India: Are Receivers Of Goods And Services, Operational Creditors?

Last Updated: 24 June 2019
Article by Divyata Badiani and Akash Chandra Jauhari

Introduction

Since 2016, the commercial industry of India witnessed a drastic change in relation to debts and outstanding thereof, through the lens of the Insolvency and Bankruptcy Code, 2016 ("IBC or Code"). Debtors saw insolvency proceedings commenced against them by their creditors to recover the dues and reorganization of the debtors, in an apparent time-bound manner. Corporate Insolvency Resolution Process ("CIRP") under Chapter II Part II of the Code can be initiated only by creditors of two types of debts i.e., (i) financial debts (Section 5(8) of the Code) and (ii) operational debts (Section 5(21) of the Code). The financial debt consists of, in a crust, a type of lending and borrowing scenario covering the requirement of payment of interest and repayment as per the scheduled terms. Further, the definition of financial debt is inclusive in nature and also illustrates certain specific types of financial debts.[2] In contrast, the definition of operational debt is exhaustive in nature to mean inter alia a claim in respect of the provision of goods or services including employment.

Pursuant to the enforcement of the Code, we have seen several attempts by different types of creditors to categorize themselves either as a financial creditor or an operational creditor in order to exercise the right to initiate CIRP against the Corporate Debtor (as set out below). One such attempt was made by a creditor in Overseas Infrastructure Alliance (India) Pvt. Ltd vs Kay Bouvet Engineering Ltd. Company Appeal (AT) (Insolvency) No. 582 of 2018 dated 21.12.2018 (NCLAT) (unreported)[3] ("Overseas Infrastructure"), wherein NCLAT proceeded to settle the status of a creditor who has advanced certain sums of money to a corporate debtor under a contract for the provision of services as an operational creditor.[4] The instant short note discusses the outcome of the aforesaid decision and analyses its implication on the interpretation of the phrase "operational debts" and "operational creditor".

The Decision

Fact

Overseas Infrastructure Alliance (India) Pvt Ltd ("Overseas/Appellant") was awarded an engineering construction contract by one Mashkour Sugar Mills, Sudan ("Mushkour") for a sugar plant in the state of Sudan ("Project"). The Project was to be financed under the Government of India's line of credit through Export-Import Bank of India ("Exim Bank") in two tranches. Kay Bouvet Engineering Ltd ("Corporate Debtor") was appointed as sub-contractor thereof. Thereafter, the parties entered into a tripartite agreement whereby Overseas subcontracted the whole of the works in relation to the Project to the Corporate Debtor. In furtherance of the same, Overseas/Appellant advanced a sum equivalent to 10% of the contract value to the Corporate Debtor as advance payment. However, since Exim Bank did not release the second tranche of the payment, Mushkour terminated the contract with the Overseas/Appellant. Consequently, the tripartite agreement came to an end. Overseas/Appellant demanded the refund of the sums advanced to the Corporate Debtor under the tripartite agreement. Subsequently, the Overseas/Appellant sought to initiate insolvency proceedings against the Corporate Debtor for the refund of the advance paid pursuant to the tripartite agreement.

Findings

Initially, NCLT dismissed the application filed by Overseas/Appellant citing that there was an existence of a dispute; however, it did not address the issue whether non-refund of the amounts paid by Overseas/Appellant as the advance amount in terms of the tripartite agreement would give rise to a claim in respect of goods and services. On an appeal, NCLAT set aside the order of the NCLT and held that there was no existing dispute in relation to the debt owed to the Overseas/Appellant. Further, it was held that "the Appellant (Overseas) having advanced 10% of the contract value to Respondent - sub-contractors (Corporate Debtor) as advance payment has a claim in respect of provision of goods or services bringing him within the definition of 'Operational Creditor', to whom an 'Operational Debt' was owed by the Respondent -'Corporate Debtor'. While examining the definition of the terms 'operational debt' and 'operational creditors' under the Code, NCLAT observed that the tripartite agreement was one which provided for the supply of goods and rendering of services and the claim of the Overseas/Appellant was one which was in respect of goods and services. Accordingly, the amount advanced by Overseas/Appellant was in the nature of advance payments in respect of the provision of goods and services and falling within the ambit of the "Operational Debt".

Textual Analysis

Overseas Infrastructure concludes that refund for the advance paid as consideration for the goods and services will fall within the definition of the Operational Debt and a person claiming the same will be an Operational Creditor. In order to appreciate the aforesaid findings, it will be relevant to analyze the definitions of Operational Debt and Operational Creditor.

