The Operational Debt Conundrum: Examining Interest and Contractual Disputes from ‘Section 9’ Perspective

[By Pooja Shukla & Mohammad Atik Saiyed]

The authors are students of Gujarat National Law University.

Introduction

In our structure, Law is like a game of billiards with a bunch of statutes, precedents, and other dynamic legal authorities clustered together, necessitating harmony amongst associated topics for the ends of justice. On the same matrix, the Insolvency and Bankruptcy Code 2016 (“IBC”) is to be read alongside several other statutes such as, inter alia, the Taxation, SARFAESI, Arbitration, Prevention of Money Laundering Act, and Indian Contracts Act on a variety of situations and shifting timeframes.

The primary goal of these established laws is to deliver justice; thus, they should be read and understood accordingly. However, while reading two statutes concurrently, questions about which one will take precedence and whether the disagreement would be resolved in accordance with the act or not occur quite often. Established with the vision of streamlining and consolidating the insolvency framework, the IBC is currently wending toward clearer jurisprudence, and, therefore, the Courts are encountering diverse legal issues.  This article will address one such legal dilemma revolving around the Indian Contracts Act and the Insolvency and Bankruptcy Code.

Operational debt and operational creditors are the key concepts to consider while addressing section 9 of the Insolvency and Bankruptcy Code (hereinafter “IBC”). The word “debt” needs to be understood differently in light of the changing times and situations, even though it has been explicitly defined. It has been defined into the following categories:

“Debt” as described in Section 3(11) of the IBC,2016 means “a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.”

“Operational Debt” as described in Section 5(21) of the IBC, 2016 means “a claim in respect of the provisions of goods or services, including employment or a debt in respect of the [payment] of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.”

“Operational Creditor” as described in Section 5 (20) of the IBC,2016 means “a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.”

On that foundation, the present blog will primarily deal with two law propositions.

  • Firstly, what contractual defaults will be covered under section 9 IBC?

Secondly, can an application under section 9 IBC be made solely based on interest?

Reflecting fundamentals of CIRP by operational creditor

The Insolvency Code constructs the foundation of the issue by providing under section 9 for the initiation of CIRP by operational creditor. In alignment, the basic principles to look at before filing an application under section 9 are:

  1. a) Whether there is an ‘operational debt’ as defined exceeding Rs. 1 Crore?[1]
  2. b) Does documentary evidence furnished with the application show that the debt described above is due and payable and has not yet been paid?
  3. c) Whether there is an existence of a dispute between the parties or the record of the pendency of a suit or arbitration proceeding filed before receipt of demand notice of the unpaid operational debt concerning such dispute?

The application would need to be rejected if any of the aforementioned requirements were not met. It is a settled principle, as per section 9(5)(ii)(d) of the IBC, that if the claim is disputed, then it cannot proceed further. However, in the case of M/S. Innoventive Industries Ltd. Vs. ICICI Bank & Anr. the Court observed, “a claim means a right to payment even if it is disputed. The Code gets triggered the moment the default of Rs.1 Lakh or more occurs” and thus, the Corporate Debtor cannot always take this as a defense.

Beginning with the legal dilemmas at hand, it is a settled principle that to claim financial damages, it must first be assessed by a decree or order of a court by an adjudicating authority. It should not be wholly arbitrary and baseless when determined u/s 73 of the Contracts act. This principle is applicable to claim all unliquidated damages and was given in the case of Union of India vs. Raman Iron Foundry, and was reiterated by a recent judgment of Tata Chemicals ltd. Vs. Raj Process Equipments and Systems Private Limited (NCLT bench, Mumbai) and sole reliance on this was placed in the case of J. Kumar Infra projects ltd. Vs. Kanta Rubber Pvt ltd (NCLT, Hyderabad Bench).

Contractual disputes

Progressing to the first conundrum dealing with contractual defaults and its effect from the IBC perspective, in the recent judgment of XYKno Capital Services Pvt. Ltd. v Rattan India Power Ltd.(NCLAT), the Tribunal made it evident that the dispute about contractual issues related to quality and efficiency of the services are not to be resolved in the proceedings of section 9 IBC, and thus, the Bench, in this case, dismissed the appeal filed by the operational creditors. However, there are some dimensions to the central question, which are addressed hereinbelow.

Breach of Warranty

In the question of breach of a warranty in the contract of sale or purchase of goods and services as given in sections 12 and 13 of the Sale of Goods Act,  NCLT as well as NCLAT recently  allowed a section 9 application  made on a breach of warranty, wherein, the central proposition was whether a dispute existed before the Demand notice issued u/s 8 or not. Although, the Supreme Court rejected the application on the ground of ‘pre-existing’ dispute and did not analyze the aspect of breach of warranty, impliedly including the same under operational debt. The Court finally cleared the position of law, stating that the IBC’s pre-existing dispute standard is not equivalent to the “preponderance of probability” principle. Thus, we can understand that the amount involved in the breach of warranty is also an operational debt.

Is the advance made for the contract an operational debt?

