The National Company Law Appellate Tribunal (NCLAT), New Delhi bench comprising Justice Anant Bijay Singh, Judicial Member and Ms. Shreesha Merla, Technical Member was recently hearing an Appeal and observed that margin money has the character of Trust for the benefit of the beneficiary, it cannot be said to be an asset of the ‘Corporate Debtor’. These FDRs cannot be realized by the ‘Corporate Debtor’ as and when it desires. The margin money is deposited in the FDRs which the ‘Corporate Debtor’ becomes entitled to only when the Margin Money is free from the obligations of the terms of the LC.
Challenge in the instant Appeal was to the Impugned Order passed by the Adjudicating Authority. By the Impugned Order, the Adjudicating Authority has directed the Appellant/Banks herein to reverse the transactions of appropriation of the margin money against the Letters of Credit and to credit the same amount of the margin money into the Current Account of the Corporate Debtor.
Facts:
The CIRP of the Corporate Debtor was initiated vide Order dated 25.07.2018. The RP filed CA 96 of 2019 & CA 164 of 2019, seeking a direction to the Respondent Banks to reverse the transaction of appropriation of the margin money of the Corporate Debtor as it was in breach of the Moratorium imposed under Section 14 of the Insolvency and Bankruptcy Code, 2016. The Adjudicating Authority allowed both Applications.
Appellant’s Submission:
It was submitted by the Counsel that the Adjudicating Authority has erroneously interfered with the netting of margin money against the Letter of Credit (LCs) carried out by the Appellant, specifically when such netting did not cause any irreparable damage to the Corporate Debtor, that the payments made to the beneficiary of LC made by the Banks along with the margin money are neither an adjustment of funds of the ‘Corporate Debtor’ towards the Appellants liability nor an exercise of the right of lien/setting of dues.
The Adjudicating Authority failed to appreciate that margin money is not a security for LC and that it becomes payable the moment default occurs on the part of the customer and that margin money falls outside the ambit of Security Interest in respect of properties of the Corporate Debtor. Hence, margin money cannot be said to be an asset of the Corporate Debtor.
The second Respondent/SBI had falsely submitted that margin money falls within the purview of Security Interest under Section 3(31) of the Code. In fact, an LC is a contract exclusively between the Creditor and the Bank and is strictly governed by the terms and conditions of the LC only.
In this regard, it was submitted that LC is basically a contract of performance guarantee and is a contingent liability of the Corporate Debtor which crystallizes on happening of an uncertain future event. An LC like a performance Bank Guarantee is a document or an Order issued by a Bank at one place, authorizing some other Bank, acting as the issuing Bank’s agent at another place, with a view to honouring the drafts or cheques of a beneficiary named in the document, for the amount stated in the letter and charge the total amount of the drafts so honoured or payments so made to the issuer of the LC. The particulars of all the drafts or cheques, drawn by the specified person against the credit are required to be endorsed at the back of the LC so that it would be easy to ascertain if the quantum of credit allowed has been utilised, and the quantum that is outstanding.
It was submitted that the issuing Bank may agree not to stipulate any margin on the Letter of Credit that the issuing Bank agrees to open in favour of its customers who are rated as excellent. The usual practice of the issuing Bank is to retain a cash margin ranging from 0% to 25% of the value of the obligation that the Bank assumes in the LC. Such margin is usually retained in the opener’s name on a no-interest basis. The margin amount is adjusted with the amount of the bill when the issuing Bank pays it on behalf of the buyer. Upon receipt of the goods on the buyer’s premises, the issuing Bank applies on it the usual margin confirming the terms of the cash credit facility that the issuing Banker may have extended to the buyer.
It was argued that an LC is an independent transaction. The issuing Bank is not at all concerned with the contract and/or dispute between the opener and the beneficiary. The issuing Bank is bound to extend from time to time the validity period of the LC. The Counsel relied on the judgment of Fargo Freight Ltd. vs. Commodities Exchange Corporation, (2004) 7 SCC 203, wherein it was held that the money payable by the issuing Bank belongs to the Judgment-Debtor.
