The IBC’s Debt Classification Tightrope: Navigating the Divide with Recent Judgments
Vanshika Srivastava & Ayushi Inani
4th Year, B.A. LL.B., National Law Institute University Bhopal
The Supreme Court of India, in its recent judgment in the case of Global Credit Capital Ltd. v. Sach Marketing (P) Ltd.[1], has brought significant clarity to the Insolvency and Bankruptcy Code 2016 (IBC) framework by distinguishing between ‘operational debt’ and ‘financial debt.’ This distinction is crucial for creditor rights, corporate rescue efforts, and the overall effectiveness of the insolvency resolution process.
Overview of the Case
Sach Marketing Pvt. Ltd. entered into agreements with Mount Shiwalik Industries Pvt. Ltd. (Corporate Debtor, CD) in 2014 and 2015, appointing Sach as its sales promoter to promote its beer for a year. These agreements required Sach to deposit a security amount with CD, repayable with interest. In 2018, insolvency proceedings were initiated against CD, and Sach claimed to be a financial creditor seeking repayment of the security deposit and accrued interest. The interim resolution professional rejected Sach’s claims, a decision upheld by the National Company Law Tribunal (NCLT). However, the National Company Law Appellate Tribunal (NCLAT) ruled in favor of Sach, classifying it as a financial creditor. This decision was challenged before the Supreme Court, leading to the present judgment.
Financial Creditors vs. Operational Creditors under IBC
- Financial Creditors: Section 5(7) of the IBC defines “a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred“. These lenders provide financial resources like banks, debenture holders, etc.
- Operational Creditors: Under Section 5(20) of the IBC defines “any person to whom an operational debt is owed, including any person to whom such debt has been legally assigned or transferred”. These are suppliers of goods and services needed for day-to-day operations.
Understanding ‘Financial Debt’ under IBC
The ‘consideration for time value of money’ was held by the National Company Law Appellate Tribunal (NCLAT), to be an essential prerequisite for a debt to be categorised as a financial debt under the Code. The tribunal ruled this in Nikhil Mehta & Sons (HUF) v. AMR Infrastructure Limited.[2] Furthermore, an analysis of the definitions of ‘financial creditors’ and ‘financial debt’ makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition.
In Pioneer Urban Land and Infrastructure Ltd. & Anr. v. Union of India & Ors.[3] the Supreme Court has discussed the meaning of the terms ‘disburse’ and ‘time value of money’ used in the principal clause of Section 5(8) of the IBC.
The term disbursed refers to the amount of money that has been paid against the consideration for the time value of money. Thus the disbursal must be of money and it must be against consideration for the time value of money, meaning thereby, the fact that such money is now no longer with the lender, but is with the borrower, who then utilizes the money.
Similarly the term “time value” has been interpreted to mean 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 of a discount in the payment.”
In Anand Sonbhadra v. Gulshan Sehti,[4] The NCLAT ruled that Amounts received from real estate allottees, whether they are genuine homebuyers or speculative investors, are considered financial debts for the purpose of verification or collation of claims by the resolution professional.
In IFCI Limited v. Sutanu Sinha,[5] The Supreme Court held that compulsorily convertible debentures do not constitute financial debt.
In Ansal Housing Limited v. Samyak Projects Private Limited,[6] The NCLAT ruled against treating amounts disbursed by a developer to a landowner under an inter-corporate deposit agreement as financial debt, as it was envisaged to be adjusted against future profits.
In Realpro Realty Solutions Private Limited v. Sanskar Projects and Housing Limited,[7] The NCLAT noted that common participation and sharing of profits and losses in a real estate project do not constitute financial debt.
In Rajeev Kumar Jain v. Uno Minda Limited,[8] The NCLAT held that disbursal of funds does not have to be made directly to the corporate debtor; it can be made on behalf of the corporate debtor or at its instructions.
In Santosh Kumar v. ASK Trusteeship Services Private Limited,[9] The NCLAT reiterated that optionally convertible debentures (OCDs) are in the nature of debt.
In Sainik Industries Private Limited v. Ritesh Raghunal RP,[10] The NCLAT noted that a debt arising from a supply transaction does not become financial debt merely because the agreement provided for a financial penalty or was secured by a pledge of shares.
In Rishima SA Investments LCC (Mauritius) v. Sarga Hotels,[11] The NCLAT upheld that a debt arising from a foreign award is treated as ‘other debt’ and not ‘financial debt.’
In Arunkumar Jayntilal Muchhala v. Awaita Properties,[12] The NCLAT interpreted ‘time value for money’ expansively to include any form of benefit accruing to the creditor as a return for providing money for a long duration.
In Surendra Kanhaiyalal Shah v. Magicon Impex Private Limited,[13] The NCLAT upheld that an interest-bearing refundable security deposit qualifies as financial debt, but sales commissions do not, due to the lack of disbursement against consideration for time value of money.
