Substantive Inquiry Essential to Establish Financial Debt under Section 7 of IBC; NCLAT Criticizes NCLT for Failing to Address Discrepancies in Financial Statements
- REEDLAW
- Oct 22, 2024
- 3 min read
NCLAT emphasized that a substantive inquiry into the true nature of transactions is essential to establish whether a debt qualifies as financial debt under Section 7 of the IBC.
The National Company Law Appellate Tribunal (NCLAT), Principal Bench led by Justice Ashok Bhushan (Chairperson) and Technical Members Mr. Barun Mitra and Mr. Arun Baroka reviewed an appeal and observed that for a transaction to qualify as financial debt under Section 7 of the IBC, it must involve disbursement for the time value of money, and mere classification as a liability or reliance on information utility records is insufficient. The Adjudicating Authority must conduct a substantive inquiry into the true nature of the transaction.
The appeal arose from a challenge by a suspended director of M/s. West Star Constructions Pvt. Ltd. against the NCLT’s order dated March 6, 2024, which admitted a Section 7 application filed by the Liquidator of M/s. Kalibre Associates Pvt. Ltd. (under liquidation). The application sought to initiate insolvency proceedings, alleging a financial debt of ₹1 crore arising from a loan advanced on November 20, 2010. Notices were issued in the appeal on April 15, 2024, and although the CoC was constituted, the NCLAT restrained it from deciding on any resolution plan pending the final hearing, which took place on September 5, 2024.
The Corporate Debtor contended that the amount advanced was a security deposit for consultancy services in the real estate sector, not a loan, and argued that no financial debt existed in the absence of a loan agreement. It further challenged the maintainability of the Section 7 application, asserting that the liquidator could not initiate insolvency proceedings purely to recover a debt. The Liquidator, however, maintained that the sum was treated as a loan in the financial statements of both parties and argued that NCLT’s permission under Section 33(5) of the IBC empowered the filing of the application.
The NCLAT observed that the NCLT’s order had been passed ex-parte due to the absence of the Corporate Debtor at the hearing. It also emphasized that under Section 5(8) of the IBC, financial debt does not require an interest component but must involve a disbursement for the time value of money. Although the ₹1 crore was recorded as a liability in the Corporate Debtor’s balance sheets, the Tribunal expressed doubt about whether the transaction met the essential criteria of financial debt, noting the absence of evidence demonstrating disbursement for the time value of money.
The Tribunal further highlighted the necessity of determining the true nature of the transaction to ascertain if it qualified as financial debt. It referred to the respondent’s reliance on the Supreme Court judgment in Global Credit Capital Limited and Another v. Sach Marketing Private Limited and Another, REEDLAW 2024 SC 04604, which allowed for a security deposit to be considered financial debt under certain conditions. However, the NCLAT found that the Adjudicating Authority failed to conduct a proper inquiry into the nature of the transaction, which warranted a remand for fresh consideration.
The NCLAT also noted that sole reliance on the NeSL report was insufficient to establish financial debt conclusively, reiterating that while such reports are relevant, they are not determinative. Referring to Dheeraj Wadhawan v. Yes Bank Limited and Another, REEDLAW 2022 NCLAT Del 03550, the Tribunal underscored the principle that information utility records, though significant, do not override the need for substantive evidence. It criticized the NCLT for not addressing the discrepancies between the financial statements and for prematurely admitting the Section 7 application based solely on the NeSL report.
In allowing the appeal, the NCLAT set aside the NCLT’s order and remitted the matter for fresh adjudication. It directed the appellant to file a reply within three weeks and granted the respondent two weeks thereafter to submit a rejoinder. The Tribunal clarified that its observations were limited to the appeal proceedings and should not influence the final determination of the Section 7 application, which must be decided on the basis of merits and evidence.
Mr. Abhishek Naik, Mr. Gulfsha Kureshi and Mr. Raunaq Kalra, Advocates represented the Appellant.
Mr. Anirban Bhattacharya, Mr. Rajeev Chowdhary and Ms. Priynaka Bhatt, Advocates appeared for Respondent No. 1.
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