Whether Operational Debt constitutes lease rent, falling within the purview of Section 9 of the Insolvency and Bankruptcy Code.
Sonal Shambhavi
5th Year B.A., LL.B (H), Chanakya National Law University, Patna
The distinction between financial creditors and operational creditors under the Insolvency and Bankruptcy Code (IBC) is pivotal in understanding the nature of their relationships with the entity in distress. Financial creditors engage in purely financial contracts, like loans or debt securities, with the entity. On the other hand, operational creditors have liabilities stemming from operational transactions, such as goods or services provided to the entity.[1]
However, the IBC acknowledges scenarios where a creditor may have both financial and operational transactions with the entity. In such cases, the creditor is bifurcated, being treated as a financial creditor for the portion related to financial debt and as an operational creditor for the portion tied to operational debt. This recognition ensures clarity and fairness in resolving insolvency cases by appropriately addressing the distinct rights and interests of different types of creditors.
In accordance with Section 9 of the Insolvency and Bankruptcy Code (IBC)[2], an operational creditor can initiate the corporate insolvency resolution process under certain conditions. Firstly, after ten days from the delivery of a notice or invoice demanding payment, if the operational creditor does not receive payment or notice of dispute from the corporate debtor, they may file an application before the Adjudicating Authority. This application must be filed in the prescribed form and manner, accompanied by the requisite fee. Along with the application, the operational creditor must furnish various documents, including a copy of the invoice or demand notice, an affidavit confirming the absence of dispute notice from the corporate debtor, and a certificate from financial institutions confirming non-payment by the corporate debtor. Additionally, any available records from information utilities confirming non-payment must be provided. The operational creditor may also propose a resolution professional to act as an interim resolution professional. Upon receiving the application, the Adjudicating Authority must decide within fourteen days whether to admit or reject it. The application will be admitted if it meets certain criteria, such as completeness, absence of repayment of the unpaid operational debt, delivery of the invoice or notice, absence of dispute notice, and no pending disciplinary proceeding against any proposed resolution professional. If the application is rejected due to incompleteness or other specified reasons, the applicant will be given an opportunity to rectify the defects within seven days. The corporate insolvency resolution process commences from the date of admission of the application. This section of the IBC ensures a structured process for operational creditors to seek resolution in cases of non-payment by corporate debtors.
Now the Issue is Whether Operational Debt constitutes lease rent, falling within the purview of Section 9 of the Insolvency and Bankruptcy Code.
The first case in this line is M. Ravindranath Reddy Vs. G. Kishan and Ors[3]. In this case the Corporate Debtor granted a license of industrial premises consisting of land measuring 1667 Sq. yards. The Corporate Debtor stopped making payment. A civil suit was also filed by the Corporate Debtor before the Civil Court. A Demand Notice under Section 8 was issued and Application under Section 9 was filed. The Adjudicating Authority admitted the Application against which order, the Appeal was filed by the suspended Director of the Corporate Debtor. The three Member Bench of National Company Law Appellate Tribunal held that:
Section 5(20) of the Insolvency and Bankruptcy Code (IBC) defines an operational creditor as someone owed an operational debt, including those to whom such debt has been legally assigned or transferred. Section 5(21) defines operational debt as a claim related to the provision of goods or services, including employment, or a debt arising under any law payable to the government or local authority. Thus, operational debt primarily involves claims related to goods, services, or statutory dues.
If a claim doesn’t fit within these categories, it cannot be classified as an operational debt, regardless of any liability owed by the corporate debtor to the creditor. The rationale for limiting CIRP initiation to operational creditors, alongside financial creditors, is grounded in the understanding that default on operational debts signifies a severe financial strain, affecting day-to-day operations, and indicating insolvency.
While the law doesn’t define goods or services explicitly, the BLRC report sheds light on operational creditors, mentioning employees, rental obligations, utilities payments, and trade credit. It suggests treating lessors/landlords as operational creditors due to monthly rent obligations. However, the legislature only includes claims related to goods and services in the definition of operational creditor and debt under Section 5(20) and 5(21) of the Code, thus, the definition does not give scope to the to interpret unpaid lease rent as operational debt.
