Test to Determine Whether a Debt is a Financial Debt U/S 5(8) IBC: Supreme Court

Background of the Case:

In this case, Sach Marketing Pvt. Ltd. entered into two agreements with M/s Mount Shivalik Industries Ltd. (Corporate Debtor) where Sach Marketing was appointed as a sales promoter. The first agreement stated that Sach Marketing would be paid Rs. 4000/- per month and would deposit a minimum security of Rs. 53,15,000/- carrying an interest of 21% per annum. The second agreement had similar terms but with a different deposit amount.

The debt arose from the agreements between the corporate debtor and the company, where the company was required to deposit a security amount with the debtor. The debtor was then obligated to pay interest on this deposit.

The Oriental Bank of Commerce invoked provisions of Section 7 of the IBC against the corporate debtor, leading to the NCLT admitting the application under Section 7. The NCLT imposed a moratorium and appointed an Interim Resolution Professional (IRP). Subsequently, the Committee of Creditors approved a resolution plan, and the NCLT rejected the respondent's application, considering them a financial creditor.

Insolvency proceedings were initiated against the Corporate Debtor, Sach Marketing filed a claim as a Financial Creditor, which was rejected. Sach Marketing then filed an application before the NCLT to treat its debt as Financial Debt, which was also rejected. However, the NCLAT allowed Sach Marketing's appeal, holding it to be a Financial Creditor. This decision was appealed to the Supreme Court.

Issues before Supreme court

Whether debt is a financial debt within the meaning of definition of financial debt given under the sub-section (8) of section 5 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’)?

Judgment

The Hon’ble Supreme Court relied on the judgments dealing with classification of creditors in Financial Creditors and Operational Creditors including Anuj Jain, Interim Resolution Professional for Jaypee Infratech Ltd Vs Axis Bank Ltd (2020) 8 SCC 401, Phoenix ARC Pvt Ltd Vs Spade Financial Services (2021) 3 SCC 475 and Pioneer Urban Land and Infrastructure Ltd. Vs Union of India & Ors (2019)8 SCC 416.

In this landmark decision, Hon’ble Supreme Court ruled that:

• There cannot be a debt within the meaning of Section 3(11) of the IBC unless there is a claim within the meaning of Section 3(6) of thereof;
• The test to determine whether a debt is a financial debt within the meaning of Section 5(8) is the existence of a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The cases covered by categories (a) to (i) of sub-section (8) must satisfy the said test laid down by the earlier part of Section 5(8);
• While deciding the issue of whether a debt is a financial debt or an operational debt arising out of a transaction covered by an agreement or arrangement in writing, it is necessary to ascertain what is the real nature of the transaction reflected in the writing; and
• Where one party owes a debt to another and when the creditor is claiming under a written agreement/ arrangement providing for rendering ‘service’, the debt is an operational debt only if the claim subject matter of the debt has some connection or co-relation with the ‘service’ subject matter of the transaction.

Accordingly, the Apex Court dismissed the appeals and upheld the judgments of NCLAT.

Source:

Global Credit Capital Limited & Anr. V. Sach Marketing Pvt. Ltd. & Anr., Civil Appeal No. 1143 Of 2022, Dated 25^th April, 2024 https://main.sci.gov.in/supremecourt/2021/30893/30893_2021_7_1501_52458_Judgement_25-Apr-2024.pdf