Elucidating ‘Security Deposit’ enigma under IBC: Financial or Operational Debt?
Manisha Soni
4th Year, BA.LL.B.(Hons), Gujarat National Law University, Gandhinagar
The Supreme Court in Global Credit Capital Limited v. Sach Marketing Private Limited has delved into the dilemma of whether ‘security deposits’ paid to a corporate debtor would amount to financial or operational debt under the Insolvency and Bankruptcy Code, 2016 (Code).
Brief facts of the matter
The contention arose from an agreement between the Corporate debtor and Sach Marketing. Pursuant to the agreement, the Corporate debtor appointed Sach Marketing as their ‘sales promoter’. The agreement mandated Sach Marketing to deposit approximately 53 lac rupees as a security deposit with the Corporate debtor, for which it will pay a certain percentage of interest per annum.
Later, the oriental bank filed a section 7 petition against the corporate debtor, invoking Corporate Insolvency Resolution Proceedings (CIRP). The moratorium under section 14 was imposed. Sach Marketing filed the claim as a ‘financial creditor’, which the Interim Resolution Professional (IRP) rejected as Sach Marketing could not be considered a ‘financial creditor’ under IBC.
Indignant at the decision of IRP, Sach Marketing moved an application before the National Company Law Tribunal (NCLT) against such a decision under section 60(5) of IBC, which the NCLT rejected. An appeal was filed before the appellate tribunal NCLAT, which ruled Sach Marketing to be not an ‘operational creditor’ but a ‘financial creditor’ u/s 5(7).
Analysis
Definitions of relevant terms of this article are:
- ‘operational creditor’ defined u/s 5(20) as a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.
- ‘Operational debt’ defined u/s 5(21) as a claim in respect of the provision of goods or services, including employment or a debt in respect of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;
- ‘Financial creditor’ defined u/s 5(7) as any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;
- ‘Financial debt’ defined u/s 5(8) means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes – (f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;…”
The essentials of a financial debt
Inferring from various Supreme Court landmark judgments on defining the term financial debt, two tests, namely ‘disbursal’ and ‘time value of money’ paired with the element of ‘commercial effect of borrowing’, need to be satisfied in this transaction to be called a financial debt.
The first requirement for a debt to qualify under the definition of ‘financial debt’ is that it should be ‘disbursed’ against the consideration of the ‘time value of money’. The apex court elaborated the term ‘disbursal’ in Pioneer Urban Land & Infrastructure v. UOI (2019) ibclaw.in 13 SC as a situation where the money has now being transferred from the lender to the borrower, who then utilizes it; differently put, disbursal means debt transaction.
On the other hand, the Insolvency Law Committee Report interpreted the term ‘time value of money’ as “compensation or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money or factoring” in a discount in the payment. In accordance with this interpretation by the committee, the interest paid by the corporate debtor on the security deposit amount is considered the ‘time value of money’.
The Supreme Court has held in Anuv Jain, Interim Resolution Professional for Jaypee Infratech Limited (2020) ibclaw.in 06 SC, that in any situation, the definition of ‘financial debt’ u/s 5(8) should not be read so expansively that it forsakes the rudimentary requirement of “disbursal against the consideration for the time value of money”.
Furthermore, the aforesaid disbursal of money against the consideration of the time value of money should culminate into the ‘commercial effect of borrowing’; this term was defined in Pioneer Urban as a transaction which is used as a tool to raise finance or where having profit is the main aim. It is pertinent to mention that the financial statements of the corporate debtor treated the security deposit amount Sach Marketing gave as “long-term loans and advances”. Hence, the transaction reflected the commercial effect of borrowing.
Piecing these three threads together, the resultant debt is a financial debt.
The essentials of a financial creditor
The generic term “creditor” means any person to whom the debt is owed. For a creditor to become a financial creditor under IBC, the debt must be shown as if the Corporate debtor owes a ‘financial debt’ to the person claiming to be a ‘financial creditor’. He/she can be the principal creditor or can be an assignee, as per section 5(7). However, the peculiar element of debt owed by the corporate debtor should not be relinquished.
A combined analysis of the statutory provisions outlined in section 5(7) and the Supreme Court’s previous Judgments leaves no room for doubt that a security depositor is a financial creditor.
Findings of Supreme Court
The court found that the security deposit payment had no correlation with any other clause under the sales agreement between the corporate debtor and Sach Marketing. The security amount was not related to the services offered by Sach Marketing, nor was there a clause that had the provision of forfeiture of the security amount. This debt was ruled to be a ‘claim’ under the ambit of section 3(6) of the Code, as Sach Marketing have the right to seek a refund of the security deposit with interest. Therefore, the court refused to consider an iota of doubt regarding the security deposit being a debt under the Code, satisfying the condition of ‘disbursal’ as mentioned earlier.
The mandate for interest payment on security deposit by corporate debtor shows that it represents consideration for the time value of money.
Moreover, the financial statement of the corporate debtor showed that the deposit amount was treated as a long-term loan and advances; therefore, in accordance with the interpretation in Pioneer Urban, it is evident that the amount raised under the agreement has a commercial effect of borrowing.
This led the Supreme Court to concurr with the NCLAT verdict.
Author’s remarks
The Supreme Court’s decision in Swiss Ribbons v. UOI (2019) ibclaw.in 03 SC underscores that a “financial creditor” is directly involved in the corporate debtor’s operations from the start, assessing viability, restructuring loans, and reorganising the business during financial distress. This unique role positions financial creditors as guardians tasked with ensuring the debtor’s survival and growth. In contrast, a person holding only a security interest over the debtor’s assets is primarily concerned with realising the value of their security without any stake in the debtor’s growth or equitable liquidation. Including such a person as a financial creditor would undermine the debtor’s rejuvenation and revival, defeating the Code’s objectives, particularly those related to the CIRP.
The judgment in Global Credit Capital emphasises the importance of a contextual and purposive interpretation of statutory definitions, urging courts to examine the real nature of the transaction underlying the written agreement before categorising a debt as financial or operational under the IBC. While the judgment establishes clear parameters, it acknowledges that the determination of the nature of debt will depend on the specific facts and circumstances of each case, even if claims arising from a single agreement may constitute both financial and operational debts.
This ruling provides valuable guidance to corporate debtors, creditors, resolution professionals, and adjudicating authorities, promoting uniformity in interpreting and applying the Code’s provisions related to financial and operational debts. Ultimately, it reinforces the principles of the Code, promoting a more efficient and equitable insolvency resolution process in India.
