The National Company Law Appellate Tribunal, New Delhi (“NCLAT”), in its judgement dated May 6, 2024, in the matter of Sanam Fashion and Design Exchange Limited v. Ktex Nonwovens Private Limited [Company Appeal (AT) (Ins.) No. 1234 of 2023], has held that a debt arising out of an advance paid towards the supply of goods or services would constitute an operational debt in terms of Section 5(21) (Definition of operational debt) of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

Sanam Fashion and Design Exchange Limited (“Appellant”) had placed an order for the supply of 10 tons of non-woven fabric by issuing a purchase order dated March 16, 2020 (“PO”) on Ktex Nonwovens Private Limited (“Respondent”). Upon sharing the PO for execution by the Respondent, the Appellant immediately issued a debit advice to its bank in India for crediting an amount of USD 200,000 (“Advance Payment”) in the Respondent’s bank account.

In terms of the PO and the invoice raised by the Respondent on the Appellant (“Invoice”), the goods were supposed to be delivered to the Appellant on March 19, 2020. However, owing to the outbreak of the Covid-19 pandemic, the export of materials from India was banned. After the lifting of the Covid-19 ban, e-mails were exchanged between the parties in relation to the supply, terms of delivery, refund of the Advance Payment and other related issues. Thereafter, the Appellant issued a demand notice under Section 8 (Insolvency resolution by operational creditor) of IBC (“Demand Notice”), demanding the repayment of the Advance Amount from the Respondent. However, the Respondent failed to respond to the Demand Notice.

Consequently, the Appellant filed a petition under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of IBC (“Section 9 Petition”), before the National Company Law Tribunal, Ahmedabad Bench (“NCLT”) for initiation of corporate insolvency resolution process (“CIRP”) against the Respondent.

In its Section 9 Petition, the Appellant iterated that as per the contract, the goods were supposed to be delivered at its office in Hong Kong, however, the Respondent had made available the goods for pick up at its plant situated at Rajkot, India. Hence, the goods never reached the Appellant.

The NCLT, vide its order dated August 10, 2023 (“Impugned Order”), rejected the Section 9 Petition filed by the Appellant, since in NCLT’s view, the Appellant had merely made an Advance Payment to the Respondent, which would not get covered under the definition of an ‘operational debt’ under Section 5(21) of IBC. Further, the terms of delivery of the goods under the Invoice was ‘Ex-Plant Rajkot’, however the Appellant had failed to pick up the said goods from the Respondent’s Rajkot plant.

Aggrieved by the Impugned Order, the Appellant filed the present appeal before the NCLAT.

Issues

Whether the Appellant is an operational creditor under IBC.

Whether there existed a breach of terms and conditions of the contract leading to a pre-existing dispute between the Appellant and the Respondent.

Arguments

Contentions of the Appellant:

The Appellant submitted that the finding of NCLT that the Advance Payment was not to be treated as an operational debt under Section 5(21) of IBC was erroneous. To support its submission, the Appellant relied on the judgment of the Hon’ble Supreme Court (“SC”) in the case of Consolidated Construction Consortium Limited v. Hitro Energy Solutions Private Limited [(2022) 7 SCC 164] (“Consolidated Construction Case”) wherein the SC had clarified that the definition of operational debt encompasses an amount paid in advance for the purchase of goods and services.

The Appellant relied on an e-mail dated March 14, 2020, received from the Respondent wherein the Respondent had confirmed the terms of delivery along with other relevant details, and contended that it was not the duty of the Appellant to lift the goods from the Respondent’s Rajkot plant.

The Appellant further submitted that a conjoint reading of the said e-mail and the PO made it evident that the Appellant was to receive the goods from the Respondent at Hong Kong, and that the NCLT had wrongly interpreted the words ‘Ex-plant Rajkot’ as appearing in the Invoice to mean that the goods were to be picked by the Appellant from the Rajkot plant of the Respondent.

The Appellant further submitted that the Respondent did not raise any dispute against the Demand Notice issued by the Appellant, and that the Respondent had sent the e-mail dated April 18, 2023, as an afterthought levelling allegations against the Appellant on its inability to pick up the goods from the Respondent’s Rajkot plant. Moreover, the NCLT had overlooked the fact that the goods were not even manufactured by March 19, 2020, which should have been a sufficient ground for the Respondent to refund the Advance Payment to the Appellant.

The Appellant contended that its Section 9 Petition was dismissed by the NCLT on the very first day, without affording it a reasonable opportunity of being heard, and hence, the Impugned Order violated the principles of natural justice.

