Companies (corporate debtors) usually provide corporate guarantees /indemnities to financial creditors (usually banks) undertaking repayment of credit facilities ( i.e. Bank Guarantees , Letter of Credits etc.) extended by the banks to the corporate debtor & / or CD’s subsidiaries / associated companies. Often these financial creditors (banks) claim the status of secured creditor for priority in distribution of funds during CIRP / Liquidation proceedings.
As the provisions of the Code ( Sub-section 7& 8 of Section 5),holder of a corporate guarantee / counter-guarantee or indemnity is a financial creditor .
Issues;
Whether the Corporate Guarantee / counter guarantee or indemnity creates any charge or lien on the assets of the company.
Whether the charge created, if any as above, is required to be registered with ROC.
The Company Law Board (1997.05.13) in S.T. Patil And Ors. vs ROC, held that corporate guarantee is not a charge over any specific assets of the company & when no charge has been created by an instrument (guarantee / indemnity), the concerned instrument / charge is not required to be registered with ROC.
Thus, following are the important ingredients to qualify a creditor as a secured creditor;
There has to be an instrument (deed / agreement etc.) creating charge / lien on the property of the company (CD).
The charge / lien so created is registered with ROC. As per section 77(3), a charge which is not registered is not to be recognised.
- Section 77(3) Notwithstanding anything contained in any other law for the time being in force, no charge created by a company shall be taken into account by the liquidator or any other creditor unless it is duly registered under sub-section (1)
Following are the provisions of different statutes on the matter, and extracts of the orders of the Company Law Board dated 13.05.1997 for ready reference please.
The Insolvency and Bankruptcy Code, 2016.
# Section 3 Definitions. –
(4) “charge” means an interest or lien created on the property or assets of any person or any of its undertakings or both, as the case may be, as security and includes a mortgage;
(27) “property” includes money, goods, actionable claims, land and every description of property situated in India or outside India and every description of interest including present or future or vested or contingent interest arising out of, or incidental to, property;
(30) “secured creditor” means a creditor in favour of whom security interest is created;
(31) “security interest” means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:
- Provided that security interest shall not include a performance guarantee;
The Companies Act, 2013.
# Section 2. Definitions.-
(16) “charge” means an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage;
# Section 77. Duty to register charges, etc.—
(1) It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India, to register the particulars of the charge signed by the company and the charge-holder together with the instruments, if any, creating such charge in such form, on payment of such fees and in such manner as may be prescribed, with the Registrar within thirty days of its creation:
- Provided that the Registrar may, on an application by the company, allow such registration to be made within a period of three hundred days of such creation on payment of such additional fees as may be prescribed:
- Provided further that if registration is not made within a period of three hundred days of such creation, the company shall seek extension of time in accordance with section 87:
- Provided also that any subsequent registration of a charge shall not prejudice any right acquired in respect of any property before the charge is actually registered.
(2) Where a charge is registered with the Registrar under sub-section (1), he shall issue a certificate of registration of such charge in such form and in such manner as may be prescribed to the company and, as the case may be, to the person in whose favour the charge is created.
(3) Notwithstanding anything contained in any other law for the time being in force, no charge created by a company shall be taken into account by the liquidator or any other creditor unless it is duly registered under sub-section (1) and a certificate of registration of such charge is given by the Registrar under sub-section (2).
The Indian Contract Act, 1872
# Section 171. General lien of bankers, factors, wharfingers, attorneys and policy-brokers. - Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract to the contrary, retain as a security for a general balance of account, any goods bailed to them; but 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.
Company Law Board (1997.05.13) in S.T. Patil And Ors. vs ROC, held that corporate guarantee is not a charge over any specific assets of the company;
# 5. When the matter came up for hearing, notice was ordered by this Bench to the company. In response to the notice served upon the company, it has raised objections to the registration of the charges. It is contended on behalf of the company that the deeds of guarantee executed by the company as well as the Jawalkar group are not valid documents creating charge over any of the assets of the company. The said documents are not valid in law, as they are not duly stamped. Nor do they create charge over any specific assets of the company.
