Security deposits carrying interest at 21% per annum, constituted financial debt under Section 5(8) of the IB Code

Supreme Court held that the security deposits under the agreements, carrying interest at 21% per annum, constituted financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 2016.

Supreme Court Bench of Justice Abhay S. Oka and Justice Pankaj Mittal was hearing appeals and held that the security deposits under the agreements, carrying interest at 21% per annum, constituted financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (IBC) due to the consideration for the time value of money, thereby qualifying the respondents as financial creditors under Section 5(7) of the IBC.

The Supreme Court addressed appeals challenging the NCLAT judgments dated 7th and 29th October 2021. The primary issue in these appeals was whether certain respondents qualified as financial creditors under Section 5(7) of the Insolvency and Bankruptcy Code, 2016 (IBC).

Civil Appeal No. 1143 of 2022

The central question was whether the first respondent was a financial creditor. The corporate debtor, M/s. Mount Shivalik Industries Limited, had entered into two agreements with the first respondent on 1st April 2014 and 1st April 2015, appointing the respondent as a ‘Sales Promoter’ with a security deposit carrying interest at 21% per annum. Initially, the first respondent filed a claim as an operational creditor, which was later amended to a financial creditor. The Interim Resolution Professional partly accepted and then rejected this claim as financial debt. The NCLAT on 7th October 2021 ruled that the first respondent was a financial creditor.

Civil Appeal Nos. 6991-6994 of 2022

These appeals questioned whether the first to fourth respondents were financial creditors of the same corporate debtor. The NCLAT's judgment on 29th October 2021 aligned with the decision in Civil Appeal No. 1143 of 2022, determining the respondents as financial creditors.

Factual Background

The Oriental Bank of Commerce invoked Section 7 of the IBC against the corporate debtor, leading to the NCLT admitting the application on 12th June 2018 and imposing a moratorium. The NCLT later approved the resolution plan by M/s. Kals Distilleries Pvt. Ltd. on 13th October 2021. The respondents had their claims as financial creditors rejected by the Interim Resolution Professional, which led to appeals to the NCLAT. The NCLAT allowed the appeals, recognizing them as financial creditors.

Submissions and Considerations

The appellants argued that the first respondent was an operational creditor, emphasizing that the agreements were intended for service provision, not financial facilities. The first respondent's counsel contended that the agreements bore characteristics of financial debt, including acknowledgement of liability and payment of interest, aligning with the IBC's definitions. The Interim Resolution Professional supported the appellants, arguing that the security deposit did not qualify as financial debt and was aligned with service agreements.

The court examined definitions under Section 3(11) and Section 5 of the IBC to determine whether the debt was financial or operational, based on the terms and nature of the agreements.

Supreme Court's Analysis

The Supreme Court referred to previous decisions, including Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited and Others, REEDLAW 2020 SC 02502 and Phoenix ARC Private Limited v. Spade Financial Services Limited and Others, REEDLAW 2021 SC 02501, which outlined the essential elements of a financial debt, emphasizing disbursal against the time value of money. The court scrutinized the agreements dated 1st April 2014 and 1st April 2015, which included security deposits and interest payments, determining that these had the commercial effect of borrowing.

Conclusion

The Supreme Court upheld the NCLAT's judgments, agreeing that the security deposits constituted financial debt, thus making the respondents financial creditors under Section 5(7) of the IBC. The appeals were dismissed without costs, and the Resolution Professional was directed to continue the CIRP process in accordance with the NCLAT's judgments.

---

Subscribers can access the case, along with case analysis, case research, ratio decidendi, headnotes, briefs, caselaw cross-references, etc. etc.

Click on the Citation

REEDLAW 2024 SC 04604