The Supreme Court in an important observation declared New Okhla Industrial Development Authority (NOIDA) as an Operational Creditor under the provisions of the Insolvency and Bankruptcy Code, 2016 contrary to its claim of being a Financial Creditor.
The Division Bench comprising of Justice KM Joseph and Justice Hrishikesh Roy dismissed NOIDA's appeal against NCLAT's order and affirmed the Tribunal's view.
Submissions by NOIDA
The primary contention of NOIDA, in the appeal was that the lease deed executed between it and Corporate Debtor is a financial lease as per the Indian Accounting Standard and therefore by the virtue of Section 5(8)d) of IBC, NOIDA qualifies as a Financial Creditor.
Section 5(8)d) of IBC
"Section 5(8)(d)- "the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;"
Learned Solicitor General appearing for the appellant contended that the most prominent and indispensable element to make a lease a financial lease is that there should be a substantial transfer of the risks and rewards incidental to ownership from the lessor to the lessee. What is contained in later rules are essentially by way of examples or illustrations. The mere fact that with reference to each one of them, the appellant may not answer the description of a financial lessor, may not suffice to deprive the appellant of the status of a financial creditor, as the vital question to be posed and answered is whether substantially there is a transfer of risks and rewards incidental to ownership.
He averred that as the Authority is charged with the statutory duty to carry out planned development of the area and group housing being residential in nature and since the construction had to be carried out in accordance with the laws in force and the appellant was also charged with the duty to regulate the activity, all that has happened is that the lease deed contains provisions for the regulatory regime. This cannot detract from the transfer of rewards substantially to the lessee.
He pointed out that pointed out that Section 5(8)d) of IBC is a catchall section and acts as a residuary reservoir, and what remains after what has been provided in the preceding provisions, are captured within its scope. He would contend that the Court must not overlook the object and scheme of the IBC.
The financial creditors occupy a position of dominance whereby they call the shots when it comes to ruling on the destiny of the corporate debtor.Under the IBC, true power vests with the Committee of Creditors. It is the financial creditors, who are at the helm of affairs of the Committee. It is the Committee which will vote and finally decide, on the Resolution Plan, which binds all. A financial creditor would be in a position to sway the views of others on the Committee. He would, in the context of the facts point out that as things stand, the Committee is virtually filled with homebuyers. It would be unjust to deny the appellant its say in the proceedings of the Committee. Huge sums of public money are at stake. As the custodian of public interest, the appellant must be vouch-safed, he submitted.
In his further contentions, he placed reliance on Pioneer Urban Land and Infrastructure Limited v. Union of India, 2019 Latest Caselaw 698 SC
Submissions by Respondent- Corporate Debtor
The Counsel fo the respondent contended that the appellant has not classified in its books of accounts classifying the lease as financial lease. The classification as operating lease or financial lease is to be made from the inception date. Neither at the time of entering into the lease deed nor subsequently has any classification been made. Under the Indian Accounting Standards, a Lessee under a capital lease transaction recognises the lease as an asset in his Balance Sheet and it is presented as Receivable at an amount equal to net investment. The objective of IAS 116 is that both the Lessor and Lessee provides relevant information. In the case of financial lease, a lessor is required to disclose in its financial statement selling profits or loss, finance income on the net investment in the lease, income relatable to variable lease, payment, not included in the measurement of the net investment of the lease. A pattern is expected. Lease payment under an operating lease are on the other hand on straight line basis or another systematic basis. There is difference of substance between the two cases. The 54 absence of classification amounts to non-compliance with mandatory requirement as to standards required under Section 133 of the Companies Act for which a penalty is provided. The lease in question does not countenance substantially the transfer of all the rewards. The Lessee in terms of clause 12 of other clauses is not permitted to assign leasehold interest. Restrictions are put even on the lessee’s shareholding. The clause relating to mortgage would inter alia indicate apart from restriction otherwise that any unearned increase in the value of the lease premises will be at the disposal of the appellant. Therefore, the gains would enure to the appellant. There is no renewal of the lease.
Reliance was placed on Mohd.Noor Vs. Mohd. Ibrahim, 1994 Latest Caselaw 383 SC
Supreme Court's Analysis
The Court, analysed in detail, all the required provisions of IBC, Companies Act and Indian Accounting Standard making up the criteria for 'Financial Lease'
Referring to Rule 63 of the Indian Accounting Standard which states that a lease will be a financial lease if the term of the lease is for the major part of the economic life of the underlying assets, even if the title is not transferred, the Court noted that the present lease is not par with the required criteria. It stated that it is for a period of ninety years and the principle of the economic life of the underlying asset which is the "land" is inapposite in the present case as its economic value is not limited.
"The lease in question is for a period of ninety years. In regard to land, the underlying asset, ‘the principle of economic life of underlying asset’, is inapposite. The economic life of land is not limited. The principle in the said situation is predicated with reference to measuring the economic life of an asset. More importantly, it speaks of the major part of the economic life of the asset. Both these concepts are inapposite and even inapplicable with regard to land. Land does not depreciate with the passage of time. Ordinarily, the price of land would only increase, unlike other assets."
In view of this, it rejected NOIDA's arguement that on the construction being completed the lease land shall be of no value to the lessor and the third party right being created, results in the economic life and the value of the asset being exhausted.
Whether on the basis of Section 5(8)(d), under the lease, what is the underlying asset as between the appellant and the corporate debtor?