Further, In the case of Promila Taneja vs. Surendri Design Pvt. Ltd.[4], the National Company Law Appellate Tribunal (NCLAT) examined the interpretation of certain provisions within the Insolvency and Bankruptcy Code (IBC) and their application to lease liabilities.
Firstly, the NCLAT highlighted that while the IBC allows for the direct import of defined terms from certain Acts, such as the Consumer Protection Act, 2019 and the Central Goods and Services Tax Act, 2017, those Acts were not explicitly covered under Section 3(37) of the IBC. Therefore, definitions from these Acts, such as those of “service” and “activities,” could not simply be applied in the context of the IBC.
Secondly, the court noted the definition of “Financial Debt” under Section 5(8)(d) of the IBC, which includes liabilities arising from leases deemed as finance or capital leases under Indian Accounting Standards. The court observed that the legislature had made specific provisions to classify certain types of leases as financial debts but had not made similar provisions for lease rents under operational debts. Consequently, the court concluded that lease rents could not be categorized as operational debts under the IBC.
The NCLAT upheld its previous decision in the matter of Mr. M. Ravindranath Reddy vs. Mr. G. Kishan & Ors., finding no fault with the impugned order. This case underscores the importance of statutory interpretation and legislative intent in determining the classification of debts under the IBC, particularly in relation to lease liabilities.
Conflicting Opinion of National Company Law Appellate Tribunal
The case of Anup Sushil Dubey Vs. National Agriculture Co-operative Marketing Federation of India Ltd. and Ors[5] emphasizes the importance of understanding legislative intent and context while interpreting statutory definitions. It highlights the discrepancy between recommendations and legislative adoption regarding the treatment of lessors/landlords as operational creditors and underscores the narrow scope of the definition of operational debt within the IBC.
The NCLAT in this case laid down criteria for proving a debt as an operational debt under the Insolvency and Bankruptcy Code (IBC), which includes:
(a) Claim related to provisions for goods and services,
(b) Employment or debt regarding dues, and
(c) Repayment of dues arising under any applicable law.
To understand these criteria, the relevant definitions from the IBC are enumerated:
- Section 3(6) defines “claim” broadly as a right to payment or remedy for breach of contract under any applicable law.
- Section 3(11) defines “debt” as a liability or obligation arising from a claim, including financial and operational debts.
- Section 3(12) defines “default” as non-payment of debt when due.
- Section 5(20) defines an “operational creditor” as a person to whom an operational debt is owed, including legally assigned or transferred debts.
- Section 5(21) defines “operational debt” as a claim related to the provision of goods or services, including employment, or a debt arising from dues payable to the government.
The law has not gone into defining goods or services – hence, one has to rely on general usage of the terms so used in the law, with due regard to the context in which the same has been used. Simultaneously, it is also relevant to understand the intention of the lawmakers. The Bankruptcy Law Reforms Committee (BLRC), in its report dated November 2015, indicates “the lessor, that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease”. Hence, the BLRC recommends the treatment of lessors/landlords as Operational Creditors. However, in the definition adopted by the Legislature only claims relating to ‘Goods and Services’ were included within the definition and purview of ‘Operational Debt’.[6]
SC Appeal Amid Conflicting NCLAT Decisions on Rent as Operational Debt
In a series of conflicting rulings, the National Company Law Appellate Tribunal (NCLAT) has sparked debate over whether unpaid rent should be categorized as operational debt under Section 5(21) of the Insolvency and Bankruptcy Code 2016. This discord prompted an appeal before the Supreme Court of India in the case of Promila Taneja versus Surendri Design Pvt. Ltd[7]. Ms. Anjoo Jain, the learned counsel representing the appellant, highlights the divergence in NCLAT decisions. Notably, the case of M Ravindranath Reddy v Mr G Kishan & Ors (17 January 2020) concluded that dues related to lease and license of immovable property do not constitute operational debt. Conversely, in Anup Sushil Dubey v National Agriculture Co-operative Marketing Federation of India Limited & Ors (7 October 2020), the NCLAT held that rent arrears from such leases do indeed qualify as operational debt. The appeal before the Supreme Court questions whether the failure to pay rent falls under the definition of operational debt, particularly considering the inclusion of both rent arrears and damages for breach of contract in the present case. This legal ambiguity has significant implications for stakeholders involved in insolvency proceedings, making clarity from the highest court essential to ensure consistency and predictability in the application of the Insolvency and Bankruptcy Code.
