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of <h1>NBFC loan to corporate debtor held financial debt under Section 5(8) IBC; Section 7 rejection set aside</h1> NCLAT held that the amount disbursed by the appellant NBFC to the corporate debtor constituted 'financial debt' under Section 5(8) IBC, as it was a ... Rejection of Section 7 application filed by the Appellant - financial debt or not - Financial Creditor having failed to establish the nature of transaction entered between the parties - HELD THAT:- An NBFC is in breach of guidelines with respect to disbursement of any amount to company statutory consequences need to be followed and there can be no quarrel to the said proposition, but the question which has arisen for consideration is as to whether the amount which was disbursed by the Financial Creditor to the Corporate Debtor is a financial debt or not. When the amount was disbursed for time value of money and the amount is nothing but a commercial borrowing, the mere fact that there is some breach of RBI Guidelines which are statutorily in character, the Corporate Debtor cannot be permitted to contend that definition of financial debt under Section 5(8) need to be looked into with reference to the guidelines. IBC is a special legislation and it has been enacted with the object and purpose of insolvency resolution for corporate persons in a time bound manner. Financial debt within the meaning of Section 5(8) has to be looked into to find out as to whether the Corporate Debtor owes a financial debt or not which empowers the financial creditor to initiate insolvency proceeding against the Corporate Debtor. Hon’ble Supreme Court in Global Credit Capital Ltd. vs. Sach Marketing (P) Ltd. [2024 (4) TMI 1067 - SUPREME COURT] has held that the nature of transaction has to be found out to take a decision as to whether debt is a financial debt or not. The real nature of transaction thus, is a key to come to decision as to whether financial debt exists or not. It is true that there are no written agreements but financial contract between the parties is reflected from bank statement and other materials which have been referred here. Even if there is no financial contract exists between the parties, Court is not precluded from looking into the real nature of transaction which can be proved by the Financial Creditor from the materials brought on the record. In the present case, Financial Creditor has brought sufficient material on record to prove that transaction between the parties was a financial debt. The materials on record, thus, clearly established that there was a financial debt and the case set up by the Respondent by giving fresh post dated cheques from 30.03.2020 to 31.03.2022 itself indicate that liability is being acknowledged and the financial debt has never been paid off. The application under Section 7 was filed on 14.11.2019. The novation of agreement is denied by the Financial Creditor and Financial Creditor clearly pleaded that it never accepted the post dated cheques. In the letter dated 24.09.2019 it was clearly stated that if the loan is not refunded within 30.09.2019, rate of interest would be 18%. The materials brought on the record thus, clearly proved that Financial Creditor successfully proved that Corporate Debtor owe a financial debt which remain unpaid. It is thus satisfied that the Adjudicating Authority committed error in rejecting Section 7 application. In result, the order dated 31.03.2022 cannot be sustained and is set aside. Section 7 application having been rejected on 31.03.2022 and the Appeal being pending thereafter and there is nothing on the record to indicate that debt has been discharged by the Corporate Debtor, one opportunity be given to the Corporate Debtor to discharge its debt along with 8% interest which was initially agreed between the parties. In the ends of justice, three months time granted to the Corporate Debtor to discharge the debt and file proof of discharge of debt before the Adjudicating Authority within three months from today. Appeal allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether the amount disbursed by an NBFC to the corporate borrower constitutes a 'financial debt' within the meaning of Section 5(8) of the Code when there is no formal written loan agreement but documentary and pleading material (bank statements, confirmations, Form 16A, letters, post-dated cheques and admissions) indicate disbursement and agreement on interest. 2. Whether compliance with RBI Master Circular / fair practices code (requirement that NBFCs convey sanction letter/terms in writing) is a pre-condition for classification of a transaction as a financial debt under Section 5(8), and whether breach of such guidelines defeats a Section 7 claim. 3. Whether the subsequent conduct/letters of the parties (supply of fresh post-dated cheques and a later letter indicating 'interest free' or different terms) amount to a novation of the original obligation such that a Section 7 application filed earlier was premature or otherwise unsustainable. 4. Whether the Adjudicating Authority erred in rejecting the Section 7 application on the ground that the 'intention of the parties is not clear' and lack of proper documentation. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Nature of the transaction: whether disbursement without a written agreement can be a 'financial debt' under Section 5(8) Legal framework: Section 5(8) defines 'financial debt' and requires examination of the real nature of the transaction; a financial debt normally involves commercial borrowing and disbursement for the time value of money. Precedent treatment: The Tribunal referred to higher-court authority holding that the real nature of the transaction is decisive and that absence of a formal written contract is not, per se, fatal where the substance reflects a financial debt; the Tribunal also relied on its own earlier view that a written financial contract is not a precondition. Interpretation and reasoning: The Court examined pleaded admissions and documentary matrix - bank statements showing transfers totalling the disbursed sum, confirmation letters expressly acknowledging receipt as 'Loan' for specified periods at 8% p.a., Form 16A evidencing interest payments, schedules of post-dated cheques and specific letters confirming loan amounts and interest. The Court reasoned that these materials demonstrate disbursement for the time value of money and a commercial