Case Laws on Definition and Scope of Financial Debt
Insolvency and Bankruptcy Code, 2016 (the “IBC”) was enacted because the earlier legislation was lopsided and favored the corporate debtors resulting in huge outstanding debts to banks and financial institutions. Say for instance, according to section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985, the protection also extended to the guarantors and therefore, creditors could not proceed against the guarantors if the debtor company was declared ‘sick’ under the said Act. The IBC further facilitates the resolution of corporate bankruptcy in a time-bound manner.
Classification of creditor
Whereas the different laws of bankruptcy and liquidation under Companies Act, 2013 or SARFAESI Act, 2002 merely added the term ‘creditor’ or ‘debt’, without any classification thereof, the IBC has introduced new and distinct concepts of ‘Financial Creditor’ and ‘Operational Creditor‘ where the banks and final institutions come under the 1st category.
Hence, going by the definitions of ‘Financial Creditor’ and ‘Operational Creditor‘ as given in the IBC, the debts also fall into 2 categories. They are ‘financial debt’ and ‘operational debt’. Before proceeding with the appeals under the provisions of the Code, the Tribunal first determines whether the debt falls within the definition of ‘Financial Creditor’ or ‘Operational Creditor’ as provided under the IBC.
Financial Debt and Operational Debt
A ‘financial debt’ has an inclusive and non-exhaustive definition given under Section 5(8) of the IBC to mean “a debt along with interest, if any, which is disbursed against the consideration for the time value of money…”
In other words, financial creditors are the relationship with the entity is a pure financial contract, such as a loan or debt security.
On the other hand an operational debt is defined under section 5(21) of the IBC to mean “a claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority”.
Time Value Of Money
As seen above, the term ‘financial debt’ means debt along with interest, if any, which is disbursed against the compensation for the time value of money. To get the interpretation of ‘financial debt’, it is important to understand the meaning of ‘Time Value of Money’. As per the Black’s Law Dictionary, the ‘Time Value’ means “the price associated with the length of time that an investor must expect until an investment matures or the related income is earned”.
The term was first analyzed in the matter of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd. (AT) (Insolvency) No. 07 of 2017. In this case, the Applicants paid almost the whole amount for the unit and in turn, were promised by the builder to be paid a sum of money on a monthly basis until the ownership of real estate units booked by them was handed over to the applicants. Nevertheless, the applicants filed an insolvency petition against the Corporate Debtor when the latter failed to pay the aforementioned ‘Assured Returns’ as promised under the contract. According to NCLT, the deal in the case was more in the nature of a sale of goods rather than in the nature of debt. On application of this order, the NCLAT considered the sale and purchase agreement between the parties in order to understand the nature of ‘assured returns’. As per the Agreement, on payment of a maximum of the consideration amount by the home buyers, the Corporate Debtor undertook to pay a fixed amount, for every calendar month, till the date of handing over of possession. This, as for the according to NCLAT, was the time value of money against the consideration.
In other words, while Applicants were investors and had fancied a committed return plan, the Corporate Debtor, on the other hand, raised the amount by way of a sale purchase agreement which has the commercial effect of a borrowing. Hence, as per Section 5(8)(f) of IBC, the amount invested by the Applicants fell within the meaning of ‘financial debt’.
Financial Institutions as Operational Creditor
As the description goes, one may wrongly perceive that all the debts/loans extended by a bank or financial institution will fall under the definition of financial debt. Nonetheless, as for the NCLT, the nature of the debt is not decided by the fact as to who is extending the loan. As noted from the cases before the adjudicating authority, it is possible that a financial institution extends a loan, however, is utilized for the business operations. One of the popular banks, Standard Chartered Bank extended financial support to Ruchi Soya Industries Private Limited. Ruchi Soya is currently experiencing insolvency resolution in which the Bank has been categorized as an operational creditor. The company received the amt. of USD 52.5 million from the Standard Chartered Bank to supply the goods to its subsidiary. The said sum was to be recovered by the Bank with interest from the subsidiary of the corporate debtor which it missed to recover and the parent company went into insolvency resolution process. Currently, the Bank has requested the NCLT, Mumbai to permit it to be categorized as financial creditor instead of current status as an operational creditor. It is yet to be seen as to how the adjudicating authority shall decide the said application.
The position of Home Buyers
The IBC as enacted in 2016, did not render clarity on the position and interests of the home buyers. While dealing with cases involving home buyers, the adjudicating authorities considerably looked into whether the contract between the home buyer and the developer provided for payment of ‘assured returns’ to the home buyer until handing over of ownership of the unit. In cases where the home buyer was not entitled to any ‘assured return’ under the purchase agreement and was only begging for a refund on account of failure of the builder to deliver possession of the unit, it was held to be not to be time value of money and thus the claim in these cases could not be termed to be a ‘financial debt’.
The Insolvency and Bankruptcy (Amendment) Ordinance, 2018, which came into power on 06.06.2018, to bring clarity and certainty in the law, brought the home buyers within the purview of financial creditors under the IBC. As a consequence, the amounts raised by the builders from allottees under real estate projects are now statutorily deemed to be amounts “having a commercial effect of a borrowing” and the outstanding to allottees is considered as financial debts.
Henceforth, the allottees being the financial creditors to the builder or the developer in a real estate projects are qualified to be the part of the Committee of Creditors with the respective voting right proportionate to the extent of the financial debt owed.
Another intriguing question is whether the position of a homebuyer who assigned all the rights in favor of a Bank by way of a Supplementary Agreement at the time of taking the loan can be operated as a financial creditor under the IBC. As per the supplementary agreement among the applicant and the corporate debtor, the applicant agreed to invest in the apartment under the housing loan scheme wherever he was liable to pay the pre-EMI interest on the bank loan amount for a period of 24 months from the date of disbursement of the bank loan amount and the corporate debtor had undertaken to pay the entire pre-EMI amount straight to the concerned bank on behalf of the applicant for the period of 24 months from the date of disbursement of the bank loan amt. The three parties further entered into a tripartite agreement. The NCLT, Allahabad in the matter of Ajay Walia v. M/s Sunworld Residency Private Limited CP (IB) 11 ALD/2018 held that the applicant can’t be held to be a financial creditor. It is appropriate to add that even after the changed position post-ordinance, any home buyer who subrogates the rights to a Bank which has lent the loan to the home buyer will not be said to be a financial creditor.