Hanging by a Thread: The Saga of Interest-Free Loans under the IBC

[Ojaswi Shankar is with ICICI Bank in Mumbai]

In Orator Marketing Private Limited v. Samtex Desinz Private Limited (26 July 2021), the Supreme Court held that a person who has advanced an interest-free loan to a corporate entity would be a ‘financial creditor’ and, hence, competent to initiate a corporate insolvency resolution process (“CIRP”) under section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”). The judgment demystifies the uncertainty around treatment of interest-free loans from an IBC perspective, by interpreting the meaning of the term ‘financial debt.’

Factual Matrix

An unsecured interest free term loan was advanced by a company to the corporate debtor for working capital purposes. In due course, a ‘default’ was committed in respect of the loan by the corporate debtor, and an application was filed to initiate a CIRP under section 7 of the IBC. The application and the appeals were dismissed by the tribunals, and the matter reached the Supreme Court on a short question of law, i.e., whether a person who advances an interest-free term loan to a corporate person can be considered to be a ‘financial creditor’ under the IBC.

Observations of the Supreme Court

Section 5(8) of the IBC defines financial debt as: – “a debt along with interest, if any, which is disbursed against a consideration for time value of money.” The  Supreme Court pointed towards the significance of the words “if any” appearing in the definition and observed that the phrase “debt along with interest” being qualified by “if any” suggests that the component of interest in ‘financial debt’ is not a sine qua non for a debt to be considered a financial debt. The emphasis was laid on the conscious insertion of certain words by the legislature in the definition, which could not have been intended to be otiose. It observed that a ‘financial debt’ means outstanding due in respect of a loan and would also include interest, if any interest were payable thereon. If no interest is liable to be paid, the outstanding principal alone would qualify as a ‘financial debt.’

The Court further remarked that the tribunals failed to take notice of an important part of the definition of ‘financial debt,’ as contained in clause (f) to section 5(8) of the IBC, which provides that any amount raised under any other transaction having a commercial effect of a borrowing shall be deemed to be a financial debt. In considering whether the said component should also reflect the element of ‘time value of money’ as set out in its principal clause for it to be considered a financial debt, the Court, inter alia relying upon its observations in CIT v. Taj Mahal [1971 3 SCC 550], – wherein it was opined that “the word ‘includes’ is often used in interpretation to enlarge the meaning of the words or phrases occurring in the body of the statute” – held the clauses to section 5(8) to be illustrative and not exhaustive.

In conclusion, the Supreme Court  held that keeping in view the objects and scheme of the IBC, an interest free term loan to meet the financial requirements of a corporate debtor has the commercial effect of a borrowing and, in the absence of an express exclusion, it should be construed to be a ‘financial debt’ under the IBC.

Critical Analysis

While interpreting the meaning of ‘financial debt’ under the IBC to include a loan without interest, the Supreme Court dilutes the significance of ‘time value of money.’ In Anuj Jain v. Axis Bank Ltd. [2020 4 SCC 401], the Court had observed that for a debt to become a financial debt, it has to be “disbursed” against a “consideration for time value of money.” The phrase “time value of money” is defined by the Insolvency Law Committee in one of its reports as “compensation or price paid for length of time for which the money has been disbursed, which may be in the form of interest paid on the money, or factoring of a discount in the payment.” Despite having such clear exposition of the meaning of ‘time value of money,’ which is said to include interest payment, the Court has taken an opposite stance in holding that a loan disbursement transaction devoid of any component of interest (time value of money) would still be a financial debt.

It appears that Supreme Court’s interpretation is based on a selective reading of the expression “commercial effect of a borrowing,” which ignores the word “commercial” appearing before the latter part of the expression. As it opined in Pioneer Urban Land & Infrastructure v. Union of India [2019 4 SCC 17], the word ‘commercial’ would generally involve transactions having profit as their main aim, and any amount raised pursuant to that objective would have a commercial effect of a borrowing. However, in the Orator Marketing case, there is no element of profit as the corporate debtor was solely obliged to return the principal amount without any interest. Therefore, the interpretation of the Supreme Court that an interest free loan would have a commercial effect of a borrowing, in absence of any profit arrangement indicating time value of money, may not be free from doubt.

Conclusion

In an atmosphere where divergent views on treatment of loans without interest were already floating due to various contradictory decisions of the tribunals, it was an opportune moment for the Supreme Court to step in and clear the air. However, the Court’s judgment in the Orator Marketing case has further complicated the jurisprudence on this aspect as it stops short in authoritatively commenting on various crucial aspects that it touched upon, as for instance, whether time value of money forms an essential basis to a financial debt, or whether the component of time value of money ought to be read into transactions falling under various clauses to section 5(8) of the IBC. The fate of these questions are now kept hanging until the matter is settled finally with a more reasoned and speaking judgment by the Supreme Court.

– Ojaswi Shankar