As per Section 5 (20) of the Code, Operational Creditor inter alia is a person to whom an operational debt is owed. In order to fall under the category of Operational Creditor, firstly, the debt owed should be an Operational Debt and secondly, such operational debt should be owed to that person i.e. the liability of the corporate debtor to pay should arise pursuant to the Operational Debt.

Accordingly, "Operational Debt" is defined under Section 5 (21) of the Code to mean "a claim in respect of the provision of goods or services including employment or a debt in respect of the payment 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". The aforesaid definition can be divided into essentially two parts being (i) a claim in respect of provisions of goods and services including employment and (ii) a debt in respect of the payment 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. The instant short note is confined to the scope of the former part.

In Section 5 (21) of the Code the phrase "provision of goods and services" is preceded by the phrase "in respect of", which may result in two possible interpretations. Firstly, the phrase "in respect of" may be interpreted narrowly to mean a monetary claim of the provider of goods or services to the Corporate Debtor ("narrow interpretation"). Secondly, the phrase "in respect of" may be interpreted widely to include any claim arising out of or in relation to the contract for the provision of goods and services i.e. even the claim of the person in receipt of the goods or services ("wide interpretation"). Clearly, NCLAT in Overseas Infrastructure applied the latter interpretation of the definition of Operational Debt.

As highlighted above phrase "in respect of" is followed by the phrase "provision of goods and services". The Oxford Dictionary of English, Ed. 2017 defines the word "provision" as the action of providing or supplying something for use. It may be noted that the use of the phrase "provision of" in place of "contract for" or "agreement for" suggests that the Code covers the action of providing or supplying goods and services and any debt arising out of or pursuant to the said action. Further, a wide interpretation might have been more acceptable had phrases like "contract for" or "agreement for" were used in place of "provision of".

Further, as per Section 8 and 9 of the Code, an application by the Operational Creditor for initiation of CIRP ought to be rejected where there is a dispute in existence. "Dispute" is defined under Section 5(6) of the Code as - "dispute" includes a suit or arbitration proceedings relating to – (a) the existence of the amount of debt; (b) the quality of goods or services; or (c) the breach of a representation or warranty. Though the definition of "dispute" is inclusive in nature[5], it is interesting to note that the three illustrations of "dispute" provided in the Code are mostly disputes raised by the receiver of goods and services and not the provider.

In contrast to the definition of "Operational Debt", Section 5(8) of the Code defines the phrase "Financial Debt" as a debt along with interest, if any, which is disbursed against the consideration for the time value of money. Unlike the definition of Operational Debt, the creditor-debtor relationship is clearly visible, as the debt owed to the creditor is debt disbursed against the consideration for the time value of money. Therefore, there is no scope in the definition of "Financial Debt" to include the debt due to the person to whom the money/capital was disbursed for consideration of the time value of money.

Guidance from external aids

The Code was enacted pursuant to the report of the Bankruptcy Law Reform Committee, November 2015 ("BLRC"). The scope of the phrases "Operational Debt" or "Operational Creditor" is explained in the BLRC Report in the following manner:

"

4.3.3 Information about the liabilities of a solvent entity

...

Liabilities fall into two broad sets: liabilities based on financial contracts, and liabilities based on operational contracts. ... Operational contracts typically involve an exchange of goods and services for cash. For an enterprise, the latter includes payables for purchase of raw-materials, other inputs or services, taxation and statutory liabilities, and wages and benefits to employees.

...

5.2.1 Who can trigger the IRP?

...

Here, the Code differentiates between financial creditors and operational creditors. Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or a debt security. Operational creditors are those whose liability from the entity comes from a transaction on operations. Thus, the wholesale vendor of spare parts whose spark plugs are kept in inventory by the car mechanic and who gets paid only after the spark plugs are sold is an operational creditor. Similarly, 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.

...

Box 5.2 – Trigger of IRP

...

The Code differentiates two categories of creditors: financial creditors where the liability to the debtor arises from a solely financial transaction, and operational creditors where the liability to the debtor arises in the form of future payments in exchange for goods or services already delivered."

Further, in this regard, it is also relevant to Notes on Clauses annexed to the Bill -

"Clause 6 provides that where a corporate debtor has defaulted in paying a debt that has become due and payable but not repaid, the corporate insolvency resolution process under Part II may be initiated in respect of such corporate debtor by a financial creditor, an operational creditor or the corporate debtor itself.

...

Additionally, operational creditors (i.e., creditors to whom a sum of money is owed for the provision of goods or services or the Central/State Government or local authorities in respect of payments due to them) are also permitted to initiate the insolvency resolution process."

The aforementioned extracts suggest that the BRLC Report proceeded on the basis of a narrow interpretation of the definition of Operational Debt and the same was also reflected in the notes on clauses.

