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Standard Penalty Provisions and Security Measures in the Agreement Cannot Alter the Fundamental Character of the Transaction



The National Company Law Appellate Tribunal, Principal Bench, New Delhi headed by Justice Ashok Bhushan held that Standard penalty provisions and security measures in the Agreement cannot alter the fundamental character of the transaction.


Based on the nature of the transaction outlined in the Agreement, the Appellant's claim qualifies as operational debt rather than financial debt. The Appellate Tribunal emphasized that standard penalty provisions and security measures in the Agreement did not alter the fundamental character of the transaction, which was for the supply of goods.


The National Company Law Appellate Tribunal (NCLAT) issued a judgment in response to an appeal challenging the order dated 17.10.2023 by the Adjudicating Authority (National Company Law Tribunal), Mumbai Bench-I. The appeal, filed by the Appellant, contested the rejection of its claim as a Financial Creditor in IA No. 2909 of 2023.


The case involved an Agreement dated 28.07.2016 between the Appellant, engaged in the sugar business, and the Respondent, 'M/s. Indian Sugar Manufacturing Company Limited' (Corporate Debtor). The Appellant claimed a financial debt of Rs. 34,65,36,490 based on the Corporate Debtor's failure to deliver sugar and pay interest. However, the Adjudicating Authority rejected the claim, categorizing it as an operational debt.


The Appellant argued in the NCLAT that the Adjudicating Authority misunderstood the transaction, emphasizing specific clauses in the Agreement. The Appellant asserted that the Corporate Debtor owed a financial debt as per the terms and conditions.


The NCLAT analyzed the definitions of 'Financial Debt' and 'Operational Debt' under the Insolvency and Bankruptcy Code. It concluded that the nature of the transaction, as reflected in the Agreement, was for the supply of goods (sugar) and, therefore, constituted operational debt. The clauses highlighted by the Appellant, such as penalty provisions and security measures, were deemed standard for supply agreements and did not change the fundamental nature of the transaction.


The NCLAT referenced the Supreme Court's judgments in Consolidated Construction Consortium Limited v. Hitro Energy Solutions Private Limited, REED 2022 SC 02517 and Pioneer Urban Land and Infrastructure Limited and Another v. Union of India and Others, REED 2019 SC 08502 which clarified the definitions of operational and financial debt. The Appellate Tribunal dismissed the appeal, affirming that the Adjudicating Authority correctly categorized the Appellant's claim as operational debt, and there was no error in the impugned order.


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