Defining the test of 'Operational Debt': Analysis

The Author, Shivam Goel, is an Advocate practising on the original and appellate side of the High Court of Delhi

A debt is something quite different from a loan. A loan contracted creates a debt, but there may be a debt created without contracting a loan. Similarly, there is a difference between a debt and liability. For example, a dividend, when proposed, does not become a debt, but only becomes a debt when declared.

The Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as the IBC) segregates debt into two categories, namely, operational debt and financial debt. The Adjudicating Authority in the IBC, not being a recovery court, concentrates on corporate insolvency resolution process rather than debt recovery. The dynamics of understanding what is operational debt becomes extremely relevant because it relates to the provision of goods and services, and activities that relate to the day to day functioning of a business entity. In order to understand the nature of operational debt and to segregate it from financial debt, we proceed with this 10-point analysis, as under:

1. What is an operational debt?

In the matter of: Innoventive Industries Ltd. V/s ICICI Bank, (2018) 1 SCC 407 it was held that:

1. The operational creditors are those creditors to whom an operational debt is owed.
2. An operational debt, in turn, means a claim in respect of the provision of goods or services, including employment, or a debt in respect of repayment of dues arising under any law for the time being in force and payable to the Government or to a local authority.
3. That financial debts are those that may be owed to financial creditors.

2. How Section 9 of the IBC application is to be examined?

In the matter of: Mobilox Innovations (P) Ltd. V/s Kirusa Software (P) Ltd., (2018) 1 SCC 353 it was held that:

While examining an application under Section 9 of the IBC, the Adjudicating Authority will have to determine:

1.  Whether there is an operational debt as defined exceeding Rs 1 lakh? (Section 4 of the IBC)
2. Whether the documentary evidence furnished with the application shows that the aforesaid debt is due and payable and has not yet been paid?
3. Whether there is existence of a dispute between the parties or the record of the pendency of a suit or arbitration proceeding filed before the receipt of the demand notice of the unpaid operational debt in relation to such dispute?

If any one of the aforesaid conditions is lacking, the application would have to be rejected. Apart from the above, the Adjudicating Authority has to follow the mandate of Section 9 of the IBC, and in particular the mandate of Section 9 (5) of the IBC, and admit or reject the application, as the case may be, depending upon the factors mentioned in Section 9(5) of the IBC.

3. Can demand notice of an unpaid operational debt be issued by a lawyer on behalf of the operational creditor?

In the matter of: Macquarie Bank Ltd. V/s Shilpi Cable Technologies Ltd, Civil Appeal No. 15135/ 2017, Supreme Court, it was held that:

1. The demand notice of an unpaid operational debt, can be issued by a lawyer on behalf of the operational creditor
2. In Para 38, it was held that:

“… the expression “an operational creditor may on the occurrence of a default deliver a demand notice…..” under Section 8 of the Code must be read as including an operational creditor’s authorized agent and lawyer, as has been fleshed out in Forms 3 and 5 appended to the Adjudicatory Authority Rules.”

4. Does operational debt generally arise against provision of goods or services?

In the matter of: Neeraj Jain V/s Cloud Walker Streaming Technologies (P) Ltd & Anr, Company Appeal (AT) (Insolvency) No. 1354/ 2019, NCLAT (Date of Decision: 24.02.2020) it was held that:

1. The word debt as defined under the IBC means a liability or obligation in respect of the claim, which is due from any person and includes both financial as well as operational debt.
2. That operational debt can only arise against provisions of Goods or Services.
3. That the choice of issuance of demand notice under Section 8 (1) of the IBC, either in Form 3 or Form 4, under the Application to Adjudicating Authority Rules, 2016, depends on the nature of the operational debt. That Section 8 (1)  of the IBC does not provide the operational creditor, with the discretion to send the demand notice either in Form 3 or Form 4, as per its convenience. The applicability of Form 3 or Form 4 depends on whether the invoices were generated during the course of transaction or not. That the copy of the invoice is not mandatory if the demand notice is issued in Form 3 of the Application to Adjudicating Authority Rules, 2016, provided the documents to prove the existence of operational debt and the amount in default is attached with the application.
4. Does the lease-rent that the tenant owes to the landlord is an operational debt?

