Piercing the ‘Syndicate Veil’: Substance Over Form

By: Armaan Patkar

A bank syndicate is a collection of banks that jointly extend a loan to a specific borrower, generally adopted in cases of financing of large projects, as it may be difficult to find a single lender to finance the entire deal. To bypass this problem, a bank or a few banks take the lead and negotiate the key terms of the loan and then arrange for other banks to participate in the deal. This distributes risks and reduces transaction costs and time, as there is no need to separately negotiate with multiple lenders.

In India, syndicated lenders often form a consortium under trust law to lend to borrowers. Such lenders often enter into inter se security trustee arrangements where one of the lenders is appointed as a security trustee on behalf of the others. The assets of the project are used as collateral for the repayment of the loan by executing a mortgage or security instrument between the borrower and the security trustee. In the past, this instrument was treated as a stand-alone instrument and was stamped accordingly. However, from here on out, in view of the Supreme Court’s decision in Chief Controlling Revenue Authority v. Costal Gujarat Power Ltd. and Ors. (CCRA v. CCPL) the security document shall be treated as embodying multiple transactions requiring separate stamping, and stamp-duty for one document could no longer be shared by all the lenders. It shall be levied on each lender separately and will have to be factored in to the cost of lending due to an increase in transaction loss.

However, the pure economic effect is unlikely to dissuade syndicate lending. The following example will illustrate this point:

Say 10 lenders form a syndicate to lend Rs. 1000 crore to project X, each lender lending a sum of Rs. 100 crore. The assets of project X, valued at Rs. 800 crore are mortgaged to lender A, one of the 10 lenders, in his capacity as the security trustee, appointed by the lenders to hold and receive the security, on behalf of the lenders. The security document is entered into between lender A as the appointed security trustee and the owner of the assets. With the rate of stamp duty @ 0.5% of the value of mortgaged assets and capped at Rs. 8 lakhs in accordance with article 6 of the Gujarat Stamp Act (hereinafter ‘the Act’), the consequent transaction loss will be as shown in the table below –

Project X

Pre-CCRA vs. CGPL Post-CCRA vs. CGPL
Loan 1000 Crore Loan 1000 Crore
Mortgage Value 800 Crore Mortgage Value 800 Crore
Stamp Duty @ 0.5% capped at Rs. 8 Lacs 8 Lakhs Stamp Duty @ 0.5% capped at Rs. 8 Lacs 80 Lakhs (8 Lakhs x 10)
Transaction Loss 0.00008% Transaction Loss 0.0008%
Net Result on Transaction Loss:

Project X would lose an additional 0.00072% (0.0008% – 0.00008%) of the total Transaction Value equivalent to 72 Lakhs.

From an economic standpoint, an additional transaction loss of 0.00072% is unlikely to be a deal breaker in syndicated lending, on account of the large size of the deal and the low cap on stamp-duty. Due to the cap, only small deals would be significantly affected by the economics of the judgement. For example, a 10 crore deal with an 8 crore mortgage value,[1] would result in a transaction loss of 0.36%.[2] However, the very nature of syndicate lending ensures that such small deals would never happen. Keeping this in mind, we may move on to examine the judgement in more detail.

Background of the Matters in Controversy

Coastal Gujarat Power Ltd. (CGPL) entered into agreements with 13 lenders, acting as a consortium trust to seek financial assistance for an ultra-mega power project in Kutch-Bhuj. The consortium executed an inter se security trustee agreement which inter alia appointed the State Bank of India (SBI), as the lead trustee and provided its duties, roles and responsibilities as the security trustee. To secure the borrowing, CGPL executed an indenture of mortgage for “delayed after assets deed” (hereinafter ‘mortgage deed’) with SBI, whereby CGPL created a mortgage on some of its assets. It is this document from which the issue arises.

Stamp-duty proceedings were initiated under the Act[3] culminating in a reference by the CCRA to a full bench of the Gujarat High Court inter alia seeking its opinion on whether a mortgage executed in favour of SBI for the benefit of all the lenders would be treated as a single document or as multiple documents, one for each of the lenders. The High Court vide its judgment and order dated 3 December, 2012[4] decided that the instrument ought to be treated as a single document and consequently, the instrument was appropriately stamped. The High Court inter alia opined that “stamp-duty is payable on instruments and not on transactions”.[5] Aggrieved by the decision, the CCRA preferred an appeal before the Supreme Court.

A Brief Note on the Arguments before the Supreme Court

The state took the “substance over form” argument and argued that the lenders had formed the consortium and had executed a single instrument with the sole purpose of evading stamp-duty. It was argued that the instrument relates to several distinct matters or transactions as CGPL availed 13 distinct loans from 13 different lenders. Therefore, the form of the transaction was a single document between CGPL and SBI but the substance was the creation of 13 separate mortgages with each of the lenders with SBI acting as an intermediary.

CGPL argued that only SBI could enforce the mortgage and that no independent right was created in favour of the other lenders. It could not be construed as multiple matters or transactions merely because a beneficial interest was created in favour of the beneficiaries of the consortium trust, i.e. the 13 lenders. Even assuming that the lenders have an individual interest in the mortgage, there is a commonality of such interest with the others and therefore, the instrument did not deal with distinct matters for the purpose of section 5 of the Act. Importantly, by stamping the mortgage deed by looking at the loan agreement, it amounts to indirectly stamping the loan agreement itself, especially when the documents have been individually stamped. When levying stamp-duty, the instrument alone should be looked at. Further, in view of the principles of strict interpretation of taxing statutes, the state cannot recover stamp-duty based upon its perception of the legislative intendment of the Act. Further, if two interpretations are possible, the one favouring the subject must prevail.

