AUTHORED BY: GAURAV PURI (MANAGING PARTNER, GLS LAW OFFICES)
Introduction
Since the inception of the Insolvency and bankruptcy Code (hereinafter ‘Code’), the legislation has been shrouded in conjecture and uncertainty leading to very frequent release of clarifications, amendments and a dire need for judicial precedents. In Swiss Ribbons, the two types of debt envisaged by the Code were held to be constitutional, i.e. Operational Debt and Financial Debt.
Section 5 (21) of the code defines operational debt as: ” a claim in respect of the provision of goods or services, including employment, or a debt in respect of the repayment 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”[1].
It is common business practice to pay an advance to the provider of goods or services. Many of these contracts between vendor-vendee or service provider and recipient include clauses of refundable advance based on default. The courts constituted under the Code are now faced with the question of whether the above-mentioned sums of money constitute “operational debt” under the code.
In recent times, a number of cases have gone to various Company Law Tribunals for admission of Corporate Insolvency Resolution Process (hereinafter ‘CIRP’), seeking refund of advance money under Section 9 of the Code i.e. the procedural requirement for initiation of insolvency procedure by an operational creditor. The respective company law tribunals that are faced with this question have given varied pronouncements over the above-mentioned question of law bringing out some determining principles for the said situation. The present article curtails its scope of research to a claim of recovery of advance paid in respect of Goods and Services under S. 5 (21) of the Code, specifically excluding the on-going debate of House-buyers.
Important Definitions to Consider
At this juncture, it is important to see how the Code defines ‘claim’, as it is the basis of the definition of operational debt. According to the Code, claims means— “(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured; (b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured”[2]
Sec. 8 of the Code lays down the procedural aspect of initiating Insolvency process i.e. insolvency resolution. The relevant part of the section is quoted herein: “An operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.”[3]
The entire process envisaged in Sec. 8 and 9 of the Code is dependent on the sum claimed being a default which triggers the code for initiation of insolvency process. Therefore, the definition of a default under the Code is pertinent which is reproduced as, “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 repaid by the debtor or the corporate debtor, as the case may be”[4]. Two important ingredients come out of the definition of default i.e. a 1) debt 2) Due and Payable.
Firstly, a default is necessarily upon non-payment of debt. Debt under the code is defined as, “debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.”[5]
Due and Payable warrant the meaning that there exists a debt that is neither “Pre-mature” nor barred by “limitation”.
In conclusion, on the bare reading of the provisions, it is clear that, to constitute an operational debt, there needs to be a rightful claim under the above-mentioned definition which is due and payable.
Judicial Pronouncements
In the SRHM Biotechnologies Pvt. Ltd. v. M/S VAB Commercial Pvt. Ltd.[6] case, a sum of 3,00,000 INR was paid as refundable advance via a mandate letter but the Court dismissed the application as it found it did not fit the elements of S. 5(21). The reason cited for the same was that a mandate letter did not constitute an agreement leading to a no agreement for exchange of goods or services.
In TATA Chemicals ltd. V. Raj Process Equipments and Systems Pvt. Ltd.[7], under a similar factual matrix, it was held that, “Refund of advance money is not in connection with the goods/services including employment or a debt in respect of repayment of dues. Corporate Debtor has taken order from the petitioner for supply of goods. The contract/order has been terminated by the Petitioner.”
The above cases bring out an important aspect i.e. Refundable Advance is a ground to claim Operational Debt under the code. Secondly, that the Court, unlike financial debt, can go into the question of whether a default has been constituted for the purpose of Section 8 by inspecting the contract/agreement/letter in whatsoever form.
In the Tata Chemicals Case (Supra) the petitioner claimed damages as part of the debt in this regard, the court observed, “Petitioner ought to have crystalised the damages then only, it would have claimed the amount of compensation.”
Therefore, though the court can adjudge the Contractual liability under the Code in terms of Operational debt, what comes out is that the question of un-liquidated damages is to be adjudged in the Civil Courts and not by the Company Law Tribunal to be constituted as part of a claim.
In M/s. Daya Engineering Works Private Limited v. M/s. Udyog Limited[8], the court denied the claim of the applicant for a lack of purchase agreement and for adding 24% p.a. penal interest along with original claim of advance.
The Courts have clarified time and again that the debt must fit the four corners of the definition of operational debt.
In various other judicial pronouncements such as Overseas Infrastructure Alliance (India) Pvt. Ltd. Vs. Kay Bouvet Engineering Ltd.,[9] it has been seen that refund for advance has been held to constitute operational debt where a lawful contract of goods or services exists, with the provision of a refundable advance conditional on default in obligations mentioned in the underlying Contract.
Conclusion
It can be safely concluded that refundable advance payments are within the ambit of the Code. They clearly constitute operational debt. The Court in this regard looks at certain elements i.e.
1) The Claim must be within the elements the Definition of operational debt.
2) There must be a valid agreement for exchange of goods or services.
3) The claim must be clearly enunciated in the Contract itself.
4) The claim will not include penal interest or damages if not quantified in the Contract itself, and therefore the application under Section 8 of the Code will be liable to be dismissed.
[1] The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, S. 5(21).
[2] The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, S. 3 (6).
[3] The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, S. 8.
[4] The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, S. 3 (12).
[5] The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, S. 3 (11).
[6] SRHM Biotechnologies Pvt. Ltd. v. M/S VAB Commercial Pvt. Ltd., CP (IB) No. 799/KB of 2018
[7] Tata Chemicals Limited. v. Raj Process Equipments and Systems Private Limited., CP
21/I&BP/NCLT/MAH/2018.
[8] M/s. Daya Engineering Works Private Limited v. M/s. Udyog Limited, CP(IB) No.
547/KB/2017.
[9] Overseas Infrastructure Alliance (India) Pvt. Ltd v. Kay Bouvet Engineering Ltd., Company Appeal (AT)
(Insolvency) No. 582 of 2018 dated 21.12.2018 (NCLAT) ; see also M/s Auspice Trading Pvt. Ltd. v. M/s Global Proserv Ltd., CP No. 1584/IBC/NCLT/MB/MAH/2017.