[Sanskar Modi and Vijpreet Pal are 3rd year BA LLB (Hons.) students at National Law Institute University, Bhopal (NLIU)]
Recently, the Supreme Court, in the case of Orator Marketing v. Samtex Desinz decided that a lender who has advanced interest-free loans to a corporate body would fall under the definition of financial creditor and thereby could initiate the Corporate Insolvency Resolution Process (‘CIRP’). The SC ruled that interest is not a sine qua non for a debt to fall within the ambit of financial debt under the Insolvency & Bankruptcy Code, 2016.
Although the decision clarifies the point that ‘interest’ is not a compulsory requirement, it fails to appreciate the principal aspect of the definition of financial debt i.e. the consideration for the time value of money. This post aims to critically analyze the ruling of the Court in light of the various precedents and argues that interest should be considered as an essential component under the definition of financial debt.
Sameer Sales entered into a loan agreement with Samtex Desinz to advance an interest-free term loan of INR 1.60 crores to Samtex. The amount was to be repaid within two years but Samtex failed to repay the outstanding due. In the meantime, Sameer Sales assigned the outstanding loan to Orator Marketing and the same was acknowledged by Samtex.
When the amount was due, Orator Marketing sent a demand notice asking for the payment of the outstanding debt but the respondent failed to repay the said amount. Orator Marketing filed an application under section 7 of the Code seeking initiation of CIRP against Samtex. However, the said application was rejected as the National Company Law Tribunal (‘NCLT’) was of the view that Orator Marketing failed to satisfy the twin requirements needed for a loan to fall within the definition of ‘financial debt’. The first requirement is that there is a debt along with interest, if any, which has been disbursed and the second requirement is that such disbursement has been made against the ‘consideration for the time value of money’.
Aggrieved by the order of the NCLT, Orator Marketing approached the National Company Law Appellate Tribunal (‘NCLAT’) under section 61 of the Code. However, NCLAT affirmed NCLT’s view and dismissed the appeal, holding that for a loan to qualify as a financial debt it should have consideration for the time value of money and the consideration should be for the financial creditor (‘FC’) and not the corporate debtor (‘CD’). Subsequently, Orator Marketing filed an appeal before the Supreme Court against the order of the NCLAT.
The Court accepted the appeal and ruled that any interest-free transaction is well within the ambit of Financial Debt mentioned under section 5(8) of the Code. The observations of the Court were mainly based on two grounds-:
Usage of the words “If any” in section 5(8) widens the scope of financial debt
The Court observed that the NCLT and NCLAT had misconstrued the definition of ‘financial debt’ mentioned under Section 5(8) by limiting its scope only to debts which are borrowed against the payment of interest. The Court pointed out the significance of the words “if any” present in the definition of ‘financial debt’, which is “a debt along with interest, if any, which is disbursed against the consideration for the time value of money.” The Court concluded that both the NCLT & NCLAT overlooked the relevance of the words ‘if any’ and therefore were not able to appreciate the fact that even if there is no interest payable on the loan, the outstanding principal would qualify as a financial debt.
Expression ‘includes’ under section 5(8) – illustrative and non-exhaustive
The Court further invalidated the orders of the NCLT and NCLAT because they interpreted the meaning of financial debt non-contextually and in isolation. The Court observed that when a doubt about the construction and/or interpretation of a statute’s provision arises, the provision must be read in the context of the statute. The legislative intent and objective, as well as the reasoning and spirit must be determined by the language employed by the legislature.
The Court reasoned that in a statute, the legislature has the authority to give either limited or expansive construction to the definition of a provision. When the provision is defined to ‘include’ anything, the definition is prima facie broad. Based on this reasoning, the Court adjudged that the definitions of ‘financial creditor’ and ‘financial debt’ reveal that a financial debt is a loan plus interest, if any, that is disbursed in consideration for the time value of money. However, it may also include money borrowed or raised in any of the ways specified in section 5(8) or in any other way, since section 5(8) is an inclusive provision and sub-clauses (a) to (i) of section 5(8) are illustrative in nature rather than exhaustive.
In this ruling, the Court relied on Dilworth v. Commissioner of Stamps which stated that the word ‘include’ is frequently employed in interpretation clauses to broaden their meaning, and when it is used in this way, these words or phrases must be interpreted as encompassing not only what they naturally indicate, but also what the interpretation clause specifies that they shall include.
Therefore, the Court ruled that since the disbursal against the consideration for the time value of money is the fundamental characteristic of a financial debt which may include any of the modes prescribed in sub-clauses (a) to (i) of section 5(8), the interest-free loan in this case would be termed as financial debt.
Although the Court in the present case clearly stated that a debt with no interest component is a financial debt, this judgment must be understood in the context of conflicting NCLT and NCLAT rulings. There are multiple NCLAT rulings which emphasize the importance of interest component in the determination of the existence of a financial debt. In Shreyans Realtors v. Saroj Realtors, the NCLAT pronounced that if the CD never agreed to the interest component of the agreement and never paid or agreed to return the loan with interest, the loan will not be considered as financial debt, and the creditor will not be referred to as a FC.
The NCLAT in Monica Ramesh Shah v. Al Fara’A Properties ruled that “consideration for the time value of money” is the fundamental characteristic of the financial debt wherein the expression “time value of money” includes interest. Further, the NCLAT in Narendra Kumar Agarwal v. Monotrone Leasing clearly stated that the interest constitutes the essential component of the time value of money. Even the Insolvency Committee Report of 2018 shows that the time value of money comprises two components: either interest or factoring of discount in payment. As a result, in order for a debt to be disbursed in consideration of the time value of money, it must have an interest component. Additionally, the Supreme Court failed to appreciate the reasoning given by the NCLAT in the present case. The NCLAT in its judgment ruled that “consideration for the time value of money” is for the sake of FC and not CD. In this scenario, the agreement was interest-free and the CD was solely obliged to return the principal amount even beyond the contract’s maturity. Hence, there was no consideration for the FC against the time value of money.
The Court has demystified the conundrum surrounding the word ‘interest’ before the phrase ‘if any’ in the definition of financial debt by ruling that Section 7 application can be filed even if no interest is attached with the debt. However, there is no clarity with respect to the phrase ‘time value of money’.
In order for an interest-free debt to qualify as financial debt, an FC must show that the funds were disbursed with ‘consideration for time value of money.’ The question of what constitutes ‘time value of money’ varies depending on the facts and circumstances; nonetheless, the FC must demonstrate that it had an interest in the subject matter for which the loan was disbursed and was profiting from it.
The ruling of the Supreme Court will have detrimental consequences as it neglected the requirement mentioned above. Given the various conflicting NCLT and NCLAT’s rulings, this judgment has raised a number of confusing issues that will seek judicial scrutiny over whether interest is an essential part of financial debt.
– Sanskar Modi & Vijpreet Pal