The ever-changing nature of Operational Debts under Insolvency and Bankruptcy Code: -

Introduction

As it’s already known, that, not every debt enables creditors to initiate Corporate Insolvency Resolution Process (CIRP) against Corporate Debtors (CD), under the Insolvency and Bankruptcy Code, 2016 (IBC or code). The code essentially bifurcates the creditors as Financial and Operational, defining them under section 5 (7) and section 5 (20), respectively. Needless to mention, that any default in payment of debt i.e., either Financial and or Operational as defined in the sections 5(8) and 5(21) enables the creditors to file for an application in order to initiate the CIRP against the Corporate Debtor in section 7 and 9 of the code, respectively.

In this article, we are discussing several judicial pronouncements relating to the interpretation of debts arising out of a settlement agreement or from an agreement to pay, constitutes an Operational debt or not. In doing so, Firstly, we would be discussing various judgments passed by the Hon’ble National Company Law Tribunal (NCLT) alongwith Hon’ble National Company Law Appellate Tribunal (NCLAT), in this regard, vis-à-vis interpretations laid down in respect of the definition of “Operational debt”.

Discussed Cases:

Delhi Control Device (P) Ltd. vs. Fedders Electric and Engineering Ltd.[1]

The brief facts of the case were, that Operational Creditor was a company engaged in providing various electrical apparatus and equipment and in course of its business, it supplied various goods to the Corporate Debtor for which an amount became due and payable. Upon non-realization the said due amount, the Operational Creditor furnished a demand notice under section 8 of the code but, the same received no reply. Nevertheless, a reminder notice was sent in reference to the first demand notice and a settlement was reached between both the parties, thereupon. The Corporate debtor agreed to pay the principal amount in two tranches of instalments out of which payment for only instalment was made with a default in the payment of remaining balance/instalment. Consequently, an application was made by the Operational Creditor before the Hon’ble NCLT for initiating CIRP against the Corporate debtor for the default in payment of Operational debt. While deciding the same application the Hon’ble NCLT, Allahabad Bench, observed and referred to one relevant clause in the said settlement agreement as entered between the parties in relation to the Operational debt, the verbatim of the same is reproduced hereinbelow:

“That the Party of the Second part has agreed that it will withdraw with prejudice and without any costs, immediately on signing of this agreement the demand notice dated 6/4/2018 along with the reminder demand notice dated 2/5/2018 issued under rule 5 (1) of the Insolvency & Bankruptcy(Application to Adjudicating Authority) Rules, 2016 claiming an amount of Rs.42,41,034/- (Forty-Two Lakhs Forty-One Thousand and Thirty-Four Only) along with 18% interest per annum from the Party of the First Part."

It was observed that upon executing the settlement agreement and as per the terms of the clause as referred hereinabove, the statutory demand notice as served to the Corporate debtor stands withdrawn and the fact that no demand notice was served upon the Corporate Debtor, in regard to the Operational debt as claimed in the present application. The tribunal held that, furnishing a demand notice under section 8 of the code is sine qua non to file an application under section 9 of the code and in view of the same, the application is liable to be rejected.

Going further, the Hon’ble NCLT also observed, that unpaid instalments as per the settlement agreement cannot be treated as Operational debt within the meaning of its definition as prescribed to it under section 5 (21) of the code and any failure(s) or breach(es) of settlement agreement cannot be a ground to trigger CIRP against Corporate debtor under the provisions of the code and remedy may lie elsewhere but, not before the Adjudicating Authority.

Mr. Nitin Gupta vs. International Land Developers Pvt. Ltd.[2]

The brief facts of the case were that, the Operational Creditor hereby used to provide legal consultancy and related services to the Corporate debtor vide 3 (three) retainership agreement executed between the parties. The Operational Creditor issued in total 36 (thirty-six) post dated cheques against the consideration of the said agreements, out of which payments from 26 (twenty-six) cheques were not realized for various reasons. Resultantly, the Operational Creditor issued 2 (two) legal notices for the outstanding amount and dishonoured cheques in Nov, 2019 following which, the parties entered into a settlement agreement in Dec, 2019. In furtherance of the same, the Operational Creditor issued various cheques against the outstanding balance to the Corporate debtor, all of which were dishonoured for the reasons of insufficient balance in account of the Operational Creditor. Further, various notices were furnished to Operational Creditor for the outstanding balance and dishonoured cheques but, the Operational Creditor failed to pay an amount of INR 3,52,878 /- (Three lakhs fifty-two thousand eight hundred seventy-eight. Thus, the application was made for the outstanding debt arising out of non-payment or breach of the settlement agreement entered between the parties. It was submitted by the Petitioner that; the dues essentially arise from the services rendered to the Operational Creditor and a settlement agreement was executed between the parties for the payment of such dues, which were also defaulted.

