The National Company Law Appellate Tribunal, Principal Bench, New Delhi (“NCLAT”), in its judgement dated January 11, 2024, in the matter of Sainik Industries Private Limited v. Ritesh Raghunath Mahajan, Resolution Professional, Indian Sugar Manufacturing Company Limited [Company Appeal (AT) (Insolvency) No. 1614 of 2023], has held that the security of refund of the advance amount cannot change the nature of the transaction into a financial debt.

Facts

Indian Sugar Manufacturing Company Limited (“Corporate Debtor”) was engaged in the business of manufacturing and sale of sugar. Sainik Industries Private Limited (“Appellant”) and the Corporate Debtor entered into an agreement dated July 28, 2016, towards the supply of 5200 M.T. of white crystal sugar to the Appellant (“Supply Agreement”). Pursuant to the Supply Agreement, the Appellant advanced an amount of INR 10 Crores to the Corporate Debtor. As per the Supply Agreement, a penalty was to be imposed in the event Corporate Debtor failed to deliver the entire/part quantity of sugar, and contemplated giving security cheques towards refund of the advance amount paid by the Appellant.

Upon the Corporate Debtor’s failure to meet its obligations under the Supply Agreement, the Appellant issued a legal notice dated January 31, 2017, calling upon the Corporate Debtor to pay applicable interest and damages. The Corporate Debtor having failed to deliver sugar as well as making payment of applicable interest prompted the Appellant to deposit the security cheques towards refund of the advance amount. However, the security cheques were dishonoured, and consequently, the Appellant initiated proceedings under Section 138 (Dishonour of cheque for insufficiency, etc., of funds in the account) of the Negotiable Instruments Act, 1881, against the Corporate Debtor.

The Appellant also filed a petition seeking initiation of corporate insolvency resolution process (“CIRP”) against the Corporate Debtor under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”). Further, the Appellant also filed a commercial suit seeking grant of money decree of an admitted amount of INR 19,55,30,723/-, after which a summary judgement was awarded on January 12, 2023 for an amount of INR 3,75,35,765/-.

CIRP was initiated against the Corporate Debtor by virtue of an application filed by Saisidha Sugar Equipments and Engineering Company Private Limited under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of IBC, by way of an order dated March 23, 2023 (“CIRP Order”), passed by the National Company Law Tribunal, Mumbai Bench (“NCLT”). On June 1, 2023, the Appellant submitted its claim to the interim resolution professional, classifying its debt of INR 34,65,36,490/- as a financial debt. Mr. Ritesh Raghunath Mahajan (“Respondent”), the resolution professional of the Corporate Debtor, rejected the claim of the Appellant and categorised the claim as an operational debt, vide his e-mail dated June 5, 2023.

Aggrieved by the same, the Appellant filed an interlocutory application before the NCLT to direct the Respondent to accept the Appellant’s claim as a financial debt. However the same was rejected by the NCLT, vide its order dated October 17, 2023 (“Impugned Order”). Further, the Appellant’s petition filed under Section 9 of IBC was also dismissed by the NCLT as infructuous since CIRP against the Corporate Debtor had already commenced by the CIRP Order.

Owing to the above, the Appellant filed an appeal before the NCLAT challenging the Impugned Order.

Issue

Whether security of refund of advance amount can change the nature of the transaction from an operational debt into a financial debt.

Arguments

Contentions of the Appellant:

The Appellant submitted that the NCLT had committed an error in appreciating the real nature of the transaction between the Appellant and the Corporate Debtor and had erroneously held that the claim of the Appellant was an operational debt, while the terms and conditions of the Supply Agreement made it clear that the claim was in fact a financial debt.

The Appellant contended that the judgement 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 Consortium Case”), relied upon by the NCLT, was not applicable to the facts of the present case, since the Consolidated Consortium Case only related to advance money given by the creditor as an operational debt. Further, the specific terms and conditions as laid down in the Supply Agreement were absent in the Consolidated Consortium Case.

