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Between the Lines | NCLAT: Security Deposit and the interest thereon would fall within the ambit of the definition of ‘Financial Debt’ under the IBC November 22, 2021
Published in: Between The Lines
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The National Company Law Appellate Tribunal Principal Bench, New Delhi (“NCLAT”) has in its judgment dated October 07, 2021 (“Judgement”), in the matter of Sach Marketing Private Limited v. Resolution Professional of Mount Shivalik Industries Limited, Ms. Pratibha Khandelwal [Company Appeal (AT) (Insolvency) No. 180 of 2021], held that ‘Security Deposit’ and the interest thereon would fall within the ambit of the definition of ‘Financial Debt’ as defined under Section 5(8)(f) of the Insolvency and Bankruptcy Code, 2016 (“Code”).
Facts
The challenge in this appeal under Section 61 of the Code read with Rule 11 of the National Company Law Appellate Tribunal Rules, 2016, was against the order dated January 18, 2021 (“Impugned Order”) passed by the National Company Law Tribunal, Jaipur Bench, (“NCLT”) wherein the decision of Ms. Pratibha Khandelwal, the resolution professional of Mount Shivalik Industries Limited (“Corporate Debtor”), (the “Resolution Professional”/ “Respondent”) was upheld, that is, she had considered the claim of Sach Marketing Private Limited (the “Appellant”) as an operational debt.
The Corporate Debtor is in the business of manufacturing and distributing beer in India. An agreement dated April 01, 2014, was executed between the Corporate Debtor and the Appellant appointing the Appellant as sales promoter for the promotion of beer for 12 months. Subsequently, after the expiry of the first agreement, on April 01, 2015, another agreement was executed, with similar terms and conditions except for one modification in Clause 10 of the agreement with respect to ‘Security Deposit’ as follows, “You have to deposit minimum security of Rs. 53,15,000/- with the Company which will carry interest at 21% per annum. We will provide you interest of Rs. 23,85,850/- at 21% per annum.”
An amount of Rs. 61,00,850/- was provided by the Appellant in the year 2014. While so, the Corporate Debtor unilaterally adjusted the remaining deposit amount of Rs. 25,00,000/- from the security balance lying in the interest fund account to the Security Deposit during the Financial Year 2015-16 as recorded in its ledgers. On March 31, 2016, the Corporate Debtor admitted the interest liability of Rs. 18,06,000/-. However, the Corporate Debtor failed to pay interest.
The Corporate Debtor was admitted into insolvency on June 12, 2018, and the Appellant filed their claim of Rs. 1,58,341/- as ‘Operational Debt’ and Rs. 1,41,39,410/- as ‘Financial Debt’ including the interest amount. The Resolution Professional addressed an e-mail dated March 18, 2019, stating that the claim for ‘Financial Debt’ has been considered as an ‘Operational Debt’. Aggrieved by the decision of the Resolution Professional, the Appellant preferred an application before the NCLT seeking a direction to quash the unlawful classification and for admitting the claim as ‘Financial Debt’. The NCLT negated the Appellant’s contention and in the Impugned Order observed that the Resolution Professional has rightly considered the claim as ‘Operational Debt’.
Issue
Whether Security Deposit and the interest thereon would fall within the ambit of the definition of ‘Financial Debt’.
Arguments
Contentions raised by the Appellant:
The Appellant argued that the NCLT has failed to appreciate that Section 5(8)(f) of the Code is a ‘residuary’ and ‘catch-all provision’ and would cover all transactions which have the commercial effect of borrowing. Further that as per the Insolvency Law Committee Report of March 2018, any transaction structure as a tool or means for raising finance would be included as ‘Financial Debt’ under Section 5(8)(f) of the Code. The Resolution Professional has no adjudicatory power and the NCLT did not take this aspect into consideration. It was further contended that one has to go into the intent of the parties while interpreting a memorandum of understanding, that the same was given by way of financial assistance attracting interest payable thereon.
It was contended that the amount deposited could not be a mere ‘Security Deposit’ as there were no other transactions between the parties and the money was mandatorily returnable after a fixed tenure without any deduction or forfeiture. It was not a fixed sum. It was argued that the Corporate Debtor has established a practice of securing ‘Financial Debt’ in the garb of ‘Security Deposits’ under various agreements, for attaining financial assistance from private entities instead of getting the same from financial institutions.
Contentions raised by the Respondent:
The Resolution Professional submitted that one of the ‘Financial Creditors’ namely, New View Consultants Private Limited had earlier challenged the decision of the Resolution Professional to include one Mahalakshmi Traders as a ‘Financial Creditor’ by way of an application before the NCLT wherein by order dated September 28, 2018, the NCLT had dismissed the application and observed that, “…sales agency commission and amounts due arising purely out of the agency relationship including the security deposit placed as between the Corporate Debtor and the respondent should be strictly excluded from the purview of ‘financial debt’ ….” (“Order”).
It was submitted that the Order had not been challenged and had since attained finality. Hence the same principle as enumerated in the Order is also applicable to the Appellant herein. Therefore, it was contended that ‘Security Deposit’ does not fall within the definition of Section 5(8) of the Code to be categorised as a ‘Financial Debt’. Further that, as per the agreement executed between the Appellant and the Corporate Debtor, the Appellant was termed as a “C&F Agent”, hired basically for promotion of sale of beer.
