Supreme Court on Whether Advance Paid is an Operational Debt under IBC

[Rohit Sharma is a Partner at Mamta Binani & Associates, Mumbai

By way of its judgment dated 4 February, 2022 in Consolidated Construction Consortium Limited v. Hitro Energy Solutions Private Limited, the Supreme Court held that an amount given as advance to another person in lieu of availing goods or service shall be construed as an operational debt and the payer of the amount shall come within the ambit of an operational creditor for purposes of the Insolvency and Bankruptcy Code, 2016. This post seeks to analyse the said judgement, which has provided a sigh of relief to the creditors who have paid an advance without receipt of any service and have been previously unable to proceed under the Code in the capacity of operational creditors.

Factual Background

Chennai Metro Rail Limited (‘CMRL’) placed an order for supply of light fittings to Consolidated Construction Consortium Limited (‘CCCL’), which in turn placed an order to a proprietary concern, by way of three purchase orders dated 24 June 2013. In order to satisfy the purchase orders, the proprietary concern sought an advance of Rs. 50,00,000, which was paid by CMRL to the proprietary concern, by way of a cheque.

However, the project to be executed by CMRL along with CCCL was terminated, which CMRL informed CCCL on 2 January 2014.  In turn, CMRL also informed that, since the amount has already been realized towards the cheque, the said amount would be deducted towards the dues outstanding from CMRL to CCC, in case the said amount of Rs. 50,00,000 is not returned. CCCL paid an amount of Rs. 50,00,000 to CMRL and instructed the proprietary concern to return the same.

In the interregnum, Hitro Energy Solution Private Limited (‘Hitro’) was incorporated on 28 January 2014,  with one of the main objectives under its memorandum of association (‘MOA’) being to take over the proprietary concern. Subsequently, CCCL sent a letter to the proprietary concern asking it to return the money to CCCL and also stated that CCCL would indemnify the proprietary concern against any claim of CMRL for the said amount. However, the proprietary concern rejected the said proposal. After a series of meetings and communication between the parties, the proprietary concern failed to remit the amount it received from CMRL.

CCCL, being left with no other option sent a demand notice to Hitro, to which a reply was received denying any outstanding to CCCL. Following the receipt of the reply, CCCL filed an application under section 9 of the Code against Hitro. The National Company Law Tribunal (‘NCLT’), Chennai Bench was pleased to admit the said petition by way of its order dated 6 December 2018 and initiate corporate insolvency resolution process against Hitro. The said order was appealed against before the National Company Law Appellate Tribunal (‘NCLAT’), New Delhi Bench, which was pleased to dismiss the said appeal, by way of its order dated 12 December 2019. The said order was appealed against before the Supreme Court and the appeal was allowed in favour of CCCL, being the appellant.

Statutory provision qua advance amount as an operational debt

The Supreme Court delved into the definition of the operational creditor and operational debt as defined in the Code. Interestingly, the Court also emphasised upon the requirements as per the provisions of the Code for serving a demand notice on its debtor and elaborated on both the formats of the notice where it is sent along with invoices and a notice without invoices.

Under the provisions of the Code, a notice under section 8 can be served in Form 3 or Form 4. The requirements for both Form 3 and Form 4 differ, as follows:

Sl. No.

Requirements under Form 3

Requirements under Form 4

1.

Total amount of debt, details of transactions on account of which debt fell due, and the date from which such debt fell due

“[Name of operational creditor], hereby provides notice for repayment of the unpaid amount of INR [insert amount] that is in default as reflected in the invoice attached to this notice.”

2.

Amount claimed to be in default and the date on which the default occurred (attach the workings for computation of default in tabular form)

3.

Particulars of security held, if any, the date of its creation, its estimated value as per the creditor.

Attach a copy of a certificate of registration of charge issued by the registrar of companies (if the corporate debtor is a company)

4.

Details of retention of title arrangements (if any) in respect of goods to which the operational debt refers

5.

Record of default with the information utility (if any)

6.

Provision of law, contract or other document under which debt has become due

7.

List of documents attached to this application in order to prove the existence of operational debt and the amount in default

The Supreme Court elaborated on the point that it is not necessary for a party to send the invoices along with a notice where there is a debt pursuant to any agreement between the parties. The Court also stated that an operational debt occurs in lieu of any operation of an enterprise. In the instant case, since the project was to be undertaken by CMRL and CCCL, whereby goods were to be purchased from the proprietary concern which in turn was to be taken over by the respondent herein, the said outstanding can be construed as an operational debt. According to section 5(21) of the Code, it is pertinent to have a nexus between the claim and the provisions of goods and services.

Considering section 8 of the Code, since a notice claiming the outstanding debt does not require invoices as a part of the notice, documents evidencing the outstanding amount are good enough to be annexed to the notice under section 8 of the Code. Accordingly, all forms of contracts for the supply of goods and services between the operational creditor and the corporate debtor evidenced through documents can form part of the demand notice under section 8 of the Code and can be considered as an operational debt.  

Judicial precedents on the issue of advance being construed as an operational debt

In Acasia Tele Services Private Limited v. Auspice Trading Private Limited, the Mumbai Bench, of the NCLT admitted the petition wherein the petitioner had given an advance to the respondent. However, the contract for supply was subsequently terminated and the refund of the advance was sought by the petitioner. Upon failing to refund the advance, the petitioner filed the petition which was then admitted.

On the other hand, the Kolkata Bench of the NCLT in SHRM Biotechnologies Private Limited v. VAB Commercial Private Limited dismissed a similar petition. The petitioner herein filed a petition on the ground that an advance of Rs. 3,00,000 was paid to the respondent for availing services of the respondent with a condition that upon failure on the part of the respondent to provide the service, the entire advance amount shall be refunded to the petitioner. However, since the respondent failed to provide the service and refund the advance amount, the petitioner filed the petition. However, the NCLT stated that the advance amount does not squarely fall within the definition of operational creditor and operational debt as defined in sections 5(20) and 5(21), respectively.

The Mumbai Bench of the NCLT in Overseas Infrastructure Alliance India Private Limited v. Kay Bouvet Engineering Limited decided in favour of the respondent on the ground that there existed pre-existing disputes. However, it did not attend to the issue of whether the petitioner is an operational creditor, since the default amount basis which the petition was filed pertains to an advance. However, the NCLAT, New Delhi decided in favour of the appellant and stated that the amount given as advance forms part of an operational debt and, hence, remitted the matter back to the NCLT, Mumbai Bench to admit the petition.

Conclusion

The contradictory judgements passed by the NCLTs and the NCLAT regarding the character of an advance amount has now been put to rest. Initially, the situation of the payers of the advance was jeopardized owing to the fact that even if the receiver of the said amount chose abandon its obligations, the payer did not have choice of filing an application for the said amount under the provisions of the Code. However, the resolution of the conundrum by the Supreme Court will introduce a great deal of certainty in the matter.

Rohit Sharma

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