While referring to the section 5 (20) and 3(12) of the code, the Hon’ble NCLT, New Delhi Bench, observed that even a mere reading of the said provisions, shows that:

10. “a claim in respect of the provisions of goods and services including employment or a debt in respect of the payment of dues arising under any law for the time being in force is an operational debt and only default in respect of that operational debt a person can initiate CIRP against the Corporate debtor.”

The verbatim of the said provisions are also reproduced hereinbelow:

Section 3 (12) of the code: - "Default" means non-payment of debt when whole or any part or installment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be;

Section 5 (20) of the code: - “Operational debt” means a claim in respect of the provision of goods or services including employment or a debt in respect of the [payment] of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;

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Further, it was held that the application was filed on the basis of the non-payment/ default made in respect of a settlement agreement does not come under the definition of the Operational debt as provided under the said provisions as referred hereinabove, reliance was placed on Delhi Control Device (P) Ltd. vs. Fedders Electric and Engineering Ltd.[3]

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Trafigura India Private Limited vs. TDT Coppers Limited[4]

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In factual background, the Operational Creditor engaged in business of producing various non-ferrous materials and related products whilst the Corporate debtor deals in manufacturing and supply of various copper cathodes. Both the parties entered into a Master Sales Agreement (MSA) in the year 2016 and then in the course of the business, payments for several invoices were defaulted by the Corporate Debtor. In, 2018, the parties entered into a settlement agreement for the payment of outstanding amount by the Corporate debtor. As per the terms of the settlement agreement, the Operational Creditor agreed to pay the entire outstanding amount by April 2019, which was further extended to May, 2019 but, the said amount remained unpaid after the expiry of the agreed term. Aggrieved from the same, the Operational Creditor furnished a demand notice to the Corporate debtor as per the provisions of the code, against which, a reply was submitted by the Corporate debtor. However, the Corporate debtor raised various disputes of several nature in respect of the said claim under the notice following which rejoinders were also adduced by the parties.

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The Hon’ble NCLT after observing the factual background, observed that the dues as claimed by the petitioner in this application does not fall under the purview of the definition of Operational debt as provided under section 5 (21) of the code. While referring to the definitions of debt, default and Operational Creditor as provided under section 3 (11), 3 (12), 5 (21) of the code, respectively, it was held that the dues arising out of non-payment or breach or violation of the terms of the settlement agreement cannot initiate CIRP against the Corporate debtor. The Hon’ble tribunal placed its reliance on the judgments, Delhi Control Device (P) Ltd. vs. Fedders Electric and Engineering Ltd.[5] and Mr. Nitin Gupta vs. International Land Developers Pvt. Ltd[6] ., passed by Hon’ble NCLT and New Delhi Bench, respectively.

M/S Brand Reality Services Limited vs. M/S Sir John Bakeries India Pvt. Ltd.[7]

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In the factual background, the Operational Creditor in this case invested and also provided consultancy services in relation to development and facilitation of the business of Corporate Debtor and the consideration arising out of the consultancy services were due to Operational Creditor. In furtherance of the same, the parties entered into a settlement agreement in the year 2018. The Corporate debtor agreed to pay the outstanding amount and issued various post-dated cheques to the Operational Creditor, which were also dishonoured. Aggrieved by the actions, Operational Creditor furnished several notices for the payment of its dues but, all of them were unattended, consequently, a demand notice under the section 8 of the code was made, thereupon. During the course of the proceedings replies and rejoinders were submitted by the parties in which various disputes upon the claim were pointed out by the Corporate debtor on various grounds and the same disputes, in turn, were countered by Operational Creditor.

The Hon’ble NCLT, New Delhi Bench, observed that the disputes raised by the Corporate debtor upon the claim raised by the Operational Creditor cannot be sustained in facts, however, the debts as claimed by the Operational Creditor in the present application does not fall under the definition of Operational debt as per the provisions of the code. It was also reiterated that, the Hon’ble NCLT not being a recovery court, any amount due for any reason whatsoever, cannot be entertained under the code as to initiate CIRP against the Corporate debtor and only financial debt alongwith operational debt can initiate the CIRP. The Hon’ble tribunal placed its reliance on every preceding judgment discussed in this article.

M/S Omega Elevators vs. Prajay Properties Pvt. Ltd.[8]

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The facts of the case are such whereby, the Operational Creditor dealing in goods and services relating to elevators and lifts agreed to supply elevators, its installations alongwith other related services to the Corporate debtor. During the course of the business, an outstanding amount became payable by the Corporate debtor to the Operational Creditor. An agreement to pay was entered between the parties for the payment of the said outstanding amount and in compliance with the terms of the agreement Corporate debtor issued 7 (seven) post dated cheques for the payment of such dues out of which only 3 (three) post dated cheques were honoured and the rest were dishonoured. Pursuant to which, a demand notice and thereupon an application under section 9 of the code was made by the Operational Creditor. During the course of the proceedings, replies and rejoinders were filed by the parties whereby the claimed amount in the application was disputed entirely by the Corporate debtor.

