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Interest on Operational Debt

Does interest form a part of the operational debt unless agreed by both the parties?
Insolvency and Bankruptcy Code, 2016 was established on June 1, 2016 under section 18 of the Companies Act, 2013 to carry out all powers, duties, and responsibilities given to it by that act and any other applicable law. Consideration of interest as part of operational debt has been a contentious issue among the various NCLT's in India. The tribunal has no jurisdiction to determine the dollar amount of the default or issue a judgement regarding the amount owed to the financial creditor.

While a summary adjudication as to the occurrence of default only requires the adjudicating authority to ascertain and record satisfaction, the authority also has the authority to initiate a CIRP (Corporate Insolvency Resolution Process) under section 10 and proceed to appoint an Interim Resolution Professional under section 16 of the Insolvency and Bankruptcy Code, 2016. This article seeks to answer the following two questions, which have arisen as a result of the split opinions on the issue of interest on operational debt in the absence of an agreement between the two parties:
  • Whether interest is chargeable on operational debt in the absence of an agreement to that effect.
  • Whether the interest alone can qualify as operational debt in order to initiate insolvency proceedings
Insolvency as defined by the Bankruptcy and Insolvency Act of 2016
When a debtor cannot pay its creditors, the situation is called insolvency. In contrast to bankruptcy, insolvency occurs when a person or business is unable to meet its financial obligations in a timely manner, or, in layman's terms, when its assets are insufficient to cover its current liabilities. In contrast, filing for bankruptcy is a formal acknowledgement of financial distress.

After filing for bankruptcy, the company has two options for satisfying its debtors:
  1. First, a debt restructuring that allows for repayment of existing debt to creditors.
  2. Second, a company is liquidated when its assets are sold to settle its debts.

A company's inability to pay its debts is a clear indicator of insolvency.
Section 2 of the Insolvency and Business Closure Act, 2016 governs the procedures to be followed in the event of the insolvency, liquidation, voluntary liquidation, or bankruptcy of: a. any company; b. any limited liability partnership. c. Individual Guarantors or Corporate Debtors d. Partnership and Proprietary Firms e. Individuals (other than Individual Guarantors) f. Any such Government Body Incorporated Under Law For The Time Being In Force As The Central Government May By Notification Specify On This Behalf

After the amendment in 2020 takes effect, a CIRP (Corporate Insolvency Resolution Process) can be initiated only for INR 1 Cr and above. The insolvency process against a corporate debtor in default may be started by any of the following:
  1. A financial creditor is a person, business, or institution (such as a bank or non-bank financial company) to whom money has been lent.
  2. An operational creditor is a provider of operational goods or services.
A corporation or limited liability partnership (LLP) that owes money to an individual is considered a corporate debtor.

Debt incurred from running a business and money owed to lenders
Before IBC, the Companies Act did not differentiate between "financial debt" and "operational debt" when deciding whether or not to initiate winding up proceedings against a company. With the advent of IBC, there are now two distinct types of debt: unsecured and secured. One, monetary obligations Second, monetary obligations incurred while running operations.

Financial debt, as defined by clause (8) of Section 5, includes the items listed in subclauses (a) through I and is defined as a debt plus interest, if any, that is disbursed against the consideration for time value of money.

Claims for the provision of goods or services, including employment, and debts for the repayment of dues arising under any law for the time being in force and payable to the Central Government, a State Government, or any local authority are all examples of "operational debts" as defined by Section 5(21).

Financial debt includes interest, whereas operational debt does not. Even for "financial debt," the presence of "interest" is not a necessary condition, as was decided in Orator Marketing Pvt. Ltd. v. Samtex Desinz Pvt. Ltd[1]. This is because the consideration for operational debt is the service or goods received by the corporate debtor from the operational creditor, making the term "interest" irrelevant in this context.

The concept of interest has not been addressed by the Supreme Court, despite the fact that the case of Swiss Ribbons (P) Ltd v. Union of India[2] addressed the treatment of Operational debt and financial debt.

In Pioneer Urban Land and Infrastructure Ltd. v. Union of India[3], the Supreme Court of India distinguished between "Operational Creditors" and "Financial Creditors," noting that "one of the important distinctions is that in an operational debt there is no consideration for the time value of money- the consideration is of the goods or services availed from the operational creditor."

Banks and other financial institutions are best suited to evaluate the corporate debtor's business viability and feasibility because that is their line of work. When deciding whether or not to extend a loan, these financial institutions carefully examine the applicant's market and socioeconomic standing. In contrast, operational creditors, such as suppliers of goods and services, are only concerned with recouping the costs they incurred as a result of providing those goods and services and are not in a position to evaluate the company's overall viability or potential for success.

Taking into account the Companies Act of 1956, courts have ruled that a company's inability to pay its debts, including the Interest, constitutes grounds for starting a winding-up proceeding. In Vijay Industries v. NATL Technologies Ltd[4].

