NCLAT Interprets the Definition of “Financial Debt” under Insolvency Law

[Medhashree Verma and Kavya Lalchandani are 3rd year B.B.A, LL.B. students at National Law University Odisha, Cuttack]

In a recent judgment in Jignesh Shah v. IL&FS Financial Services Limited & Anr., the National Company Law Appellate Tribunal (NCLAT) dealt with the interpretation of the term ‘financial debt’ under the Insolvency and Bankruptcy Code, 2016. It is only when the debt extended by the creditors falls under the definition of ‘financial debt’ that they are considered as ‘financial creditors’ and become eligible to move an application under section 7 of the Code. Therefore, the interpretation of the term financial debt has considerable bearing on whether the corporate insolvency resolution process can be triggered in a given case.   

Facts

IL&FS Financial Services Limited filed a section 7 application before the National Company Law Tribunal (NCLT), Mumbai against La-Fin Financial Services Pvt. Ltd for a default on the financial debt. This arose from a Share Purchase Agreement (SPA) by which ‘IL&FS had purchased almost 4.42 Cr. Equity shares of MCX Stock Exchange Limited (MCX-SX) which came to about 2.46% of the equity share capital of MCX-SX. Further, a Letter of Undertaking (LOU) was entered into between IL&FS, La-Fin and MCX-SX. The LOU obligated La-Fin to offer to purchase the shares of MCX-
SX that have been acquired by IL&FS within three years of such an investment being made by IL&FS in MCX-SX. The same provided IL&FS with an option to exit the investments that it has in MCX-SX. 

However, due to the Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges) Regulations, 2006 (MIMPS) issued by the Securities and Exchange Board of India (SEBI), a scheme of reduction of share capital was introduced by MCX-SX. It was negotiated that the terms of the SPA and LOU will be accordingly honoured. However, after approval of the scheme of reduction of capital from the Bombay High Court, IL&FS was informed that the LOU has become infructuous and cannot be carried out anymore. After the Bombay High Court ruled that the SPA and LOU were lawful and can be carried out without affecting the MIMPS Regulations, IL&FS repeatedly called upon La-Fin to honour its commitment as per the LOU.

Therefore, IL&FS exercised the put option vested with it.  IL&FS filed a suit against La-Fin for specific performance according to its obligation under the LOU. It issued a statutory demand notice under sections 433 and 444 of the Companies Act, 1956 regarding the same. The petition was transferred to the NCLT. The corporate debtor preferred an appeal to the NCLAT against the decision of the adjudicating authority for admitting the section 7 application. La-Fin argued that the amount payable is not in the nature of financial debt and, hence, there is no relationship of debtor and creditor amongst the parties.

Decision of the NCLAT:

The NCLAT quoted the definition of financial debt under section 5(8) of the Code as follows:

“financial debt” means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

(a) money borrowed against the payment of interest; ………

(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause”

The NCLAT observed that the SPA and LOU show that IL&FS had disbursed the money with the objective of having an economic gain. Moreover, it was also found that the terms of the SPA and LOU required not only purchase of shares but also the amount that had to be paid by La-Fin had fallen due on a particular date. The NCLAT held that there was an element of ‘time value of money’ in the present case, specifically when the corporate debtor had undertaken to reverse the said transaction by purchasing the shares within a specific period of time along with the 15% internal rate of return on the transaction. Therefore, it was held that the amount disbursed by IL&FS amounts to financial debt, and hence, the application under section 7 of the Code can be admitted.

Conclusion

In this case, the NCLAT has broadened the scope of ‘financial debt’ by interpreting that exercise of a put option can give rise to a relationship of debtor-creditor and the same amount so payable can fall under the ambit of financial debt giving rise to proceedings under the Code. This shows that the primary requirement to be met for an obligation to result as a financial debt is ‘time value of money’. The same is conventionally understood as payment of interest on the principal amount received as loan. However, it has now become clear that any payment obligation that involves consideration of time value for money paid (whether in the nature of credit as understood in the traditional sense or not) will fall under the definition of financial debt, and the failure to meet the same can lead to insolvency proceedings as well.

Medhashree Verma & Kavya Lalchandani

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