INTRODUCTION
Insolvency and Bankruptcy Code 2016 (further referred as Code) has been introduced to ensure a better credit evaluation of companies and give them a chance of survival when they are distressed. The Code gives the recognised creditors an opportunity to file for insolvency in cases of default by the corporate. As such under the Code, there have been various regulations which deal with specific procedures but the code is still evolving and the judicial bodies are trying to keep their interpretation within its contours and provide justice.
Section 3 deals with the general definition of the code and section 5 lays chapter-specific definitions. The invocation or triggering of insolvency process can be done by creditors which are classified as “operational creditors”[1] and “financial creditors.”[2] The nature of debt, operational[3] or financial[4], differentiates between the two.
The Dictionary of Accounting[5] defines lease as a contract “for letting or renting a building, a piece of land or a piece of equipment for a period against payment of a fee.” It guarantees the lessee (tenant) use and guarantees the lessor(landlord/owner), periodic payments for such use. Such a contract is legal and binding on both the parties. The Ind AS -17 for Leases[6] also defines “lease” in similar lines as an agreement whereby the lessor conveys to the lessee the right to make use of an asset for specified time in return for a decided amount.
Financial lease is an alternate way of borrowing or getting finance which is used by corporate entities. In such leases, lessor is a financier and the lessee is the one who enjoys the use, rewards and risks arising from the ownership. As per the Ind AS-17, operating lease is any lease other than financial lease. “A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.”[7]
IBC AND LEASES
Financial Debt under its sub-clause includes “the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed.”[8] This solves the issue with respect to financial leases which now recognises the Financial Lessor as a Financial Creditor under the IBC and the consequent rights that flow from it.
The issue arises in cases where the lessor is not recognised under the IBC as the debt owed to him may or may not be categorised under Operational Debt. The NCLT and NCLAT in different benches have varied opinion on this issue.
ISSUE:
The problem in cases where it is not recognised by the tribunal is that, the lessor has no remedy in the Code. The provision which will then be looked into is the terms of contract and suits for recovery. The lessor will have to opt for arbitration of the disputes or the claims if there is a consensus on the same or he will have to file a civil suit. The hope is, if a financial creditor or other operational creditor files for insolvency, the lessor might get some dues paid under the Waterfall mechanism clause “any remaining debts and dues.”[9] He can try to prove his claim under Regulation 9A[10] which deal with “claims by other creditors” wherein Form F has to be filed to prove his claims. The lessor being the owner can sell off the property in accordance with the terms of contract if the lessee does not finally pay.
Another problem that happens is with respect to “goods or services.” The IBBI Regulation, 2016[11] defines the term “essential goods and services” to the extent they do not constitute direct input to output. The tribunals have tried to relate “goods and services” definition under the CGST Act[12] but there is doubt if it can be used to interpret insolvency provisions.
JUDICIAL INTERPRETATION:
A three step formula has been time and again used to define the scope of “operational debt.” “Firstly default must fall within the definition of ‘claim.’ Secondly such claim should be capable of being treated as a ‘debt’ and, finally, the ‘debt’ should fall within the confines of Section 5(21).”[13]
The NCLT bench[14] had said that reference to the definition of “goods or services” under the fiscal statutes are incorrect since fiscal statutes and the code have different purposes and the interpretation is broad in fiscal statutes whereas the code has to be interpreted strictly. The NCLAT Delhi, after analysing the case of Appellant who was the tenant held that, since the claims were not made with respect to “provision of goods or services” and the repayment dues do not come under any existing law, he does not qualify as “operational creditor” to invoke section 9.
The 2015 Report [15]had recommended that “the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease.” The Supreme Court in Mobilox Case[16] relied on the above report which upheld the right of the lessor as an operational creditor as the report showed an intention to include the lessors as operational creditor.[17]
Presence of “Effect potentiality in the premises let out on lease for the commercial/retail purpose, an element of service is involved in the immovable property and therefore, the same falls within the ambit of operations and thereby construes as an operational debt and as such the creditor as an Operational Creditor.”
In Manjeera Retail Holdings case[18] the Hyderabad bench also held “that claim towards outstanding lease charge do not falls under Operational Debt as defined under IBC. It is understood from the facts that the premise was being used for carrying out the “operations” of the business and thus failure to recognise the petitioner as “operational creditor” leads to him being left remedy less under the Code.[19]
The NCLT Kolkata Bench in Sarla Tantia V/s Nadia Health Care (P) Ltd [20] question arose whether consideration received by way of lease or license fee falls under providing services and if an action for recovery of arrears of rent is maintainable under section 9? The tribunal held it in the affirmative and based its decision on the BLRC report and the CGST Act.
