ltd., and the Appellants filed claims as financial creditors, which were initially admitted, placing them on the Committee of Creditors (“CoC”). Respondent No. 1 subsequently filed an application before the NCLT, contesting this inclusion on the basis that the Appellants’ claims are derived from various DoH executed between the Appellants and Reliance Communication Infrastructure Ltd., Reliance Communications Ltd., Reliance Telecom Ltd., and the Corporate Debtor (“RCom entities”). These DoH stipulated inter alia the provision of assets as security and an undertaking to cover debt shortfalls among the RCom entities. Concurrently, a Resolution Plan was submitted and subsequently approved by the NCLT. An appeal against this approval was filed before the NCLAT. NCLAT disposed of the appeal, observing that the NCLT may reconsider the Resolution Plan after deciding Respondent 1's application, if necessary.

Subsequently, the NCLT dismissed Respondent No. 1’s application, prompting a further appeal to the NCLAT. The NCLAT allowed this appeal, holding that the DoH did not constitute a guarantee, thereby precluding the Appellants’ classification as financial creditors. Hence the present appeals were filed.

The Supreme Court took note of the judgement passed in CCE & Service Tax v. Northern Operating Systems (P) Ltd.¹, where it was held that the nomenclature of any contract or document is not decisive of its nature. An overall reading of the document and its effect is to be seen by the courts. The Court then took note of Section 126 and 127 of the ICA and held that a contract becomes a guarantee when the contract is to perform the promise or discharge the liability of a third person in case of default.

Thus, when a person enters into a contract to perform or discharge the liability of a third party, the contract becomes a contract of guarantee. Analysing the DoH, the Court concluded that the Corporate Debtor’s undertaking to discharge the RCom entities’ liabilities constituted a guarantee under Section 126 of ICA.

Addressing relevant provisions of the IBC-Sections 5(7), 3(12), and 7(1)-the Court clarified that default is a prerequisite only for CIRP initiation under Section 7(1) and not for establishing a financial debt. Regarding Section 14 (moratorium), the Court held that it imposes an embargo on recovery proceedings and does not extinguish the claims of creditors. It was held that if such an argument is accepted, then no creditor would be able to raise a claim after moratorium is issued. Consequently, the impugned order was set aside, and the Appellants were held to be Financial Creditors. This judgment further clarifies the scope of "financial debt" and classification of creditors under the IBC.

By - Ansh Mittal