A Dilemma!
Insolvency and Bankruptcy Code (‘the Code’) defines ‘operational debt’ as claims arising in respect of provision of goods or services. The term ‘claim’ under the Code refers to right to payment or right to remedy for breach of contract if such breach gives birth to a right to payment. As per the present interpretation of the definition, where the buyer, bound by a goods or services contracts, has not paid the seller for the goods received, such debts will squarely cover under the definition of operational debt. Though, things get foggier in situations where the buyer has paid an advance amount to the seller but has not received any goods or services in exchange. In such a case, an important question of whether a claim arising without exchange of any goods or services can be classified as an operational debt needs to be answered with a clarity as to how the same has to be determined.
Since the advent of the Code, the adjudicating authority and the appellate authority has relied upon and restricted itself to the bare text of the Code to interpret the legislative intent to unscramble the numerous issues that have arisen. The above is the one peculiar concern that has surfaced since the inception of the Code as to whether seeking a refund of an advance given to a corporate debtor would tantamount to an ‘operational debt’ as under Section 5(21) of the Code? The Adjudicating Authorities, in several instances, have answered the particular concern in negative.
The issue first arose in SHRM Biotechnologies Pvt. Ltd. v. VAB commercial Pvt. Ltd.[1], where the NCLT held that since the appellant, which invoked section 9 of the Code, was not rendering any goods or services to the debtor, he would not be called an operational creditor. The bench also perused section 5(21) of the Code and carved out three important elements – (i) debt arising out of provision of goods; or (ii) services; or (iii) out of employment. Since the appellant was not falling within the ambit of any of these elements, the bench dismissed the application.
Even the NCLT Mumbai in TATA Chemicals Ltd. v. Raj Process Equipments and Systems Pvt. Ltd.[2], while rejecting the application held that the petitioner has not provided any goods/services to the debtor and his claim cannot be called an operational debt. Hence, the Adjudicating Authorities have adhered to the four corners of the definition as inscribed in the Code.
Both the benches failed to give any cogent reasons as to why the particular claims could not be classified as an operational debt. The order lacked any reliable reasoning or analysis for the conclusion that the bench reached in the above-mentioned matters.
However, recently in Sunteck Realty Limited v Goodwill Theatres Private[3], the NCLT Mumbai bench has taken a different approach and tried clearing the dust around the confusion by answering the question as to whether advance paid to corporate debtor is a ‘Operational Debt’ or not. It has laid down that the advance payment is an operational debt by applying intention test.
In the present case the Goodwill Theatres Private Limited (“Corporate Debtor”) approached Sunteck Realty Limited (“Operational Creditor”) for their property’s redevelopment. The parties planned to sign a Development management agreement (“DMA”) for executing the development project. Therefore, they executed a term sheet to agree on the basic terms and conditions of the DMA. Via the said term sheet the operational creditor was appointed as the project manager for performing as the contractor of the corporate debtor in consideration of the development management fees. Scope of services and payment of development management fees were well captured within the clauses of the term sheet. According to the term sheet the operational creditor had to deposit an advance amount of INR 2.51 crores upon the signing the term sheet which was set to be returned back along with the interest on the termination of the term sheet. It also mentioned about executing the DMA on or before the expiry of the two months from signing of the term sheet and if the parties fail to sign the agreement within the specified time period, the term sheet will automatically terminate unless extended in writing.
The operational creditor deposited the advance payment to the corporate debtor upon singing the said term sheet. However, the parties mutually decided to terminate the term sheet and accordingly the DMA was never executed between the parties in terms of the term sheet. Upon such failure, the operational creditor sent a demand notice to recover the advance paid to the corporate debtor. However, the corporate Debtor failed to repay the advance made to them, in result of which the operational creditor approached the tribunal under section 9 of the Code as operational creditors. The operational creditor, in view of the term sheet, claimed that it is an operational creditor under the Code and therefore claims that the advance paid to the corporate debtor for availing goods and services is an ex-facie debt under the Code.
On contrary, the corporate debtor claimed that Sunteck Realty Limited was not an operational creditor because they didn’t supply any good or services to the company. The corporate debtor contended that the term sheet was merely an agreement to enter into an agreement and was not a concluded agreement between them in order to give Sunteck Realty Limited the right to file the present petition before the tribunal as operational creditor.
APPLICATION OF INENTION TEST
NCLT noted that the intention of parties while executing the term sheet was to clearly indicate that the operational creditor was being engaged to perform services in relation to the project as an agent or contractor of the corporate debtor in exchange for payment of development management fees. Scope of services and payment of fees was also explicitly defined in the term sheet. The tribunal further pointed out that the mutual obligations detailed in the term sheet, clearly demonstrated that the operational creditor was engaged to provide services to the corporate debtor, therefore the advance amount of INR 2.51 crore given was part of the service rendered by them and thus, should be construed as an ‘operational debt’ in terms of Section 5(21) of the Code.
ANALYSIS
It shows from the above case that the advance paid in the situation where the underlying basis of the advance amount is a contact to transfer goods or services, such an advance amount given shall be treated as operational debt, because the intention of the parties was to engage in exchange of goods or services.
In 2020, the same issue arose before the Hyderabad bench of NCLT in Sri Lakshmikantha Spinners Ltd. v. Chinnam Poorna Chandra Rao[4]. The Bench did not go into the question of whether advance payment claims should come under operational debt implying that the advance claims arising out of contracts regarding provision of goods or services still come under operational debt despite the fact that there was no actual exchange of goods or services.
CONCLUSION
There is a need for an amendment in Section 5(21) of the Code as to deliver some clarity to the creditors regarding the advance paid by them. The definition of “operation debt” is ambiguous on two points. First, with regard to the direction of flow of provision of goods or services and secondly, the provision does not stipulate that the provider of goods or services shall be the creditor and the recipient shall be the corporate debtor. An operational debt is only a claim “in respect of provision of goods or services”. Hence, there might be instances where the party paying advance may be regarded as a creditor, and the party to provide goods/services is then regarded as debtor against the advance amount. Secondly, the section is not very clear as to whether the provision of goods and services should have already taken place on the date of filing of claim, or on the date of making the application, as the case may be, or whether such provision of goods and services may be for future as well., to be recognized as an operational debt. SECTION 5(21) of the Code.
The intention test applied by the NCLT’s Mumbai Bench in Sunteck Realty Limited v Goodwill Theatres Private(Supra) provides a useful solution which combines both the legislative requirements for a claim arising from advance payments to be counted under operational debt by requiring that there be an underlying contractual intention to buy goods or services; and also puts buyers on an equal footing with sellers in terms of having a right to file petition under the Code.
[1] C.P. (IB) No. 799/KB of 2018
[2]CP 21/I&BP/NCLT/MAH/2018
[3]C.P. (IB) 3990/MB/2019 (Decided on 07.01.2021)
[4] CP (IB) No.562/7/HDB/2018 (decided on 06.07.2020)