Contentions of the Respondent:

The Respondent submitted that as per the Invoice, the terms of delivery of the goods was ‘Ex-Plant Rajkot’, which was prima facie evidence that the Respondent was required to prepare and keep the goods ready for collection by the Appellant from the Respondent’s Rajkot plant.

The Respondent further submitted that it had duly manufactured the goods, prepared the consignment, and informed the Appellant about the same. This established the Respondent’s willingness to fulfil its obligations under the PO.

The Respondent contended that while the Appellant had successfully collected the goods of the second consignment after the Covid-19 ban was lifted, it had intentionally failed to pick the first lot which reflected the Appellant’s wilful failure in fulfilling its contractual obligations. The Respondent further submitted that it was under the belief that the Appellant would collect the goods from the Rajkot plant, and hence continued to store the goods for a period of 3 years as evidenced in the e-mails exchanged between the parties from March, 2020 onwards.

The Respondent submitted that the NCLT had passed the Impugned Order in its favour after duly considering the material on record, since the Appellant had failed to bring forth any evidence to prove that the parties had in fact agreed to deliver the goods in Hong Kong.

The Respondent contended that the Appellant was conveniently trying to shift its burden onto the Respondent, as a means to escape its liability and was misusing the provisions of IBC as a recovery mechanism to extract undue and unjust amounts from the Respondent, despite the lack of compliance on their part.

Observations of the NCLAT

With respect to the issue on whether the Appellant was to be considered as an operational creditor under IBC, the NCLAT observed that in the Consolidated Construction Case relied upon by the Appellant, the SC had opined that when the appellant encashed a cheque for advance payment for the supply of light fittings despite the contract being subsequently terminated, such encashment gave rise to an operational debt in favour of the appellant, and the appellant was considered to be an operational creditor under IBC.

In NCLAT’s view, the Consolidated Construction Case squarely applied to the facts of the present case as there was a clear nexus between the Advance Payment made by the Appellant and the supply of goods and services.

While deliberating on the issue on whether there existed a breach of the terms and conditions of the contract leading to a pre-existing dispute, the NCLAT observed that from the documents submitted on record, it was clear that the delivery was to be made at the Respondent’s Rajkot plant, and not at Hong Kong as claimed by the Appellant. The NCLAT observed that the Respondent on the other hand had informed the Appellant of the readiness of the goods and had requested the Appellant to pick up the goods from Respondent’s Rajkot plant after the lifting of the Covid-19 ban. These events reflected a pre-existing contractual dispute between the parties, which the Appellant was trying to settle through the IBC mechanism.

The NCLAT relied on the judgement of the SC in the case of Mobilox Innovations Private Limited v. Kirusa Software Private Limited [(2018) 1 SCC 353] (“Mobilox Innovations Case”), wherein the SC had held that once a notice is received by a corporate debtor under Section 8(2) of IBC, it is enough to prove that a dispute is pending and it is not necessary that a suit/arbitration should also be pending. The SC while pronouncing its judgment in the Mobilox Innovations Case, relied on another judgement of the SC in the case of Kay Bouvet Engineering Limited v. Overseas Infrastructure Alliance (India) Private Limited [(2021) 10 SCC 483] wherein it was held that one of the objects of IBC qua operational debts (which debts are usually smaller than financial debts) is to ensure that the amount of such operational debts do not enable the operational creditors to put the corporate debtor into CIRP prematurely or initiate the process for extraneous considerations.

Decision of the NCLAT

In view of the above, the NCLAT held that the Appellant would be considered as an operational creditor under IBC, since an ‘operational debt’ would include a debt arising from a contract in relation to the supply of goods or services from the Respondent.

Further, since a pre-existing dispute already existed between the Appellant and the Respondent, the Section 9 Petition filed by the Appellant could not be admitted, and accordingly, the NCLAT dismissed the petition filed by the Appellant.

VA View:

The NCLAT has rightly relied on the Consolidated Construction Case and provided much needed clarity on the scope of ‘operational debt’, by including a debt which arises out of an advance payment made to a corporate debtor for the supply of goods or services within the ambit of ‘operational debt’ under the framework of IBC.

The definition of ‘operational debt’ contained in IBC means a claim in respect of the provision of goods or services. Hence, the operative requirement is that the claim must bear some nexus with the provision of goods or services. In the instant case, since there was a clear nexus between the Advance Payment made by the Appellant and the supply of goods and services, the NCLAT has rightly categorized the Appellant as an operational creditor of the Respondent.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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