The Conundrum of ‘Interest’ as a part of Debt under IBC: The Dust Settles

[By Neelabh Niket and Sanchita Makhija]

The authors are students at the Hidayatullah National Law University.

Introduction

Recently, the National Company Law Appellate Tribunal (‘NCLAT’) in the case of Mr. Prashat Agarwal, Member of Suspended Board of Bombay Rayon Fashions Ltd. Vs. Vikash Parasrampuria (hereinafter referred to as the ‘Bombay Rayon case’) held that under Section 4 of the Insolvency & Bankruptcy Code (‘IBC’), an operational creditor can club the ‘interest’ with the principal amount to arrive at the threshold limit of Rs. 1 Crore, which is the default limit for filing of applications under Part II of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the ‘IBC’), provided that the interest was perspicuously stipulated in an invoice or an agreement.

In doing so, the three-judge bench effectively overruled the law laid down by the National Company Law Tribunal (‘NCLT’) Delhi in CBRE South Asia Private Limited v. United Concept and Solutions Private Limited (hereinafter referred to as the ‘CBRE case’), which had provided a ruling contrary to the Bombay Rayon case by holding that the principal and interest cannot be clubbed together to reach the Rs. 1 crore threshold limit.

In this article, the authors seek to analyze the recent judgment of the Bombay Rayon case and its possible implications on similar cases pertaining to the treatment of ‘interest’ as debt.

Factual Matrix

The Appellant, Bombay Rayons Fashions Limited (hereinafter referred to as the ‘Corporate Debtor’) was supplied goods by the Respondent, ‘Vikash Parasrampuria’, the sole proprietor of the firm ‘Chiranjilal Yarns Trading’ (hereinafter referred to as the ‘Operational Creditor’). For the said supply, the Operational Creditor had raised nine invoices, out of which the Corporate Debtor did not make the payment for five invoices. The remaining principal amount was Rs. 97,87,220 and a condition for payment of 18% interest was made in all the invoices.

The Operational Creditor, ergo, filed a Section 9 Application, which was admitted by the NCLT, and the Corporate Insolvency Resolution Process (‘CIRP’), was initiated. Aggrieved by the said order, an appeal was filed in the NCLAT by the Corporate Debtor.

Ruling and Analysis

The NCLAT analyzed the definition of the term ‘debt’ and subsequently the term ‘claim’ and stated that if interest has been unambiguously stipulated in an invoice or agreement, then it will fall under the ambit of the ‘right to payment,’ which has been anchored in the definition of ‘claim’ under Section 3(6) of the IBC.

In doing so, the NCLAT also distinguished the judgment of NCLT Mumbai in Steel India vs. Theme Developers Pvt. Ltd.( ‘Steel India Case’)’ by stating that, unlike the Steel India case, the interest was stipulated in the invoices in the case in hand. Furthermore, the NCLAT sought the support of the case of Pavan Enterprises v. Gammon India and overruled the CBRE judgment into the bargain.

In the CBRE judgment, the court, after due analysis of the definitions of the terms ‘debt’ and ‘claim,’ had held that since the definition of claim is common for both Operational and Financial Debts, the definition of both the terms shall be considered to understand the legislature’s intention. After analyzing the definitions of the said terms, the Adjudicating Authority (‘AA’) arrived at the conclusion that Operational Debt does not include interest as the definition of Operational Debt does not explicitly incorporate the term ‘interest’; unlike Financial Debt which clearly specifies the term ‘interest’.

It should be noted that the Court in the CBRE case had failed to understand that the connotation of the term ‘interest’ is distinguishable in the case of an Operational Debt and a Financial Debt. The term ‘interest’ is explicitly mentioned in the definition clause of Financial Debt as it is an inherent component of the same. This interest clause as disbursed against the consideration for the time value of money makes the debt a ‘Financial Debt’. (It is another case, however, that the Supreme Court (‘SC’) has rendered this interest redundant for Financial Creditors in the case of Orator Marketing.).

