Refund Of Advance Is Not Operational Debt – The General Proposition & The Anomaly

[By Devansh Rathi]

The author is a student at the Dr Ram Manohar Lohiya National Law University, Lucknow

Introduction –

Since the advent of the Insolvency and Bankruptcy Code of 2016 (“the Code”), the adjudicating and the appellate authority has relied upon and confined itself to the bare text of the Code to interpret the legislature’s intent to disentangle the numerous issues that have arisen. One peculiar concern that has surfaced was whether seeking a refund of an advance given to a corporate debtor would tantamount to an ‘operational debt’ as under Section 5(21) of the Code? The Adjudicating Authorities, in various instances, have answered the same in negative. The issue first arose in SHRM Biotechnologies Pvt. Ltd. v. VAB commercial Pvt. Ltd., where the NCLT held that since the appellant, which invoked section 9 of the Code, was not rendering any goods or services to the debtor, he would not be called an operational creditor. The bench also perused section 5(21) of the Code and carved out three important elements – (i) debt arising out of provision of goods; or (ii) services; or (iii) out of employment. Since the appellant was not falling within the ambit of any of these elements, the bench dismissed the application. Even the NCLT Mumbai in TATA Chemicals Ltd. v. Raj Process Equipments and Systems Pvt. Ltd., while rejecting the application held that the petitioner has not provided any goods/services to the debtor and his claim cannot be called an operational debt. Hence, the Adjudicating Authorities have adhered to the four corners of the definition as inscribed in the Code.

However, the NCLAT in Overseas Infrastructure Alliance (India) Pvt. Ltd. v. Kay Bovet engineering Ltd. (“Kay Bovet”) has taken a different approach when perusing the same issue which happens to be the crux of this writing. The author doesn’t aim to criticize the judgement but to highlight the discrepancy and offer a viable reason of the Appellate Authority behind such a discrepancy.

The Tripartite Agreement in Kay Bovet –

A tripartite agreement was signed between the employer, the contractor (operational creditor/appellant), and the sub-contractor (corporate debtor/respondent). As per the agreement, the Respondent was engaged in designing, engineering, supplying, installing, testing, etc. of factory plant for the employer while Appellant was responsible for all activities pertaining to engineering, procurement and construction as EPC contractor and had to handover the project to the employer upon its completion. In an essence, the contractor was rendering services to the employer while the sub-contractor was rendering the services both to the employer and the contractor, with an objective to fulfil the needs of the employer.

In pursuance of the same, the contractor advanced 10% of the contract value to the sub-contractor. However, due to some reason, the tripartite agreement was terminated and the contractor sought a refund of the amount advanced.

The bench while looking through the terms of the agreement ruled that the agreement provided for the rendering of services and supply of goods and the contractor’s claim was in such respect. Hence, the contractor’s advance payment to the sub-contractor would make him an operational creditor. The bench also refuted the respondent’s claim of a pre-existing dispute which was sub-judice before the Hon’ble High Court.

Analysis –

An operational creditor is someone who supplies a good or renders a service, just like a financial creditor who is granting a financial loan. Even the person who is availing the financial loan won’t be a financial creditor even if due to the terms of the contract, further amounts are to be disbursed as the person who is taking the loan is not doing so for the time value of money or interest. The essential ingredient for an operational creditor is that the debt due to them has to have arisen because they have either given goods or rendered some services. Therefore, in ordinary circumstances, a refund of advanced money would not be an operational debt as the buyer is not owed any amount because he has not supplied any goods or services but the debt is actually due, as for some reason the contract could not be concluded.

However, the NCLAT in Kay Bovet has taken a different stand but it suffers from certain discrepancies. Here, the sub-contractor was rendering services to the employer and the contractor; however, the contractor was not rendering any services to the sub-contractor but only to the employer. In light of the same, if we examine section 5(21) which says – “a claim in respect of the provision of goods and services….” The term ‘in respect of’ should here mean only pertaining to that particular provision of goods or rendering of services to that party and not to any other third person. But as per the facts, the contractor was not providing any goods or services to the sub-contractor. Here the claim of the contractor was pertaining to the provision of goods and services but those goods and services were rendered by the contractor to the employer and not to the sub-contractor.

The stance taken by the NCLAT would have been appropriate if the contractor would have been rendering the services or providing goods to the sub-contractor. The facts of the case are silent on the same as the judgement doesn’t state anything explicitly. To buttress the decision taken by the NCLAT one would have to rely on the implicit logic that the contractor and subcontractor were rendering a service to each other to ultimately fulfil the needs of the employer. The Contractor advanced money to the subcontractor but the Contractor may also have been providing materials, services, etc. The judgment doesn’t reproduce the agreement. Sometimes, in the case of subcontracting, the contract may have provisions such as that certain material to be used for construction will be provided by the main contractor to the subcontractor. In such case, the NCLAT may have felt that the contractor was also to provide goods and services to the subcontractor. Since we don’t have access to the contract in its entirety and since the NCLAT has not explained in detail, it is hard to determine.

Certain judgements rendered by NCLT or NCLAT do not explain in detail the reasoning or do not record a particular argument even though such an argument would have been raised orally in the courtroom regarding a point. It is quite possible that the contract in Kay Bouvet may have provided that certain resources were to be provided by the main contractor to the sub-contractor such as manpower, know-how, materials, etc. However, non-inclusion of those clauses of the contract, if there were any, in the judgement rendered by the NCLAT has led to the confusion in the first place.

Conclusion –

The facts of Kay Bouvet are peculiar to the issue at hand and diverse from the ones of SHRM Biotechnologies and TATA Chemicals. This might be the reason why the NCLAT took a divergent approach. However, it should have given a proper detailed rationale to establish the same. Nonetheless, the same has not been appealed before the Hon’ble Supreme Court and hence it would be safe to assume that it is the law of the land.

Despite the Kay Bouvet verdict, the Adjudicating Authority has adhered to the judgements and the rational propounded in the SHRM Biotechnologies and the TATA chemicals. NCLT, Mumbai in December 2019 in Shantanu Bharat Agarwal v. Indotech Industrials Solutions Pvt. Ltd. bluntly relied on the aforementioned judgements to refute the admission under section 9 by stating that if the refund of advance money was not in connection with goods or services it would not be called an operational debt.

On several instances, in order to determine whether a particular debt would be called an operational debt or not, the appropriate authority has abided by the literal interpretation as entailed in section 5(21).

Nonetheless, to answer whether the refund of advance would be an operational debt or not, the purported operational creditor has to have a claim in respect of the provision of goods and services and that too from the debtor. And the same will be ascertained from the agreement governing contractual relation between such person and the Corporate Debtor.





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