The Court noted that though the flats to be constructed are contemplated in the lease, it is not the same as understanding them as the subject matter of the lease. The flats would be the subject matter of the sub-lease. No doubt, from the lease and the sub-lease the right of the lessee or rather its obligation under the lease is to put up the residential flats 94 which he can transfer in terms of the lease. It may be true that the terms of the lease are made binding on the sub- lessee. However, as between the lessor and the lessee, the underlying asset would be the plot of land.
In this backdrop, the Court further rejected NOIDA's arguement that that the land will be of no value to the lessor as having no force because the nature of underlying asset, namely, land which indeed ordinarily would have perennial value.
Rule 62 and Rule 65
The Court went on to examine the contents of Rule 62 and Rule 65 which provides that a lease may be so classified as a financial lease, if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
It noted that the concept that to constitute a lease, a financial lease, it is not indispensable that the ownership is in all cases transferred from the lessor to the lessee is relevant when the lease term is for the major part of the economic life.
The Court cited IBC, 2016 wherein Parliament has defined financial lease in two enactments, to state that ordinarily a financial lease would be a lease which is born as a lease but ends as a sale and the lease does involve transfer of ownership from the previous owner, namely the lessor to the lessee.
The Court also referred to the legal precedents in The State of Orissa & ANR Vs. M/S. Chakobhai Ghelabhai And Company, 1960 Latest Caselaw 156 SC, State of Tamil Nadu V. Binny Ltd.,
Citing Shroff & Co. Vs. Municipal Corporation of Greater Bombay & ANR, 1988 Latest Caselaw 220 SC, the Court reiterated that the expression incidental means ‘necessary’ in certain contexts which does not mean a matter of causal nature only and therrefore in the context of the provision in question, the expression “incidental to” would mean arising out of or otherwise connected with.
"In other words, the risks and rewards must flow out of ownership. The rewards must be those arising out of ownership. This in fact is central to understanding the concept of a finance lease."
IN this background, the Court held that all rewards incidental to the ownership are not transferred to the lessee by NOIDA and thus the conditions of Rule 62 and 65 do not meet in the present scenario and therefore, NOIDA cannot be considered as a Financial Creditor under Section 5(8)(d) of IBC.
Amendment to classify NOIDA as a Financial Creditor
While the Court observed that with regard to the existing provisions, NOIDA is not a Financial Creditor, the possibility of amendment to make it so is always there as Legislature has the deciding power for future course.
Conclusion
The Court rejected the primary contention of NOIDA in view of Section 5(8)(f) of the IBC.
"We are of the view that in the facts of the appeals before us, we are unable to hold that the lessee has raised any amounts from the appellant. The question, therefore, of considering the last limb of Section 5(8)(f), namely, whether it has commercial effect of a borrowing could not arise. But we can safely say that the obligation incurred by the lessee to pay the rental and the premium cannot be treated as an amount raised by the lessee from the appellant. It may be noticed that it is reasonably possible to find that the lessee has raised this amount which it had to pay to the appellant from some other sources. The reliance on the concept of ‘a tool of raising finance’ canvassed by the appellants would be carrying things too far and to allow them to invoke it carries with-it far-reaching implications and bears dangerous portent for the purpose of Section 5(8)(f). We would think that the concept of disbursement as present in the main provision appears to be mandatory in Section 5(8)(f). The purport of Section 5(8)(f) is to provide for an exhaustive catch-all provision."
The Court however, accepted the arguement that recourse to general provision of Section 5(8)(f) can be made even after referrence to special provision of Section 5(8)(d) but noted that lease in question doesn't fulfill the criteria.
The Court remarked that Section 5(8)(a) to Section 5(8)(e) proceed on the basis that there is a transaction.
"We may notice that what Section 5(8)(d) of the IBC provides for is, any liability in respect of any lease, inter alia, which is, however, confined to a finance or capital lease. We are not ruling out the possibility that, in a lease, not a finance or a capital lease, falling under Section 5(8)(d), if it otherwise fulfils the requirements of Section 5(8)(f), it would not fall under the definition of the word ‘financial debt’. In other words, Section 5(8)(d) includes only a finance or a capital lease, which is deemed, as such, under the Indian Accounting Standards. Section 5(8)(f) is a residuary and catch all provision. A lease, which is not a finance or a capital lease under Section 5(8)(d), may create a financial debt within the meaning of Section 5(8)(f), 182 if, on its terms, the Court concludes that it is a transaction, under which, any amount is raised, having the commercial effect of the borrowing."
"All that we are finding, in the facts of this case, is that the lease in question does not fall within the ambit of Section 5(8)(f). This is for the reason that the lessee has not raised any amount from the appellant under the lease, which is a transaction. The raising of the amount, which, according to the appellant, constitutes the financial debt, has not taken place in the form of any flow of funds from the appellant/lessor, in any manner, to the lessee. The mere permission or facility of moratorium, followed by staggered payment in easy installments, cannot lead us to the conclusion that any amount has been raised, under the lease, from the appellant, which is the most important consideration."
The Court dismissed the appeal uphelding the view of NCLAT.
Case Title: NEW OKHLA INDUSTRIAL DEVELOPMENT AUTHORITY vs ANAND SONBHADRA
Case Details: CIVIL APPEAL NO. 2222 OF 2021
Coram: Justice KM Joseph and Justice Hrishikesh Roy
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