Per contra, ‘interest’ in the case of Operational Debt, is not something which is fundamental to the nature of the debt. It can be claimed to be a part of the debt, only if it is contractual in nature and has been clearly stipulated. Thus, ‘interest’ may or may not exist depending upon the clauses enshrined in a contract. The AA had erroneously deemed equivalent the connotation of the term ‘interest’ under both the definitions by placing them on the same pedestal, whilst in reality, they are very distinct.

The term ‘interest,’ as has been mentioned in the definition clause of Financial Debt, is almost synonymous with the debt availed, while ‘interest’ in the case of an Operational Debt is a creature of a Contract that arises from a right of payment. The consideration in the case of Operational Debt is ‘the goods or services that are either sold or availed of from the operational creditor’ and there is no time value of money involved in the case of Operational Debt, as was held in the landmark case of Pioneer Urban Land and Infrastructure Ltd. v. Union of India.

Therefore, unlike Financial Debt, the concept of ‘time value of money’ is not prevalent in the cases of Operational Debt. As interest is a token of representation of the ‘time value of money’, the same is not indispensable for Operational Debt, thereby rationalizing the omission of the term from the definition of Operational Debt.

Implications

If the CBRE judgment is strictly followed, then a part of the debt, which has been mutually agreed as interest cannot be levied and collected without a hitch, as it would require an additional case in the Debt Recovery Tribunal, rendering the clause redundant under IBC. For instance, the Real Estate industry which comprises various Lease & License agreements feeds extravagantly on the interest rates, and these amounts usually run in crores. Given that the NCLAT has recently categorized Lease & License debt as ‘Operational Debt’, the landowners would face an uphill task to recover the hefty interest component applicable therein.

It becomes pertinent to state here that the implications of this judgment will not only be limited to cases where interest is clubbed with the principal amount but shall also extend to the cases wherein an application is filed solely pertaining to unpaid interest.

In the past, the AAs have time and again rejected applications pertaining to the initiation of the CIRP filed apropos of debt solely pertaining to the interest amount. For example, the NCLAT in the case of Amsons Communication Pvt Ltd. v. M/s ATS Estates Pvt. Ltd had ruled earlier that an Application under Section 9 of Code could not be converted into proceedings for recovery of interest by Operational Creditor on delayed payment, as it was against the object of Code. In a similar vein, in  S.S. Polymers v. Kanodia Technoplast Ltd, the AA yet again rejected the application with the following observation, that the application

should be treated to be an application pursued by the applicant with malicious intent (to realize only interest) for any purpose other than for the resolution of insolvency, or liquidation of the corporate debtor.”

However, neither of these cases had any clear stipulation of interest in the invoice or the agreement which only weakened the operational creditor’s position.

In a major shift, the NCLAT through the instant judgment has differed from the abovementioned proposition and has categorically included ‘interest’ as an integral part of the operational debt to cross the threshold of Rs 1 Crore. Consequently, once the interest component is classified as a part of the debt and it remains unpaid it can be termed as an event of ‘default’, as Section 3(12) of IBC defines ‘default’ as any non-payment of debt when the whole or any part or installment of the amount of debt has become due and payable and is not repaid by the debtor. In other words, even if the entire principal amount has been paid off but if the unpaid interest amount exceeds the threshold of Rs. 1 Crore, an application under Section could be filed.

It is worthwhile to mention here that the SC in the case of Vijay Industries vs M/S. Natl Technologies, albeit in the context of winding up of a Company, had also held that failure of the company to pay the agreed interest or the statutory interest would come within the purview of the word ‘debt’.

Conclusion

By including ‘interest’ as a part of the debt, the NCLAT has timely answered the vexing question and quelled the fears of many Operational Creditors who rely substantially on the interest component. The judgment promises to have a far-reaching impact on the evolving IBC jurisprudence, especially on cases that deal either directly or tacitly with ‘interest’ and related components.

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