Supreme Court clarifies the distinction between assignment and security interest in lease rental discounting: Infrastructure Leasing and Financial Services Ltd vs HDFC Bank Ltd (2023) INSC 929 (19 October 2023)

Date of the Judgment: 19 October 2023
Citation: (2023) INSC 929
Judges: S. Ravindra Bhat, J., Dipankar Datta, J.
Can a lender claim ownership over rental income when a borrower assigns it as security for a loan? The Supreme Court of India recently addressed this question, clarifying the difference between an assignment and a security interest in lease rental agreements. This judgment impacts how financial institutions and borrowers structure their loan agreements, particularly in lease rental discounting scenarios. The judgment was delivered by a two-judge bench comprising Justice S. Ravindra Bhat and Justice Dipankar Datta, with the opinion authored by Justice S. Ravindra Bhat.

Case Background

Infrastructure Leasing and Financial Services Ltd (IL&FS), the borrower, sought financial assistance from Housing Development Finance Corporation Ltd (HDFC), the lender. On 22 June 2018, HDFC sanctioned a financial facility of ₹400 crores to IL&FS. Subsequently, on 25 June 2018, a Master Facility Agreement (MFA) was executed between the two parties. This agreement included the creation of an escrow account with Housing Development Finance Corporation Bank Limited (Escrow Bank). On the same day, an Assignment Agreement (AA) was also executed, stipulating that the loan and interest would be paid from the income generated from IL&FS’s Business Centre Services Agreements/Lease/Leave and License Agreements. The agreement stated that the receivables from these contracts were assigned and pledged to HDFC to cover the loan and interest, and a Power of Attorney was also executed as a security interest.

Timeline

Course of Proceedings

The NCLT initially ordered the supersession of the IL&FS board in response to a petition filed by the Union of India (UoI) under Sections 241 and 242 of the Companies Act, 2013. The NCLT declined to issue a moratorium similar to that under Section 14 of the Insolvency and Bankruptcy Code (IBC). Aggrieved by this, appeals were filed before the NCLAT. The NCLAT issued an interim order on 15 October 2018, staying legal proceedings against IL&FS and its group companies, including actions to enforce security interests. Following this order, disputes arose regarding the transfer of funds from the escrow account to HDFC. IL&FS argued that the transfers violated the NCLAT order, while HDFC claimed ownership of the assigned receivables. The matter was then referred to Justice (Retd.) D.K. Jain, who directed HDFC and the Escrow Bank to reverse the debits. The NCLAT, in the impugned order, held that the assignment of receivables to the extent of principal and interest was valid and outside the scope of the freeze order.

Legal Framework

The court examined the following legal provisions:

• Sections 241 and 242 of the Companies Act, 2013: These sections deal with applications to the Tribunal for relief in cases of oppression and mismanagement.
• Section 5 of the Transfer of Property Act, 1882: This section states that all kinds of property can be transferred.
• Section 6 of the Transfer of Property Act, 1882: This section specifies the kinds of properties that cannot be transferred, such as personal claims and choices in action.
• Section 3 of the Transfer of Property Act, 1882: This section defines an “actionable claim” as a claim to an unsecured debt or a beneficial interest in movable property not in the claimant’s possession. “actionable claim” means a claim to any debt, other than a debt secured by mortgage of immoveable property or by hypothecation or pledge of moveable property, or to any beneficial interest in moveable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accuring, conditional or contingent”
• Sections 130, 131 and 132 of the Transfer of Property Act, 1882: These sections deal with the transfer of actionable claims, requiring a written instrument for the transfer to be effective. “130. Transfer of actionable claim — (1) The transfer of an actionable claim [whether with or without consideration] shall be effected only by the execution of an instrument in writing signed by the transferor or his duly authorised agent, shall be complete and effectual upon the execution of such instruments, and thereupon all the rights and remedies of the transferor, whether by way of damages or otherwise, shall vest in the transferee, whether such notice of the transfer as is hereinafter provided be given or not”

Arguments

Arguments by IL&FS:

• The Master Facility Agreement (MFA) and other agreements indicate that the facility was a loan repayable within 96 months, with the receivables serving as security for the loan and not a transfer of title.
• The Escrow Account was created to facilitate repayment, and the receivables deposited were assets of IL&FS held as security for the loan.
• The Assignment Agreement (AA) should not be read in isolation, and the term “pledge” indicates that the receivables were meant as security, not a transfer.
• The transaction was a loan secured by a charge over the property and receivables, not a sale of debt.
• The lender filed its claim as a secured creditor of IL&FS, further indicating that it was a loan transaction.