Operational Debt Classification for Lease Dues: Lingering Ambiguity
In the Jaipur Trade Expocentre Pvt. Ltd. v. Metro Jet Airways Training Pvt. Ltd[8]. case, a full-bench of the National Company Law Appellate Tribunal (NCLAT) established that dues related to the lease and license of immovable property are classified as ‘operational debt’ under Section 5(21) of the Insolvency & Bankruptcy Code, 2016 (IBC). This ruling contradicted the earlier decision in M Ravindranath Reddy v. G Kishan [9], where the NCLAT had deemed such dues not to be ‘operational debt’. The Jaipur Trade case’s significance is heightened by an ongoing Supreme Court appeal against the decision in Promila Taneja v. Surendri Design Pvt. Ltd.,[10] aiming to address the validity of the Ravindranath ruling.
The appellant entered into a License Agreement with the respondent, granting them use of premises for running an Educational Establishment from June 1, 2017, for an initial five-year period, at a monthly lump sum of Rs. 4,00,000 plus taxes. Despite initial partial payments, subsequent cheques totalling Rs. 40,00,000 were dishonoured. The appellant sent a Demand Notice under Section 8 of the Insolvency and Bankruptcy Code, 2016 (IBC) for total dues of Rs. 1,31,20,788, but received no response. The respondent initiated civil proceedings after the notice. The Adjudicating Authority dismissed the Section 9 Application, stating that the claim does not constitute unpaid operational debt as it pertains to the grant of a license for immovable property. The Operational Creditor filed an appeal against this decision.
The 5-judge bench in this case addressed two questions referred to it by a three-member bench through an order dated 09.03.2022:
- Whether the judgment of this Tribunal in the case of ‘Mr. M. Ravindranath Reddy vs. Mr. G. Kishan & Ors.’ Lays down correct Law?
- Whether claim of the Licensor for payment of License Fee for use and occupation of immovable premises for commercial purposes is a claim of ‘Operational Debt’ within the meaning of Section 5(21) of the Code.
The Tribunal examined a previous judgment, specifically the three-member bench decision in Mr. M. Ravindranath Reddy Vs. Mr. G. Kishan & Ors[11]., the corporate debtor had granted a license for industrial premises, but stopped making payments, leading to civil litigation. The Tribunal, in that case, determined that since the lessor had filed a petition to realize enhanced lease rent, it did not fall within the definition of ‘operational debt’ under Section 5(21) of the Insolvency & Bankruptcy Code (IBC). The Tribunal emphasized that any debt arising without a direct nexus to the corporate debtor’s operations cannot be considered operational debt.
Further, the Tribunal analysed its judgment in Promila Taneja’s case, which followed the Ravindranath precedent which reiterated that reliance on definitions of ‘service’ in other statutes like the Consumer Protection Act, 2019, and the Central Goods and Services Tax Act, 2017, was not relevant to determine operational debt under the IBC.
Holding the decision of Promila Taneja’s case wrong, the tribunal noted that when an agreement explicitly includes payment of GST for services covered by the agreement, the definition of ‘service’ in the Central Goods and Services Tax Act, 2017 becomes relevant. Additionally, it emphasized that even when a term isn’t defined in the statute, its meaning in common usage should be considered to understand its purpose and significance. This marked a departure from its previous stance in the Promila case, showing a more liberal interpretation of section 3(37) of the IBC. The NCLAT emphasized considering the general understanding of terms when they’re not explicitly defined in the statute to ascertain their meaning and intent.