In Virigineni Anjaiah v. Pridhvi Asset Reconstruction and Securitization Company Limited,[14] The NCLAT ruled that Claims arising from a recovery certificate issued by the Debt Recovery Tribunal (DRT) constitute financial debt and give rise to a fresh period of limitation.
In Pawan Kumar Manguturam Bairagra v. Encore Asset Reconstruction Company Limited, The NCLAT held that an asset reconstruction company acquiring assets of a corporate debtor under a registered assignment deed is considered a lender for the maintainability of a Section 7 application, even when the deed is pending stamp duty adjudication.
In Gokul Kripa Colonizers and Developers Private Limited v. Radiant Hotels Private Limited,[15] The NCLAT held that an obligation to pay money under an agreement of sale in a real estate project does not qualify as financial debt due to the absence of disbursement for time value of money.
In present judgement financial debt is defined as one that involves the time value of money. This means there must be a loan or disbursement of funds, along with interest, that compensates the lender for waiting to receive their money back. While the IBC provides specific categories (a) to (i) for financial debts like loans and debentures, these categories still need to satisfy the core principle of time value of money. In simpler terms, even if the specific method of borrowing (like a loan or debenture) doesn’t explicitly mention interest, the debt must ultimately be traceable to the concept of borrowing money with interest to be considered a financial debt under the IBC. This ensures that only creditors who take on the risk of lending money and waiting for a return on their investment qualify as financial creditors under the Code.
However, it is not necessarily important to have interest charged on a debt for it to be considered as a financial debt. There are other ways in which the time value of money may be determined. Some such ways are mentioned below-
- Loan Agreements: Even if the loan doesn’t explicitly state interest if it has other provisions that reflect the time value of money, such as a discount on repayment for early settlement or a premium for delayed payment, it can qualify as financial debt.
- Bond or Debenture Issuance: The issuance of bonds or debentures involves the borrower receiving funds with an obligation to repay at a future date, often with periodic interest payments. Even zero-coupon bonds, which do not pay periodic interest but are issued at a discount to face value, reflect the time value of money.] etc.
Understanding ‘Operational Debt’ under IBC
Operational Debt: As per Section 5(21), operational debt involves claims related to the provision of goods or services, including employment.
Key judgments include:
The Supreme Court conferred a broad interpretation to the definition of the term ‘operational debt’ by widely interpreting the phrase “in respect of”. This interpretation was stated in the case of M/s Consolidated Construction Consortium Limited Versus M/s Hitro Energy Solutions Private Limited.[16] This broader interpretation aims to encompass all those who provide or receive operational services to the corporate debtor, ultimately resulting in an operational debt.
In Innova Premises Co-operative Society Limited v Marathon Nextgen Realty Limited,[17] The tribunal ruled that Money collected from allottees for maintenance or taxes is operational debt.
In Gupta Textiles v. Darshan Patel,[18] It has been declared that Operational creditors cannot be paid via partly paid redeemable preference shares.
In Sanam Fashion & Design Exchange Ltd. v. Ktex Nonwovens Private Limited,[19] The NCLAT ruled that An amount paid as an advance qualifies as operational debt if there is a clear nexus with supply.
In present judgement the Court analysed the applicability of Section 5(21), which defines ‘operational debt’ and explained that “operational debt means a claim in respect of the provision of goods or services including employment”, and for it to be applicable the claim must be regarding the provisions of goods or services, therefore, in the case of a contract of service, there must be a correlation between the ‘service’ agreed to be provided under the agreement and the ‘claim’. Moreover, 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.
Conclusion
India’s insolvency regime is evolving, and the IBC continues to undergo changes. Clear distinctions between financial and operational debts are fundamental for effective insolvency resolution. The Supreme Court’s verdict in Global Credit Capital Ltd. v. Sach Marketing (P) Ltd. emphasizes the distinct roles of these debts in the insolvency framework, contributing to a more robust legal foundation.
Understanding these nuances is critical for practitioners and stakeholders, ensuring that the IBC fulfills its role in providing a fair and efficient resolution process.
This structured analysis of recent judgments and their implications on debt classification under the IBC is essential for legal professionals and stakeholders involved in insolvency proceedings. By maintaining clarity on the distinction between financial and operational debts, the IBC can better serve its purpose in facilitating corporate recovery and protecting creditor rights.
References:
[4] 2021 SCC OnLine NCLAT 2737
[6] (2023) ibclaw.in 804 NCLAT
[7] (2023) ibclaw.in 763 NCLAT
[10] (2024) ibclaw.in 28 NCLAT
[11] (2024) ibclaw.in 203 NCLAT
[12] (2024) ibclaw.in 196 NCLAT
[13] (2024) ibclaw.in 98 NCLAT
[14] 2024 SCC OnLine NCLAT 568
[15] 2022 SCC OnLine NCLT 9513
[16] (2022) 7 SCC 164.
[17] 2023 SCC OnLine NCLT 10258