The Judgement and the Long Arm of the Law

After considering the matter, the Supreme Court inter alia held that “it is manifest that the instrument of mortgage came into existence only after separate loan agreements were executed by the borrower with the lenders with regard to separate loan advanced by those lenders to the Respondent borrower.” The court noted that since separate loan agreements were entered into with the lenders, on a proper construction of the instrument, it may be regarded as 13 distinct transactions with respect to section 5 of the Act.[6]

Concluding remarks

Section 5 of the Act has been construed to empower the State to levy duty on the transaction de hors the mortgage deed. This judgement is likely to have far-reaching implications on the stamp-duty regime and other statutes which follow similar principles of interpretation. Transaction structuring will have to be circumspect as the courts may now go into the surrounding circumstances and not merely the contents of the document in question. Complex transactions involving common documentation will have to be carefully drafted to avoid scrutiny on the crucible of “substance over form”. This may be indicative of a paradigm shift from levy of duty on instruments to a levy of duty on transactions, especially in view of the surrounding circumstances. It is this thought and not the economic loss that may deter future deals.

For those who disagree with the decision of the Supreme Court, it would be worth noting one of the arguments of CGPL before the Gujarat High Court stating that such an interpretation would lead to absurd situations. By way of illustration, it was submitted that if a company issues debentures to numerous persons and creates a common security by way of mortgage through the creation of a single debenture trust-deed, such debenture trust-deed would evidence a single transaction of mortgage to secure the amounts borrowed from multiple debentures holders. Applying the same logic, this document would also have to be treated as a single document evidencing multiple mortgages in favour of each of the debenture-holders.

Furthermore, the Supreme Court seems to have looked past the nature of a trustee, who holds and receives the mortgaged property for and on behalf of the lenders, i.e. cestui que trust. Despite the trustee having the sole power to enforce the terms of the mortgage deed, the consortium trustee is treated as a mere instrumentality of the syndicated lenders. In doing so, the Supreme Court has pierced the ‘syndicate veil’, so to speak.

Lastly, the Supreme Court has not placed any restrictions or limitations on the use of discretion in looking beyond the contents of the instrument and exploring the circumstances surrounding the transaction, leaving the door wide open for judicial legislation.

[1] Other facts in the above example remaining the same.

[2] Pre – CCRA vs. CGPL: 8 Crore x 0.5% = 4 Lacs = 0.04% (cap not applicable)

Post – CCRA vs. CGPL: 8 Crore x 0.5% x 10 lenders = 40 Lacs = 0.4% (cap not applicable)

Difference in stamp duty = 0.4% – 0.04% = 0.036% net additional transaction loss

[3] The mortgage deed was stamped for an amount of Rs 4,21,000/- and was registered. However, according to the Chief Controlling Revenue Authority (CCRA), the document was required to be stamped to the tune of Rs. 54,62,000/-. Accordingly, the CCRA made a demand for the unpaid amount of Rs. 50,41,000/- from CGPL. Thereafter, the document was forwarded to the Deputy Collector for consideration of the matter. After hearing the matter, the Deputy Collector confirmed the finding of the CCRA. CGPL preferred a revision application to the CCRA under section 53(1) of the Act which was dismissed and thereafter, CGPL preferred another application to the CCRA, this time for reference under section 54(1-A) of the Act. This application was allowed that the matter was referred to the Gujarat High Court.

[4] Coastal Gujarat Power Ltd v Chief Controlling Revenue Authority 2013(6) CTC GUJHC (FB) 11.

[5] The High Court inter alia held that since there was only one instrument creating the mortgage and the relationship between the CGPL and SBI, i.e. between the borrower and the security trustee, is independent of the relationship between the borrower and the lending banks, it was held that the mortgage deed cannot be treated as a combination of thirteen lenders. The court also relied on the fact that SBI alone had the power to enforce the document against CGPL and no rights in the mortgaged property had been created in favour of the 13 lenders or any other persons.

[6] In arriving at its conclusion, the Supreme Court relied on the decision of a constitution bench judgment of the Supreme Court in the case of The Member Board of Revenue v Arthur Paul Benthall AIR 1956 SC 35, wherein the Supreme Court inter alia held as follows:

“We are unable to accept the contention that the word “matter” in Section 5 was intended to convey the same meaning as the word “description” in Section 6. In its popular sense, the expression “distinct matters” would connote something different from distinct “categories”. Two transactions might be of same description, but all the same, they might be distinct. If A sells Black-acre to X and mortgages White-acre to Y, the transactions fall under different categories, and they are also distinct matters. But if A mortgages Black-acre to X and White-acre to Y, the two transactions fall under the same category, but they would certainly be distinct matters. If the intention of the legislature was that the expression ‘distinct matter’ in Section 5 should be understood not in its popular sense but narrowly as meaning different categories in the Schedule, nothing would have been easier than to say so. When two words of different import are used in a statute in two consecutive provisions, it would be difficult to maintain that they are used in the same sense, and the conclusion must follow that the expression “distinct matters” in Section 5 and “description” in Section 6 have different connotations”.

(Armaan Patkar graduated from Symbiosis Law School, Pune in 2013 and is currently an associate at Cyril Amarchand Mangaldas, Mumbai.)