Observations of the NCLAT
The NCLAT noted that Clause 10 of the agreement was a conditional clause meaning thereby that only in the event of the Appellantmakingsuchadeposit,hewouldbeappointedasasalespromoter. ThesaidclausestipulatedthattheAppellant should deposit minimum security of Rs. 53,15,000/- with the Corporate Debtor which will carry interest at 21% per annum. Thereafter, though the minimum ‘Security Deposit’ of Rs. 53,15,000/- carrying interest at 21% per annum was retained, the amount against which interest at 21% per annum would be paid by the Corporate Debtor to the Appellant was modified to Rs. 32,85,850/-. The NCLAT further noted that, from the provisions of the agreement, it was clear that the Appellant was required to provide adequate funds to cover the operational and other expenses required for running the depot. Further, it was seen from the said agreement that over and above the interest of Rs. 53,15,000/- a further sum of Rs. 7,85,850/- was also to be provided by the Appellant and interest of 21% per annum would be paid for the said amount. It is significant to mention here that this amount was not even termed as ‘security’ in the agreement dated April 01, 2014.
The NCLAT observed that, for a debt to be termed as ‘Financial Debt’, the basic elements that are to be seen is whether (a) there is disbursal against consideration for the time value of money; and (b) whether it has a commercial effect of borrowing. The definitions provided in Sections 5(7) and 5(8) of the Code provide that a ‘Financial Creditor’ refers to a person to whom ‘Financial Debt’ is owed and includes even a person to whom such debt has been legally assigned or transferred to.
The NCLAT observed that the Legislature has included any financial transaction in the definition of ‘Financial Debt’ which are usually for a sum of money received today, to be paid over a period of time in instalments, or a single payment in future. The NCLAT noted that the expression time value has been defined in Black’s Law Dictionary as “the price associated with the length of time that an investor must wait until an investment matures or the related income is earned”. In the instant case, the word ‘Security Deposit’ mentioned in Clause 10 of the agreement has to be given the correct interpretation. The NCLAT observed that the true effect of the transaction ought to be determined from the terms of the agreement, keeping in view, the facts and circumstances of the case.
The NCLAT observed that, in the instant case, the ‘Sales Promotion Agreement’ mandated a ‘Security Deposit’ carrying interest at 21% per annum. It was not in dispute that the Corporate Debtor did not adhere to the payment of interest and that there was a default. In other words, neither the ‘Debt’ nor the ‘Default’ was disputed. The only question which arose was whether it is an ‘Operational Debt’ or a ‘Financial Debt’. The Appellant had specifically denied securing any ‘stocks’, ‘goods’ or other properties to the Corporate Debtor and was only appointed for the sole purpose of sales promotion of beer.
The NCLAT noted that the financial statement of the Appellant for the financial year 2017-18 shows revenue from interest on the ‘Security Deposit’. The financial statements mention the ‘Security Deposit’ under the head of other financial liabilities alongwith entries such as ‘interest accrued on borrowings’. The NCLAT observed that the said amounts were treated as long term loans and advances in the financial statement of the Corporate Debtor for the financial year 2015-16 and under ‘other long term liabilities’ for the financial year 2016-17. The NCLAT reiterated that the ‘Security Deposit’ amount had admittedly an element of interest payable at 21% per annum and hence could be construed as having commercial effect of borrowing.
The NCLAT noted the fact that amounts were paid with a specific term and tenure as evident from the term loan dated April 01, 2014, and April 01, 2015, which specified the time periods. The Corporate Debtor had accepted the ‘Security Deposit’ from the Appellant and credited the interest for some time against such amounts for the period 2014-15. The NCLAT observed that the payment of interest on the amounts borrowed by the ‘Corporate Debtor’ is nothing but consideration for the time value of money and the interest is being paid to the Appellant for using the money belonging to the Appellant over a period of time. The NCLAT accordingly arrived at the conclusion that the status of Appellant is that of a ‘Financial Creditor’ vis-à-vis the amount of ‘Security Deposit’ as per Section 5(7) read with Section 5(8) of the Code.
Decision of the NCLAT
The NCLAT held that the ‘Security Deposit’ in question is a ‘Financial Debt’. Consequentially this appeal was allowed and the Impugned Order was set aside by the NCLAT.
VA View:
In this Judgement, the NCLAT has rightly analyzed that, any of the transactions specified in Clauses (a) to (i) of Section 5(8) of the Code would fall within the ambit of the definition of ‘Financial Debt’ only in the event if they include the essential elements stated in the principal clause that is an element of disbursal, against the consideration for the time value of money and has the commercial effect of borrowing.
The NCLAT relied upon precedents and observed that the case of a deposit is something more than a mere loan of money. It will depend on the facts of each case whether the transaction is clothed with the character of a deposit of money. The surrounding circumstances, the relationship and character of the transactions and the manner in which parties treated the transactions will throw light on the true form of the transactions. For a person to be defined as a Financial Creditor of the Corporate Debtor, it had to be shown that the Corporate Debtor owed a Financial Debt to such a person.
For more information please write to Mr. Bomi Daruwala at [email protected]