In order to support its arguments, the Appellant relied on the judgement of the SC in the case of Pioneer Urban Land and Infrastructure Limited and Another v. Union of India and Others [(2019) 8 SCC 416] (“Pioneer Urban Case”), wherein the SC had laid down the test for establishing a financial debt, which in the Appellant’s view, was applicable to the facts of the present case.

Contentions of the Respondent:

The Respondent contended that the transaction between the Appellant and the Corporate Debtor was a transaction for the supply of sugar and the debt arising out of such a transaction was clearly an operational debt within the definition of ‘operational debt’ under Section 5(21) (Definition of ‘operational debt’) of IBC.

The Respondent submitted that the Appellant itself had filed a petition under Section 9 of IBC claiming its operational debt, which was thereafter dismissed by the NCLT as infructuous. Hence, the Appellant could not be allowed to change its stand and contend that the debt arising from the transaction was a financial debt, since the terms and conditions of the Supply Agreement clearly indicated that the nature of the transaction was that of the supply of goods and services. Besides, the provision in the Supply Agreement to give security was not uncommon even in cases of supply of goods and services. Merely because security was given to the Appellant by the Corporate Debtor, it could not lead to a conclusion that the transaction amounted to a financial debt.

Observations of the NCLAT

The NCLAT examined the definition of ‘operational debt’ under Section 5(21) of IBC and observed that any claim in respect of the provision of goods or services would fall within the said definition. The NCLAT observed that the Supply Agreement clearly indicated that the Appellant and the Corporate Debtor had entered into an agreement for the sale and delivery of 5200 M.T. of white crystal sugar. The NCLAT further observed that in the Consolidated Consortium Case, the SC had considered the provisions of Section 5(21) of IBC and held that the expression ‘in respect of’ in Section 5(21) of IBC ought to be interpreted in a broad and purposive manner in order to include all those who provided or received operational services from a corporate debtor, ultimately leading to operational debts.

In NCLAT’s view, the Consolidated Consortium Case was squarely applicable to the facts of the instant case, since in that case an advance was given for carrying out the supply of goods, the project was subsequently cancelled and a claim for return of advance was laid in the said context. A similar question as to whether an advance payment was an operational debt or not arose in the said case and the SC had ruled that the advance constituted an operational debt.

The NCLAT analysed the clauses set out in the Supply Agreement and observed that the provision providing for penalty in case of failure or refusal to deliver the sugar was not uncommon in an agreement of supply and that the existence of such a clause would not mean that the Appellant’s claim would constitute a ‘financial debt’. Moreover, the clauses of the Supply Agreement relied upon by the Appellant in no manner reflected that the transaction between the Appellant and the Corporate Debtor was a financial transaction, and that the debt due was in the nature of a financial debt.

The NCLAT observed that the Appellant while filing an application under Section 9 of IBC claiming its operational debt indicated that the Appellant considered itself as an operational creditor. Thus, the conduct of the Appellant fully supported the stand taken by the Respondent that the Appellant’s claim was an operational debt.

Decision of the NCLAT

The NCLAT found that no error had been committed by the NCLT in rejecting the interlocutory application filed by the Appellant, and that the Appellant’s claim had rightly been held as an operational debt. Hence, the NCLAT dismissed the appeal filed by the Appellant.

VA View:

The NCLAT has rightly observed that none of the clauses in the Supply Agreement reflected that the deal between the parties was a financial transaction and that the debt due to the Appellant was a financial debt. Besides, the Appellant filing an application under Section 9 of IBC, claiming its operational debt, indicated that the Appellant considered itself as an operational creditor and not a financial creditor.

Through this judgement, the NCLAT has emphasized that the debt arising out of a transaction for the supply of goods and services is an operational debt within the definition of ‘operational debt’ under Section 5(21) of IBC. The provision in an agreement providing for penalty in case of failure or refusal to deliver goods is not uncommon in an agreement of supply and that the existence of such a clause had no bearing on the nature of the transaction.

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

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