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NCLAT's Tryst with Margin Money: A Tale of Judicial Inconsistency




Authors: Nutan Keswani and Pushkar Deo



5th and 4th year Students respectively at University of Petroleum and Energy Studies, Dehradun




I. Introduction


Controversy around the invocation of bank guarantee during the moratorium


The question of invocation of bank guarantee during moratorium has vexed insolvency practitioners for a long time with multiple conflicting decisions by the National Company Law Appellate Tribunal (“NCLAT”) and various benches of the National Company Law Tribunal (“NCLT”). Section 14 of Insolvency and Bankruptcy Code, 2016 (“Code”) mandates that no action of enforcement, foreclosure, or recovery of any ‘security interest’ along with transfer, alienation, encumbrance of any assets shall be permitted during the continuance of the moratorium period in order to preserve the assets of the corporate debtor and ensure its rehabilitation. The definition of the term ‘security interest’ under Section 3(31) of the Code excludes a performance bank guarantee (“PBG”) from its ambit. Thus, a PBG could be invoked by a beneficiary even during the moratorium period.


In spite of the clear legislative mandate, the question of invocation of PBG went through extensive judicial scrutiny until the matter was finally settled in GAIL (India) Limited v Rajeev Manaadiar , wherein NCLAT explicitly held-


Moratorium order will not be applicable on the Performance Bank Guarantee given the fact that definition of the ‘security interest’ under Section 3(31) Code explicitly excludes Performance Bank Guarantee from the purview of security interest.

The issue pertaining to Non-Performance Bank Guarantee (“NPBG”) was recently clarified by NCLAT in Bharat Aluminium Co. Ltd. v J.P. Engineers Pvt. Ltd. wherein it held that even an NPBG can be invoked during the moratorium. This ratio was premised on amended Section 14(3)(b) which exempts ‘surety in a contract of guarantee’ from the application of moratorium and Supreme Court’s judgment in SBI v V Ramakrishnan which affirmed that moratorium does not operate to bar actions against guarantors to the debt of the corporate debtor. Thus, the position of law as it stands today allows invocation of bank guarantees (both PBG and NPBG) during the period of moratorium. This controversy was finally put to rest by the abovementioned judgments but the status quo prevailed only until the retreating chill winds.


II. What is Margin Money in the context of bank guarantee?


In an attempt to reduce the risk exposure involved in issuing a guarantee, banks generally prefer the issuance of secured guarantees which are backed up by assets provided by the borrower as collateral. These secured assets are meant to be used by the bank to proportionately set off its liability in the event of invocation of a bank guarantee. Margin money is one such collateral provided by the borrower to secure a bank guarantee, which is parked with the bank as a fixed deposit receipt during the validity period of the guarantee and is used to honor payment during invocation. In case a bank guarantee matures without being invoked, this margin money gets credited back to the borrower.



III. Conundrum over treatment of margin money during CIRP


There has been a lot of judicial inconsistency over the appropriation of margin money during CIRP. In the case, of Bank of Baroda v Sundaresh Bhat (“Bank of Baroda Case”) NCLAT held that appropriation of margin money by a bank after initiation of the Corporate Insolvency Resolution Process (“CIRP”) is impermissible by the virtue of Section 14 of the Code.


However, in Indian Overseas Bank v Arvind Kumar (“Indian Overseas”), NCLAT took a contrary stance and barred the resolution professional to claim margin money deposited by the corporate debtor with the bank on the premise that upon invocation of bank guarantee, margin money goes towards payment to the beneficiary and hence there remains nothing which can be reversed to the corporate debtor.


Thereafter in SBI v Debashish Nanda , NCLAT went back to its stance in the Bank of Baroda case and ruled that margin money which was kept in the FD account of corporate debtor belongs to the corporate debtor and therefore, the said account could not have been debited during the period of moratorium.



IV. Recent Controversy regarding Margin Money


On 20 July 2021, the principal bench of the NCLAT at New Delhi in the case of C&C Construction Ltd. v Power Grid Corporation of India Ltd. (“C&C Construction”) while deciding on plea for invocation of a bank guarantee during the moratorium, directed the bank to release the full value of the guarantee after deducting the amount provided by the corporate debtor as margin money for issuance of that guarantee. While it accepted that guarantee payment is a responsibility of bankers whereby payment must go out of the fund of banks and not from funds of the corporate debtor but nonetheless, it was held that protection of moratorium would extend to ‘margin money component of the guarantee payment as the underlying object to keep the corporate debtor alive during CIRP may be affected by the release of this margin money, which was originally contributed by the corporate debtor.


These conflicting rulings by NCLAT raise doubts about treatment of margin money on invocation of bank guarantee during the moratorium, more specifically, whether a bank can utilize the margin money parked with it to honor the bank guarantee or it must hold the margin money in reserve on account of the moratorium and meanwhile pay the residual amount to the beneficiary.


