Supreme Court clarifies definition of Financial Debt under IBC for Interest-Free Loans: Orator Marketing vs. Samtex Desinz (2021)

Date of the Judgment: July 26, 2021

Citation: (2021) INSC 518

Judges: Indira Banerjee, J., V. Ramasubramanian, J.

Can an interest-free loan, given to a company for its working capital, be considered a ‘financial debt’ under the Insolvency and Bankruptcy Code (IBC)? This was the core question before the Supreme Court in this case. The Court had to determine if a lender of such a loan could initiate the Corporate Insolvency Resolution Process (CIRP) against the borrower under Section 7 of the IBC. The Supreme Court, in this judgment, clarified the scope of ‘financial debt’ under the IBC, holding that it is not mandatory for a debt to have an interest component to be considered a ‘financial debt’. The judgment was authored by Justice Indira Banerjee, with Justice V. Ramasubramanian concurring.

Case Background

M/s Sameer Sales Private Limited (Original Lender) provided a term loan of Rs. 1.60 crores to M/s Samtex Desinz Pvt. Ltd. (Corporate Debtor) to meet its working capital needs. This loan was for a period of two years and was interest-free. The Original Lender later assigned this outstanding loan to M/s Orator Marketing Pvt. Ltd. (Appellant). The Appellant claimed that the Corporate Debtor was to repay the loan by 01.02.2020, but Rs. 1.56 crores remained outstanding despite some payments.

Timeline:

Course of Proceedings

The Appellant filed a petition under Section 7 of the IBC in the National Company Law Tribunal (NCLT) to initiate the Corporate Insolvency Resolution Process (CIRP). The NCLT dismissed the petition, stating that the Appellant was not a ‘financial creditor’ because the loan was interest-free. The NCLT emphasized that the loan was not disbursed against the ‘consideration for the time value of money’ as required under Section 5(8) of the IBC. The National Company Law Appellate Tribunal (NCLAT) upheld the NCLT’s decision, leading to the appeal before the Supreme Court.

Legal Framework

The Supreme Court examined the definition of ‘financial debt’ under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (IBC).

Section 5(8) of the IBC defines “financial debt” as:

“a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes— (a) money borrowed against the payment of interest; (b) any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent; (c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument; (d) 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; (e) receivables sold or discounted other than any receivables sold on non-recourse basis; (f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing; (g) 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; (h) 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; (i) 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.”

The Court also referred to Section 3(11) of the IBC, which defines ‘debt’ as:

“a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.”

The Court noted that the definition of ‘financial debt’ includes the phrase “if any,” indicating that a debt can be a financial debt even without interest. The Court also observed that the definition of ‘financial debt’ is inclusive and not exhaustive.

Arguments

Appellant’s Submissions:

• The Appellant argued that the loan was a financial debt as it was disbursed against the consideration for the time value of money, even though it was interest-free.
• The Appellant contended that the definition of ‘financial debt’ under Section 5(8) of the IBC is inclusive and not exhaustive.
• The Appellant submitted that the loan was given to meet the working capital requirements of the Corporate Debtor, which had the commercial effect of a borrowing.
• The Appellant stated that the development of the business of the Corporate Debtor was enough consideration for the time value of money.
• The Appellant relied on the inclusive nature of the definition of ‘financial debt’ under Section 5(8) of the IBC to argue that the absence of interest should not exclude the loan from being considered a financial debt.

Respondent’s Submissions:

• The Respondent contended that the loan was interest-free and therefore, not a financial debt as defined under Section 5(8) of the IBC.
• The Respondent argued that the loan was not disbursed against the consideration for the time value of money.
• The Respondent relied on the loan agreement, which explicitly stated that the loan was interest-free.
• The Respondent emphasized that the loan was extended by a related party and was not a typical financial transaction.
• The Respondent argued that the Appellant failed to prove that the loan was disbursed against consideration for the time value of money.

Issues Framed by the Supreme Court

The main issue before the Supreme Court was:

1. Whether a person who gives a term loan to a Corporate Person, free of interest, on account of its working capital requirements is not a Financial Creditor, and therefore, incompetent to initiate the Corporate Resolution Process under Section 7 of the IBC.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

✓ Poppatlal Shah Vs. State of Madras, AIR 1953 SC 274*: The Court used this case to emphasize the importance of interpreting statutory provisions in light of the general purpose of the Act.