It was contended that margin money for the LC is the part payment provided by the Corporate Debtor to the Banks to honour the liability for procuring the material to be used for its activity as ‘a going concern’. It was submitted that margin money is not a security for LC but is the share of the Corporate Debtor's contribution to procuring the raw material. The amount of margin money is not debited to make any recovery or adjustment towards the dues of the Bank, but the payment is made to the supplier of the material to keep the ‘Corporate Debtor’ as ‘a going concern’. The payment under LC by the Bank along with margin money is not an appropriation of the Corporate Debtor’s fund towards the dues of the issuing Bank.
Security Interest as provided for in Section 3(31) of the Code excludes Performance Guarantee which is similar in nature to an LC. SBI has wrongly assumed margin money to be a security for LC. Margin money in the form of the FDRs becomes the property of the Bank, the moment default on the part of the Customer takes place.
First Respondent’s Submission:
It was submitted by the RP that Respondents 3 to 7 had issued LC on behalf of the ‘Corporate Debtor’ for making the payment to the Corporate Debtor’s suppliers for supplying raw material. The ‘Corporate Debtor’ provided margin money in the form of Fixed Deposits with respect to the LCs and demand loans of the issuing Bank.
It was submitted that the disclosure made in the Balance Sheet is only the accounting disclosure in order to reflect the true and fair picture of the assets and liabilities of the Company in accordance with Indian Accounting Standards. The Appellant itself recognized that the margin money extended by the ‘Corporate Debtor’ is a ‘Security’ while submitting its claim in Form C with IRP. The IRP admitted the claim after netting the margin money available with the Appellant. The comparison between an LC and ‘Performance Guarantee’ has no relevance at all in the instant case.
Counsel for the first Respondent submitted that as per Section 14 of the IBC during the subsistence of the Moratorium, there was a complete prohibition on any action relating to foreclosure, recovery or enforcement of security interest created by the ‘Corporate Debtor’ in respect of any of its property. He further concluded that the IRP has admitted the claim of the Appellant with a disclaimer that the amount admitted may change subsequently on the basis of reconciliation or on the basis of any additional information received on the existing claim.
The Learned Counsel placed reliance on the Judgment of the Appellate Tribunal in State Bank of India vs. Punjab National Bank & Ors., REED 2019 NCLAT Del 04521, in support of his argument that margin money belongs to the ‘Corporate Debtor’ and was kept in the FD Account and therefore the said account could not have been debited during the period of Moratorium.
Second Respondent’s Submission:
It was submitted that on 30.10.2018 when the claims of the ‘Financial Creditors’ were admitted and uploaded on the website of the ‘Corporate Debtor’, it was seen that six Banks including the Appellant herein had liquidated the FDs of the ‘Corporate Debtor’ which was available with them as margin money against the LCs issued on behalf of the ‘Corporate Debtor’. It is submitted that this was taken subsequent to the commencement of CIRP and therefore the RP addressed letters to the Respondent Banks to reverse the transactions. The matter was discussed during the fifth, seventh & eighth CoC Meetings and it was decided that the RP would seek direction from the Adjudicating Authority against the six Banks.
It was submitted that the Adjudicating Authority has rightly directed the six Banks to reverse the transactions and credit the Current Account of the ‘Corporate Debtor’ as the margin money is an asset of the ‘Corporate Debtor’ and the same cannot be foreclosed or recovered during a Moratorium period under Section 14(1)(c) of the Code. It is contended that till the margin money is not appropriated it continues to be an asset of the borrower.
