Heading	Details
CITATION	[2024] 5 S.C.R. 215 : 2024 INSC 340
YEAR OF JUDGEMENT	2024
STATUES REFERRED	Insolvency and Bankruptcy Code, 2016
APPELLANT	Global Credit Capital Limited & Anr.
RESPONDENT	Sach Marketing Pvt. Ltd. & Anr.
BENCH	Justice Abhay S. Oka and Justice Pankaj Mithal

Introduction:

The case Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr. (Civil Appeal No. 1143 of 2022) discusses some major issues concerning the that they are all contained in the code known as the Insolvency and Bankruptcy Code, 2016 (IBC), that also involves the difference between financial debts and operational debts. This pertains with reference to that query, which says, whether all the security deposit moneys will be treated as financial indebtedness, or all such deposit moneys will be operational debt defined in Section 5 of the IBC, in accordance with the contracts.

The agreements dated 1st April 2014 and 1st April 2015 would be the ones on which the disputes hinge and for which the debtor-company, Mount Shivalik Industries Limited, and Sach Marketing Pvt. Ltd. These agreements appoint Sach Marketing as a sales representative under which things are going to happen requiring Sach Marketing to deposit very huge security amounts on which interest will be charged at the rate of 21% Per Annum. Thus, whilst claiming to be a financial creditor, Sach Marketing was considered by the corporate debtor as an operational creditor, claiming that such agreements were service-related.

The NCLAT, however, held that the security deposits were financial debts since they satisfied the crux timer value of money and the market impact of borrowing tests in Section 5(8) of the IBC. The case subsequently reached the Supreme Court, which upheld the NCLAT ruling confirming that these agreements reflect financial arrangements instead of operational obligations.

The judgment thus highlights the need to consider the actual character of transactions in determining whether such debts should properly be termed financial or operational debts, and the consequent effect on the rights of creditors in corporate insolvency resolution processes. This decision is in line with the time value of money principles that undergird the conception of financial debt under IBC.

Fact of the Case:

The dispute in Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr. was whether amounts really constituted financial debt under the Insolvency and Bankruptcy Code (IBC), 2016. The corporate debtor, M/s. Mount Shivalik Industries Limited, had entered into agreements on April 1, 2014 and April 1, 2015, with Sach Marketing Pvt. Ltd., appointing the latter as a Sales Promoter to promote Mount Shivalik’s beer in Ranchi, Jharkhand. Then Sach Marketing has to deposit somewhat of Rs. 5315,000 as security at an annual interest of 21%, but the agreements made no mention of forfeiture of the security deposit. Further, Sach Marketing earned a nominal monthly remuneration of 4,000 without sales-related commissions. 

In 2018, Oriental Bank of Commerce pinched insolvency proceedings against the above-mentioned corporate debtor under Section 7 of the IBC, after which Sach Marketing initially filed a claim as an operational creditor. Later, the claim was modified to seek recognition as a financial creditor by arguing that the consideration security deposit constituted financial debt with reference to the interest payable on it. 

First, the claim was accepted as operational and financial debt in part but in the later period rejected by the Interim Resolution Professional as financial debt. Such rejection was upheld by the NCLT and then overruled by the NCLAT, thus recognizing Sach Marketing as a financial creditor. The highest court, in a favorable consideration of the findings of the NCLAT on appeal, held that a security deposit is a matter falling within the meaning of financial debt under Section 5(8) of the IBC, as it conveys time consideration. The Court noted that the real nature of the transaction must be interrogated and hence the relationship of the transaction must be seen with regard to financial arrangements rather than taking the terms set out on paper at face value.

Issues Raised:

1. Whether there can be a debt under the sub-section (11) of Section 5 of the IBC; and 

2. How does one test whether the debt qualifies as a financial debt under section 5, subsection 8.

3. Is it absolutely the need of the hour to know the true nature of the transaction written into the agreement in order to determine whether it is a financial debt or an operational debt?

4. As per the Insolvency and Bankruptcy Code, when a debt is considered to be an operational debt.

Argument of Plaintiff:

The grounds on which the plaintiffs contended that the agreements were towards operational debt were by referring to agreements dated 1 April 2014 and 1 April 2015 for the appointment of the first respondent-Sach Marketing Pvt. Ltd. as a “Sales Proposer” for the sale of beer produced by the corporate debtor Mount Shivalik Industries Limited. This being so, since the agreements were executed for the rendering of services, the resulting debt must be classified operational under Section 5(21) of the Insolvency and Bankruptcy Code, 2016 (IBC). 

