Recognition of Financial Debt Under IBC: NCLAT Upholds Loan Validity Based on Substance Over Form
- REEDLAW
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REEDLAW Legal News Network reports: In a significant judgment, the National Company Law Appellate Tribunal (NCLAT), New Delhi Bench, reaffirmed that the recognition of financial debt under the Insolvency and Bankruptcy Code, 2016 (IBC), must depend on the substance and real intent of the transaction rather than its mere form. The Appellate Tribunal held that when documentary evidence such as bank statements and acknowledged interest payments substantiate a genuine financial transaction, the absence of a formal sanction letter or written loan agreement does not invalidate the debt. This ruling reinforces the principle that substance prevails over form in determining financial debt under the IBC.
The National Company Law Appellate Tribunal (NCLAT), New Delhi Bench, comprising Justice Ashok Bhushan (Chairperson) and Technical Member Mr. Barun Mitra, while adjudicating a Company Appeal, held that in insolvency proceedings under the IBC, the recognition of financial debt must be guided by the actual nature and substance of the transaction. The Tribunal observed that clear documentary evidence, such as bank records and admitted interest payments, can sufficiently establish the existence of a financial debt, even in the absence of a formal sanction letter or written agreement. The decision underscores that non-banking financial companies can initiate insolvency proceedings if credible evidence of financial lending exists, thereby upholding the principle of substance over form.
This Appeal was filed by the Financial Creditor challenging the order dated 31.03.2022 passed by the Adjudicating Authority (National Company Law Tribunal, Kolkata Bench-I), which rejected the Section 7 application filed by the Appellant against the Corporate Debtor. The Appellant, a Non-Banking Financial Company (NBFC), had advanced a loan amounting to Rs. 1,60,00,000/- to the Corporate Debtor between 18.03.2019 and 12.07.2019, with agreed interest at 8% per annum. The Corporate Debtor issued post-dated cheques in lieu of the disbursed amount, which were subsequently dishonoured. Further, the Corporate Debtor, by letter dated 25.07.2019, requested the return of these post-dated cheques due to changes in the authorised signatory of its bank account. The Corporate Debtor also made partial interest payments, with the Financial Creditor depositing TDS for interest paid up to June 2019. Despite the issuance of a demand notice on 24.09.2019, no payment was made, and the Appellant proceeded to file the Section 7 application on 18.11.2019.
The Adjudicating Authority, while accepting that the disbursement of Rs. 1,60,00,000/- had occurred, rejected the application on the grounds that the Financial Creditor failed to submit the statutory documentation mandated by RBI guidelines, specifically a sanction letter detailing the loan amount, interest rate, and terms. The Authority concluded that the nature of the transaction remained unestablished as a financial debt under the Insolvency and Bankruptcy Code (IBC).
Upon appeal, it was argued that the absence of a written agreement does not preclude recognition of a financial debt when the existence of a loan and interest was admitted by the Corporate Debtor. The Appellant relied on various documents, including bank statements, account confirmations, and assessment forms, to prove the transaction’s financial nature. The Court noted that the Corporate Debtor had acknowledged receipt of the loan with interest and provided post-dated cheques indicative of liability.
The Respondent contended that compliance with the RBI’s Master Circulars and guidelines was mandatory, and the failure of the Financial Creditor to furnish loan sanction documentation was fatal to the Section 7 claim. The Respondent also submitted that subsequent novation purportedly altered the arrangement, rendering the application premature.
The Appellate Tribunal held that the transaction was a commercial borrowing, reflecting the time value of money, evidenced by admitted interest payments. It emphasised that the IBC’s objective of speedy insolvency resolution necessitates examining the real nature of the debt beyond formal documentation. The Tribunal referred to precedents confirming that a written contract is not an absolute precondition for establishing financial debt where sufficient material establishes the transaction’s nature.
The Tribunal further found from correspondence that the Corporate Debtor acknowledged the debt through the issuance of fresh post-dated cheques up to March 2022, yet the Financial Creditor never accepted novation and proceeded with the Section 7 application timely. The Appellate Tribunal set aside the Adjudicating Authority’s order and directed the Corporate Debtor to discharge the debt along with 8% interest within three months. Failure to do so would compel admission of the insolvency application.
In sum, the appeal succeeded on the basis that clear evidence demonstrated the existence of financial debt notwithstanding the absence of formal sanction letters, and the Adjudicating Authority erred in rejecting the claim solely on such grounds. The judgment underscored the imperative to look at substance over form in ascertaining financial debt under insolvency laws, consistent with the objectives of the IBC and applicable regulatory frameworks. Parties were directed to bear their own costs.
Ms. Sadapurna Mukherjee, Advocate, represented the appellant.
Mr. Abhishek Anand, Mr. Ashish Choudhury, Mr. Akash Agarwal, Mr. Abhishek Arora, Mr. Anand Kamal and Ms. Prachi Grover, Advocates, appeared for the respondent.
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