After, going through the averments made by both the parties, the Hon’ble NCLT Hyderabad Bench, noted that a default in the terms of an agreement to pay, as entered between the parties in the present case does not fall under the definition of Operational debt as per the provisions of the code. However, it was also noted that an existence of dispute in the present matter was apparent on various grounds. The tribunal also placed its reliance upon the judgments cited hereinabove.

Maldar Barrels Pvt. Ltd. vs. Pearson Drums & Barrels Pvt. Ltd.[9]

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The facts of the case are as such that the Operational Creditor and the Corporate debtor entered into a transaction, where an outstanding amount was due on the part of the Corporate debtor. Consequently, a CP (IB) No. 513/KB/2017 under section 9 of the code was filed by the Operational Creditor, which in turn was admitted by the Hon’ble NCLT Kolkata Bench, thereby, initiating CIRP against the Corporate debtor. Subsequently, the Corporate debtor approached the Operational Creditor and both the parties entered into a settlement agreement, thereupon. At this time, the case escalated upto the Hon’ble Supreme Court of India in Civil Appeal No. 778 of 2018, in which the Hon’ble Supreme Court took on record the settlement agreement entered between the parties and in exercise of its powers under Article 142 of the Constitution of India, set aside the order passed by the Hon’ble Tribunal. As per the terms of the agreement, it was agreed by the Corporate debtor that, the amount as agreed between the parties as full and final settlement shall be paid in 37 instalments. It was agreed specifically laid down in the agreement that, time shall be the essence of the contract and any extension of time in payment of any instalment shall not be granted. The parties agreed that any delay in payment of any instalments shall extinguish every concession provided under the settlement agreement including enabling the Operation Creditor to file a fresh application under section 9 for the remaining amount. However, some delays were made by the Corporate debtor in paying the instalments as per the agreed terms of the settlement agreement and owing to such delays in payment of instalments, the Operational Creditor filed a fresh application under section 9 of the code.

The Hon’ble NCLT held that, the forum before the application is made, is not a forum for implementation of a settlement agreement that, too when a major portion of the outstanding amount has already been paid by the Corporate debtor and also observed that the amount prayed for by the Operational Creditor as operational debt if awarded would lead to unlawful enrichment. Further, it was held that the Operational Creditor could take other legal resort for implementation of the settlement agreement if it chooses to do so and the application was thereby rejected.

The present appeal lies against the impugned order passed by the Hon’ble NCLT Kolkata Bench in CP No. (IB) 1499/KB/2019 filed by the Operational Creditor against the dismissal of its fresh application under section 9 of the code against the Corporate debtor. In the Appeal, the Appellant submitted that as per the clause of the agreement and section 55 of the Indian Contract Act, 1872, where time is essence of the contract, the Corporate debtor has made various defaults and hence, enabling it to file fresh application under the code. In reply, the Respondents also placed their reliance upon various judgments passed by the apex court alongwith the section 55 and 62 of the Indian Contract Act, 1872 and contended that, the Operational Creditor has accepted the delayed payment without any demur or dispute raised against the same earlier and hence, by the same conduct, a substitute contract was entered between the parties every time any delayed payment was accepted in contravention of the terms of the contract. It was also contended that, the terms in the agreement provided for imposition of applicable interest in case any payment was delayed and as per the terms of the agreement, the apex court in this regard has held that whereby a penalty is stipulated as a consequence of delay in the contract, it cannot be said that time is an essence in such contracts.

The Appellant also submitted that, the terms of the agreement also provided that any waiver of its not availing any remedy under the agreement shall not cause or mean in waiver of such rights of the Operational Creditor, and in view of the same, the concession on the settlement agreement stands withdrawn praying for accepting the fresh application under section 9 of the code by the Operational Creditor.

The Hon’ble NCLAT New Delhi, held that, the Operational Creditor has not been able to make out a case that time was essence of the agreement in the present case and the contentions and reliance placed upon judgments by the Respondents were accepted. However, the NCLAT passed no observations in respect to the contention of the Respondent involving section 62 of the Indian Contract Act, 1872 and also observed that, Operational Creditor is at liberty to seek redressal elsewhere for implementation of its settlement agreement. Lastly, the appeal was dismissed and the impugned order passed by the Hon’ble NCLT bench was upheld.

Analysis:

There are various questions that we have identified and believe are pertinent to be analysed in view of the judicial pronouncements as discussed hereinabove.

1.??????If unpaid instalments/ breach/ violation arising out of any settlement agreement or an agreement to pay are not considered to be Operational debt and whether the position changes in case the settlement agreement executed in respect of any operational debt comprises of an enabling provision entitling Operational Creditor to file a fresh application under section 9 of the code upon any default/violation/breach or unpaid instalments arising out of any such agreement?

