Between the Lines | Supreme Court: Interest free term loans advanced to a corporate person are not excluded from the purview of a financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 August 24, 2021
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The Hon’ble Supreme Court (“SC”) has in its judgment dated July 26, 2021, in the matter of Orator Marketing Private Limited v. Samtex Desinz Private Limited [Civil Appeal No. 2231 of 2021] (“Judgement”) held that the definition of financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) does not exclude an interest free loan and that it would have to be construed to include interest free loans advanced to finance the business operations of a corporate body.
M/s Sameer Sales Private Limited (“Original Lender”), advanced a term loan of INR 1.60 crores to M/s Samtex Desinz Private Limited (“Corporate Debtor”) for a period of two years in order to enable the Corporate Debtor to meet its working capital requirements. Thereafter, the Original Lender assigned the outstanding loan to M/s Orator Marketing Private Limited (“Appellant”). As per the loan agreement, the loan was due and payable on February 1, 2020. According to the Appellant, the Corporate Debtor made some payments, however, INR 1.56 crores remained outstanding.
The Appellant filed an application under Section 7 of the IBC before the National Company Law Tribunal, New Delhi (“NCLT”) seeking the initiation of the Corporate Insolvency Resolution Process (“CIRP”) against the Corporate Debtor. The NCLT rejected the application of the Appellant on the ground that the Appellant had extended an interest free loan and had failed to prove that the loan was disbursed against consideration of time value of money. Thereafter, the National Company Law Appellate Tribunal, New Delhi (“NCLAT”), upheld the order of the NCLT on the aforementioned ground that since the money borrowed is not against payment of interest, it could not be termed as a financial debt under Section 5(8) of the IBC.
Being aggrieved by the order of the NCLAT, the Appellant filed the present appeal before the SC under Section 62 of the IBC.
Whether a person who extends a term loan to a corporate person free of interest, for its working capital requirements is not a financial creditor and therefore, incompetent to initiate CIRP under Section 7 of the IBC.
Contentions raised by Appellant:
It was the submission of the Appellant that since even after a period of two years, the loan still remained due, it must be thereafter treated as a financial debt. The Appellant relied on the judgment of the NCLAT in the matter of Mack Soft Tech Private Limited v. Quinn Logistics India Limited [ Company Appeal (AT) (Ins) No.143 of 2017], to submit that when there is disbursement and default, it should be construed as a financial debt. It was further contended that after the execution of the assignment agreement in its favour, the Appellant, not being a related party and having taken the assignment for consideration, the loan extended would be a financial debt.
Observations of the Supreme Court
The SC observed that the definition of financial debt under Section 5(8) of the IBC was misconstrued by both the NCLAT and the NCLT by reading the same in isolation and out of context and hence the judgment and order of the NCLAT affirming the order of the NCLT was patently flawed.
It was further noted that, in a plethora of judgments, it has been observed that while construing and/or interpreting any statutory provision, the legislative intent of the statute must be looked at and that each word, phrase or sentence has to be construed in light of the general purpose of the act itself. Therefore, when the meaning of a certain provision in a statute is to be construed, the statue has to be read as a whole; the previous state of the law, the general scope and ambit of the statute and the mischief that it was intended to remedy, would all be relevant factors.
The SC relied on its judgment in Pioneer Urban Land and Infrastructure Limited v. Union of India [4 (2019) 8 SCC 416], where numerous previous judgments including Innoventive Industries Limited v. ICICI Bank Limited [2 (2018) 1 SCC 407] and Swiss Ribbons Private Limited and Another v. Union of India and Others [3 (2019) 4 SCC 17] were referred to and held that even individuals who were debenture holders could be financial creditors who could initiate CIRP.
The SC further observed that the definition of financial debt under Section 5(8) of the IBC cannot be read in isolation, without considering other relevant definitions, particularly, the definition of ‘claim’ in Section 3(6), ‘corporate debtor’ in Section 3(8), ‘creditor’ in Section 3(10), ‘debt’ in Section 3(11), ‘default’ in Section 3(12) and ‘financial creditor’ in Section 5(7) along with Sections 6 and 7 of the IBC. In order to arrive at its decision, the SC relied on the definition of financial debt in Section 5(8) of the IBC which provides that “a debt along with interest if any which is disbursed against the consideration of the time value of money and includes money borrowed against the payment of interest, as per Section 5 (8) (a) of the IBC” and observed that the NCLT and the NCLAT have overlooked the words “if any” which could not have been intended to be otiose. ‘Financial debt’ would mean outstanding principal due in respect of a loan and would also include interest thereon, if any . In the event that there is no interest payable on the loan, only the outstanding principal would qualify as a financial debt. Therefore, both the NCLAT and the NCLT failed to notice Clause (f) of Section 5(8) of the IBC, in terms whereof a financial debt includes any amount raised under any other transaction, having the commercial effect of borrowing.
Additionally, it was observed that sub-clauses (a) to (i) of Section 5(8) of the IBC are illustrative and not exhaustive. It was noted that the legislature has the power to define a word in a statute and that such definition may be restrictive or extensive but when the word is defined to include something, then such definition is prima facie extensive. While making the aforesaid observation, the SC referred to its judgment in State of Bombay v. Hospital Mazdoor Sabha and Others [6 AIR 1960 SC 610], wherein it was held that “It is obvious that the words used in an inclusive definition denote extension and cannot be treated as restricted. Where we are dealing with an inclusive interpretation, it would be inappropriate to put a restrictive interpretation upon words of wider denotation.”
Lastly, the SC noted that, taking into account the aims, objectives and scheme of the IBC, there is no discernible reason as to why a term loan to meet the financial requirements of the Corporate Debtor for its operation, which obviously has the commercial effect of borrowing, should be excluded from the purview of financial debt. It was further observed that the trigger for initiation of CIRP by a financial creditor under Section 7 of the IBC is the occurrence of default by the corporate debtor and default includes financial debt and operational debt. Further, the definition of debt is also expansive and it includes, inter alia, financial debt. Therefore, since, the definition of financial debt under Section 5(8) of the IBC does not exclude an interest free loan, it would have to be construed to include interest free loans advanced to finance the business operations of a corporate body.
Decision of the Supreme Court
In view of the above, the SC allowed the appeal and set aside the orders of the NCLT and the NCLAT which dismissed the petition of the Appellant under Section 7 of the IBC. It was also directed that the petition filed by the Appellant under Section 7 of the IBC before the NCLT would stand revived and is to be considered afresh in accordance with the law and findings in the present Judgement.
Since the commencement of the IBC, it has been observed consistently that a debt would require the elements of ‘debt along with interest’ or ‘time value of money’ to qualify as a financial debt under Section 5(8) of the IBC. The SC observed that the orders of the NCLT and the NCLAT were patently flawed having misconstrued the definition of ‘financial debt’ by reading the definition in isolation and out of context. The SC further clarified that a term loan meeting the financial requirements of a Corporate Debtor for its operation has the commercial effect of borrowing, and hence should not be excluded from the purview of a financial debt.
The SC in this Judgement, giving regard to the aim, objective and scheme of the IBC has rightly clarified that clauses (a) to (i) of the said Section are not exhaustive and it is to be construed to include an interest free loan. The SC held that the definition of ‘financial debt’ cannot be read in isolation, without taking into consideration other relevant definitions of the IBC as the statute has to be read as a whole.
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