The Tribunal held that rent dues from a leasehold property, as in the Ravindranath and Promila Taneja cases, do not constitute operational debt was not correct and it failed to adequately address the definition of ‘service’ under Section 5(21) of the IBC.
Following the judgements of Jaipur Trade’s Case, the NCLAT in the cases of Smartworks Coworking Spaces Private Limited Vs. Turbot HQ India Private Limited[12] and Hotel Horizon Private Limited Vs. PCK Corporation LLP[13] held that that license fees falling under ‘Operational Debt’.
Conclusion
The interpretation and application of the Insolvency and Bankruptcy Code (IBC) regarding lease liabilities remain contentious, as evidenced by ongoing legal deliberations. While certain rulings, such as Anup Sushil Dubey[14] advocate for considering lessors/landlords as operational creditors due to monthly rent obligations, the legislative framework of the IBC confines the definition of operational debt to claims related strictly to goods and services.
Moreover, the Jaipur Trade Expocentre Pvt. Ltd. v. Metro Jet Airways Training Pvt. Ltd. case[15], which established lease-related dues as ‘operational debt’ under Section 5(21) of the IBC, stands in contrast to earlier judgments like M. Ravindranath Reddy v. G. Kishan and Promila Taneja[16]. The latter ruling considered that lease rents could not be categorized as ‘operational debts’ under the IBC.
The uncertainty surrounding these interpretations has prompted an appeal to the Supreme Court. This ongoing appeal underscores the need for clarity on the classification of lease liabilities under the IBC. Until resolved, this issue remains open-ended, leaving room for further legal interpretation and clarification.
References:
[1] Bankruptcy Law Reforms Committee, Final Report, Para 5.2.1
[3] M. Ravindranath Reddy vs. G. Kishan and Ors. (17.01.2020 – NCLAT) : (2019) ibclaw.in 517 NCLAT
[4] Promila Taneja vs. Surendri Design Pvt. Ltd. (10.11.2020 – NCLAT) : (2020) ibclaw.in 428 NCLAT
[5]Anup Sushil Dubey vs. National Agriculture Co-operative Marketing Federation of India Ltd. and Ors. (07.10.2020 – NCLAT) : (2020) ibclaw.in 293 NCLAT
[6]Anup Sushil Dubey vs. National Agriculture Co-operative Marketing Federation of India Ltd. and Ors. (07.10.2020 – NCLAT) : (2020) ibclaw.in 293 NCLAT, Para 16
[7] Promila Taneja v. Surendri Design (P) Ltd., (2021) ibclaw.in 02 SC
[8] Jaipur Trade Expocentre Private Limited Vs. Metro Jet Airways Training Private Limited, (2022) ibclaw.in 209 NCLAT
[9] M. Ravindranath Reddy vs. G. Kishan and Ors. (17.01.2020 – NCLAT) : (2020) ibclaw.in 95 NCLAT
[10] Promila Taneja v. Surendri Design (P) Ltd., 2021 (2021) ibclaw.in 02 SC
[11] M. Ravindranath Reddy vs. G. Kishan and Ors. (17.01.2020 – NCLAT) : (2019) ibclaw.in 517 NCLAT
[12] Smartworks Coworking Spaces Private Limited Vs. Turbot HQ India Private Limited, (2023) ibclaw.in 329 NCLAT
[13] Hotel Horizon Private Limited Vs. PCK Corporation LLP, MANU/NC/3418/2023
[14] Anup Sushil Dubey vs. National Agriculture Co-operative Marketing Federation of India Ltd. and Ors. (07.10.2020 – NCLAT) : (2020) ibclaw.in 293 NCLAT
[15] Jaipur Trade Expocentre Private Limited Vs. Metro Jet Airways Training Private Limited, (2022) ibclaw.in 209 NCLAT
[16] M. Ravindranath Reddy vs. G. Kishan and Ors. (17.01.2020 – NCLAT) : (2019) ibclaw.in 517 NCLAT