In the matter of: Jindal Steel & Power Ltd. V/s DCM International Ltd., Company Appeal (AT) (Insolvency) No. 288/2017, NCLAT (Date of Decision: 28.11.2017), held as follows:

“… Admittedly, the Appellant is a tenant of Respondent. Even if it is accepted that a Memorandum of Understanding has been entered between the parties in regard to the premises in question, the Appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and the debt in respect of the repayment of dues does not arise under any law for the time being in force payable to the Central Government or State Government, we hold that the Appellant tenant do not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-section (21) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to ‘I&B Code’) for triggering Insolvency and Bankruptcy Process under Section 9 of the ‘I&B Code’.”

6. Operational debt comprises of what all?

In the matter of: M. Ravindranath Reddy V/s G. Kishan & Ors, Company Appeal (AT) (Insolvency) No. 331/ 2019, NCLAT (Date of Decision: 17.01.2020), it was held that any debt arising without nexus to the direct input to the output produced or supplied by the corporate debtor, cannot, in the context of the IBC, be considered as an operational debt, even though it is a claim amounting to debt.

Further, it was held that an operational debt is essentially a claim in respect of the following:

(a)  provision of goods;

(b)  provision of services, including employment; or

(c)  a debt arising under any statute and payable to Government/local authority.

If the claim by way of debt does not fall under any of the three categories as mentioned above, the claim cannot be categorised as an operational debt, even though there may be a liability or obligation due from the corporate debtor to the creditor.

7. Whether default in payment of instalment due in terms of a settlement agreement, an operational debt?

Recently, in the matter of: Brand Realty Services Ltd V/s John Bakeries India (P) Ltd, (IB) 1677 (ND)/ 2019, NCLT (Delhi), it was observed that:

1. NCLT is not a recovery court. When a default of either financial debt or operational debt occurs, then financial creditor or operational creditor can file an application for initiating corporate insolvency resolution process under Section 7 or Section 9 of the IBC, respectively.
2. In Para 13, it was observed that:

“… In light of that facts, when we shall consider the case in hand then we find that the settlement agreement on the basis of which the present application is filed by the applicant does not come under the definition of operational debt. At this juncture, we would like to refer a decision of NCLT Allahabad bench in “Company Petition (IB) No. 343/ALD/2018 in the matter of M/s Delhi Control Devices (P) Limited V/s M/s Fedders Electric and Engineering Ltd.” decided on 14.05.2019, in which the NCLT Allahabad bench held that “unpaid instalment as per the settlement agreement cannot be treated as operational  debt as per Section 5 (21) of IBC. The failure or Breach of settlement agreement can’t be a ground to trigger CIRP against Corporate Debtor under the provision of IBC 2016 and remedy may lie elsewhere not necessarily before the Adjudicating Authority”, and similar view is followed by this Bench in IB No. 507/ND/2020.”

8. Whether ‘Income Tax’ or ‘Value Added Tax’ come within the meaning of ‘Operational Debt’?

In the matter of: Pr. Director General of Income Tax (Admn. & TPS) V/s M/s. Synergies Dooray Automotive Ltd. & Ors, Company Appeal (AT) (Insolvency) No. 205/ 2017, NCLAT (Date of Decision: 20.03.2019), it was held that:

1. That ‘Income Tax’, ‘Value Added Tax’ or other statutory dues, such as ‘Municipal Tax’, ‘Excise Duty’, etc. come within the meaning of ‘Operational Debt’.
2. That the Central Government, the State Government or the legal authority having statutory claim (Income Tax or VAT), come within the meaning of ‘Operational Creditors’, regard being had to the scheme of the IBC.
3. That ‘Operational Debt’ in normal course means a debt arising during the operation of the Company (‘Corporate Debtor’). The ‘goods’ and ‘services’ including employment are required to keep the Company (‘Corporate Debtor’) operational as a going concern. If the Company (‘Corporate Debtor’) is operational and remains a going concern, only in such case, the statutory liability, such as payment of Income Tax, Value Added Tax etc., will arise. As the ‘Income Tax’, ‘Value Added Tax’ and other statutory dues arising out of the existing law, arises when the Company is operational, therefore such statutory dues have direct nexus with operation of the Company. Therefore, all statutory dues including ‘Income Tax’, ‘Value Added Tax’ etc. come within the meaning of ‘Operational Debt’.
4. Whether “retention money” being part of the main bill/ invoice, is an operational debt?

