[Diya is a student at NALSAR University of Law.]
India has had a very unstable insolvency law regime where the Insolvency and Bankruptcy Code 2016 (IBC or Code) has provided a breakthrough. Unlike the previously lopsided insolvency laws, IBC has well-distinguished concepts of financial and operational debts, a distinction that carries importance when creditors go for a corporate insolvency resolution process (CIRP). Section 5(7) defines a financial creditor (FC) as “any person to whom a ‘financial debt’ is owed”. Thus, the definition of financial debt holds significance.
Section 5(8) of the IBC defines financial debt as “a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes- (a) money borrowed against the payment of interest…”. The time value of money (TVM) is the most essential element of financial debt and is usually reflected by the interest charged against a loan. In the case of DF Deutsche Forfait AG v. Uttam Galva Steel Limited, the National Company Law Tribunal (NCLT) said that a “transaction is financial (and not operational) if money is lent in contemplation of returns in the form of interest”. However, interest is not the only factor reflecting the TVM. For instance, in the case of Shailesh Sangani v. Joel Cardoso, the National Company Law Appellate Tribunal (NCLAT) held that interest is not the only indicator of financial debt but the only consideration is that a loan should be given “against the time value of money, with or without bearing interest”. Therefore, these rulings give rise to a dilemma about what exactly constitutes the TVM.
Further, the definition of time value in the Black’s Law Dictionary is “the price associated with the length of time that an investor must wait until an investment matures or the related income is earned”. In majority of the cases, the price associated with delayed time is paid in the form of interest. Hence, the recent Supreme Court’s decision in the case of Orator Marketing Private Limited v. Samtex Desinz Private Limited raised eyebrows as it expressly held that interest-free loans can constitute financial debt in case of defaults.
M/s Sameer Sales Private Limited (lender) granted an interest-free loan to its sister company, M/s Samtex Desinz Private Limited (corporate debtor) for a period of two years. The debt was payable to M/s. Orator Marketing Private Limited (FC), a third party, who filed for a CIRP when the loan was defaulted. The contention before the courts was whether a loan given without an interest can be ‘financial debt’ under Section 5(8) of the Code.
The NCLT and the NCLAT dismissed the claim stating that an interest-free loan is not financial debt due to a lack of “consideration for time value for money”. Thus, the petitioners are not FCs and cannot initiate a CIRP.
Observations of the Apex Court
Surprisingly, the Supreme Court reversed the NCLAT judgment and asked the NCLT to revive the petition for CIRP. The court took a contrary view in its landmark ruling giving the following rationale.
In order to understand the overall object and purpose of the Code, the Court looked at the legislative intent behind it. The court cited Innoventive Industries Limited v. ICICI Bank Limited. (Innoventive Industries) where Nariman, J. asserted that default must be interpreted in the widest possible manner as per Section 3(12) of the Code. Reading all definitions and the larger purpose of the code in conjunction with one another, the court concluded that a CIRP can be initiated by an FC whenever there is a debt that has been defaulted, which holds true for the present case.
S.5(8) is Inclusive and Not Exhaustive
The court remarked that the tribunals had misinterpreted the definition of 'financial debt', ignoring the words “if any”. It read the definition in the sense that financial debt is the principal amount due in respect to any loan granted along with interest, if there is any. In case there is no interest payable, the financial debt only amounts to the principal that is due.
Moreover, the court also laid emphasis on the word “includes” in Section 5(8). Citing the Privy Council decision in Dilworth v. Commissioner of Stamps [(1899) AC 99], it opined that when a definition mentions the word “includes”, it is meant to enlarge the scope of definition. It will be exhaustive only when the provision sufficiently indicates otherwise. The court opined that the section is not exhaustive and has a larger scope than what has been previously interpreted.