In M/s Seth Thakurdas Khinvraj Rathi[21] the NCLT Delhi Bench held that “the unpaid amount arising out of a Leave & License Agreement as well as License & Hire Charges Agreement for use and occupancy of immovable property was held to be Operational Debt and the petitioner therein was Operational Creditor.”
In Parmod Yadav & Anr. v. Divine Infracon (P) Ltd, which was dismissed by the NCLAT, the NCLT analysed the provisions and led down that “any debt arising without nexus to the direct input to the output produced or supplied cannot be in the context of the Code be considered as “operational debt” even though it can be a claim amounting to a debt.”
The issue with this case is that it is an overreach of power. The Tribunal cannot add additional criteria for a debt to be classified as Operational Debt. Especially when there are varied opinions on the issue, it should have recommended the appropriate authority to look into it and should have granted relief to the petitioners.
Following the above case, another recent judgment in the same lines was passed in M. Ravindranath Reddy case.[22] The Tribunal’s opinion was “the alleged debt on account of purported enhanced rent of leasehold property does not fall within the definition of the operational debt in terms of Section 5(21) of the Code.”
CONCLUSION
As the code provides for a speedier and effective procedure than compared to other proceedings, and since the object of the code is to balance the interests of all the stakeholders, it is necessary that the lease obligations be recognised under the category of “operational debt.” Since there is scope for new interpretations and the terms of the code are wide, it should be interpreted in a favourable manner to support the claims of creditors.
If we try to understand the definition, there is scope for wide interpretation as it is an inclusive one and does not give an exhaustive list for only those transactions that can be covered. The legislative intent might have been to keep the interpretations open to serve the purpose and dynamic nature of business transactions that should be under the scope of the Code.
Analysing the views of the Tribunals with no decisive judgment by the Supreme Court on this topic, it is of utmost importance that the cases are dealt uniformly by the Tribunals in so far as to establish a general practice can be evolved until a final law or decision. It has become a matter of luck if the lessor’s action will succeed or not as each Bench deals with the issue differently. Alternate dispute forums play an important role in cases where there is a scope of negotiation and out of court settlements.
Reference:
1. IBC 2016, Section 5(20): Operational creditor means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred;
2. IBC 2016, Section 5(7): Financial creditor means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;
3. IBC 2016, Section 5(21)
4. IBC 2016, Section 5(8)
5. S.M.H Collin, “Dictionary of Accounting” (4th edn, A&C Black, 2007) available at https://ahmadladhani.files.wordpress.com/2008/12/dictionary-accounting.pdf
6. Indian Accounting Standards-17, ‘Leases’ available at < https://www.mca.gov.in/Ministry/pdf/Ind_AS17.pdf>
7. Anita Baid, ‘Inclusion Of Assets Taken On Lease In The Liquidation Estate Of The Lessee’ ( Vinod Kothari, 2018) available at < http://vinodkothari.com/wp-content/uploads/2018/03/Inclusion-of-assets-taken-on-lease-in-the-liquidation-estate.pdf>
8. IBC 2016, Section 5(8)(d)
9. IBC 2016, Section 53(1)(f)
10.Insolvency and Bankruptcy Board of India (Insolvency Resolution Process of Corporate Person) Regulations 2016
11.IBBI Regulation 2016, Reg 32
12.Central Goods and Services Act 2017, schedule II
13.Parmod Yadav & Anr. v. Divine Infracon (P) Ltd and Jindal Steel & Power Ltd. v. DCM International Ltd
14.Jindal Steel & Power Ltd. v. DCM International Ltd 2017 SCC Online NCLT 989
15.“Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design” 5.2.1
16.Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd AIR 2017 SC 4532
17.Karan Valecha, ‘Streamlining Operational Debt’ (LexisNexis India, November 2019) available at
18.Manjeera Retail Holdings Pvt. Ltd. v. Blue Tree Hospitality Pvt. Ltd. C.P No. 61/9/HDB/2019
19.Ezresolve, ‘Analysis on Whether Arrears of Rent come under Operational Debt under IBC’ (Ezresolve, 21 October 2019) available at
20.CP(IB) No. 108/KB/2018
21.M/s Seth Thakurdas Khinvraj Rathi v. M/s Cals Refineries Ltd C.P.(IB)-447(ND)/2017
22.M. Ravindranath Reddy Vs. Mr G. Kishan & Ors.
About the author –
This article is
authored by Shefali Agarwal, Final year law student at National Law University Odisha.
