[Shivankar Sukul and Vedaant S. Agarwal are IV-year law students at the National Law University, Jodhpur]
The Supreme Court of India (“the Court”) in Orator Marketing Pvt Ltd v. Samtex Desinz Pvt Ltd, (“Orator”) held an interest free term loan as a ‘financial debt’ in clear defiance of the statutory scheme under the Insolvency and Bankruptcy Code, 2016 (“the Code”), which necessitates consideration for the time value of money essential for such classification. While the judgment purports to interpret the term ‘financial debt’ and bring out the legislative intent behind it, the Court overlooks the statutory requirement of ‘time value of money’, thereby disturbing the scheme of the Code.
Analysis of the Judgment
The appeal before the Court was to decide the competence of the applicant to initiate the corporate insolvency resolution process (“CIRP”) under section 7 of the Code. For this, the Court had to determine whether a simple term loan granted to the corporate debtor, without any interest, was sufficient to treat the applicant as a financial creditor. Thus, the question before the Court was whether the said transaction could be treated as a ‘financial debt’ as defined in section 5(8) of the Code.
The statutory language of section 5(8) of the code, which formed the basis of the reasoning reads: “Financial debt means a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money.” It further includes other transactions, such as amounts raised through debentures or home buyers, under sub-clause (a) to (i) of section 5(8) of the Code.
While answering the issue, both the adjudicating authority (“NCLT”) and the appellate authority (“NCLAT”) held that the concerned transaction fell outside the scope of financial debt because of the absence of the consideration for time value of money. Therefore, they came to the conclusion that the applicant could not be treated as a financial creditor and was thus, not eligible to initiate CIRP under section 7 of the Code.
However, the Court took a contrary view holding the said transaction to be a financial debt. In doing so, it relied on the wording of section 5(8) to deemphasize the requirement of interest while disbursing the loan. It was their opinion that even “if there is no interest payable on the loan, the outstanding principal would qualify as a financial debt”. Further, it took into consideration clause (f) of section 5(8), whereby a transaction, having the commercial effect of borrowing would also constitute a financial debt. Accordingly, it held the said transaction, the term loan, to have the commercial effect of borrowing, and to fall within the purview of a financial debt. Therefore, the applicant could step in as a financial creditor and initiate CIRP against the corporate debtor.
The reasoning of the Court regarding the non-imperative nature of “interest” seems reasonable, overlooking the concept of “time value of money” is bound to have several unintended consequences corrosive to the scheme of the Code.
Dilution in Concept of Consideration for Time Value of Money
The exposition that interest is not material to classification of a transaction to be termed “financial debt” has been echoed by several cases, such as Shailesh Sangani v. Joel Cardoso and B.V.S Lakshmi v. Geometrix Laser Solutions Private Limited. However, in these cases, the courts have invariably highlighted that consideration for time value of money nonetheless remains a prerequisite for a transaction to be termed as a financial debt.
However, it is pertinent to note that, interest and consideration for time value of money are two different concepts. This difference has been very eloquently discussed by the US Supreme Court in Till v. SCS Credit Corp. Its Indian counterpart, namely Pioneer Infrastructure v. UOI, reiterated this distinction under the Code. It held that interest is the cost of borrowing, represented in the form of periodic percentage rate of the total amount lend. Whereas, consideration for time value of money is a compensation for the length of time, where the lender is denuded of the benefit of his money which would have potential earning benefits for him. Hence consideration for time value of money may be represented in various forms such as ‘interest levied ‘or ‘cash flows discounted’ at the time of payments.
