The Supreme Court has clarified that a financial institution cannot initiate corporate insolvency proceedings under Section 7 of the Insolvency and Bankruptcy Code, 2016, if the loan is disbursed directly to a third party - such as a builder - and the underlying transaction is contractual in nature, not a straightforward debt-obligation between lender and borrower.
Background & Facts
The Dispute
The dispute arose from a complex real estate financing arrangement involving Dhanlaxmi Bank Limited (Bank), M/s. Emerald Mineral Exim Pvt. Ltd. (Corporate Debtor or CD), Bengal Shrachi Housing Development Ltd. (Builder), and West Bengal Housing Infrastructure Development Corporation Limited (WBHIDCL). The Bank sanctioned a loan of Rs. 1.50 crores to the CD for purchasing a commercial unit in the Synthesis Business Park, Kolkata. However, the loan was not disbursed to the CD but directly to the Builder under a quadripartite agreement.
Key Facts
- On 06.04.2011, the CD entered into an agreement for sale with the Builder for unit SBP-9C(A), measuring 5893.5 sq. ft.
- On 27.06.2011, the Bank sanctioned a loan of Rs. 1.50 crores to the CD for purchasing the unit.
- On 29.06.2011, a quadripartite agreement was executed among the Bank, CD, Builder, and WBHIDCL, stipulating that the Bank would disburse the loan directly to the Builder.
- On 13.09.2011, the Bank disbursed Rs. 1.34 crores directly to the Builder.
- On 31.03.2013, the CD executed a nomination agreement transferring the unit to Jupiter Pharmaceuticals Limited (JPL) for Rs. 2,26,77,250.
- On 22.04.2013, a copy of the nomination agreement was furnished to the Bank.
- On 10.06.2013, a deed of conveyance was executed by the CD in favor of the Builder and WBHIDCL for the same amount.
- On 25.04.2014, the CD executed an acknowledgement of liability.
- On 05.07.2014, the Bank classified the CD’s account as a Non-Performing Asset (NPA).
- On 22.07.2014, the CD again acknowledged its liability.
- On 07.09.2015, the CD proposed a one-time settlement of Rs. 74 lakhs, but the cheques issued were dishonored.
- On 28.01.2016, the Bank initiated proceedings under the Recovery of Debts Due to Banks & Financial Institutions Act, 1993 before the Debt Recovery Tribunal (DRT) for recovery of Rs. 1,80,32,125.50 as of 11.12.2015, with interest at 14.25% per annum.
- On 20.09.2016, the DRT held that the Bank’s charge over the property remained valid and directed the Builder to deposit Rs. 1.50 crores as security, which was done on 27.09.2016.
- On 28.09.2016, the Bank filed a winding-up petition against the CD under the Companies Act, 1956.
- On 19.04.2019, the matter was transferred to the National Company Law Tribunal (NCLT) under Section 7 of the Insolvency and Bankruptcy Code, 2016, following the Central Government’s notification.
Procedural History
- 20.02.2020: NCLT admitted the Section 7 petition, initiating Corporate Insolvency Resolution Process (CIRP) against the CD, holding that a financial debt and default were established.
- 02.08.2022: NCLAT set aside the NCLT order, holding that the Bank was not a financial creditor under Section 7 because the loan was disbursed to the Builder, not the CD, and the transaction was contractual in nature.
- 07.05.2026: Supreme Court heard the appeal against the NCLAT order.
Relief Sought
The Bank sought to set aside the NCLAT order dated 02.08.2022 and restore the NCLT’s order dated 20.02.2020, thereby reinstating the CIRP against the Corporate Debtor.
The Legal Issue
The central question was whether a bank can be classified as a financial creditor under Section 7 of the Insolvency and Bankruptcy Code, 2016, when the loan amount is disbursed directly to a third party (builder) under a quadripartite agreement, and the underlying transaction involves contractual obligations relating to property transfer rather than a direct borrowing arrangement.