Arguments by HDFC:

• The facility extended to IL&FS was a Lease Rental Discounting (LRD) loan, which involves the assignment/sale of rent receivables to the financing entity.
• The assigned receivables were the exclusive property of HDFC, and IL&FS had no right or title to the monies in the Escrow Account.
• The NCLAT order dated 15 October 2018, was restricted to the assets of IL&FS and did not cover the assigned receivables.
• The transfer of ownership of a portion of the rent receivables was sufficient to pay the principal and interest, with the residual portion remaining with IL&FS.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue:

• Whether the documents executed by IL&FS, by which rents were made over to HDFC, constituted an assignment and thus fell outside the scope of an asset and security freeze order made by the NCLAT.

Treatment of the Issue by the Court

Authorities

The court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• Yellapu Uma Maheswari and Ors. vs. Buddha Jagadheeswararao & Ors. [2015 (11) SCR 849]: The court used this case to emphasize the importance of substance over form in interpreting documents.
• Assam Small Scale Ind. Dev. Corp. Ltd. & Ors. v. J.D. Pharmaceuticals & Anr [2005 (4) Suppl. SCR 232]: The court relied on this case to reinforce that the nature of a transaction is determined by its substance, not its nomenclature.
• V. Lakshmanan v. B.R. Mangalagiri & Ors [1994 Supp (6) SCR 56]: This case was used to support the principle that the label given to an agreement is not decisive.
• Super Poly Fabriks Ltd. vs. Commissioner of Central Excise, Punjab [2008 (6) SCR 1076]: The court cited this case to reinforce the principle that substance prevails over form in contract interpretation.
• S. Chattanatha Karayalar v The Central Bank of India & Ors [1965 (3) SCR 318]: The court relied on this case to support the principle that multiple documents forming part of one transaction must be read and interpreted together.
• Mewa Lal and Ors. vs. Tara Rani [AIR 1973 All 165]: The court cited this case to differentiate between the transfer of an actionable claim and the sale of property.
• Sunrise Associates vs Govt. Of NCT of Delhi [2006 Supp(2) SCR 421]: The court used this case to define “actionable claim” and to determine if the transaction involved the transfer of an actionable claim.
• Noor & Ors. v G.S. Ibrahim (Dead) by LRs [2003 Supp (2) SCR 204]: This case was cited to support the idea that the right to recover arrears can be assigned.
• ICICI Bank v Official Liquidator of APS Star Industries Ltd [2010 (12) SCR 644]: The court used this case to support the principle that rights under a contract are assignable, unless personal in nature or restricted by law or agreement.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Substance over Form: The court emphasized that the true nature of a transaction is determined by its substance rather than the labels or nomenclature used in the documents.
• Reading of all Documents Together: The court considered all the contemporaneous documents (MFA, AA, Escrow Agreement, and Power of Attorney) together to understand the true intent of the parties.
• Lease Rental Discounting (LRD): The court recognized the LRD arrangement as a financial agreement where a substantial portion of the rent receivables is assigned to the creditor bank.
• Transfer of Actionable Claims: The court noted that future rents are considered debts and can be transferred as actionable claims under the Transfer of Property Act, 1882.
• Assignment of Debt: The court concluded that the rents payable to IL&FS were assigned to HDFC, making HDFC the owner of those receivables to the extent of the loan and interest.

Logical Reasoning:

The court considered alternative interpretations, such as the argument that the transaction was merely a security interest. However, it rejected this interpretation because the documents, read together, clearly indicated an assignment of the debt (i.e., the rents payable) to HDFC. The court emphasized the importance of the substance of the transaction over its form and concluded that the intent was to transfer ownership of the receivables to HDFC to the extent of the loan and interest.