It is my view that the stipulation arises out of a mere case in which the respondent insisted on putting up a minimum as security to earn interest at 21% per annum and not a financial facility advanced to the corporate debtor but a condition to become “Sales Promoter.” As said by plaintiffs in the matter, The corporate borrowers did not intend to borrow or avail of any financial facility from the respondent. It was contended by them that the security deposit became a prerequisite for such a role and was not disbursed against consideration for time value of money, which is the basis of classifying it as financial debt as per Section 5(8) of the IBC.

Even though the agreements provided for interest payment on the security deposit, the plaintiffs maintained that this did not convert the transaction into a financial debt. They opposed the interpretation made by National Company Law Appellate Tribunal, stating that such misinterpretation made the debt as a financial one and discontinued any consideration of the service-oriented nature of the transaction. The plaintiffs relied on judicial precedents, Such judgments as Swiss Ribbons Pvt. Ltd. v. Union of India and Pioneer Urban Land & Infrastructure Ltd. v. Union of India lay down the usual principles regarding a ‘financial debt’, including that it must feature the time value of money, and also that not every transaction involving an interest must and can qualify under ‘financial debt’. They claimed that the agreements were basically service agreements, not contracts for raising finance or borrowing, and that even the recognition of the liability or the booking of the interest component should not affect the inherent service character of the agreements.

Argument of Defendant: 

On the 1st of April, 2014, and on the 1st of April, 2015, the first respondent, namely sach marketing private limited, was appointed as a sales promoter in accordance with the agreements quoted above. It is stated in no uncertain terms with extraneous arrangements that the corporate debtor is intended to rely upon obtaining services of the first respondent. But, before one gets appointed as a marketing promoter, the initial security deposits would be deemed a condition precedent for such appointment. The initial security deposits, therefore, cannot be regarded as any financial facility availed of by the corporate debtor.

The defence has argued the transaction, in question, to be one of operational debt as defined under clause (21) of Section 5 of IBC 2016. The appellants have a counter to the arguments of the by asserting that the debtor in default has intended to avail itself of the operational services of the first respondent and that the sum paid as security deposit ought not to be interpreted or construed as financial assistance to above debtor. The appellants contended that mere booking or payment of interest on the security deposit would not ipso facto qualify the transaction as a “financial debt” under the definition given in subsection (8) of Section 5 of the IBC. They alleged, further relying on judgments of the Supreme Court, that the payment of interest is not in itself a decisive criterion for deciding whether or not the debt is a financial debt. The argument was that the NCLAT interpreted a security deposit as financial debt by laying importance on interest. NCLAT has nearly changed the definitions of financial and operational debts in IBC, as argued by the appellants.

Principal Applied:

A liability, or obligation that a debt could be, must arise from a claim as stated in Section 3(6) of the Insolvency and Bankruptcy Code (IBC). In a claim, an obligation must exist with respect to payment or remedy. It should also clear through clauses (a) through (i) in Section 5(8) other than the being-for-time-value of money parameter. The section must be analyzed for the real substance of the transaction beyond the words of the agreement to ascertain whether the obligation is financial or operational.

Financial debt typically arises from transactions with commercial effects of borrowing, such as advanced amounts regarded as loans or obligations to pay interest reflecting a time value attached. On the other hand, operational debt arises from debts related to the sale of goods or services directly linked to such activities. The nature of the transaction and the real intent also play a critical role. In service agreements, it is essential to ascertain whether the claim relates to the work performed to classify it as operational debt. In some cases, while the agreements might refer to services, the amounts involved and their treatment in financial statements may indicate financial debt. Furthermore, the expansive interpretation of financial debt under clause (f) of Section 5(8) allows for identifying even unconventional loan disbursements, as liabilities, financial debts that satisfy the definitions of cash disbursement for the importance of time in relation to the money serves as the commercial effect of borrowing, for example, deposits coupled with obligations to pay interest.

Judgement:

The judgment from Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr. (Civil Appeal No. 1143 of 2022) centered primarily on whether a specific debt constituted as a financial or operational one under the head of Insolvency and Bankruptcy Code, 2016 (IBC). The Appeals were thrown out and upheld the NCLAT’s decision. 

