Whether a Refund of Advance is an Operational Debt

[Richa Saraf and Shreya Jain are with Vinod Kothari Consultants Pvt. Ltd.]

It is not an unusual business practice to collect advance monies from consumers before providing goods or services to them. In such a scenario, consumers constantly bear the risk of not being able to recover the advance amount in the event the provider of goods or services abruptly ceases operations and, as such, also fails to supply the goods or services. The National Company Law Tribunal (NCLT), Kolkata, in its recent ruling, in SHRM Biotechnologies Private Limited v. VAB Commercial Private Limited, determined the issue whether a claim towards refund of advance money would fall within the definition of “operational debt”. The NCLT held in negative, stating that the creditor neither did render any service to the corporate debtor nor did provide any goods to the corporate debtor, and thus such prepayment would not constitute an operational debt.

Although the said issue has been dealt with in numerous cases, however, due to contradictory stands taken by the NCLT benches, the ambiguity continues. In this post, we seek to analyse the NCLT order.

Facts of the case

SHRM Biotechnologies Pvt. Ltd., the applicant in the instant case, approached VAB Commercials Pvt. Ltd., the corporate debtor, for arranging for an investor. On the basis of a mandate letter, the applicant paid certain amount as advance to the corporate debtor. According to the mandate letter, in case the corporate debtor is not able to arrange for any investor, the entire advance paid was to be refunded to the applicant. Despite breach of terms, the corporate debtor did not refund the advance amount. The applicant contended that the corporate debtor has failed to provide requisite services and also not refunded the advance amount; hence, a demand notice was served on the corporate debtor. Further, there was no dispute raised by the corporate debtor and, in fact, the corporate debtor did not appear before the adjudicating authority to contest the application, and therefore the application should be allowed.

The moot issue for consideration was whether a claim towards repayment of advance, in terms of breach of mandate letter signed and executed by the applicant and the corporate debtor, comes under the ambit of “operational debt” for the purpose of section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC).

Interpretation of the relevant provisions

To determine whether the application is at all maintainable, the NCLT deliberated on the term “operational debt” as contained in the IBC. According to section 5(21), “operational debt” means:

(a)        claim in respect of provision of-

(i)      goods or

(ii)      services, including employment; or

(b)       debt in respect of payment of dues arising under any law for the time being in force and payable to-

(i)      the Central Government,

(ii)     any State Government; or

(iii)     any local authority.

The applicant could definitely not be categorised as Central Government, any State Government or any local authority. The next question for consideration was whether the debt would fall under the ambit of “claim in respect of the provision of goods or services.” It was observed that the applicant has not rendered any service, nor provided any goods to the corporate debtor. In this regard, the NCLT also placed reliance on Sajive Kanwar v. AMR Infrastructure, wherein the NCLT, Principal Bench analysed the definition of operational debt. The relevant extract is as follows:

“It is doubtful whether it would include all debts other than financial debt because we do not find any such legislative intendment…”

Again, in Daya Engineering Works Pvt. Ltd. v. UIC Udyog Ltd., the applicant made advance payments for certain materials, for which there was a short supply. An application was, therefore, filed under section 9 of the IBC, but the matter was dismissed on the ground that the amount due to the applicant did not fall under any of the aforementioned elements of the definition of operational debt, and hence, there exists no operational debt at all.

Our analysis

To emphasize, the term “operational debt” is defined to mean “claim in respect of provision of goods or services….” It may be argued that the definition of “operation debt” is ambiguous on two counts. First, with regard to the direction of flow of provision of goods or services, the provision does not stipulate that the provider of goods or services shall be the creditor and the recipient shall be the corporate debtor. An operational debt is only a claim “in respect of provision of goods or services”. Hence, there might be instances where the party paying advance may be regarded as a creditor, and the party to provide goods or services is then regarded as debtor against the advance amount. Secondly, the section is not very clear as to whether the provision of goods and services should have already taken place on the date of filing of claim, or on the date of making the application, as the case may be, or whether such provision of goods and services may be for future as well.

Considering the aforementioned, it is quite possible to arrive at alternative interpretations of the definition. In fact, in Auspice Trading Private Limited v. M/s Global Proserv Limited, a creditor, being aggrieved due to the non-repayment of advance, approached NCLT, Mumbai under section 9 of the IBC. The application was admitted by NCLT, initiating corporate insolvency resolution process against the debtor.

To further substantiate, there are potentially three types of claims: financial, operational and others. The category of other claims was added mainly for home buyers, pursuant to the Supreme Court ruling in Jaypee Infratech. It is also pertinent to mention that the erstwhile section 271(1)(a) of the Companies Act, 2013 for failure to pay money has been deleted, leaving no scope for a winding up application by creditors. In essence, the only remedy seems to be the IBC. While it is true that the IBC is not a proper remedy for commercial claims which are otherwise undisputed, there may be a case of inability to pay or discrete insolvency. But the interpretation of the word “claims”, and the distinction between financial and operational debt should not be given a narrow interpretation. It is certainly acceptable to construe the term “financial debt” with a precise meaning so as to include financial facilities only; however, the word “operational debt” should be interpreted widely so as to minimise the third category, other claims, which is only a claim without a right. Such a remediless claim, must be minimised.

Richa Saraf & Shreya Jain

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4 comments

  • IMPROMPTU

    The term defined is “ópratinal debt” . Clause (b) refers to, –
    i) “debt”, with no prefix- operational, as in clause ((a) .; and
    ii) adds – “in respect of payment of dues arising”.

    POSER (s) (:
    A) Should not, according to a conjoint and harmonious reading , -the logical and better view be,that – the legislative intent be regarded to have been to cover, also claim in respect of payment of dues arising- in respect of provision of goods or services as envisaged in clause (a) ?

    B) Is not, even if the intent has not been made clear, from the viewpoint of the subject -claimant, – with no discrimination- an interpretation in favour of claimant also referred to in clause (a) , called for, by doing violence to the deficient language, as inevitable?

    Over to law lords at large for deliberation !

  • To ADD-on(:
    The Insolvency and Bankruptcy Code, 2016 and the related unpleasant developments may have been of the most concern to “creditors”, in its comprehensive sense. For its purposes, terms used and specially defined, in respect of debts covered within its domain, are, Financial- and operational-debts (apart from “others”).
    The need for such a special but convoluted definition is anybody’s guess. Going by common sense, the term “DEBT” is a simple concept, and for all materialistic purposes, connotes and is wholly connected to only financial transactions. As regards ‘operational’, debts come into being only in respect of any entity’s field of ‘óperation’ of business / profession.
    For related material for INFO.- https://www.google.co.in/search…
    For a recent development >
    https://www.facebook.com/swaminathanv3/posts/1953130858096524

  • Section 5(2) specifies the claims should be in respect of provision of services. The Act does not specify that the services should have been rendered. As long as the claim is in respect of provision of services it should in my view be classified operational debt. A claim for repayment of advance made for provision of services is a claim against provision of services. The Act also does not specify which are the services that are covered under the claim for provision of services(Section 5(2). One way to look at is that the clause “claim for provision of services, including employment” will cover only services which are in connection with the production /manufacture / provision of services but that seems to be too narrow an interpretation because of the use of words “including employment” which expands the scope of the area of services. A more proper interpretation of the clause shall be that the services are in relation to the business and should be in connection / incidental to the business.

    Further claim has been defined under Section 3(6) of the Act as under:
    “claim” means –
    (a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured;
    (b) 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;
    In the case of an advance payment for services to be rendered, the supplier / creditor is entitled to a right of repayment for a breach of contract and hence the amount asked for will get covered as a claim under the Act.

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