The conundrum arising from claiming the status as ‘financial creditor’ of a corporate debtor reached Supreme Court, challenging the confirmation of such status by the National Company Law Appellate Tribunal (NCLAT). While deliberating upon the issue and before confirming the judgment of NCLAT, the Hon’ble Supreme Court found the occasion to refer to and interpret inter-alia the definition of the term ‘financial debt’ prescribed under Section 5(8) of the Insolvency and Bankruptcy Code (IBC), among other provisions thereof. Interestingly, the status of claimant as a ‘financial creditor’ was identified against advancing an interest bearing security deposit to the corporate debtor, that too under a contract, wherein the claimant was required to provide services to the corporate debtor.

Factual matrix of the case sets out that pursuant to the underlying contract, the claimant was appointed as ‘Sales Promoter’ to promote the beer manufactured by the corporate debtor. As per conditions of the contract the claimant was required to deposit a substantial amount of security deposit carrying interest @21% per annum. As against providing of ‘Sales Promoter’ services, the contract contemplated only a monthly payment of Rs. 4,000/- (Rupees Four Thousand). No commission was payable against the sales. Eventually the banker of the corporate debtor initiated CIRP against it, leading to appointment of Resolution Professional (RP) and submission of claims by the creditors. The claimant herein submitted claims as ‘financial creditor’ claiming refund of security deposit with interest, which was rejected by the RP construing the status of claimant as ‘operational creditor’. The agitation before NCLT under Section 60(5) was also rejected, against which appeal was filed before NCLAT, which was allowed. Thus SLP came to be filed before Supreme Court.

While deliberating on the issues, the Supreme Court referred to the meaning of ‘debt’ defined under Subsection (11) of Section 3, and the meaning of ‘claim’ defined under Subsection (6) of Section 3 of IBC, to interpret and hold that there cannot be a ‘debt’ within the meaning of Section 3(11) unless there is a ‘claim’ within the meaning of Section 3(6). Pertinently, the nature of a ‘debt’ has to be identified against the ‘claim’ made for such ‘debt’. Deliberating on the nature of debt involved in the case, it was found that the contract did not provide for forfeiture of the security deposit, leading to the conclusion that corporate debtor was liable to refund the same with interest. It was thus held that since the security deposit had no correlation with any other clause of the contract, the security deposit amount represents ‘debt’ covered under Section 3(11) of IBC, because, the right to seek a refund of the security deposit with interest is a ‘claim’ within the meaning of Section 3(6) of IBC.

In this backdrop, the Supreme Court referred to the definition of ‘financial debt’ prescribed under Subsection (8) of Section 5, as well as clauses (a) to (i) thereof, to interpret and hold that the cases covered by the categories (a) to (i) of Subsection (8) must satisfy the test laid down by the parent provision of Subsection (8) of Section 5, i.e. financial debt means a ‘debt’ alongwith interest, if any, ‘disbursed’ against the ‘consideration for time value of money’. In that context, the Supreme Court referred to its previous Judgment rendered in the case of [Phoenix ARC Pvt. Ltd.], to note the meaning of ‘disbursement’ as “the act of paying out money”, meaning thereby, “the money is now no longer with the lender, but is with the borrower, who then utilizes the money”. Further as regards the expression ‘time value of money’ the Supreme Court noted the interpretation 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 of a discount in the payment.”

While being conscious of inclusive definition of the term ‘financial debt’ under Section 5(8), the Supreme Court noted that Clause (f) of Section 5(8) provides for two conditions, i.e. the transaction does not fall within the preceding Clauses (a) to (e) and further that the transaction has the ‘commercial effect’ of ‘borrowing’. In that context, the Supreme Court noted from another judgment in the case of [Pioneer Urban Land and Infrastructure Ltd.], the interpretation of the term ‘borrowing’ and ‘commercial effect’, as appearing in clause (f) of Subsection (8) of Section 5 of IBC, wherein the dictionary meaning of the term ‘borrow’ was taken note of as “to obtain or receive something, such as money on loan for temporary use, intending to give it or something equivalent back to the lender”. The term ‘commercial’ was noted to mean as “having profit as the main aim”. It was thus interpreted that even though the ‘borrowing’ may be a loan of money for temporary use, it does not necessarily imply that “transaction must culminate in money being given back to the lender”. The expression ‘borrow’ was held to be so expansive as to cover the advance given by a homebuyer to real estate developer for being used in the construction of project, so long as it is contemplated in the agreement to give “something equivalent” to money (like flat/apartment) back to the homebuyer. Further, the builder as well as the homebuyer were held to have commercial interest in the project.

In the facts of the case, the attempt to categorize the security deposit amount as ‘operational debt’ was found as erroneous. In that context while referring to the definition of ‘operational debt’ within the meaning of Section 5(21), the expression “a claim in respect of the provision of goods of services” was taken specific note of. It was observed that in a case of contract of service, there must be correlation between the ‘services agreed to be provided’ and the ‘claim’. It was accordingly, held that the only ‘claim’ under the contract which can be identified against the ‘provision of services’ under the contract, is the claim of Rs. 4,000/- per month, and therefore, the ‘claim’ of refund of security deposit with interest was denied to be an ‘operational debt’ by any stretch of imagination.

Against this backdrop, the transaction of deposit of security was held to fall within Clause (f) of Section 5(8), as it fulfilled the requisite conditions; the first condition being, the transaction is not covered within the preceding Clauses (a) to (e). In that context the definition of the word ‘Transaction’ as appearing in section 3(33) was referred, as including an agreement or arrangement in writing for transfer of assets, funds, goods, etc. from or to the corporate debtor. The same was held to be fulfilled in the present case, as confirmed from the written agreement contemplating for transfer of funds to the corporate debtor. As regards the second condition, regarding the transaction being in the nature of commercial effect of borrowing, the fulfilment of the same reflected from the contract, as well as the financial statement of corporate debtor, which had categorized the security deposit as ‘other long term liabilities’ and also recorded the payment of interest on the said amount of deposit. It was thus held that the security amount raised under the contract had the commercial effect of borrowing.

This judicial pronouncement of Supreme Court, has reconfirmed the interpretations of various provisions of IBC concerning the status of ‘financial creditor’, and provides clarity and guidance, particularly while assessing and categorizing the claims by the Resolution Professionals. This Judgment may also serve as a guiding light to the adjudication of the heap of pending litigations, agitating similar decisions of Resolution Professionals, and help in early disposal of cases lined up before Adjudicating Authorities. It may not, however, be ignored that this judgment may lead to increase in the claims seeking status of ‘financial creditor’ and consequent disputes arising from such claims.