The question only finds its existence to the sole reason that the said contention was entertained by the Hon’ble NCLAT in the Maldar Barrels Judgments. However, the plausible inference in this regard may be that, existence of a settlement agreement or an agreement to pay in furtherance of, essentially, an Operational debt changes the nature in which the debts arise. It is evident from the above-referred judgments that, the debts claimed under the application against the Corporate debtor shall immediately relates to claims arising out of supply or delivery of goods and or services also including dues out of employment and not from the violation of a mere provision of an instrument not relating to an operational debt does not fall under the purview of section 5 (20) of the code. The only reason the enabling provision may entitle the Operational Creditor to file a fresh application for the default or non-payment arising out of any settlement agreement where, it also provides an ipso facto term rescinding the effect of such settlement agreement or extinguishing any and every concession as granted under the settlement agreement in case any terms of it is violated/ breached or have been defaulted. Technically, it restores the position of the Corporate debtor and places it as it was placed earlier to the execution of such settlement agreement. Hence, it can be reasonably inferred that such enabling provisions under the settlement agreement or an agreement to pay may entitle the operational creditor to file a fresh application for the default under the provisions of the code.

2.??????Whether interpretation of the definition of “Operational debt” should be restricted to the nature in which the debts arise rather than on the nature of the transactions for payment of the same?

In this regard, it is pertinent to refer to a judgment passed by the Hon’ble NCLAT New Delhi, Mr. M. Ravindranath Reddy vs. Mr. G. Kishan & Ors.[10] , wherein, the term “Operational debt” was defined in detail.

“any debt arising without nexus to the direct input to the output produced or supplied by the corporate debtor, cannot, in the context of Code, be considered as an operational debt, even though it is a claim amounting to debt.”

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The said judgment also refers to another judgment passed by the Hon’ble SC in, Pramod Yadav & Anr. Vs. Divine Infracon (P) Ltd.[11] , wherein the apex court observed that “the word “operational” or for that matter “operation” has not been defined anywhere in the Code. The General Clauses Act, 1897, also do not define the term. Hence, the term has to be given a meaning as ordinarily understood. The dictionary meaning of “operational” is given as “of or relating to operation” (Merriam Webster). Similarly, the meaning of “operation” is given as “ready for use or able to be used”.

Also, it refers to the Bankruptcy Law Reform Commission report from Nov 2015, wherein it defines “Operational Creditor” as “Operational creditors are those whose liability from the entity comes from a transaction on operations.[12] ”

It is quite evident from the definitions as provided hereinabove that the ascertainment of fact, whether a debt constitutes an operational debt or not depends upon the nature, circumstances and purposes for which the debt, claimed, became due on the Corporate debtor. In view of the same, it can be contended that, a debt otherwise an operational debt does not cease to be an operational debt upon entering into a settlement agreement or an agreement to pay. It can be reasonably argued that instruments do not necessarily change the nature of debt in this regard. Also, if we take into consideration the analysis under question no. 1, it can be said that a mere absence of an enabling provision in an instrument should not cause this mischief whereby, operational debts of same nature are placed differently. It would be reasonable to say that this interpretation would cause mischief to one party.

Conclusion

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However, the various Hon’ble NCLT and NCLAT has taken similar views in holding that payments in respect to any default, violation, breach, delays, unpaid instalment/ payments under or arising out of any settlement agreement or an agreement to pay is not operational debt under the provisions of the code. There are several questions still to be answered, in order for the issue to be settled once and for all. According to me, the interpretation of the term “Operation debt” is much more restrictive in nature as it only considers the debts which arises immediately or directly from any provisions of goods and or services also including dues including employment but, restricts a debt which essentially arises out of the same nature of transactions. Needless to state, that the manner of the payment or realisation of the said debt can be agreed upon between the parties in innumerable ways, and hence, it is pertinent to determine the nature of an Operational debt on merits of the case and nature of the debts rather than, outrightly rejecting the same under blanket restriction.?

[1] C P No. (IB) 343/ALD/2018.

[2] CP No. (IB) 507/ND/2020.

[3] supra at 1.

[4] CP No. (IB) 2817/ND/2019.

[5] supra at 3

[6] supra at 2

[7] CP No. (IB) 1677/ND/2019.

[8] CP No. (IB) 691/9/HDB/2019.

[9] CA (AT) (Ins) 872 of 2020.

[10] CA (AT) (Ins) No. 331 of 2019

[11] CP No. (IB) 209/ND/2017

[12] The Bankruptcy Law Reform Commission Report, dated 04th Nov, 2015, accessed at https://ibbi.gov.in/BLRCReportVol1_04112015.pdf