Comment and Analysis
The Supreme Court looked at the concept of financial debt narrowly. The series of judgments that have come forth with respect to the IBC show that the code is supposed to be read in a unison, meaning that the major scheme of the code must be given importance. However, the judgment is an individualistic interpretation of Section 5(8) of the Code, in the sense that it was only based on a literal, word-by-word reading of the text which forms the core of its critique.
Commercial Effects of Borrowing
The court said that the loan given in this case has “obvious” commercial effects due to it being granted to fulfil commercial requirements. Court’s understanding of the “commercial effects of borrowing” seems vague as the court fails to provide sufficient explanation for the same. The phrase “commercial effects of borrowing” was explained in Pioneer Urban Land and Infrastructure Limited and Another v. Union of India and Others. In that case, the court said that the word “commercial would generally involve transactions having profit as their main aim”. In the present case, the objective was not to earn profit as there was no interest charged against the loan even after the due date of payment expired.
The court justified its reasoning by saying that the profit can be realised in any form and manner. In Kolla Koteswara Rao v. S.K. Srihari Raju, the court observed that since an interest-free loan and a waiver of loan amount leads to a profit for the corporate debtor (CD), it must have the commercial effects of borrowing. The element of profit is largely seen from the perceptive of the creditor who realises it in the form of interest. Considering the lender and the CD were sister companies, it could be argued that the profit could be realised in the form of commercial growth of the debtor company. However, applying this rationale to the present case, the commercial revival of the debtor company would be profitable to the lender as opposed to the FC as both entities are separate in this case. The creditor, in fact, had no incentive in the said transaction, and thus, it is a mere financial aid provided by one party to the other.
Time Value of Money
The court overlooked a primary element of financial debt, the TVM. The Supreme Court has overturned multiple precedents which have asserted that TVM is reflected by the element of interest in a loan transaction. For instance, cases such as Shreyans Realtors v. Saroj Realtors and Narendra Kumar Agarwal v. Monotrone Leasing have time and again asserted that interest-free loans are not financial debt and that interest is the most common indicator of the TVM.
An assertive interpretation of the TVM was given in the case of Nikhil Mehta v. AMR Infrastructure (Nikhil Mehta) where the NCLAT said that “the legislature has included such financial transactions in the definition of 'Financial debt' which are usually for a sum of money received today to be paid for over a period of time in a single or series of payments in future. It may also be a sum of money invested today to be repaid over a period of time in a single or series of instalments to be paid in future”. Paying the time value is a vital element according to Section 5(8) as that factor must be present irrespective of there being an interest. Thus, the rationale of the court in saying that mention of the words “if any” gives a free pass to eliminate the TVM factor, is flawed and superficial. The interpretation of the legislative intent is also very narrow in Orator Marketing as opposed to Nikhil Mehta. In the latter, the interpretation is based on the practical and popular meaning of the phrase “time value” which is monetary value of the time for which the money is borrowed.
A report by the Bankruptcy Law Reform Committee has mentioned that for one to qualify as an FC, his relation with the CD should be purely financial. In the present case, the transaction was not entirely financial as the no-interest clause was added only due to the relation of sister companies between the parties. Further, the court made an analogy with cases like Innoventive Industries and Swiss Ribbons Private Limited and Another v. Union of India and Others noting that debenture holders and fixed deposit holders can also initiate CIRP as FCs. However, the court fails to note that both debentures and fixed deposits have the element of time value present in some or the other form and, therefore, directly fall under the purview of Section 5(8).
The judgment will have massive impact on the future insolvency proceedings in India. This will give rise to excessive claims as the number of unsecured transactions in the country is very high. The reasoning of the court was very narrow, derived by only a bare reading of Section 5(8) in isolation with the Code. This judgment blurs the line between unsecured creditors and large secured financial institutions and banks. Clearly, the latter holds more importance because they give huge amounts of loans for longer periods, non-payment of which can lead to serious loss to the trade and economy. In the author's opinion, this degree difference was ignored by the court while understanding the larger scheme of the code.