Lessons Learned from the Home-Buyers Controversy

The initial days of the Code saw an adamant struggle by different types of home-buyers of the real estate projects to categorize their debt as financial debt or operational debt. Their struggle ended with the enactment of the IBC (Second Amendment) Act, 2016, wherein the definition of "financial debt" was suitably amended[6]. Amidst this struggle, few failed attempts were made by certain home-buyers to categorize their debts as Operational Debt.[7]

It may be noted that the term "services" is not defined under the Code. Taking a cue from the definition of the term "service" provided under Section 2(1) (o) of the Consumer Protection Act, 1986, it can be inferred that it includes provision of facilities in connection with the housing construction. Pursuant to it, the real-estate developers are service providers to the home-buyers. Therefore, applying the wide interpretation adopted by NCLAT in Overseas Infrastructure, the debt owed to the home-buyers would fall under the definition of "Operational Debt", as it will include the refund of advance/money paid for receiving services from the real-estate developers. In this light, it becomes necessary to appreciate the findings of the NCLTs, the NCLAT and the Supreme Court of India on the question whether the debt owed to the home-buyers are "Operational Debt"

In Sajive Kanwar v. AMR Infrastructure C.P. No. 06/2017 dated 16.02.2017 (unreported) (NCLT-Principal Bench), the petitioning creditor was a home-buyer, and the default was due to delay in completion of the real-estate project and failure to pay assured returns. The NCLT-Principal Bench held that the petition cannot be treated as the one under Section 9 of the Code. It was inter alia observed that the expression "Operational Debt" must fulfil following substantive elements namely: (a) Debt arising out of provisions of goods; (b) services; or (c) out of employment. It was also observed that it is doubtful whether it would include all debts other than 'Financial Debt' because there is no such legislative intent from Part II of IBC.

The aforesaid findings were affirmed by the NCLT-Principal Bench in Col. Vinod Awasthy v. AMR Infrastructure Ltd. C.P No. (IB)-10(PB)/2017 dated 20.02.2017 (unreported) (NCLT-Principal Bench). It was reiterated that in order to fall under the definition of "Operational Debt" the debt has to arise out of the provision of goods or services. The Tribunal also noted that the refund sought to be recovered is necessarily associated with the delivery of the possession of immovable property which has been delayed. It was held that the petitioner, in this case, has neither supplied any goods nor has rendered any service to acquire the status of the "Operational Creditor". Given the time line of the Code, it is not possible to construe Section 9 read with Section 5(20) & (21) of the Code so widely to include within its scope even the cases, where dues are on account of advance made to purchase the flat or a commercial site from a construction company like the Respondent in the present case especially when the Petitioner has remedies available under the Consumer Protection Act, 1986 and the general law of the land.

Further, in Pawan Dubey v. J.B.K. Developers Pvt. Ltd. C.P. No. (IB) – 19 (PB)/2017 dated 31.03.2017 (unreported) (NCLT-Principal Bench) dealing with a similar fact situation the NCLT relied on its decision in Col. Vinod Awasthy v. AMR Infrastructure Ltd. and dismissed the petition filed under Section 9 of the Code. On appeal, NCLAT[8] declined to interfere with the order of the NCLT. NCLAT held that the Appellant was not Operational Creditors. The decision of the NCLAT was upheld by the Supreme Court in Pawan Dubey v. J.B.K. Developers Private Ltd. Civil Appeal No. 11197 of 2017 dated 15.09.2017 (unreported) (Supreme Court of India) wherein it was held that "we agree with the view taken by the NCLAT that refund of money paid along with interest thereon arising out of cancellation of allotment of a flat will not be subsumed in the definition of "operational debt" under the IBC, 2016".

Similarly, in Satish Mittal v. Ozone Builders & Developers Pvt. Ltd. Company Appeal (AT) (Insolvency) No. 75 of 2017 dated 13.07.2017 (unreported) (NCLAT) the question before the NCLAT was whether a home-buyer claiming a refund of the deposited amount can initiate CIRP under Section 9 of the Code.[9] NCLAT did not categorize it as operational debt as admittedly the claim was inter alia not made in respect of goods, no services were rendered. Also, the claim did not arise under any law for the time being in force and was merely based on the receipt.

It can be reasonably concluded that the NCLT, the NCLAT and the Supreme Court of India leaned in favour of the narrow interpretation. It is worth mentioning that the home-buyers struggle for categorizing their debt as operational debt faded with early recognition of the same as financial debt by the Judiciary[10] and the Legislature. This conclusion might not have been the case had there been a more continuous and adamant attempt for categorizing the home-buyers debt as operational debt.