✓ Innoventive Industries Ltd. Vs. ICICI Bank Ltd., (2018) 1 SCC 407*: The Court reiterated the scheme of the IBC, highlighting that the insolvency process begins when a default occurs and a financial debt is a debt disbursed against consideration for the time value of money.

✓ Swiss Ribbons Pvt. Ltd. And Anr. Vs. Union of India and Others, (2019) 4 SCC 17*: The Court referred to this case to emphasize that the IBC is a beneficial legislation aimed at the revival of corporate debtors and that a financial debt includes interest, if any, disbursed against the time value of money.

✓ Pioneer Urban Land and Infrastructure Ltd. Vs. Union of India, (2019) 8 SCC 416*: The Court cited this case to support the view that even individuals like debenture holders and fixed deposit holders can be financial creditors under the IBC.

✓ Dilworth v. Commissioner of Stamps, (1899) AC 99*: The Court used this case to explain that the word ‘include’ is generally used in interpretation clauses to enlarge the meaning of words and phrases.

✓ State of Bombay v. Hospital Mazdoor Sabha and Ors, AIR 1960 SC 610*: The Court cited this case to emphasize that words used in an inclusive definition denote extension and cannot be treated as restricted.

✓ CIT Andhra Pradesh v. Taj Mahal Hotel Secunderabad, (1971) 3 SCC 550*: The Court used this case to highlight that the word ‘includes’ is often used to enlarge the meaning of words in interpretation clauses.

✓ Anuj Jain, Interim Resolution Professional for Jaypee Infratech Ltd. V. Axis Bank Ltd., (2020) 8 SCC 401*: The Court referred to this case to reiterate that for a debt to be a financial debt, it must be a disbursal against the consideration for the time value of money.

✓ Prabhudas Damodar Kotecha Vs. Manhabala Jeram Damodar, (2013) 15 SCC 358*: The Court cited this case to emphasize that words of a statute must be given their ordinary meaning when the language is plain and precise.

What weighed in the mind of the Court?

The Supreme Court emphasized the inclusive nature of the definition of ‘financial debt’ under Section 5(8) of the IBC. The Court noted that the phrase “if any” in the definition indicates that interest is not a mandatory component of a financial debt. The Court also considered the purpose of the IBC, which is to revive and continue the operations of corporate debtors. The Court reasoned that excluding interest-free loans for working capital from the definition of ‘financial debt’ would defeat the purpose of the IBC.

Logical Reasoning:

The Court reasoned that the definition of ‘financial debt’ in Section 5(8) of the IBC is inclusive and not exhaustive. The Court observed that the words “if any” in the definition of ‘financial debt’ clearly indicate that a debt can be a ‘financial debt’ even if it does not carry interest. The Court also noted that the loan was given to meet the working capital requirements of the Corporate Debtor, which had the commercial effect of a borrowing. The Court stated that the NCLT and NCLAT had misconstrued the definition of ‘financial debt’ by reading it in isolation and out of context.

The Supreme Court held that the term loan advanced to meet the working capital requirements of the Corporate Debtor, even if interest-free, should be included within the purview of a ‘financial debt’. The Court observed that the definition of ‘financial debt’ under Section 5(8) of the IBC is inclusive and not exhaustive. The Court also noted that the phrase “if any” in the definition indicates that interest is not a mandatory component of a financial debt. The Court stated that the loan was disbursed for the working capital needs of the corporate debtor, which has the commercial effect of borrowing.

“The NCLT and NCLAT have overlooked the words “ if any” which could not have been intended to be otiose. ‘Financial debt’ means outstanding principal due in respect of a loan and would also include interest thereon, if any interest were payable thereon. If there is no interest payable on the loan, only the outstanding principal would qualify as a financial debt.”

“Both NCLAT and NCLT have failed to notice clause(f) of Section 5(8), in terms whereof ‘financial debt’ includes any amount raised under any other transaction, having the commercial effect of borrowing.”