# 8. I have considered the pleadings and heard the arguments of learned counsel for the petitioners and the company. The issues that arise for consideration are :
(a) Whether the transaction covered under the deeds of guarantee and commitment dated July 7, 1988, is registrable under Section 125 of the Act ?
# 11. In this case, the petitioners are seeking extension of time for registration of the particulars of charge covered by the following deeds dated July 7, 1988.
(a) Deed of guarantee executed by the company through its chairman and managing director and one of the directors (annexure "J") undertaking not to transfer or mortgage or hypothecate or alienate by any other means the company's assets till discharge of the liabilities.
(b) Deed of guarantee executed by the newly constituted board of directors and shareholders of the company undertaking to clear all the liabilities of the company and relieve the erstwhile chairman, managing director, director and other shareholders from the liabilities (annexure "K") and
(c) Deed of guarantee executed by the chairman and managing director of the company in his official as well as individual capacity undertaking not to mortgage or sell the company's assets or the shares till settlement of the entire dues (annexure "L").
# 12. It is clear from the deeds of guarantee that the undertaking was not to encumber the company's assets till closure of the liabilities due to the petitioners. None of the deeds of guarantee created a charge on the company's assets. The learned principal civil judge, Jamakhandi in O. S. No. 40/1991/LQs had upheld execution of the aforesaid deeds undertaking not to transfer shares or by any means encumber the company's assets.
In this context, the decision in Heathstar Properties Ltd. (No. 2), In re [1966] 36 Comp Cas 768 ; [1966] 2 Comp LJ 246 (Ch D) relied upon by counsel for the petitioners, has no relevance for the issue before this Bench. It may be worthwhile to quote the words of the learned judge (Plowman J.) in the said decision at page 777 which run as follows :
"If the case were one which the document sought to be registered could not in any circumstances be described as a charge, the position might be different. . ."
# 15. Thus, considering all facts and circumstances mentioned in the petition and the legal position as explained above, I am of the view that the transaction covered by the deeds of guarantee dated July 7, 1988, (annexures "J", "K" and "L") is not a registrable charge under the provisions of Section 125 of the Act.
Concept of Negative Lien or Negative Pledge
There is no legal definition of 'negative lien'. Lien is the right to retain goods of a borrower or pledgor for the debt. Negative Lien is used in banking parlance for a borrower to undertake not to create any charge on his property without the consent of the lender.
The borrower may sometimes be having non-encumbered assets which are not charged to the bank as security. The borrower is thus free to deal with these assets and may even sell them if he so desires. To restrict this right of the borrower, the bank may sometimes request him to give an undertaking to the effect that he will neither create any encumbrance on these assets nor sell them without the previous permission of the bank so long as the advance continues.
This type of an undertaking obtained by the bank is known as 'Negative Lien'. Negative lien is in the form of a personal assurance or undertaking which has binding effect but confers no right on the bank to proceed against the property itself and thus creates no encumbrance or charge on the property. The case of Knott v. Shepherdstown Manufacturing Co. 5 S.E. 266 (W. Va. 1888) may be examined at this juncture to help bring some clarity to the issue. It was held in Knott that Negative Pledgee’s remedies are purely contractual and that the covenant confers no right in the property. The Court held, “Of course the agreement’s negative pledge covenant creates no lien on or pledge of any property. It is simply negative; an agreement not to do a particular thing. The creation of a lien is an affirmative act, and the intention to do such act cannot be implied from an express negative. It seems to me that both of these clauses of the obligation that is, the negative pledge covenant and a covenant to keep the property insured are simply personal covenants, for the breach of which the remedy must be sought in a court of law. ”
The generally accepted view as mentioned before is that the negative pledge does not create a proprietary or security interest and is therefore not registrable. [Tracy Hobbs, The Negative Pledge: A Brief Guide, 8(7) J.I.B.L.269(1993)]
Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.
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