The Hon’ble Supreme Court (“H SC”) in the matter of Global Credit Capital Limited & Anr v. Sach Marketing Private Limited & Anr[i] has passed common judgement wherein it has upheld the order of National Company Law Appellate Tribunal which categorized lenders as financial creditors for the purpose of Insolvency & Bankruptcy Code, 2016 (“Code”).

Factual Aspect:

Sach Marketing Private Limited (“SMPL”) has entered into two agreements during the years 2014 and 2015 with Mount Shivalik Industries Limited (“CD”) whereby CD appointed SMPL as a “Sales Promoter” to promote the beer manufactured at its factory for a period of 12 months.

 

  1. Under the terms of the said Agreements, SMPL was liable to deposit certain amounts with the CD as security deposits which were repayable with interest by the CD.
  2. As things stood, Corporate insolvency resolution process was initiated against the CD in the year 2018 and SMPL filed a claim financial creditor claiming security deposit and interest as a “financial debt”.
  3. The Interim Resolution Professional (“IRP”) rejected the claim of SMPL on the grounds that SMPL could not be treated as a financial creditor. Aggrieved by the rejection, SMPL preferred an application before the National Company Law Tribunal (NCLT) seeking a direction to admit its claim of Rs. 1.41 crore as a financial creditor. The NCLT dismissed the said application and SMPL appealed to the NCLAT.
  4. SMPL allowed the appeal by SMPL holding that SMPL was a financial creditor of the CD as a transaction which has the commercial effect of borrowing falls within the definition of “financial debt” under Section 5(8)(f) of Code. As against the categorization, the appeal came to be filed by the successful resolution applicant before the H SC.

Contentions Raised:

  1. It was averred that Agreements were service agreements as CD had appointed SMPL to promote the beer manufactured by it, and this was a service rendered by SMPL, and therefore the amounts paid towards security deposit were liable to be treated as an “operational debt” under Section 5(21) of the Code, and not as a financial debt.
  2. Security Deposit paid by SMPL under the Agreements was merely a condition precedent to be satisfied for its appointment as a “Sales Promoter” of the CD, and that this could not be equated to money disbursed to the CD as a financial debt. Therefore, these amounts would not satisfy the definition of a “financial debt” under Section 5(8) of the Code
  3. Further, it was averred that the amounts paid towards security deposit were acknowledged by the CD in its books, and interest was payable towards the said amounts, would not be sufficient to treat the said amounts as a “financial debt” under the Code.
  4. In response, SMPL contended that the Agreements did not contain any provision for deductions or forfeiture of the security deposits paid by it, and that the amounts paid towards the said deposits, were liable to be repaid with interest.
  5. Therefore, considering the true nature of the Agreements, NCLAT was right to hold the amounts paid towards the security deposit under the Agreements, as a ‘financial debt’, since all three criteria namely (i) disbursal, (ii) time value of money and (iii) commercial effect of a borrowing as specified under Section 5(8) of the IBC were satisfied.

Issue for consideration:

vi. The sole issue for consideration before the H SC was “whether the amounts paid by SMPL to the CD as a security deposit under the Agreements, could be treated as ‘financial debt’ within the meaning of Section 5(8)(f) of the Code”.

vii. Definitions examined: Section 3(6)[ii]; Section 3(11)[iii] and Section 5(8)[iv]. H SC analyzed the definitions of claim and debt and held that a ‘claim’ is a right to receive a payment whether under law, or equity, or arising as a remedy for breach of contract, and a ‘debt’, whether operational, or financial could only arise in respect of a claim under Section 3(6). H SC also examined Section 5(8) of the Code which defined the term ‘financial debt’, holding that the categories enlisted under sub-clauses (a) to (i) of Section 5(8), must satisfy the test of being a debt, along with interest if any, which is disbursed against the consideration for time value of money.

viii. In the above backdrop, H SC clarified that a debt arising out of a written agreement/arrangement providing for rendering of services, would be an operational debt, only if the claim made in respect of the debt, has some connection or nexus with the service rendered under the agreement. The real nature of the transaction would have to be determined, and the agreement could not be taken at face value.

ix. Therefore, merely because the written agreement is an agreement providing for rendering of services, would not always lead to a conclusion that the debt arising out of said agreement was an operational debt.

x. The reading of Agreements in question did not contemplate forfeiture of the security deposit paid by SMPL nor the security deposit was linked to the performance of the other conditions of the Agreements or the service rendered by SMPL under the Agreements.

xi. Therefore, CD was liable to refund the security deposit amount with interest to SMPL without any right of forfeiture, and SMPL’s right to seek a refund of the security deposit would amount to a “claim” within the meaning of Section 3(6) of the Code.

xii. The debt in question would be the amounts paid by SMPL as security deposit which were repayable with interest by the CD and H SC arrived at a conclusion that said amounts could not be said to be an operational debt, since a plain reading of Section 5(21) which defines ‘operational debt’ indicates that it pertains to a claim arising in respect of the provision of goods or services.

xiii. H SC also noted the definition of “transaction” in Section 3(33) of the Code which includes arrangements for transfer of assets, funds, goods from or to the CD. The H SC also discussed to NCLAT’s findings that the amounts paid towards the security deposit had been treated by the CD as long-term loans and advances in its financial statements, and that the CD had informed SMPL that interest would be credited by the CD to Sach’s account.

Conclusion:

xiv. The H SC upheld the order by NCLAT and held that the CD treated the said amounts as borrowings from SMPL, and consequently, SMPL was a financial creditor of the CD as the amounts raised under the two agreements by way of “security deposit” had the commercial effect of borrowing.

Observations

xv. We observe that the first condition of applicability of clause (f) of Section 5(8) of the Code 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).

xvi. 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. Therefore, the condition for the applicability of clause (f) is that the transaction must have the commercial effect of borrowing. The test to determine whether a debt is a financial debt is the existence of a debt along with interest, if any, which is disbursed against the consideration for the time value of money. 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. The H SC applied the said test and arrived at finding that the amounts covered by security deposits under the agreements constitute financial debt.

xvii. The heading clause used in any of the agreements cannot be used as an interpretative tool to the understand the real intent of the agreements.

AUTHOR: RAVI CHARAN PENTAPATI, PARTNER

 

Footnotes

[i]  Civil Appeal No. 1143 OF 2022 & others

[ii] Claim

[iii] Debt

[iv] Financial debt

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