The Supreme Court distinguished between two scenarios, one in which the amount of debt is not definite or ascertainable and another in which the principal amount stood admitted but the dispute arose as to whether any agreement had been entered into for payment of the rate of interest, by citing the provisions of the Payment of Interest Act, 1978 and the need to avoid multiplicity of proceedings. The Supreme Court refused to dismiss the winding up proceeding and even granted interest at its own discretion.

Do You Have to Pay Interest on Working Capital Loans?
Various NCLTs have reached opposite conclusions on this matter. It was never the intention of legislature to put an obligation upon the Adjudicating Authorities to decide the rate of interest, and interest is not chargeable in the absence of an agreement stipulating "interest." This was the ruling made by the National Company Law Bench in Chandigarh in the case of Wanbury Ltd. v. Panacea Biotech Ltd[5]. It was pointed out that under IBC, the adjudicating authority has no authority to impose interest on the parties or to set the rate of interest.

The NCLT also decided that the appellant's submitted invoices did not warrant interest payments because they lacked a "specific clause of for interest." There was no decision made on the merits of the case because the parties settled the appeal out of court before it reached the NCLAT.

Read Section 15 of the MSME Act, 2006, and the situation takes on new significance: if the buyer fails to pay the seller on time, the buyer "shall be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed date or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified to the Reserve Bank."

When the National Company Law Tribunal (NCLT) New Delhi Bench was presented with the issue of interest in relation to the MSME Act on August 31, 2017, it disallowed the appellant's claim for interest on the grounds that the parties' agreement expressly provided that no interest shall be payable on any money due to the appellant.

The National Company Law Tribunal also ruled that a claim involving the interest could only be referred to the Micro and Small Enterprises Facilitation Council for adjudication because the appellant was registered under the MSME Act.

Interest cannot be claimed as a "industry practise" on an operational debt, as held by the NCLT Mumbai in Vitson Steel Corp Pvt Ltd. v. Capacite Infraprojects Ltd[6]. The National Company Law Appellate Tribunal (NCLAT), in Steel India v. Theme Developers Pvt Ltd[7]., affirmed the latter approach and ruled that interest could not be claimed unless it was agreed upon by the parties.

The NCLT Mumbai Bench addressed the matter of Govind Sales v. Gammon India Limited[8], in which the applicant sought to recover the interest amount from the alleged corporate debtor in accordance with Sections 15 and 16 of the MSME Act. That Gammon India had paid Govind Sales the full principal amount was an admitted fact.

Gammon India had objected to Govind Sales' application on the grounds that it was not properly verified as a micro, small, or medium enterprise (MSME). The NCLT rejected this argument, finding that Govind Sales had merely attached a "Udyog Aadhar Memorandum-Online Verification" form to prove that it was indeed an MSME.

An intriguing question arose in the petition of Swastik Enterprise v. Gammon India Limited[9], and that was whether or not the petitioner could press for admission of petition only on the basis of interest amount after having received the principal operational debt. It was decided that the petition could not be maintained because the "operational debt" in question could not be ascertained, despite the fact that the "Principle amount of debt" had been paid and duly accepted by the petitioner, and the claim of interest remained unsubstantiated in the absence of cogent evidence.

The National Company Law Tribunal (NCLT) of Mumbai ruled in Asmi Enterprise v. Yog Industries that the Liquidator lacked jurisdiction to hear a claim that had expired.

As goods or services are supplied against money, there is also some time value of money for a "operational debt," as was noted in the case of D.F. Deutsche Forfait AG v. Uttam Galva Steel Ltd[10]. It was noted that it would be unreasonable to assume that consideration for delays in payment would be left unpaid for extended periods of time.

Any delay beyond the credit period should entitle the creditor to claim "interest," as it is common knowledge that today's money is worth less than yesterday's. "On commercial side, the [operational] creditor claiming interest is quite normal and justifying, after all, business is always run keeping in mind the time value of money," the NCLT stated.

The rulings in cases like Wanbury, SS Polymers, Swastic Enterprise have not shied away from categorically excluding interest in the operational debt. Cases like Swastik Enterprises are a proof that not only is the interest included in the operational debt is not allowed but the petition solely for the purpose of interest is also not allowed in the court of law and therefore in my opinion these judgements uphold the essence of the IBC, 2016.

Since the National Company Law Tribunal, under the IBC, is not usually envisaged as a body to enter into detailed examination of evidence and therefore, in absence of a written contract with respect to payment on interest, the debate further intensifies as to whether National Company Law Tribunal can admit such petitions and determine the rate of interest.

Even though it is really a need of the hour that the Honourable Supreme Court passes a judgement bringing clarity on to the topic, but in the absence of such a judgement the majority of adjudicating authorities have protected the interests of debtors.

  1. Civil Appeal No. 2231 OF 2021
  2. (2019) 4 SCC 17.
  3. (2019) 8 SCC 416.
  4. (2009) 3 SCC 527
  5. 2017 SCC Online NCLT 475
  6. CP (IB) No.1579/MB/C-IV/2019
  7. 2020 SCC Online NCLAT 200.
  8. CP 1727/IBC/NCLT/MAH/2017
  9. 2018 SCC Online NCLT 9730
  10. 2017 SCC Online NCLT 546.

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