Supreme Court lays down tests to determine whether a debt is a financial debt or an operational debt under IBC
In a recent judgment the Hon’ble Supreme Court has laid down tests to determine whether a debt is a financial debt or an operational debt under IBC
ABCAUS Case Law Citation:
ABCAUS 3982 (2024) (04) SC
Important Case Laws relied upon:
Pioneer Urban Land and Infrastructure Ltd. & Anr v. Union of India & Ors 2019) 8 SCC 416
Phoenix ARC Private Limited v. Spade Financial Services Limited & Ors (2021) 3 SCC 475
V.E.A. Annamalai Chettiar & Ors. v. S.V.V.S. Veerappa Chettiar & Ors AIR 1956 SC 12
Jaypee Infratech Limited v. Axis Bank Limited & Ors
Swiss Ribbons Private Limited and Anr. v. Union of India & Ors (2019) 4 SCC 17
In the instant case, civil appeals were filed challenging judgments and orders passed by the National Company Law Appellate Tribunal (the NCLAT) holding that the creditors were financial creditors and not operational creditors.
The main issue involved in these appeal were whether the creditor was a financial creditor within the meaning of sub-section (7) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (the IBC).
The corporate debtor had appointed the said creditor as its ‘Sales Promoter’. One of the conditions incorporated by the corporate debtor in the letter/agreement was that the respondent would deposit a security amount with the corporate debtor, which will carry interest @21% per annum.
The Bank invoked the provisions of Section 7 of the IBC against the corporate debtor. The National Company Law Tribunal (the NCLT) admitted the application under Section 7 of the IBC and imposed a moratorium under Section 14 of the IBC. An Interim Resolution Professional (IRP) was also appointed.
Initially, the creditor filed a claim with the IRP as an operational creditor. The claim was withdrawn, and a new claim was filed as a financial creditor. However, the IRP rejected the claim on the ground that the creditor could not be considered a financial creditor.
However, the NCLAT held that the creditor was a financial creditor and not an operational creditor. Subsequently the NCLT approved the resolution plan.
In another appeal, four different creditors had provided financial assistance to the corporate debtor. The Resolution Professional rejected the claims of the four creditors as financial creditors. Though the NCLT rejected the applications of the creditors, the NCLAT allowed the appeal of the creditors.
The Hon’ble Supreme Court observed that where one party owes a debt to another and when the creditor is claiming under a written agreement/arrangement providing for rendering ‘service’, the debt is an operational debt only if the claim subject matter of the debt has some
connection or co-relation with the ‘service’ subject matter of the transaction. The written document cannot be taken for its face value. Therefore, it is necessary to determine the real nature of the transaction on a plain reading of the agreements.
The Hon’ble Supreme Court noted that under the sales promotion agreement, the respondent’s creditor’s monthly remuneration was very low and no commission was payable. Also, the agreement could be terminated by giving thirty days’ notice. Since the security deposit payment had no correlation with any other clause under the agreements, as held by the NCLAT, the security deposit amounts represent debts covered by sub-section (11) of Section 3 of the IBC. The reason is that the right of the creditor to seek a refund of the security deposit with interest is a claim within the meaning of sub-section (6) of Section 3 of the IBC as the first respondent was seeking a right to payment of the deposit amount with interest. Therefore, there is no manner of doubt that there is a debt in the form of a security deposit mentioned in the said two agreements.
The Hon’ble Supreme Court observed that there was no doubt that there is a debt with interest @21% per annum. The provision made for interest payment shows that it represents consideration for the time value of money. In the light of the definition of a financial debt under sub-section (8) of Section 5 of the IBC, it was noted that the first condition of applicability of Section 5(8)(f) of the IBC is that the amount must be raised under any other transaction. Any other transaction means a transaction which is not covered by clauses (a) to (e). Clause (f) covers all those transactions not covered by any of these sub-clauses of sub-section (8) that satisfy the test in the first part of Section 8. The condition for the applicability of clause (f) is that the transaction must have the commercial effect of borrowing. In this case, there was an arrangement in writing for the transfer of funds to the corporate debtor. Therefore, the first condition incorporated in clause (f) was fulfilled
The Hon’ble Supreme Court further observed that as recorded by the NCLAT, the corporate debtor informed the creditor that it had provided the interest in its the books and that the sum will be credited to the account of the creditor on the date of payment of TDS. The financial statement of the creditor showed revenue from the interest on the security deposit. It was also held that the amounts were treated as long-term loans and advances in the financial statement of the corporate debtor. Therefore, it is evident that the amount raised under the agreements had the commercial effect of borrowing as the corporate debtor treated the said amount as borrowed from the creditor.
The Hon’ble Supreme Court opined that the amounts of security deposits under the agreements constitute financial debt. Since, it is a financial debt, the creditor who owned it is a financial creditor under sub-section (7) of Section 5 of the IBC.
The Hon’ble Supreme Court laid down the following tests to determine whether a debt is a financial debt or an operational debt under IBC:
Tests to determine whether a debt is a financial debt or an operational debt under IBC:
1. There cannot be a debt within the meaning of sub- section (11) of section 5 of the IB Code unless there is a claim within the meaning of sub-section (6) of section 5 of thereof;
2. The test to determine whether a debt is a financial debt within the meaning of sub-section (8) of section 5 is the existence of a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The cases covered by categories (a) to (i) of sub-section (8) must satisfy the said test laid down by the earlier part of sub-section (8) of section 5;
3. While deciding the issue of whether a debt is a financial debt or an operational debt arising out of a transaction covered by an agreement or arrangement in writing, it is necessary to ascertain what is the real nature of the transaction reflected in the writing; and
4. Where one party owes a debt to another and when the creditor is claiming under a written agreement/arrangement providing for rendering ‘service’, the debt is an operational debt only if the claim subject matter of the debt has some connection or co-relation with the ‘service’ subject matter of the transaction.
Accordingly, the division bench of the Hon’ble Supreme Court confirmed the impugned judgments of NCLAT and dismissed the appeals.
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