Counsel for the second Respondent argued that the Financial Statements of the Corporate Debtor’s Balance Sheet only provide additional information of details of liquid cash available with the ‘Corporate Debtor’ after notionally reducing the margin money amount deposited with the Banks. This is in line with the accounting standard practice. As per the Balance Sheet of the ‘Corporate Debtor’, the margin money amount is reflected as an asset of the ‘Corporate Debtor’ under the heading ‘Cash and Cash Equivalence’ and ‘Bank balances other than Cash and Cash Equivalence’. He further clarified that the Appellant itself in its claim Form-C submitted before the IRP classified the amount of margin money of Rs.1,26,92,34,923/- as ‘security’.
Learned Counsel submitted that once the LC is invoked and honoured by the Bank, the Bank in turn raises a full demand of the complete amount of LC upon the ‘Corporate Debtor’ and recovers the same from the Corporate Debtor’s Saving Bank Account/Current Account. Once, the LC amount is paid by the ‘Corporate Debtor’, the margin money deposited with the Bank can be utilized as margin money for another LC transaction. However, in the event of non-availability of funds and default by the ‘Corporate Debtor’, the Bank in turn appropriates the margin money kept with it as FD and also exercises its right against the goods of the ‘Corporate Debtor’, securitized with the Bank. These principles have also been upheld and reiterated in a number of cases.
It was submitted that the Court also placed reliance on Section 171 of the Indian Contracts Act, 1872, which states that Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract to the contrary, retain as security for a general balance of an account, any goods bailed to them. Still, no other persons have a right to retain, as a security for such balance, goods bailed to them, unless there is an express contract to that effect. Therefore, Banks hold the margin money in the trust of the borrower, they do not have any right over the same and can only utilize it under certain special circumstances subject to the contract between the Bank and the borrower.
Counsel for the second Respondent concluded that the exception to Moratorium under Section 14(3)(b) of the IBC ‘a surety in a contract of guarantee to a Corporate Debtor’ is not applicable to the facts of this case. This Section 14(3)(b) is applicable only to an asset of third-party surety and not assets of the ‘Corporate Debtor’ itself.
Appellate Tribunal’s Assessment:
The Appellate Tribunal noticed that a brief question which arose in the present Appeal was whether margin money deposited by way of an FDR against a Letter of Credit (LC) is an asset of the ‘Corporate Debtor’? Whether margin money construes, a ‘Security’ as provided for under the Code? Whether this margin money can be appropriated by the Appellant Bank during the period of Moratorium on the ground that it does not form a part of the asset of the ‘Corporate Debtor’?
In the instant case, the LC Agreements dated 13.02.2018 & 12.03.2018 executed by the Appellant specifies that the goods and services received by way of these LC transactions would be security for the whole LC amount including margin money.
It was the case of the Appellant that these LCs are independent contracts whereby the Appellant undertook to make payment to the beneficiary on demand. Margin money for the LC is a part payment provided by the ‘Corporate Debtor’ to the Banks to honour the liability for procuring the material to be used for its activity as ‘a going concern’. It is the case of the Appellant that margin money is not a security for LC but is a share of the contribution of the ‘Corporate Debtor’ to procure any raw material. It is relevant to examine whether margin money falls within the definition of ‘Security Interest’ as defined under Section 3(31) of IBC and also to examine if it falls within the purview of Section 14 of the IBC.
Sections 14(3)(a) and 14(3)(b) provide that sub-Section (1) of the IBC shall not apply to ‘a surety in a contract of guarantee to a Corporate Debtor’. It is the case of the Appellant that margin money is not a security and does not fall within a definition of ‘Security Interest’ as ‘no ‘Security Interest’’ is created by the ‘Corporate Debtor’ on the margin money. It is submitted by the Appellant that it is the usual practice of the issuing Bank to retain a cash margin ranging from 0% to 25% of the value of the obligation that the Bank assumes in the LC. The margin amount is adjusted in the amount of the bill and the issuing Bank pays it on behalf of the buyer. Upon receipt of the goods on the buyer’s premises, issuing Bank applies on it the usual margin confirming the terms of the cash credit facility that the issuing banker may have extended to the buyer. The issuing Bank is bound to extend from time to time the validity of the period from the LC.