“The definition of ‘debt’ is also expansive and the same includes inter alia financial debt. The definition of ‘Financial Debt’ in Section 5(8) of IBC does not expressly exclude an interest free loan. ‘Financial Debt’ would have to be construed to include interest free loans advanced to finance the business operations of a corporate body.”

There were no dissenting opinions in this case.

Key Takeaways

• An interest-free term loan given for a company’s working capital can be considered a ‘financial debt’ under the IBC.
• The definition of ‘financial debt’ under Section 5(8) of the IBC is inclusive and not exhaustive.
• The phrase “if any” in Section 5(8) indicates that interest is not a mandatory component for a debt to be considered a financial debt.
• Lenders of interest-free loans for working capital can initiate the Corporate Insolvency Resolution Process (CIRP) under Section 7 of the IBC.
• The judgment clarifies that the focus should be on whether the loan has the commercial effect of borrowing, rather than solely on the presence of interest.

Directions

The Supreme Court set aside the orders of the NCLT and NCLAT. The petition filed by the Appellant under Section 7 of the IBC was revived and directed to be decided afresh in accordance with law and in light of the findings of the Supreme Court.

Development of Law

The ratio decidendi of this case is that a term loan advanced to meet the working capital requirements of a Corporate Debtor, even if it is interest-free, can be considered a ‘financial debt’ under Section 5(8) of the IBC. This judgment clarifies the scope of ‘financial debt’ and establishes that the absence of interest does not exclude a loan from being considered a financial debt if it has the commercial effect of borrowing. This is a change in the previous understanding where the presence of interest was considered a key factor in determining a financial debt.

Conclusion

The Supreme Court’s judgment in M/s Orator Marketing Pvt. Ltd. vs. M/s Samtex Desinz Pvt. Ltd. clarifies that an interest-free loan provided for working capital can be considered a ‘financial debt’ under the IBC. This decision is significant as it broadens the scope of ‘financial debt’ and allows lenders of such loans to initiate CIRP under Section 7 of the IBC. The Court emphasized the inclusive nature of the definition and the commercial effect of such borrowings, thereby setting aside the restrictive interpretations of the NCLT and NCLAT.

Category

✓ Insolvency and Bankruptcy Code, 2016

✓ Section 5(8), Insolvency and Bankruptcy Code, 2016

✓ Financial Debt

✓ Corporate Insolvency Resolution Process

✓ Working Capital Loans

FAQ

Q: What is a financial debt under the Insolvency and Bankruptcy Code (IBC)?

A: A financial debt is a debt that is disbursed against the consideration for the time value of money. It includes money borrowed with interest, as well as other transactions that have the commercial effect of borrowing.

Q: Can an interest-free loan be considered a financial debt under the IBC?

A: Yes, according to this Supreme Court judgment, an interest-free loan can be considered a financial debt if it is disbursed for the working capital needs of a company and has the commercial effect of borrowing.

Q: What does “time value of money” mean in the context of financial debt?

A: “Time value of money” refers to the concept that money available now is worth more than the same amount in the future due to its potential earning capacity. In the context of financial debt, it means that the money is given with the expectation of a return or benefit, even if that return is not in the form of interest.

Q: Can a lender of an interest-free loan initiate the Corporate Insolvency Resolution Process (CIRP) under the IBC?

A: Yes, this judgment clarifies that a lender of an interest-free loan for working capital can initiate CIRP under Section 7 of the IBC, as such a loan can be considered a financial debt.

Q: What was the main point of contention in this case?

A: The main point of contention was whether a loan given without interest could be considered a financial debt under the IBC. The NCLT and NCLAT had held that it could not, but the Supreme Court overturned that decision.

Q: What is the significance of the phrase “if any” in the definition of financial debt?

A: The phrase “if any” in the definition of financial debt indicates that interest is not a mandatory component of a financial debt. This means that a loan can still be considered a financial debt even if it does not carry interest.

Q: What does this judgment mean for companies that take interest-free loans?

A: This judgment means that companies that take interest-free loans for working capital may be subject to the Corporate Insolvency Resolution Process (CIRP) if they default on repayment, as the lender of such a loan can now be considered a financial creditor.