Deciphering Supreme Court’s Ruling in Global Credit Capital v. Sach Marketing
Aparana Sharan
3rd Year, LL.B , Government Law College, Mumbai
Introduction
The Insolvency and Bankruptcy Code of 2016 (“IBC”) lays out clear distinctions between ‘financial debt’ and ‘operational debt,’ which have been refined through judicial interpretation over time, particularly in cases where the application of the given definitions wasn’t straightforward. This categorisation is crucial as it determines the divergent rights, obligations, and procedural requirements governing debt realization for both financial and operational creditors under the IBC.
A recent landmark ruling by the Supreme Court (“SC”) in the case of Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr. [[i]] (“GCCL Case”) addressed the classification of Sach Marketing’s claim against Mount Shivalik Industries Limited. The central issue revolved around the nature of “security deposits”. The SC’s decision provided vital clarity and guidance regarding differentiation between these two types of debts under the IBC by establishing certain parameters.
Brief Facts of the Case
Under two agreements dated April 1, 2014, and April 1, 2015, the Corporate Debtor engaged Sach Marketing as a ‘Sales Promoter’ to promote beer manufactured by the Corporate Debtor in Ranchi, Jharkhand, for twelve-month periods under each agreement. These agreements stipulated a monthly payment of INR 4000 to Sach Marketing for promotional activities. Furthermore, one of the conditions mandated Sach Marketing to deposit a minimum security amount of INR 53,15,000/- with the Corporate Debtor, accruing interest at 21% per annum. The agreements also specified that the Corporate Debtor would pay interest on INR 7,85,850/- at 21% per annum. The terms of the April 1, 2015 agreement mirrored those of April 1, 2014, with the sole variation being that the Corporate Debtor was obligated to pay interest on INR 32,85,850/- at 21% per annum.
Initially, Sach Marketing lodged a claim as an operational creditor, but later retracted it, instead opting to file a claim as a financial creditor. The interim resolution professional (“IRP”) acknowledged Sach Marketing’s claim partially as operational and financial debt. However, the claim was ultimately rejected on the grounds that Sach Marketing did not meet the criteria to be classified as a financial creditor. Subsequently, Sach Marketing submitted an application to the National Company Law Tribunal (“NCLT”) under Section 60(5), which was also dismissed. Sach Marketing then appealed this decision to the National Company Law Appellate Tribunal (“NCLAT”), which concluded that Sach Marketing should be categorised as a financial creditor based on the nature of the claims arising from the agreements. This decision of the NCLAT was challenged before the SC, forming the crux of the present article.
Analysing the Supreme Court’s Verdict
The SC stressed that determining whether a debt arising from a written agreement for services constitutes an operational debt or financial debt requires examining the true nature of the transaction based on a plain reading of the agreements, beyond the face value of the written document.
The SC, upon meticulously analysing the agreements, observed certain peculiarities. Notably, it found that Sach Marketing, acting as a sales promoter for the beer produced by the Corporate Debtor, was compensated with a mere INR 4,000 per month. This nominal monthly payment did not include any commission based on sales quantity, which is atypical for such promotional agreements.
Interpretation of financial debt under Section 5(8) of IBC
The definition of “Financial Debt” under Section 5(8) of the IBC introduces the term “means and includes”. Thus, the SC, relying on Anuj Jain, IRP for Jaypee Infratech Limited v. Axis Bank Limited [[ii]] (“Jaypee”) and Phoenix ARC Private Limited v. Spade Financial Services Limited & Ors. [[iii]] (“Phoenix ARC”), emphasised that the essential element of “disbursal”, specifically “against the consideration for time value of money”, must be present at the genesis of any debt for it to be categorised as ‘financial debt’ within the meaning of Section 5(8) of the IBC. This debt may be of any nature, but a portion of it is always required to involve disbursal against consideration for the time value of money.