Conclusion

Gauging the contours of the above discussion it is evident that NCLAT in Overseas Infrastructure has broadened the scope of the phrase "Operational Debt" to include within its ambit the advance paid in receipt of goods and services. NCLAT in Overseas Infrastructure has adopted a wide interpretation and not limited it to the monetary claim of the provider of the goods or services.

Further, the approach reflected in the BLRC Report, the notes on clauses and the lesson learnt from the home-buyers controversy points is towards acceptance of the narrow interpretation to the definition of debt. The textual analysis of the phrase "provision of" and the definition of the word "dispute" suggests a narrow interpretation. Also, it appears that such a narrow interpretation was adopted by the decision of the Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India Writ Petition (Civil) No. 99 of 2018 dated 25.01.2019 (unreported) (Supreme Court of India) wherein the Supreme Court upheld the constitutional validity of the Code. The Supreme Court while highlighting the intelligible differentia between the Financial Creditor and the Operational Creditor, observed that:

"27. ... Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with Operational Creditors are relatable to supply of goods and services in the operation of business.... Operational debts also tend to be recurring in nature and the possibility of genuine disputes in case of operational debts is much higher when compared to financial debts. A simple example will suffice. Goods that are supplied may be substandard. Services that are provided may be substandard. Goods may not have been supplied at all. All these qua operational debts are matters to be proved in arbitration or in the courts of law."

"44. ...operational creditors, who provide goods and services, are involved only in recovering amounts that are paid for such goods and services, and are typically unable to assess viability and feasibility of business. The BLRC Report, already quoted above, makes this abundantly clear"

However, a comparison of the language used in the definition "Operational Debt" and "Financial Debt" suggests that wide interpretation is intended to be applied to the definition of "Operational Debt". In an ideal scenario, payment/repayment of money by the provider of goods and services will only occur in the case of non-performance of the parties to the contract for goods and services. The narrow interpretation takes into account the ideal scenario where the contract for goods and services is performed. On the other hand, the wide interpretation covers an exception i.e. a situation of non-performance of the contract of goods and services. Therefore, it might be that the definition of "Operational Debt" was drafted and enacted in the background of the ideal scenario, but the language adopted by the Legislature brings the exception within its ambit.

In view of the above discussion, it will be interesting to see how the Courts and Tribunals in India will respond tothis development in the field of Insolvency Law.

The opinion expressed in this short note are those of the authors for academic purposes, and they do not reflect, in any way, opinion of the institutions to which they are affiliated.

[2] Wadhwa Law Chambers, Guide to Insolvency and Bankruptcy Code, First Edition 2019, at page 91.

[3] The appeal in the aforementioned matter is pending before the Hon'ble Supreme Court of India.

[4] See also M/s Nupower Renewables Pvt. Ltd. v. Cape Infrastructure Pvt. Ltd. TCP/3(IB)/CB/2017 dated 07.07.2017 (NCLT-Chennai) wherein the creditor paid advance amount to the corporate debtor for development of wind-power project. The corporate debtor did not perform the services as agreed. The corporate debtor agreed to refund the sum, but failed to make payment as promised. Thereafter, the creditor took steps under the Code and an application was filed under Section 9 of the Code. The main issue before NCLT was whether creditor is an "Operational Creditor" as provided under Section 5(20) of the Code. NCLT held that: "The definition of "Operational Debt" refers to claim in respect of the provisions of goods and services or dues arising under any law. Therefore, we have to construe the term "Operational Debt' with respect to purposive and contextual interpretation. Therefore, the petitioner's claim falls within purview of 'Operational Debt'."

[5] Mobilox Innovations P. Ltd. v. Kirusa Software (P.) Ltd., (2018) 1 SCC 353.

[6] The definition of financial debt was amended to include any amount raised from an allottee under a real estate project shall be deemed to be as amount having the commercial effect of a borrowing.

[7] Wadhwa Law Chambers, Guide to Insolvency and Bankruptcy Code, 1st Edition 2019.

[8] Pawan Dubey v. J.B.K. Developers Pvt. Ltd Company Appeal (AT) (Insolvency) No. 40 of 2017 dated 03.08.2017 (unreported) (NCLAT)

[9] Supreme Court of India in Satish Mittal v. Ozone Builders & Developers Pvt. Ltd. Civil Appeal No. 15440 OF 2017 dated 09.10.2017 dismissed the appeal against NCLAT's decision.

[10] Nikhil Mehta & Sons (HUF) v. AMR Infrastructure Ltd. [2017] 141 CLA 281 wherein NCLAT categorized certain type of home-buyers as financial creditors as the home-buyers were required to pay the total sale consideration upfront and the real-estate developer was required to committed returns till the actual possession was handed over.

Co-Author Name: Akash Chandra Jauhari

Email: acjauhari.12@gmail.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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