Merely Mortgaging Property Without Lending Money Does Not Create Financial Debt : NCLT Hyderabad

The National Company Law Tribunal (NCLT) at Hyderabad has held that a person who only mortgages his property as collateral security cannot be treated as a financial creditor of the borrower if he has not advanced any money.

A bench of Judicial Member Rajeev Bhardwaj and Technical Member Sanjay Puri said the insolvency law can be invoked only if there is a financial debt, which necessarily involves disbursal of money against consideration for time value.

The tribunal observed, “A person who merely mortgages his property as collateral security does not become a creditor of the borrower in the absence of having advanced money.”

It added, “Such a person only creates a security interest to secure an existing debt owed to a lender. A mortgage deed, in the absence of disbursal or a covenant creating a primary debt obligation, does not by itself create a financial debt.”

The ruling was delivered in insolvency proceedings initiated by PL Srinivas Reddy against Techtrans Constructions India Pvt Ltd. Reddy claimed that he had stepped into the shoes of a financial creditor after mortgaging his personal properties to secure loans taken by the company.

The tribunal observed that the credit facilities were sanctioned by State Bank of India in favour of the company, and not Reddy. An equitable mortgage by deposit of title deeds of Reddy's property was created on March 12, 2013, to secure loans of more than Rs. 100 crore.

No amount was disbursed by Reddy to the company. There was also no guarantee deed or contractual clause that made him liable to repay the loan.

After the company defaulted in March 2023, the bank initiated recovery proceedings and issued a sale notice for the mortgaged property. Reddy approached the Debts Recovery Tribunal and obtained interim protection. This was subject to him depositing Rs. 2 crore. He deposited only Rs. 1.5 crore.

Rejecting his arguments, the tribunal held that if a mortgage deed does not create a payment obligation on the borrower, the mortgagor cannot claim the status of a creditor. It said that a provider of collateral security cannot, on the basis of part payment during recovery proceedings, claim subrogation unless the entire debt is discharged.

The tribunal also cautioned that insolvency proceedings cannot be used as a substitute for recovery actions or as a tool to stall enforcement of security interests.

"The provisions of the IBC not for genuine insolvency resolution, but as a defensive mechanism to obstruct lawful recovery proceedings. The insolvency mechanism under the IBC is not intended to be used as a substitute for recovery proceedings or as a tool to stall enforcement of security interests", it said.

Holding that there was no disbursal of money to the borrower, the tribunal held that the Reddy could not be treated as a financial creditor. It dismissed his plea and imposed costs of Rs 5 lakh on Reddy