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FINANCIAL DEBT - Insolvency and Bankruptcy Code

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FINANCIAL DEBT - Insolvency and Bankruptcy Code
May 15, 2018
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Section 3(11) of the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short) defines the term ‘debt’ as a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.  Thus according to this definition a debt is a liability in respect of a claim which is due from any person.  The debt is of two types- operational debt and financial debt.

Financial debt

Section 5(8) of the code defines the expression ‘financial debt’ as a debt along with interest, if any, which is disbursed against the consideration for the time value of money.  The financial debt also includes the following-

(a) money borrowed against payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its de-materialized equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital issue under the Indian Accounting Standards or such other accounting standards as may be prescribed;

(e) receivables sold or discounted other than any receivables sold on non-recourse basis;

(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;

(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or a financial institution;

(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to (a) to (h).

The definition has an inclusive clause.  Therefore the list enumerated above which are to be included are not exhaustive.    The phrase ‘disbursed against the consideration for the time value of money’ has been the subject of interpretation in a handful of cases under the Code.  The expression ‘time value’ has been interpreted to mean 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.

Financial creditor

Section 5(7) defines the expression ‘financial creditor’ as any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

Claim in an insolvency resolution process

The Adjudicating Authority admits an application filed by a financial creditor or operational creditor or the corporate applicant initiating corporate insolvency resolution process as per the prescribed procedure contained in the code, rules and regulations.  On admission of the application the Adjudicating Authority appoints an interim resolution professional who will take the management and control of the corporate debtor and call for claims from the creditors.  The interim resolution professional will constitute a Committee of Creditors in which financial creditors will find place.  The voting is granted according to the share of the claim.

After the receipt of claims the interim resolution professional will categorize the claim as financial debt, operational debt and other claims.  Disputes arose as to this categorization.  In this article some case laws are discussed.

Commitment charges – a financial debt

In ‘Nikhil Mehta & Sons V. AMK Infrastructure Limited’- 2017 (8) TMI 1017 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, NEW DELHI the appellate tribunal fond that the agreement shows  that the respondent agreed to complete the construction of shopping mall on or before December 2009, in all respects and was required to complete and handover the shop in the shopping mall before the said date.  It was agreed upon by the respondent that since the appellants paid most of the amount the respondent was ready to pay ‘monthly committed returns’ to the appellants.  However as the appellants were not required the monthly return till December 2008, i.e., till 9 months so the respondent corporate debtor undertook to make a consolidated payment of ₹ 99,600 less TDS.  For every calendar month the corporate debtor was liable to pay committed return with effect from January 2009 till the date of handing over the possession to the appellants.  Therefore it is clear that the amount disbursed by the appellants was ‘against the consideration of the time value of the money and the respondent corporate debtor raised by the amount by way of sale purchase agreement having a commercial right of borrowing.  The financial cost includes interest of loans and other charges.  Therefore the commitment charges which include interest on loan, showing against the head ‘financial cost’ having accepted by the corporate debtor in their annual return, the Appellate Tribunal held that the appellants have successfully proved that they are ‘financial creditor’ within the meaning of section 5(7) of the Code.  The Appellate Tribunal set aside the impugned order of the Adjudicating Authority which held that it s a pure and simple agreement of sale and purchase of a piece of property and has not acquired the status of financial debt as the transaction does not have the time value of money.  The Appellate Tribunal remanded the matter to the Adjudicating Authority directing to admit the application preferred by the appellants and pass appropriate order, if the application under section 7 is otherwise complete.  In case it is found to be not complete, the appellants should be given seven days’ time to complete the application as per proviso to Section 7 of the Code.

Cost for development of exploration block – a financial debt

In re ‘Gujarat State Petroleum Corporation Limited’ – 2018 (1) TMI 125 - NATIONAL COMPANY LAW TRIBUNAL, ALLAHABAD, the applicant company and the corporate debtor were jointly engaged under a joint operating agreement in an exploration project and payment required to be made in it by the corporate debtor towards the cost of development was actually paid by the applicant company on behalf of the corporate debtor, but the latter had failed to repay the same.  The resolution professional classified the claim as operational debt and put the applicant as operational creditor.  The main grievance of the applicant is that its debts have not been classified as financial debt by the interim resolution professional.   The prayer of the applicant is to treat the applicant as a financial creditor to the corporate debtor and to include it as a member of Committee of Creditors of the corporate debtor company.  In case the applicant is not allowed, then it would have to suffer a grave and irreparable loss and injury.

The Adjudicating Authority held that it is strange to note that while the claim of the present applicant as a financial debts and financial creditor is not accepted by the resolution professional but on the other hand, a member of the suspended management of the corporate debtor is very well participating in such meetings.  The Adjudicating Authority is of the view that the present transaction which relate to a cash fall within the definition of commercial effect of borrowing coming under the definition of section 5(8)(f) and (h)  of the Code.  The Adjudicating Authority held that the present applicant deserves to be treated as a financial creditor and its claim of expense incurred by it fall within the ambit and scope of a financial debt having commercial effect of borrowing.   Hence it is entitled to be included in the Committee of Creditors as a financial creditor.  However the ratio of its voting share can be decided by the Committee of Creditors by taking into consideration the actual amount incurred by the corporate debtor but excluding the interest component and other miscellaneous expenses.

Home-buyers – financial creditors?

The Government constituted a committee terms as ‘Insolvency Law Committee’ to make consolidated reports on the insolvency law for its efficient functioning.  The Committee submitted its reports to the Government.  In their report the committee considers the financial debt as one of the subject.  The Committee’s attention was drawn to the significant confusion regarding the status of the buyers of under construction apartments as creditors under the code.  Multiple judgments have categorized them as neither fitting within the definition of ‘financial creditor’ nor ‘operational creditor’.

Non inclusion of home buyers in any of the categories may be cause for worry since it deprives them the right to initiate corporate insolvency resolution process and the right to be on the Committee of creditors and the guarantee of receiving at least the liquidation value under the resolution plan.

The Committee agreed that the amounts raised under home buyer contracts are a significant amount, which contributes to the financing of construction of an asset in the future.  The disbursement of money is made in relation to a future asset and the contracts usually span a period of 4 to 5 years or more.  The Committee deliberated that the amount so raised are used as a means of financing the real estate project and are thus in effect a tool for raising finance, and on failure of the project, the money is repaid based on time value of money.   On a plain reading of section 5(8)(f) of the Code, it is clear that it is a residuary entry to cover debt transactions not covered under any other entry, and the essence of the entry is that ‘amount should have been raised under a transaction having the commercial effect of a borrowing.  Further the amount of money given by home buyers as advances for their purchase is usually very high and frequent delays in delivery of possession, may have a huge impact.    Moreover the general practice is that these contracts are structured unilaterally by construction companies with little or no say of the home buyers.  A denial of the right of a class of creditors based on the technalities within a contract that such other creditor may not have had the power to negotiate, may not be the spirit of the Code.

The Committee concludes that the current definition of ‘financial debt’ is sufficient to include the amounts raised from home buyers under a real estate project and they are to be treated as financial creditors under the Code.  It may be prudent to explicitly clarify that such creditors fall within the definition of financial creditor, by inserting an explanation to section 5(8)(f) of the Code.


By: Mr. M. GOVINDARAJAN - May 15, 2018



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