‘FINANCIAL DEBT’ UNDER INSOLVENCY AND BANKRUPTCY ACT, 2016

In insolvency resolution proceedings the term ‘debt’ plays a vital role.  The debt may be either financial debt or operational debt.  The Financial debtor may initiate corporate insolvency resolution process (‘CIRP’ for short) against the corporate debtor for the financial debts owed by the corporate debtor under section 7 of the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short).  Likewise, the operational creditor may initiate CIRP against the corporate debtor under section 9 of the Code for the dues of operational debt owed by the corporate debtor to the operational creditor.

Financial debt

The expression ‘financial debt’ is defined under section 5(8) of the Code as a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes-

• money borrowed against the payment of interest;
• any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;
• any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;
• the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;
• receivables sold or discounted other than any receivables sold on non-recourse basis;
• any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing-

• any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing; and
• the expressions, 'allottee' and 'real estate project' shall have the meanings respectively assigned to them in clauses (d) and (zn) of section 2 of the Real Estate (Regulation and Development) Act, 2016;

• any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;
• any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;
• 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.

In Swiss Ribbons Pvt. Ltd. And Anr. Versus Union of India And Ors. - 2019 (1) TMI 1508 - Supreme Court,  the Supreme Court held that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money.

The NCLAT in Priyal Kantilal Patel Versus IREP Credit Capital Pvt. Ltd. & Anr. - 2023 (2) TMI 73 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, PRINCIPAL BENCH, NEW DELHI,  held that the nature of financial debt would not change in respect of application filed on account of breach of the consent terms in respect of the original financial debt.

The NCLT, Mumbai, in M/s. DF Deutsche Forfait AG and Anr. Versus M/s Uttam Galva Steel Ltd. - 2017 (4) TMI 1111 - NATIONAL COMPANY LAW TRIBUNAL, MUMBAI held that a transaction will be considered as an operational debt if the payment is made to goods or services and if money is lent in contemplation of returns in the form of interest will be a financial debt.

Financial Creditor

Section 5(7) of the Code defines the expression ‘financial creditor’ as any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

Case laws

In some cases, the NCLT/NCLAT declares some debts as financial debts.

1. Inter-corporate deposit

In Narendra Kumar Agarwal, Suman Agarwal Versus Monotrone Leasing Private Limited, Bimal Kanti Chowdhry IRP - 2021 (1) TMI 717 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, NEW DELHI the NCLAT held that if Inter-Corporate Deposit is made for a certain period which was to be paid back with interest, then such transaction will fall in the definition of 'financial debt'.

2. Security deposit

In Sach Marketing Pvt. Ltd. Versus Resolution Professional of Mount Shivalik Industries Ltd., Ms. Pratibha Khandelwal - 2021 (10) TMI 644 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, PRINCIPAL BENCH, NEW DELHI, the NCLAT held that ‘Security Deposit’ and the interest thereon would fall within the ambit of the definition of ‘Financial Debt’ as defined under section 5(8)(f) of the Code. The said amount of debt was treated as ‘Financial Debt’.

3. Compulsorily Convertible Debentures

In M/s IFCI Limited Versus Sutanu Sinha, Asset Care Reconstruction Enterprise Ltd (ACRE) - 2023 (6) TMI 1492 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, CHENNAI, the NCLAT held that the terms and conditions of the Compulsorily Convertible Debentures (CCD) and the intention of the parties nowhere specify that the instrument would take the character of a ‘financial debt’. At the time of disbursal of the amount, it was to be treated as equity alone and not as debt. Merely because interest is payable on the CCDs, in the case of a default, it cannot be construed that the CCDs fall within the definition of ‘financial debt’ under section 5(8) of the Code.

4. Share subscription

In Sanjay D. Kakade Versus HDFC Ventures Trustee Company Ltd and Ors - 2023 (11) TMI 1219 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL NEW DELHI, the NCLAT held that the amount raised by corporate debtor through share subscription cum shareholding agreement had commercial borrowing effect with corporate debtor’s business, therefore a financial debt. 

5. Refund of share application money

In Mr. Kushan Mitra Versus Mr. Amit Goel, CMYK Printech Limited - 2021 (12) TMI 739 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, PRINCIPAL BENCH, NEW DELHI the NCLAT held that the refund of share application money in the event of non-allotment of shares attracts interest as provided for under section 42(6) of the Companies Act, 2013 and therefore qualifies the essential ingredients of ‘Financial Debt’ under section 5(8) of the Code.

6. Money received from the allottee

In Pioneer Urban Land and Infrastructure Limited & Another Versus Union of India & Others - 2019 (8) TMI 532 - Supreme Court, it was held that in real estate projects, money is raised from the allottee, against consideration for the time value of money. Thus, allottees are to be regarded as Financial Creditors.

The following will not come under the definition of ‘financial debt’-

1. Joint Development Right

In M/s. Vipul Limited Versus M/s. Solitaire Buildmart Pvt. Ltd. - 2020 (8) TMI 740 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, NEW DELHI, the NCLAT held that the Joint Development Agreement entered, is a contract of reciprocal rights and obligations, both parties are admittedly Joint Development Partners, who entered into a consortium of sorts for developing an Integrated Township and for any breach of terms of contract, section 7 Application is not maintainable as the amount cannot be construed as financial debt as defined under section 5(8) of the Code.

2.  Forward Purchase agreement

In Paramount Consultants and Corporate Advisors Private Limited Versus Prabhat Technologies (India) Limited (formerly known as Prabhat Telecom (India) Limited) - 2021 (1) TMI 271 - NATIONAL COMPANY LAW TRIBUNAL, MUMBAI BENCH, it was held that the amount raised under a Forward Purchase Agreement (FPA) would not come within the definition of a ‘financial debt’ unless it bears the dual attributes of having been disbursed against the consideration for time value of money and has the commercial effect of a borrowing.

3. Interest

In Budhpur Buildcon Pvt. Ltd Versus Mr. Abhay Narayan Manudhane, Resolution Professional of Corporate Debtor Housing Development and Infrastructure Limited - 2022 (9) TMI 488 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, PRINCIPAL BENCH, NEW DELHI, it was held that  Interest per se in any business contract cannot be termed to make the debt as a financial debt, if it is in the nature of liquidated damages or in the nature of penal interest, which is a result of compensation for breach of contract which is stipulated for penal interest.

Conclusion

While deciding the issue of whether a debt is a financial debt or an operational debt arising out of a transaction covered by an agreement or arrangement in writing, it is necessary to ascertain what is the real nature of the transaction reflected in the writing.