Corporate Insolvency: Boundaries of Operational Debt: Part 1

[Job Michael Mathew is V year student at NALSAR University of Law, Hyderabad]

The Insolvency and Bankruptcy Code 2016 defines an “operational debt” in section 5(21) as “aclaim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority”.Claims of operational debt typically arise in the context of non payment for purchase of raw materials, wages, statutory charges or the like by one party to the other. According to the definition of operational debt, it will relate to either claims relating to provision of goods or services including employment or dues that are to be paid to governmental authorities. A typical case of operational debt will involve two parties where party “A” supplies certain goods or services to party “B” and party B refuses to make payment for the same.  Claims typically arise from bilateral relationship where one party is initiating insolvency proceedings against another party who refused to make payments for some goods supplied or services rendered.

This post aims to consider if it is permissible under the Code for an applicant who has a claim, but has not supplied any goods or services, to initiate insolvency proceedings under section 9 as an operational creditor. Such a situation might arise in case of a simple bilateral relationship as explained above or in slightly different circumstances as will be explained below. For example, it will arise if party “B” makes advance payments to “A” for provision of certain goods or services and “A” refuses to make supply of goods or provide the service. The question is whether it is permissible for “B” to initiate insolvency proceedings under section 9 in such a circumstance. 

Such a situation may also arise as evident from a decided case in Metal Power Analytical India Private Limited v Crystaline Exports Private Limited, [2017] 88 taxmann.com 133; [2018] 145 SCL 141 (NCLT – Mum).  In that case there were three parties A, B and C. A owns a land and a building in the said land. A leases out the land and sells the building to B in a lease-cum-sale deed.  One of the terms of the deed is that A would be responsible for paying all outgoings with respect to the property such as electricity bills, water bills, maintenance charges among others.  Let’s assume C to be all the different parties to whom A was supposed to make payments under the lease-cum-sale deed. At the relevant time, A refused to make the payments. Since there was a risk that non payment of such dues will adversely impact B’s enjoyment of the land and building, B decided to make these payments to C.  The question is whether B can initiate insolvency proceedings against A under section 9 of the Code as an operational creditor.

At the outset it is important to clarify that there have been judgments from different benches of the National Company Law Tribunal (NCLT) indicating that an applicant had to have supplied goods or rendered services to initiate insolvency proceedings under Section 9. Examples include Ranual Technologies Private Limited v Calprin Ads Private Limited, [2018] 93 taxmann.com 386 (NCLT – Kolkata) and Rahul Sayal v S.S Conbuild, [2018] 96 taxmann.com 282 (NCLT – New Delhi). However, it is humbly stated that those judgments are not applicable to the question that is being discussed in this post. Those judgments arrived at a finding that the claims raised did not relate to provision of goods or services and therefore such a claim cannot be an operational debt. Having held as such, the statement that an applicant needed to have supplied goods or rendered services to initiate insolvency proceedings under section 9 need to be seen as obiter dictaand not the main holding of those cases.  

To be clear, there are two elements to be fulfilled for a debt to be an operational debt. Firstly, it must be a claim and, secondly, it must relate to provision of goods or services.  In the decided cases discussed above, the second element was not satisfied and for that reason the claims were held not to be operational debts. Once it is established that the claim did not relate to provision of goods or services, there is no need to enquire who supplied the goods or rendered the service. Therefore, it is opined that these judgments have no implication on the question at hand.

Going back to the fact situation at hand, two questions that need to be answered are whether there is a claim and, if so, whether it relates to a provision of goods or services. A “claim” is defined in section 3(6) of the Code and means:

(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured; and

(b) a right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured.

According to the facts at hand, there has been a breach of the terms of the lease-cum-sale deed which gives rise to a right to payment and therefore it can be said that section 3(6)(b) is implicated. The second question is whether such breach is in relation to provision of services. In order to answer this question, we need clarity with respect to two issues. An operational debt requires a claim with respect to provision of goods or services. The claim in our fact situation is a right to remedy for a breach of contract as provided in section 3(6)(b). The first issue is whether the combined reading of sections 3(6) and 5(21) means that the contract which has been breached should be of relating to provision of goods or services or whether it means that the term that has been breached should be one dealing with provision of goods or services. The first interpretation would mean that only contracts the main purpose of which is the provision of goods or services would be covered. The second interpretation will cover each and every type of contract and the only condition is that the term that was breached should deal with the provision of goods or services.

 With respect to this point, there is conflicting judicial guidance.  Tribunals have held that transactions relating to transfer of immovable property do not come within the ambit of operational debt as they do not relate to provision of good or services (Col. Vinod Awasthy v AMR Infrastructure Limited and Jindal Steel and Power Limited v DCM International Limited, IB No. 200/ND/2017). Tribunals did not consider it necessary to undertake a secondary level analysis of the specific terms of the contract that was breached, but rather excluded the application of operational debt simply on the basis that the contract in question related to transfer of immovable property. In spite of this, there is a general understanding that lease rents due to a lessor would come under the ambit of operational debt as evidenced by a decision in Mahesh Madhavan v M/S Black and Green Mobile Solutions as well as the Bankruptcy Law Reform Committee Report. The obligations to pay the rent as well as the amount to be paid are terms in a lease agreement which is a contract in relation to transfer of immovable property. In my opinion it is contradictory to hold that transactions relating to transfer of immovable property can never come under the ambit of operational debt and but at the same time consider lease rents as operational debts. There are no legal or policy reasons to not consider a certain debt as an operational debt simply because of its presence in a contract relating to transfer of immovable property if the debt arises from a provision of goods or services. Therefore, in my opinion the term ‘breach of contract’ as used in section 3(6) read with ‘in relation to provision of goods or services’ in section 5(21) means that the breach should relate to provision of goods or services and not that the contract should relate to provision of goods or services.

[Continued here]

Job Michael Mathew 

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