Supreme Court: Whether a Creditor providing an Interest bearing Security Deposit is a financial creditor under IBC

Supreme Court: Whether a Creditor providing an Interest bearing Security Deposit is a financial creditor under IBC

Corporate Debtor (‘CD’) entered into two Service Agreements with the Creditor and in lieu thereof, CD has taken an interest bearing security deposit from such Creditor. The question before the Hon’ble Supreme Court was whether such arrangement makes the creditor a financial creditor within the provision of the Insolvency & Bankruptcy Code, 2016 (‘IBC’).

PARTIES CONTENTIONS

CD argued that the Creditor is an ‘operational creditor’ under Section 5(21) of IBC as he has entered into the service agreement to provide ‘services’ to CD. Further the money deposited by the Creditor was not towards any financial facilities and therefore, the Creditor is not a financial creditor. Payment of interest cannot be the only criterion for ascertaining whether the debt is a financial debt. It is also contended that security deposit was taken to ensure performance of Agreement and there is not disbursal of debt.

Per contra, as per Creditor, considering the true nature of the Service Agreements the three requirements of financial debt are satisfied i.e., disbursal, time value of money and commercial effect of borrowing which in turn makes the Creditor a Financial Creditor. Reliance is also placed on Section 5(8)(f) which is a residuary provision and defines any transactions having commercial effect of borrowing or fund raising as financial debt.

RELEVANT PROVISIONS

Sub-section (11) of Section 3 of the IBC defines ‘debt’, which reads as under:

“3. In this Code, unless the context otherwise requires,- .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..

(11) “debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt;”

“Claim” is defined under sub-section (6) of Section 3 of the IBC, which reads as under:

“3. In this Code, unless the context otherwise requires,- .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .

(6) “claim” means – (a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured; (b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;”

Sub-section (8) of Section 5 of the IBC defines “financial debt”, which reads as under:

“5. In this Part, unless the context otherwise requires,- .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..

(8) “financial debt” means a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money and includes–

…

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

Sub-section (21) of Section 5 defines “operational debt”, which reads as under:

“5. In this Part, unless the context otherwise requires,- .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..

(21) “operational debt” means 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;”

ANALYSIS

After analyzing the relevant provisions and judicial precedents, the Hon’ble Supreme Court concluded as under:-

• Under the scheme of IBC, there cannot be a ‘debt’ unless there is a ‘claim’;

 

• ‘Financial debt’ and ‘operational debt’ are included in the definition of ‘debt’. Thus, financial debt or operational debt must arise out of a liability or obligation in respect of a ‘claim’.

 

• The test to determine whether a ‘debt’ is a ‘financial debt’ ‘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 Section 5(8) must satisfy the said test.

 

• For ‘debt’ to be ‘financial debt’, the requirement of existence of a debt, which is disbursed against the consideration for the time value of money, is an essential part even if it is not necessarily stated therein.

 

• The words “time value” have 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.

 

• Sub-clause (f) Section 5(8) subsumes within it, amounts raised under transactions which are not necessarily loan transactions, so long as they have the “commercial effect” of a “borrowing”.

 

• “Commercial” would generally involve transactions having profit as their main aim.

 

• 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;

 

• 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.

 

• Provision for payment of interest by itself is not the only material factor in deciding the nature of the debt.

 

CONCLUSION

Applying above position of law on the facts of the case, the Court held as under:-

• Under the Service Agreement, the amount paid as security by the Creditor to the CD has no correlation whatsoever with the performance of services.

 

• Further, there is no clause regarding forfeiture of the security deposit or part thereof, therefore, the CD was liable to refund the security deposit after the period specified therein was over with interest.

 

• Thus, the Creditor has a right to seek a refund of the security deposit with interest. This ‘right’ to seek refund with interest amounts to a ‘claim’ which in turn means that the security deposit is a ‘debt’ under IBC.

 

• For a ‘debt’ to be an ‘operational debt’, 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.

 

• However, under the Service Agreement, the only claim which the Creditor will have any connection with the services rendered will be the claim of Rs.4,000/- per month which is the fixed fee consideration in addition to the security deposit. Since this claim does not concern provision of goods or service, therefore, by no stretch of imagination, the debt of the Creditor can be an operational debt.

 

• Even though the provision for payment of interest by CD 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 Rs.4,000/- per month has no relation with the service supposed to be rendered by the Creditor.

 

• On the contrary, the provision made for interest payment on security deposit shows that it represents consideration for the time value of money. Further, from the financial statements of CD, it is evident that the amount raised under the Service Agreement has the commercial effect of borrowing as CD has treated the said amount as borrowed from the Creditor.

 

Thus, the Court held that the amounts covered by security deposits under the Service Agreements constitute ‘financial debt’ which in turn makes the Creditor in the present case a ‘Financial Creditor’ of CD.