It is pertinent to note that the requirement of consideration for time value of money is essential to the scheme envisioned in the Code. Financial creditors are a specific class of lenders who have a wide-ranging powers, such as, voting on the future of the corporate debtor and making important decisions about the future of the corporate debtor, thereby necessitating impartiality of financial creditors in the CIRP. Hence, maintaining an arm’s length between the financial creditors and the promoters of the corporate debtor is central to effective functioning of the insolvency regime, which is ensured by the element of consideration for time value of money. The intention to include only creditors involved in the affairs of corporate debtor with purely profit motive is also evident in the BLRC Report which clearly states that:
“Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or a debt security.” (¶5.2.1)
The absence of consideration for time value of money raises a strong presumption against the bona fides of the transaction, as no lender at arm’s length would advance a loan where he stands to lose the potential rate of returns on holding the money while running the risk of non-payment in case of default or insolvency of the company, unless there is some ulterior motive or collusion behind the transaction. A strong suspicion hinting towards the collusive nature of such transactions is also evident in the observations of the three-judge bench of the Court in the Phoenix case where it stated that:
“A transaction which is sham or collusive would only create an illusion that money has been disbursed to a borrower with the object of receiving consideration in the form of time value of money, when in fact the parties have entered into the transaction with a different or an ulterior motive. In other words, the real agreement between the parties is something other than advancing a financial debt.” (¶46)
Hence, the element of consideration for time value of money is central to maintaining objectivity of the process as it ensures that the group of financial creditors are not involved in the CIRP with any ulterior purpose. However, the Court in Orator’s case proposed a view detrimental to the scheme of the Code by ignoring the consideration for time value of money
Flawed Understanding of the Commercial Effect of Borrowing
As held in Anuj Jain v. Axis Bank Ltd, the consideration for the ‘time value of money’ is not just limited to the principal clause of section 5(8) but forms an essential part of all the transaction listed under sub-clause (a) to (i) of section 5(8) of the Code, even if it is not expressly stated within those clause.
Equally, the term ‘commercial effect of borrowing’ is envisaged to account for a wide range of transactions with the profit element shrouded therein. This requirement of profit element emanates from the interpretation of the word “commercial” as given in Pioneer’s case.
“Commercial would generally involve transactions having profit as their main aim. Piecing the threads together, therefore, so long as an amount is “raised” under ……..agreement, which is done with profit as the main aim, such amount would be subsumed within Section 5(8)(f)” (¶67)
When analyzed from the perspective of the Orator, it could be observed that the Court predominantly based its decision on section 5(8)(f), while going against the interpretation given to the word ‘commercial’ in Pioneer’s case. Without addressing the status of interest free term loans, the Court categorized such transactions under section 5(8)(f) and consequently failed to adequately justify the nuance of ‘commercial effect of borrowing’.
Extinguishing the Class of Other Creditors
The scheme envisioned by the Code as it stands after the amendment brought in 2017 categorizes creditors in broadly three categories which are financial creditors, operational creditors and other creditors. While the classes of operational and financial creditors were intended to comprise of lenders who met the specific requisites laid down in the Code, the class of other creditors was later added by the legislature to cover the creditors who did not meet the aforesaid requirements. Regulation 9A of the (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 which lays down the procedure of filing claims by the other creditors are a clear testament to this understanding of the code.
However, the court in Orator has ignored this clear legislative demarcation between the classes of creditors. Going by the interpretation in Orator, every lender will be covered under the contours of financial creditors as every debt, no matter howsoever structured, contains the element of ‘commercial effect of borrowing’. For instance, even security deposit holders who earlier fell under the category of other creditors, would now be able to claim in capacity of financial creditors because the sum advanced as a security deposit or advance money could be argued to have the commercial effect of borrowing. This leaves the category of other creditors redundant.
The definitional standard of ‘financial debt’ coupled with the judicial interpretation holds the consideration for time value of money a quintessential component in classification of debt and veracity of the transaction. Accordingly, the consideration for time value of money contributes significantly in avoiding transactions detrimental to the scheme of the Code, while its absence effectively jeopardizes the integrity of the CIRP.
However, the Court in Orator has not only failed to bring out the legislative intent behind section 5(8) but has also diluted the provision by overlooking justification for time value of money, thereby setting a questionable precedent for the future. Although the decisions in Pioneer and Phoenix, rendered by three-judge benches, hold precedence over Orator, it is still important to point out that Orator goes against the scheme of the Code.
The divergence of opinion would result in vagueness. Ultimately, it is important to recognize the policy behind inclusion of time value of money and allow only legitimate transactions entered at arm’s length within the purview of financial debt.
– Shivankar Sukul & Vedaant Aggarwal