borrowing, i.e., a financial debt, even absent a singular, formal loan agreement. Ratio vs. Obiter: Ratio - where documentary and pleading material (including admissions by the corporate debtor) establish that funds were advanced as a commercial borrowing with agreed interest, the absence of a written loan agreement does not preclude classification as financial debt under Section 5(8). Conclusion: The transaction qualified as a financial debt; the Financial Creditor proved that the Corporate Debtor owed a financial debt which remained unpaid. Issue 2 - Effect of RBI Master Circular/fair practices code non-compliance on classification as financial debt Legal framework: NBFCs are bound by RBI directions/master circulars which require NBFCs to convey sanction letters/terms in writing and maintain records; such directions are statutory in character and binding on NBFCs. Precedent treatment: The Court acknowledged authoritative pronouncements that RBI master circulars/directions are statutory and binding on NBFCs, and accepted that breach may attract statutory consequences. Interpretation and reasoning: The Court distinguished between (a) statutory/regulatory consequences for an NBFC's non-compliance with RBI guidelines and (b) the distinct statutory inquiry under the Code as to whether the underlying obligation amounts to a financial debt. The Tribunal held that where the substance of the transaction demonstrates a commercial borrowing for time value of money (admitted interest, disbursement, corroborating documents), the mere fact of non-compliance with RBI guidelines does not convert the nature-of-debt inquiry into one which must be resolved solely by reference to those guidelines. IBC being a special statute concerned with insolvency resolution, the definitional inquiry for 'financial debt' requires examination of the real nature of the transaction rather than treating regulatory non-compliance as an automatic bar to Section 7 relief. Ratio vs. Obiter: Ratio - regulatory non-compliance by an NBFC with RBI master circulars does not by itself negate the existence of a financial debt where the real nature of the transaction (from documentary and pleading evidence) shows commercial borrowing and agreed interest; regulatory consequences remain available separately. Conclusion: The Adjudicating Authority erred in elevating non-compliance with RBI guidelines to a determinative ground for denying classification as a financial debt; such non-compliance does not automatically defeat a Section 7 claim where the material shows a financial debt. Issue 3 - Novation by subsequent conduct/letters and prematurity of Section 7 application Legal framework: Novation requires clear evidence that the parties intended to extinguish the old obligation and substitute a new one; conduct and writings evidencing fresh terms can operate as novation if unambiguous and accepted by both parties. Precedent treatment: The Court applied ordinary principles of contract/novation to the pleadings and documents on record. Interpretation and reasoning: The Court analysed the sequence of letters: an earlier letter requesting return/collection of post-dated cheques and a later letter from the corporate debtor enclosing fresh post-dated cheques (dated to between 30.03.2020 and 31.03.2022) and, in correspondence, a response from the Financial Creditor demanding refund and threatening higher interest from a specified date. The Tribunal noted that the Financial Creditor denied acceptance of the purported novation and had specifically reserved its rights; moreover, the later letters (including those relied upon by the corporate debtor) themselves acknowledged the original loan and liabilities. The Court found no clear and unambiguous mutual novation discharging the original obligation prior to the Section 7 filing; the earlier Section 7 application was therefore not rendered premature by an effective novation. Ratio vs. Obiter: Ratio - mere issuance of fresh post-dated cheques and communications indicating proposed altered terms does not establish novation where (i) the creditor does not accept the new arrangement, (ii) the documents continue to acknowledge the original liability, or (iii) the creditor has expressly reserved rights and treated the debt as continuing. Conclusion: No effective novation was proved; Section 7 filing in November 2019 was not premature on the ground of novation. Issue 4 - Whether the Adjudicating Authority erred in rejecting the Section 7 application for lack of clarity of intention and documentation Legal framework: Under Section 7, a financial creditor may initiate insolvency proceedings where a corporate debtor owes a financial debt and defaults; the Adjudicating Authority must examine evidence to determine existence of debt and default on material before it. Precedent treatment: The Tribunal relied on the principle that the real nature of the transaction governs classification as financial debt and that pleadings and documents may suffice to establish financial debt even without a formal loan agreement. Interpretation and reasoning: The Court reviewed the impugned order's reasons (that the intention was unclear and required NBFC to produce sanction documentation) and contrasted them with the contemporaneous documentary record and admissions by the corporate debtor. The Tribunal found that the Adjudicating Authority selectively required documentary formality despite clear evidence (admissions, confirmation letters, interest payments, Form 16A, bank entries, post-dated cheques) proving disbursement and agreed interest. The Court concluded that the Adjudicating Authority wrongly equated lack of a particular formal document with absence of financial debt and therefore erred in rejecting the Section 7 application. Ratio vs. Obiter: Ratio - an adjudicating authority cannot reject a Section 7 application solely on the basis of absence of a particular formal sanction document where the surrounding records and admissions establish disbursement as a commercial borrowing and default. Conclusion: The Adjudicating Authority committed error in dismissing the Section 7 application; its order was set aside. The Court directed that the corporate debtor be given a limited period (three months) to discharge the debt (principal with the originally agreed 8% p.a. interest) and file proof; failing which the Adjudicating Authority shall admit the Section 7 application.
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