Test To Determine Whether A Debt Is A Financial Debt U/S 5(8) IBC: Supreme Court Explains

The Supreme Court, in a recent judgment, discussed the test to determine whether a debt is a financial debt within the meaning of sub-section (8) of section 5 of the Insolvency and Bankruptcy Code, 2016 (IBC)

The court also held that there cannot be a debt under Section 5(11) unless there is a claim under Section 5(6) of the Code. 

The Court held thus in a batch of civil appeals filed by a company against the judgments and orders of the National Company Law Appellate Tribunal (NCLAT).

The two-Judge Bench of Justice Abhay S. Oka and Justice Pankaj Mithal observed, “Sub-section (21) of Section 5 defines “operational debt”… The second part of the definition which deals with the payment of dues arising under any law, will not apply. However, for the applicability of the first part, the claim must be concerning the provisions of goods or services. Therefore, in the case of a contract of service, there must be a correlation between the service as agreed to be provided under the agreement and the claim. The reason is that the definition uses the phraseology “a claim in respect of the provision of goods or services”. Assuming that both the agreements are genuine in the sense that they reflect the true nature of the transaction, the only claim under the agreements which will have any connection with the services rendered by the first respondent will be the claim of Rs.4,000/- per month as provided in clause (1) of both the agreements. Only this claim can be said to be concerning the provision of services.”

The Bench said that where one party owes a debt to another and when the creditor is claiming under a written agreement/arrangement providing for rendering 'service', the debt is an operational debt only if the claim subject matter of the debt has some connection or co-relation with the ‘service’ subject matter of the transaction.

Senior Advocate Gopal Jain appeared for the appellants while Senior Advocate C.U. Singh appeared for the respondents.

In this case, there were two agreements of 2014 and 2015 between the corporate debtor and the first respondent (Sach Marketing Pvt. Ltd.). The agreements were in the form of letters addressed by the corporate debtor to the respondent company and the corporate debtor appointed the same as a ‘Sales Promoter’ to promote beer manufactured by the corporate debtor for 12 months. One of the conditions incorporated by the corporate debtor in the agreement was that the respondent should deposit a minimum security of Rs. 53,15,000/- @ 21% interest per annum. The terms of the 2015 agreement were identical and the only difference was that under the second one, the corporate debtor was to pay an interest on Rs. 32,85,850/- @ 21% p.a.

The Oriental Bank of Commerce invoked provisions of Section 7 of Insolvency and Bankruptcy Code, 2016 (IBC) against the corporate debtor and the NCLT admitted the application under Section 7 of IBC. It imposed a moratorium under Section 14 IBC and the second respondent was appointed as the Interim Resolution Professional (IRP). During the pendency of application filed by the respondent, the Committee of Creditors (CoC) approved a resolution plan submitted by a company named Kals Distilleries Pvt. Ltd and in 2021, the NCLT rejected the application of the respondent. Being aggrieved, the respondent preferred an appeal before the NCLAT and it was held that the respondent was a financial creditor and not an operational creditor. Hence, the matter was before the Apex Court.

The Supreme Court in view of the above facts noted, “Sub-section (8) of Section 5 of the IBC defines “financial debt” … The definition incorporates the expression “means and includes”. The first part of the definition, which starts with the word “means”, provides that there has to be a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The word “and” appears after the word “money”. Before the words “and includes”, the legislature has not incorporated a comma. After the word “includes”, the legislature has incorporated categories (a) to (i) of financial debts. Hence, the cases covered by categories (a) to (i) must satisfy the test laid down by the earlier part of the sub-section (8).”

The Court added that the test laid down therein is that there has to be a debt along with interest, if any, and it must be disbursed against the consideration for the time value of money.

“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. What is surprising is that for acting as a Sales Promoter of the beer manufactured by a corporate debtor, only a sum of Rs.4,000/- per month was made payable to the first respondent. Apart from the sum of Rs.4,000/- per month, there is no commission payable to the first respondent on the quantity of sales”, it further noted.

The Court said that right of the first respondent to seek a refund of the security deposit with interest is a claim within the meaning of Section 3(6) of the IBC as the first respondent is seeking a right to payment of the deposit amount with interest and therefore, there is no manner of doubt that there is a debt in the form of a security deposit mentioned in the two agreements.

“… by no stretch of imagination, the debt claimed by the first respondent can be an operational debt. We are conscious of the fact that the provision for payment of interest by the corporate debtor by itself is not the only material factor in deciding the nature of the debt. But, in the facts of the case, the payment of the amount mentioned in clause (10) of the letter has no relation with the service supposed to be rendered by the first respondent”, it also held.

The Court observed that the first condition of applicability of clause (f) is that the amount must be raised under any other transaction and any other transaction means a transaction which is not covered by clauses (a) to (e). It added that 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.

“The condition for the applicability of clause (f) is that the transaction must have the commercial effect of borrowing. “Transaction” has been defined in sub-section (33) of Section 3 of the IBC, which includes an agreement or arrangement in writing for the transfer of assets, funds, goods, etc., from or to the corporate debtor. In this case, there is an arrangement in writing for the transfer of funds to the corporate debtor. Therefore, the first condition incorporated in clause (f) is fulfilled”, it said.

The Court enunciated that the amount raised under the two agreements has the commercial effect of borrowing as the corporate debtor treated the said amount as borrowed from the first respondent.

“As it is a financial debt owed by the first respondent, sub-section (7) of Section 5 of the IBC makes the first respondent a financial creditor”, remarked the Court while concurring with the NCLAT’s view.

The Court, therefore, summarized the following legal conclusions:

a. There cannot be a debt within the meaning of sub-section (11) of section 5 of the IB Code unless there is a claim within the meaning of sub-section (6) of section 5 of thereof;

b. The test to determine whether a debt is a financial debt within the meaning of sub-section (8) of section 5 is the existence of a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The cases covered by categories (a) to (i) of sub-section (8) must satisfy the said test laid down by the earlier part of sub-section (8) of section 5;

c. 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; and

d. Where one party owes a debt to another and when the creditor is claiming under a written agreement/ arrangement providing for rendering 'service', the debt is an operational debt only if the claim subject matter of the debt has some connection or co-relation with the ‘service’ subject matter of the transaction.

Accordingly, the Apex Court dismissed the appeals and upheld the judgments of NCLAT.

Cause Title- Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr. (Neutral Citation: 2024 INSC 340)

Appearance:

Appellants: Senior Advocate Gopal Jain and AOR Mithu Jain.

Respondents: Senior Advocate C.U. Singh, Advocates N.P.S. Chawla, Sujoy Datta, Kinjal Goyal, Kashish Chhabra, Bidya Mohan, AOR Ashish Rana, Advocates Abhishek Anand, Mohak Sharma, AOR Karan Batura, Advocates Siddharth Naidu, Anusuya Sadhu Sinha, and AOR M/S. KSN & Co.

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