Above legal observed implications put the existence or non-existence of a debt under Section 5(11) of IBC, i.e. the debt under the section is a claim under Section 5(6) as an enforceable right to payment or remedy for breach of contract. As such qualifying debt as a ‘financial debt’ under Section 5(8) must be debt that disburses itself against a consideration for time value of money, and fall into categories of Section 5(8) from (a) to (i), all of which should fulfill this basic test.

In determining the nature of the debt being either financial or operational, the reality of the transaction must be examined rather than merely what is represented in the written agreement. A document cannot be taken solely in the face value. A debt can be operational only if it generates a claim regarding the provision of goods or services. For instance, it must directly refer to the services offered under the agreement.

At present, it is observed that the accords made between a corporate debtor and Sach Marketing Pvt. Ltd. include an agreement related to a security deposit bearing an interest at a rate of 21%. The main ground for this arrangement is basically making respondent a sales promoter against the lowest service charges of ₹4,000 a month. There is no fatal clause in the agreements related to forfeiture of the security deposit and is to be returned along with the interest concerned by the corporate debtor.

The finding of the case has demonstrated that the security deposits were debts bearing interest and thus fell within the definition of financial debts as laid down in clause (8) of section 5 of the IBC. And the effect of these deposits was that of borrowing; since the corporate debtor treated these deposits as long-term liabilities in its financial statements. The claim for operational debt was refused because it could not be related to any service rendered, except monthly service fee for ₹4,000 therein qualifies as operational claim.

The respondent, Sach Marketing Pvt. Ltd., was correctly classified as a financial creditor, entitling them to rights under the IBC’s insolvency resolution process. The Supreme Court upheld the NCLAT’s decision, dismissing the appeals filed by the appellants, and directed that the Corporate Insolvency Resolution Process (CIRP) should continue as per the NCLAT’s judgment.

Analysis:

The corporation was involved in two contracts with Sach Marketing Pvt. Ltd. These contracts also included a security deposit which would accrue interest at the rate of 21%. The main object of the contracts was to appoint the respondent as a sales promoter at a cost of only ₹4,000 per month. However, the agreements do not allow forfeiture. Therefore, the corporate debtor must refund the security deposit with interest.

The findings of the case showed that these security deposits regarding such debts with interest satisfied the definition of financial debts as outlined under Sub-section (8) of Section 5 of the IBC. These deposits had achieved a commercial effect of borrowing since they were treated by the corporate debtor as long-term liabilities in its financial statements. The operational debt claim was dismissed as it had no link with any service rendered except for the monthly service fee of ₹4,000, which qualified as an operational claim.

The recognized creditor was thereby discerning Sach Marketing Private Limited in its pronouncements as a financial creditor endowed with potential entitlements under the IBC solvency resolution process. The Supreme Court, too, dried up the appeals by the appellants against the decision of the NCLAT and directed that CIRP should be continued according to the judgment of the NCLAT.

Conclusion:

Under sub-section (11) of Section 5 of the Insolvency and Bankruptcy Code, 2016, “debt” means a “claim” as defined under sub-section (6) of Section 5. Without a valid claim, no debt can arise since creation of a claim is a precondition for a debt’s existence. If wherever the debt exists “interest” is due on the same (if applicable), but it must be disbursed against consideration having regard to the time value of money. Satisfying this primary test, clauses (a) to (i) are defined for a debt as constituting financial debt.

Thus, to classify debt as either financial or operational, the real nature of the transaction as manifested in the written agreement would be examined. That is, any written document cannot describe an act when viewed at face value, for the essence should be unearthed. In the case of operational debts with service agreements, the debt must be claims arising directly out of services to be provided under the agreement.

Here, we have amounts covered by the security deposits categorized as financial debts. The said creditor has also been rightly characterized a s a financial creditor by the National Company Law Appellate Tribunal (NCLAT). Therefore, the appeals were dismissed and the proceedings of Corporate Insolvency Resolution Process (CIRP) were thus directed to proceed according to the judgments of NCLAT.

References:

1. Statutory Provisions Referenced:

• Insolvency and Bankruptcy Code, 2016: Sections 3(6), 3(11), 5(8), 5(11), 5(21), 60(5)

2. Core Principles Discussed:

• Interpretation of “financial debt” under Section 5(8)
• The necessity of linking claims with consideration for the time value of money
• Commercial effect of borrowing under Section 5(8)(f).

This article is written by Nakul Bhatnagar ; Intern at Legal Vidhya.

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