While the NCLAT has been divided in its opinion on the issue, in a larger context, treatment of margin money depends on whether it can be understood as ‘asset’ or ‘security interest’ of the corporate debtor, so as to bring it within the protective shield of the moratorium and hence bar any claim over it during CIRP.



V. Decoding the nature of Margin Money


For the purpose of carrying on CIRP, the resolution professional is entitled to take control over assets of the corporate debtor, however, it can take control of only those assets to which corporate debtor would have been entitled, had there been no order for moratorium under Section 14 of the Code. This merits a discussion into a pertinent question i.e. ‘whether margin money can be deemed to be an asset of corporate debtor?’


Margin money can be simply understood to be a fund contributed by the borrower which is earmarked to be used by the bank while honoring bank guarantee in the event of invocation. The High Court of Bombay in the case of Reserve Bank of India v Bank of Credit Commerce was presented with an opportunity to thoroughly examine the nature of margin money, wherein it held that that margin money is a separate identifiable fund that is earmarked for honoring letters of credit by the bank and hence, shall be construed as ‘asset held in trust’. In Phoenix ARC Pvt. Ltd. v Anush Finleash & Construction Pvt. Ltd., NCLT Delhi dealt with the interpretation of ‘asset held in trust’ in the context of the Code and held that-


27. On looking at the comparative chart of Explanation given to Sec. 18 and Sec. 36(4), it is a clear indication that assets held under Trust cannot be considered as the asset of the Corporate Debtor. When margin money has the character of trust for the benefit of the beneficiary, as long as the Bank Guarantee Contract is not determined, the margin money will have the character of Trust. When it is not the asset of the Corporate Debtor, the Corporate Debtor, either during the CIRP process or after the CIRP period, will not have any legal right to have a claim on the said asset.

(emphasis supplied)


Therefore, it is clear that margin money, being an ‘asset held in trust’ for a third party cannot be counted in as an asset of the corporate debtor under Section 36 of the Code and hence shall not be subject to moratorium under Section 14 of the Code.


Furthermore, the definition of ‘security interest’ under Section 3(31) of the Code explicitly excludes performance guarantee, and thus, actions incidental to performance guarantee (such as the contribution of margin money) cannot be called as falling within the ambit of the Code. In the backdrop of this, margin money becomes inconsequential for the purpose of ensuring that breathing space to the corporate debtor as firstly, it is not an asset of the corporate debtor; and secondly, insolvency proceedings against the corporate debtor may not be affected by the release of margin money deposited with a bank for the purpose of honoring the guarantee.


VI. Analysis: Where does C&C Construction fall short?


The aforementioned discussion on the nature of ‘margin money’ makes it amply clear that it cannot be treated as an asset of a corporate debtor. In light of this conclusion, NCLAT’s decision in C&C Construction is erroneous. While allowing encashment of bank guarantee minus the margin money, the NCLAT tacitly relied on the principles contained in Section 14 of the Code and hence, treated margin money as an ‘asset of corporate debtor’, which cannot be alienated during the continuance of moratorium.


In effect, the NCLAT directed the bank to release the guarantee amount only after making the necessary deduction for margin money, which in our opinion, is contrary to the basic contractual principle that the liability of the surety and the principal borrower towards the beneficiary is co-extensive. By reducing the margin money, the beneficiary of the bank guarantee, who has already suffered losses due to non-performance of the obligation by the corporate debtor, is forced to take a cut. In certain cases, many banks demand margin money to the extent of 100% of the guaranteed amount. In such situations, going by the ratio of C&C Construction, the beneficiary would be bereft of any claim against the bank, which frustrates the very purpose of a bank guarantee.


Although this judgment makes it convenient for the banks to make guarantee payment only to the extent of their actual liability by deducting margin money, however, it has been rendered far more complex for the lender/beneficiary invoking the guarantee to accept part payment under the guarantee from the bank and then make a different claim for leftover part (equivalent to margin money) from corporate debtor, all this when the corporate debtor is undergoing insolvency. This situation dilutes the usefulness of a guarantee for a lender or beneficiary.


Furthermore, in such commercial dealings, bankers require margin money as a security for the primary purpose of reducing their upfront liability during invocation. While in Indian Overseas, NCLAT recognized the utility of margin money and declined to reimburse it to the resolution professional, but it went back on its own word in C&C Construction, wherein it affirmed the corporate debtor’s claim over the margin money and hence extended the liability of the bank, which is contrary to the fundamental object of issuing a secured bank guarantee.


It is also interesting to note that the decision in Indian Overseas was given by a three-member bench whereas the decision in C&C Construction was pronounced by a two-member bench. Thus, in line with the doctrine of precedents, the decision in C&C Construction is rendered per incuriam on this aspect.


Considering the tail of conflicting decisions, it is extremely important for the NCLAT or Supreme Court of India to finally clarify and settle this position as contrary decisions result in delays due to ambiguity which is against the very spirit of the Code i.e. timebound rehabilitation of the stressed entity.




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