Admittedly, the amount of margin money is not debited to make any recovery or adjustment towards the dues of the Bank, but the payment is made to the supplier of the material to keep the Company ‘as a going concern’. It is also seen that the payment under the LC along with the margin money cannot be said to be an appropriation of the Corporate Debtor’s funds towards the dues of the issuing Bank. A perusal of Clause 8 of Form-C as provided for under the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons), Regulations, 2016, the Claim submitted by the Banks specifically provides for the list of securities and it is pertinent to mention that there is no mention of ‘margin money’ in this list of securities. Furthermore, the margin money which is in the form of FDRs becomes the property of the Bank, the moment there is a default on behalf of the Company. In the instant case, the FDRs cannot be said to be a property of the ‘Corporate Debtor’ as the date of default is much prior to the date when the Moratorium was invoked. A perusal of the material on record also shows that the entries which have been justified against the LCs and the payment loans are not shown as ‘assets of the Corporate Debtor’ in its Balance Sheet and Moratorium can be applicable under Section 14 of the IBC only to the assets of the ‘Corporate Debtor’.
Margin money is construed as the substratum of a Trust created to pay to the beneficiary to whom the Bank Guarantee is given. Once any asset goes into trust by documentation for the benefit of the beneficiary, the original owner will not have any right over the said asset unless it is free from the Trust. The Appellate Tribunal observed that margin money has the character of Trust for the benefit of the beneficiary, it cannot be said to be an asset of the ‘Corporate Debtor’. These FDRs cannot be realized by the ‘Corporate Debtor’ as and when it desires. The margin money is deposited in the FDRs which the ‘Corporate Debtor’ becomes entitled to only when the Margin Money is free from the obligations of the terms of the LC.
It was the case of the Respondents that the LC cannot be equated to that of a Bank Guarantee and that they are different terms used in different situations. This Tribunal is of the view that while different, both Bank Guarantees and LCs assure the third party that if the borrower defaults on what it owes, the Bank would step in on their behalf. LCs are especially important in international transactions. An LC carries a higher risk for the Bank as the Bank makes the payment of an LC when it becomes due. However, the Hon’ble Supreme Court discussed at length in Cooperative Federation Ltd. vs. Singh Consultants and Engineers (P) Ltd., (1988) 1 SCC 174, how an LC is akin to a Performance Guarantee.
Thus, the Appellate Tribunal observed that in terms of its functions, a Performance Guarantee is similar to that of an LC. Further, the contention of the Respondents that the Banks have erroneously invoked the LCs and liquidated the margin money during the period of Moratorium, cannot be sustained. The material on record did not establish that any ‘Security Interest’ was created by the ‘Corporate Debtor’ with margin money. The provision of Section 14(3)(b) specifically excludes the Application of Section 14 to a ‘surety’ in a contract of Guarantee to a ‘Corporate Debtor’. This Tribunal is of the earnest view that LC is basically akin to a contract of Guarantee, as it is a contingent liability of the ‘Corporate Debtor’ which gets crystallized on the happening of a future event.
For all the aforenoted reasons, the Appellate Tribunal were of the considered view that margin money can in no manner be said to be a ‘Security Interest’ as defined under Section 3(31) of the IBC. Section 14(1)(c) prohibits any action to foreclose, recover or ensure any ‘Security Interest’ created by the ‘Corporate Debtor’ in respect of its property. As the Appellate Tribunal held that no ‘Security Interest’ was created by the ‘Corporate Debtor’ with respect to the margin money that was deposited by the ‘Corporate Debtor Company’ towards the opening of the LC in the Appellant Bank. The banks appropriated this money during the Moratorium period was justified as it was already held that the amount was not an asset of the ‘Corporate Debtor’. Therefore, a conjoint reading of Section 3(31) and Section 14 of the Code makes it abundantly clear that margin money is not included as a ‘Security’ and is not an asset of the ‘Corporate Debtor.
The appeal was allowed and the Order of the Adjudicating Authority was set aside.
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