Moreover, cases falling under categories (a) to (i) of Section 5(8) of the IBC would be classified as ‘financial debt’ only if they meet the criteria outlined in the earlier part of the sub-section (8). The test outlined therein necessitates the existence of a debt along with interest, if any, and it must be disbursed against consideration for the time value of money. In the instant case, the Court affirmed the fulfilment of initial condition outlined in Section 5(8)(f), evident through the existence of a debt carrying 21% per annum interest rate indicating consideration for the time value of money.
Applicability of Section 5(8)(f)
Relying upon its judgment in Pioneer Urban Land and Infrastructure Ltd. & Anr. v. UOI & Ors. [[iv]] (“Pioneer Urban Land”), the Court further explained that for the applicability of Section 5(8)(f), the amount must be raised under ‘any other transaction,’ which refers to a transaction not covered by clauses (a) to (e), provided it has the “commercial effect of borrowing.” The SC held that there were written agreements detailing the transfer of funds to the corporate debtor. Thus, the amount fell within the definition of ‘transaction’ as per Section 3 (33) of the IBC.
The corporate debtor’s financial statements for financial years 2015-16 and 2016-17 showed interest payments to Sach Marketing on the security deposit, categorised as (i) ‘long-term loans and advances’ and (ii) ‘other long-term liabilities’, respectively. This accounting approach was pivotal for the SC in determining that the amounts raised, by way of deposit of security, under the said Agreements constituted ‘borrowing’. This reasoning aligns with Pioneer Urban Land, where upfront funds intended for temporary use and eventual asset return, along with interest accounting, were deemed borrowing under Section 5(8)(f) of the IBC. Consequently, the broad interpretation of “borrowing” from Pioneer Urban Land was applied here, classifying the disputed amounts as ‘financial debt’ based on commercial substance and accounting, rather than merely the form of the Agreements.
In the given scenario, the apex court made clear determinations regarding the nature of the obligations outlined in the agreements. Firstly, it deemed the provision for the monthly payment of INR 4000/- to “promote work” as an operational debt due to its direct correlation with the services provided under the agreement. Conversely, the provision concerning the deposit of security and the accrued interest was categorised as a financial debt, lacking any link to the services rendered. The absence of a forfeiture clause in the security deposit agreements rendered the corporate debtor liable for refunding the security deposit, along with interest of 21% per annum, after the specified period, as noted by the SC. This absence of correlation with other clauses in the agreements led to the classification of the security deposit amounts as financial debt under Section 3(11) of the IBC. The court further emphasised that Sach Marketing’s right to seek a refund of the security deposit with interest constituted a claim within Section 3(6) of the IBC, as it involves a right to payment of the deposit amount with interest.
Considering these facts, the Supreme Court definitively ruled that the amounts deposited as security under the two agreements had the commercial effect of borrowing, as the Corporate Debtor treated these amounts as borrowed from Sach Marketing. Thus, the second condition of clause (f) of Section 5(8) was satisfied, classifying the debt as a financial debt under the IBC.
Conclusion
The SC’s ruling in the GCCL Case marks a pivotal moment for India’s insolvency resolution framework. By adopting a contextual and purposive interpretation of statutory definitions, the Court underscored the importance of assessing the true nature of transactions to classify debt under the IBC as either financial or operational. This approach emphasizes that criteria like the “time value of money” and the “commercial effect of borrowing” should not be mechanically applied.
The ruling introduces a clear two-pronged test to determine if a debt qualifies as financial, assessing both the interest concerning the time value of money and the commercial effects of borrowing. This clear guidance is crucial for stakeholders, ensuring accurate classification of creditors for their participation, voting rights, and distribution of proceeds during resolution. It aims to mitigate disputes over debt classification, thereby streamlining the insolvency process.
Furthermore, the decision offers essential guidance to corporate debtors, creditors, resolution professionals, and adjudicating authorities, facilitating a more nuanced approach to debt classification. As a landmark ruling, it promotes uniform interpretation and application of IBC provisions regarding financial and operational debts, bolstering efficiency and equity in India’s insolvency proceedings.
References:
[iii] (2021) 3 SCC 475