Arguments Presented
For the Appellant
The Bank argued that the CD was the true borrower under the facility agreement and quadripartite agreement, having paid interest and executed acknowledgements of liability. It contended that clauses 2 and 19 of the quadripartite agreement confirmed the CD’s liability. The Bank further argued that its recourse to multiple statutory remedies - including the DRT and IBC - did not constitute forum shopping, as each forum addressed distinct aspects of the dispute. It emphasized that the Rs. 1.50 crores deposited by the Builder with the DRT remained in escrow and had not been released, thus the debt remained outstanding.
For the Respondent
The respondents contended that the transaction was not a simple loan-debt relationship but a structured real estate financing arrangement where the Builder bore primary obligations regarding construction, delivery, and transfer of the property. The disbursement to the Builder, not the CD, meant the Bank’s claim was not against the CD as a borrower but against the Builder as a contractor. The dispute, they argued, was contractual and already being adjudicated before the DRT, making the invocation of IBC an abuse of process.
The Court's Analysis
The Supreme Court examined the structure of the quadripartite agreement and the nature of the transaction. It emphasized that Section 7 of the IBC requires the existence of a financial debt - defined as a debt disbursed against the consideration for the time value of money - and a default in repayment. The Court held that the mere existence of a loan agreement does not automatically confer financial creditor status if the disbursement and obligations are structured around third-party performance.
"The structure of transaction reveals that Bank’s disbursement was intrinsically linked to performance of Builder’s obligation. In such circumstances, the transaction cannot be viewed in isolation as a simple financial lending arrangement between the Bank and the CD."
The Court noted that the quadripartite agreement imposed significant obligations on the Builder, including refunding the loan amount if the sale was cancelled, ensuring clear title, and obtaining approvals. The Bank’s lien and control over the property were contingent on the Builder’s performance, not the CD’s repayment capacity alone.
The Court further held that the dispute was predominantly contractual, involving competing claims over property transfer and builder obligations, and was already being adjudicated before the DRT. The deposit of Rs. 1.50 crores by the Builder under the DRT’s order confirmed that the matter was actively under judicial review.
"The Code operates as a collective insolvency resolution mechanism and not as a forum for the adjudication of individual contractual claims."
The Court reiterated that using the IBC as a recovery tool, especially where the debt arises from a complex contractual arrangement involving third parties, amounts to an abuse of process. It cited Pioneer Urban Land and Infrastructure Ltd. v. Union of India and Glas Trust Company LLC v. BYJU Raveendran to reinforce that the IBC is not a substitute for civil remedies.
The Verdict
The appeal was dismissed. The Supreme Court upheld the NCLAT’s order dated 02.08.2022, which set aside the NCLT’s order initiating CIRP. The Court held that the Bank was not a financial creditor under Section 7 of the IBC because the loan was disbursed to the Builder, not the Corporate Debtor, and the transaction was contractual in nature. There shall be no order as to costs.
What This Means For Similar Cases
Financial Creditor Status Requires Direct Disbursement to Borrower
- Practitioners must establish that the financial debt was disbursed directly to the corporate debtor for the time value of money; disbursement to a third party (e.g., builder, vendor, contractor) negates financial creditor status under Section 7.
- Loan agreements with third-party disbursement clauses must be scrutinized for whether the corporate debtor is the true obligor or merely an intermediary.
IBC Cannot Be Used as a Recovery Tool for Contractual Disputes
- Where the dispute involves construction delays, property transfer, or builder obligations, the appropriate forum remains civil courts or specialized tribunals like DRTs.
- Filing a Section 7 petition in such cases invites dismissal on grounds of abuse of process, as confirmed by Pioneer and Glas Trust.
DRT Proceedings Preclude IBC Initiation
- If recovery proceedings are already pending before the DRT and a security deposit has been made, the IBC cannot be invoked as a parallel remedy.
- The existence of an active adjudicatory process under another statute is a strong indicator that the IBC is being misused.
Documentation Must Reflect True Economic Substance
- Courts will look beyond the form of the agreement to its substance. A loan agreement labeled as such will not suffice if the economic reality shows the corporate debtor is not the primary obligor.
- Banks must ensure that loan disbursements and security arrangements are structured to reflect direct debtor-creditor relationships if IBC recourse is intended.