The court held that the use of the term “pledge” in some places in the documents did not undermine the fact that the rents payable to IL&FS were absolutely assigned to HDFC. The court also emphasized that the provisions of the Transfer of Property Act, 1882, allow for the transfer of debts, which are defined as actionable claims. In this case, the rents payable by IL&FS tenants were considered debts that were transferred to HDFC.

“The effect of these documents is what the court is concerned with. It is a known principle of contract interpretation, that the substance of a document, is discernible from its terms, rather than the label or its nomenclature.”

“The Lease Rental Discounting (LRD) arrangement – a new kind of financial agreement by which a banker allows credit facilities to a commercial property owner, has the flexibility of ensuring that the asset owner is given access to credit. The dominant condition is that a substantial portion or the entire rent or receivables which the owner would be entitled to are made – sold or assigned, absolutely to the creditor bank.”

“In the present case, the rents payable by IL&FS tenants, lessees and licensees are debts, which stood transferred to the creditor, i.e. HDFC Bank. Therefore, the NCLAT’s conclusions are unexceptionable; the challenge to its correctness, therefore fails.”

There were no minority opinions in this case.

Key Takeaways

• Substance over Form: Courts will look at the substance of a transaction, not just the labels used in the documents.
• Lease Rental Discounting: In LRD agreements, the assignment of rent receivables can transfer ownership to the lender.
• Actionable Claims: Future rents are considered debts and can be transferred as actionable claims under the Transfer of Property Act, 1882.
• Document Interpretation: All related documents must be read together to determine the true intent of the parties.

Directions

No specific directions were given by the Supreme Court in this case.

Development of Law

The ratio decidendi of this case is that in Lease Rental Discounting (LRD) arrangements, the assignment of rent receivables can transfer ownership to the lender. This clarifies that such transactions are not merely security interests but actual transfers of actionable claims. This judgment reinforces the principle that courts will prioritize the substance of a transaction over its form. There is no change in the previous position of law, rather the court has re-emphasized the established legal principles.

Conclusion

The Supreme Court dismissed the appeal, holding that the transaction between IL&FS and HDFC was an assignment of receivables, not merely a security interest. The court emphasized that in Lease Rental Discounting (LRD) agreements, the assignment of rent receivables can transfer ownership to the lender. This decision clarifies the distinction between assignment and security interest in lease rental agreements and has implications for how financial institutions and borrowers structure their loan agreements.

Category

Parent Category: Transfer of Property Act, 1882
Child Categories:

• Section 3, Transfer of Property Act, 1882
• Section 5, Transfer of Property Act, 1882
• Section 6, Transfer of Property Act, 1882
• Section 130, Transfer of Property Act, 1882
• Section 131, Transfer of Property Act, 1882
• Section 132, Transfer of Property Act, 1882
• Assignment of Actionable Claims
• Lease Rental Discounting
• Security Interest

FAQ

Q: What is Lease Rental Discounting (LRD)?
A: Lease Rental Discounting (LRD) is a financial arrangement where a lender provides credit to a property owner by taking an assignment of the future rental income from that property. It is a way for property owners to access funds based on the expected rental revenue.

Q: What is the difference between an assignment and a security interest?
A: An assignment involves the transfer of ownership of a right or asset, while a security interest is a claim over an asset to secure a debt. In an assignment, the assignee becomes the owner of the asset, whereas, in a security interest, the creditor has a claim over the asset until the debt is repaid.

Q: What is an “actionable claim” under the Transfer of Property Act, 1882?
A: An actionable claim is a claim to an unsecured debt or a beneficial interest in movable property not in the claimant’s possession. It is a right that can be enforced in a civil court.

Q: How does this judgment affect future lease rental agreements?
A: This judgment clarifies that in LRD agreements, the assignment of rent receivables can transfer ownership to the lender. This means that lenders can claim ownership over the assigned rentals, and borrowers should be aware of this when structuring their agreements.

Q: What does “substance over form” mean in contract interpretation?
A: “Substance over form” means that courts will look at the true nature of a transaction, rather than just the labels or terminology used in the documents. The court will examine the underlying intent and purpose of the agreement.