Not only in the written contracts but also the advance offered in oral contracts amounts to operational debt under section 9 of the IBC. Recently, this was held by the NCLAT in the case of Chipsan Aviation Pvt. Ltd. vs. Punj Lloyd Aviation ltd. wherein an advance of Rs. 60,00,000/- was paid by the operational creditor to the corporate debtor and the Court, while relying on an SC judgment, observed that the definition of “operational debt” includes advance payment.

Is interest an operational debt?

Dealing with the aspect of section 9 application for interest amount raising substantial questions of whether interest can be claimed as operational debt and if yes, then can it be claimed independently of the principal. In the case of SBF Pharma vs. Gujarat Liqui pharma caps Pvt. Ltd (NCLT bench, Ahmedabad), it was held that a section 9 application could not be solely made for recovery of interest. Furthermore, the NCLT Bench, Delhi, recently upheld this position in the case of  Saraf Chits Private Limited & Anr. v KAD Housing Private Limited, wherein it was made clear that if the principal amount has been completely paid, CIRP proceedings could not be initiated. Not only just the NCLTs but also the NCLAT in 2018, in the case of Krishna Enterprises vs. Gammon India Ltd., elaborated the word ‘debt,’ ‘claim,’ and ‘dispute’ wherein it held that the principal amount had to be treated as a liability in respect to the claim made to the corporate debtor.

However, it  has been lucidly settled that interest is adebt when claimed along with the principal amount; but application under section 9 of the IBC cannot be initiated solely for the interest amount however, interest can be claimed when principal debt exists. (Para 13)

What if the interest rate is not mentioned:

When the interest rate is very well stated in the contracts or the invoices that the parties have relied on or are being charged in their ordinary course of business, that stated rate will be considered. The question that arises is if the parties have not foreseen any such circumstances, then what amount of interest rate is to be paid during insolvency? The real issue arises when it is not specified, as there is no settled principle on these lines. In the case of Swastik Enterprises vs. Gammon India Ltd. (para 6.5), NCLT had clearly laid down the basic requirements to be fulfilled while claiming for interest, which are enlisted hereinbelow:

  • Claim made should be enforceable in law
  • There needs to be cogent admissible evidence
  • The rate of interest should be appropriately documented
  • Both parties should agree upon the interest rate

The petition of the operational creditor was dismissed by the Tribunal stating that as the principal amount of the debt had been paid, the interest amount stood unsubstantiated in the absence of cogent evidence. Thus, the “operational debt” also stood unascertainable and the section 9 application was held to not be maintainable. This case placed reliance on the judgment by NCLT, Chandigarh.

Contrarily, in Steel India vs. Theme Developers Pvt. Ltd., while referring to the above cases, the Tribunal took a different view and held that when the interest amount had not been predetermined, it could not be claimed arbitrarily. It also pointed out that if there was no pre-decided amount or provision of interest payable in the parties’ books of accounts with no existing practice of charging separate interest in cases of default, then the interest amount could not be charged.

From a panoramic perspective, there is no settled principle on this. There have been cases in the past where the Supreme Court has decreased the interest rate to 12% from 24%; in one instance, it has charged 6% interest in the absence of any contractual clause related to interest.

Should debt, including interest, be more than one crore or include interest be more than one crore?

The one crore threshold under Section 9 has to be satisfied by the principal amount or by principal including interest cumulatively?

Generally, creditors file an application for insolvency rather than going for a civil suit to recover their default payments to get a speedy solution. The tribunals as well as the Supreme Court have made it very clear that section 9 of the IBC is not a debt collection forum (NCLAT) by noting that,“It is not the object of the IBC that CIRP should be initiated to penalize solvent companies for non-payment of disputed dues claimed by an operational creditor.” (Para 31)SC.

So, the party contending to be an operational creditor not only has to fulfill all the basic principles laid above but also = establish the existence of “debt”; i.e. ‘operational debt’ has to be a claim with regard to the provision of goods or services.

With regard to the one crore condition under section 9, there has been muddled jurisprudence developed by the NCLT’s, but contemporarily, in Mr. Prashat Agarwal vs. Vikash Parasrampuria, the NCLAT Bench dismissed the appeal admitting a section 9 application where the interest amount was included with the principal amount in the claim. Thus, it can be understood that the interest claimed can be accounted as debt claim  ] to satisfy the ‘one crore’ condition under section 9 for filing of CIRP proceedings.

Concluding perspective

There have been instances where the order by different NCLT benches have been divergent in the same line of the law, which is now eventually been settled by the Supreme court and NCLAT with the changing times. To dissolve and sum up, mere contractual breaches cannot be dealt within the umbrella of insolvency and bankruptcy code and Section 9 application (Para 31)  application cannot be initiated for debt recovery purposes as it is not a debt collection forum, but instead a beneficial legislation intended to put corporate debtors on its feet. The Supreme Court can develop a principle dealing with the situations when interest rates are not mutually agreed upon. If a clear response cannot be connected to the question, then a model framework providing a preconditioning test together with the outlines of the scope/ambit may be decided.

[1] Earlier the limit was One Lakh; but vide notification dated 24.03.2020, it has been increased to one crore.

https://www.mca.gov.in/Ministry/pdf/Notification_28032020.pdf

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at – cbcl@nliu.ac.in