Recently, on July 26, 2021, a Division Bench of the Supreme Court pronounced a judgement1 upholding that interest free loans would fall under the definition of 'financial debt' as defined under section 5(8) of the Insolvency and Bankruptcy Code, 2016 (IBC).
Facts leading to Supreme Court's decision
M/s Sameer Sales Private Limited (Original Lender), advanced a term loan of INR 1.60 crores to its sister concern, M/s Samtex Desinz Pvt. Ltd. (Corporate Debtor) for a period of two years for working capital requirement. The Original Lender assigned the outstanding loan to M/S Orator Marketing Pvt. Ltd. (Appellant).
The Appellant filed an application under section 7 of IBC for initiation of corporate insolvency resolution process (CIRP) against the Corporate Debtor. The adjudicating authority (AA) rejected the section 7 application vide its order dated February 1, 2020. While rejecting the application, the AA held that neither the loan agreement has any provision regarding the payment of interest nor there is any supporting evidence/document to establish applicable rate of interest to be paid on the said loan. Also, that the Appellant failed to prove that the loan was disbursed against consideration for time value of money, particularly when it has been affirmed that no interest has been paid and was not payable at any point of time. For this, the AA relied on the appellate tribunal's decision of Dr. B.V.S. Lakshmi vs. Geometrix Laser Solutions Private Limited2.
Further, the AA relied on the decision of appellate tribunal in the case of Shreyans Realtors Private Limited & Anr. vs. Saroj Realtors & Developers Private Limited,3 to observe that when corporate debtor never accepts the component of interest and has given no undertaking to repay the loan with interest, then such debt cannot be termed as 'financial debt' under section 5(8) of IBC.
Being aggrieved by the order of the AA, the Appellant preferred an appeal before the appellate tribunal. In appeal, the order of AA was confirmed, and accordingly, the appeal was dismissed. Against the said order of appellate tribunal, the Appellant preferred appeal before the Apex Court.
Apex Court's Order
Apex Court referred to the definition of 'financial debt' as contained in section 5(8) of IBC to observe that the same cannot be read in isolation, without considering other relevant definitions. It then proceeded to discuss the definitions of 'claim' in section 3(6), 'corporate debtor' in section 3(8), 'creditor' in section 3(10), 'debt' in section 3(11), 'default' in section 3(12), 'financial creditor' in section 5(7) and, provisions of sections 6 and 7 of the IBC.
Section 5(8) defines 'financial debt' to mean 'a debt along with interest, if any, which is disbursed against the consideration of the time value of money and includes money borrowed against the payment of interest'. Basis the same, the Apex Court observed that the orders of AA and appellate tribunal are flawed as they have overlooked the words 'if any', which the legislature, could not have intended to be otiose.
Apex Court proceeded to observe that 'financial debt' means outstanding principal due in respect of a loan and would also include interest thereon, if any interest were payable thereon. If there is no interest payable on the loan, only the outstanding principal would qualify as a 'financial debt'.
Also, the court observed that both the appellate tribunal and AA have failed to notice clause(f) of section 5(8), which provides that 'financial debt' includes any amount raised under any other transaction, having the commercial effect of borrowing.
Apex Court also referred to the decision of Pioneer Urban Land and Infrastructure Ltd. Vs. Union of India,4where it was held that even individuals who were debenture holders and fixed deposit holders, are financial creditors who could initiate the CIRP.
Basis the aforesaid observations, the Apex Court held that 'money borrowed against payment of interest' is one type of financial debt, among various kinds of financial debt as enumerated under section 5(8)(a) to section 5(8)(i) of IBC. Also, that the definition of 'financial debt' in section 5(8) of the IBC does not expressly exclude an interest free loan. Hence, the Apex Court held that 'financial debt' would have to be construed to include interest free loans advanced to finance the business operations of a corporate body.
This decision is solely based on the interpretation of term 'if any' as contained alongside 'interest' in the definition of 'financial debt' under section 5(8). However, the phrase 'time value of money' was not discussed. Essentially, this phrase assumes that money, for what it is worth today, would be more in future. Therefore, the question remains as to what constitutes 'time value of money' in an interest free loan. The Apex Court's decision has not elaborated on this aspect.
1. M/s Orator Marketing Private Limited vs. M/s Samtex Desinz Private Limited, Civil Appeal No. 2231/2021
2. Company Appeal (AT) (Insolvency) No. 38 of 2017
3. Company Appeal (AT) (Insolvency) No.311 of 2018
4. (2019) 8 SCC 416
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