In the matter of: Ashish Mohan Gupta V/s Hind Inn & Hotel & Anr, Company Appeal (AT) (Insolvency) No. 1282/ 2019, NCLAT (Date of Decision: 12.02.2020), it was held that:

1. Retention money being part of the main bill is an operational debt.
2. In Para 29, it was held that:

“… We have dealt with the issues and grounds raised by the Appellant and held that the Respondent No. 2 falls under the category of Operational Creditor and the 'debt' is an Operational Debt as per law, which is due and payable. We have also dealt with the issues of limitation and pre-existence of dispute, if any, and hold that there is no pre-existence of dispute and Application is not barred by limitation. Further, we hold that the retention money is a part of main bill which, admittedly an Operational Debt. In view of the aforesaid reasons, we do not find any illegality in the order passed by the learned Adjudicating Authority, in admitting the application under Section 9 of IBC.”

10. Can claim amount towards interest on loan alone be termed as operational debt?

In the matter of: M/s. Steel India V/s Theme Developers (P) Ltd, Company Appeal (AT) (Insolvency) No. 1014/ 2019, NCLAT (Date of Decision: 11.02.2020), it was held that:

1. Claim amount towards interest on loan alone cannot be termed as operational debt.
2. It was held that:

“… It is pertinent to mention that “Operational Creditor” issued first demand notice on 28th December 2018. Based on this first demand notice the “Corporate Debtor” made the payment of the principal amount, and only an interest amount of Rs.22,64,054/- remained outstanding towards interest, for which the “Corporate Debtor” raised the dispute. After that, the “Operational Creditor” issued the demand notice on 15th January 2019. Application for initiation of corporate insolvency resolution process under Section 9 of the I & B Code was filed before the Adjudicating Authority. Before the issuance of the second demand notice, the dispute relating to the payment of interest was existing. Therefore, the Adjudicating Authority rejected the Application by the Impugned Order. It is also pertinent to allege that the outstanding amount is towards interest on the delayed payments, for which there was a pre-existing dispute, before issuance of demand notice. The alleged claim amount, towards interest on loan alone, cannot be termed as an “Operational Debt”. For the reasons aforesaid, we are not inclined to interfere with the order passed by the Learned Adjudicating Authority.”

Takeaways:

1. Debt is a sum of money due under an express or implied agreement as a bond or bill or note; amount due or payable from one person to another in return for money, services, goods, or other obligation.
2. The words ‘debt owed’ means ascertained or certain amount which is opposed to inchoate, contingent, future, un-ascertained, uncertain or imperfect obligations.
3. The term ‘payable’ has two meanings: (1) owing and (2) payable at a particular point of time, and when this expression is used without any qualification it generally means payable at once.
4. What is an operational debt? An operational debt means a claim in respect of the provision of goods or services, including employment, or a debt in respect of repayment of dues arising under any law for the time being in force and payable to the Government or to a local authority.
5. Can demand notice of an unpaid operational debt be issued by a lawyer on behalf of the operational creditor? Yes.
6. Does operational debt generally arise against provision of goods or services? Yes.
7. Does the lease-rent that the tenant owes to the landlord is an operational debt? No.
8. Whether default in payment of instalment due in terms of a settlement agreement, an operational debt? No.
9. Whether ‘Income Tax’ or ‘Value Added Tax’ come within the meaning of ‘Operational Debt’? Yes.
10. Whether “retention money” being part of the main bill, is an operational debt? Yes.
11. Can claim amount towards interest on loan alone be termed as operational debt? No.