Supreme Court Clarifies Financial Creditor Status Under IBC: NOIDA Lease Dues Not a Financial Debt (May 17, 2022)

Introduction

Date of the Judgment: May 17, 2022

Citation: 2022 INSC 459

Judges: K.M. Joseph J. and Hrishikesh Roy J.

Can a government authority be considered a financial creditor under the Insolvency and Bankruptcy Code (IBC) simply because it is owed money under a lease agreement? The Supreme Court of India recently addressed this critical question in a case involving the New Okhla Industrial Development Authority (NOIDA). The core issue was whether NOIDA’s dues from a lease agreement with a corporate debtor should be classified as a financial debt, which would grant NOIDA a significant say in the corporate insolvency resolution process (CIRP).

The Supreme Court, in this judgment, clarified the scope of ‘financial debt’ under the IBC, particularly concerning lease agreements and the status of development authorities as financial creditors. The judgment was delivered by a two-judge bench comprising Justice K.M. Joseph and Justice Hrishikesh Roy, with Justice Joseph authoring the opinion.

Case Background

The case involves a dispute over whether NOIDA, a development authority, should be treated as a financial creditor in the CIRP of a corporate debtor. NOIDA had leased land to the corporate debtor for the construction of residential flats. The lease agreement, entered on July 30, 2010, stipulated a premium of Rs. 46,14,69,996.50, with 10% paid upfront and the remainder to be paid in installments along with interest. The lease was for a term of 90 years.

Initially, NOIDA filed a claim as an operational creditor but later sought to be recognized as a financial creditor, claiming that the lease was a financial lease. The National Company Law Tribunal (NCLT) rejected this claim, stating that the lease did not meet the criteria of a financial lease under Indian Accounting Standards. The National Company Law Appellate Tribunal (NCLAT) upheld the NCLT’s decision, leading to the present appeal before the Supreme Court.

The core dispute revolves around interpreting the lease agreement and determining whether it constitutes a financial debt under Section 5(8) of the IBC.

Timeline

Legal Framework

The judgment primarily revolves around the interpretation of key provisions of the Insolvency and Bankruptcy Code, 2016 (IBC), and the Uttar Pradesh Industrial Area Development Act, 1976 (UPIAD Act). The relevant provisions include:

• 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…” followed by specific clauses.
• Section 3(11) of the IBC: 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.”
• Section 3(6) of the IBC: Defines “claim” as “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…”
• Section 5(21) of the IBC: 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.”
• Section 3(33) of the IBC: Defines “transaction” as “includes a agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor.”
• Section 6 of the UPIAD Act: Outlines the functions of the Authority, including planned development and transfer of land.
• Section 7 of the UPIAD Act: Grants the authority the power to transfer land through sale, lease, or otherwise.

Arguments

Arguments by the Appellant (NOIDA):

• NOIDA argued that the lease agreement should be classified as a financial lease under Section 5(8)(d) of the IBC, as it substantially transferred the risks and rewards of ownership to the lessee.
• It contended that the lease involved a “disbursement” of funds, as the lessee was granted possession of the land after paying only 10% of the premium, with the remaining amount payable in installments.
• NOIDA submitted that the lease agreement had the “commercial effect of a borrowing” under Section 5(8)(f) of the IBC, as the lessee effectively raised funds from NOIDA to develop the property.
• It emphasized that as a statutory authority with a long-term interest in the development of the area, NOIDA should be considered a financial creditor to protect public interest.
• NOIDA argued that it is similar to a bank as it provides a mechanism for the lessee to obtain land with easy payment terms.

Arguments by the Respondent (Resolution Professional and Intervenors):

• The respondents contended that the lease was not a financial lease under Indian Accounting Standards, as the ownership of the land was not transferred to the lessee.
• They argued that there was no “disbursement” of funds from NOIDA to the lessee, which is a necessary condition for a financial debt under Section 5(8) of the IBC.
• The respondents submitted that the lease agreement did not have the “commercial effect of a borrowing” as NOIDA was acting as a development authority and not as a lender.
• They argued that NOIDA had initially claimed to be an operational creditor, and the claim to be a financial creditor was an afterthought.
• It was also contended that NOIDA, being a public authority, would not act in the best interests of the CIRP, and would be more interested in recovering its dues than in the resolution of the corporate debtor.
• The respondents argued that the dues to NOIDA are statutory dues, and hence should be treated differently than financial debt.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for consideration:

1. Whether the appellant is entitled to be treated as a financial creditor within the meaning of the IBC?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

• Cases:
  • Pioneer Urban Land and Infrastructure Limited and Another vs. Union of India (UOI) and Others, (2019) 8 SCC 416 (Supreme Court of India)
  • Swiss Ribbons Private Limited and Another v. Union of India and Others, (2019) 4 SCC 17 (Supreme Court of India)
  • Orator Marketing Private Limited v. Samtex Desinz Private Limited, 2021 SCC Online SC 513 (Supreme Court of India)
  • Asea Brown Boveri Ltd. v. Industrial Finance Corporation of India and Others, (2004) 12 SCC 570 (Supreme Court of India)
  • Mohd. Noor and Others v. Mohd. Ibrahim and Others, (1994) 5 SCC 562 (Supreme Court of India)
  • Aneeta Hada v. Godfather Travels and Tours Private Limited, 2012 (5) SCC 661 (Supreme Court of India)
  • State of Orissa and Another V. M/S. Chakobhai Ghelabhai and Company, AIR 1961 SC 284 (Supreme Court of India)
  • State of Tamil Nadu V. Binny Ltd., Madras, 1980 Supp SCC 686 (Supreme Court of India)
  • M/s. Shroff and Co. v. Municipal Corpn. of Greater Bombay and Another, 1989 Supp 1 SCC 347 (Supreme Court of India)
  • Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited and Others, (2020) 8 SCC 401 (Supreme Court of India)
  • Union of India and Others v. R.C. Jain and Others, (1981) 2 SCC 308 (Supreme Court of India)
  • New Okhla Industrial Development Authority v. Chief Commissioner of Income Tax and others, (2018) 9 SCC 351 (Supreme Court of India)
  • Housing Board of Haryana v. Haryana Housing Board Employees’ Union and Others, (1996) 1 SC 95 (Supreme Court of India)
  • Commissioner of Income Tax, Lucknow v. U.P. Forest Corporation, (1998) 3 SCC 530 (Supreme Court of India)
  • State of Orissa v. State of A.P., (2006) 9 SCC 591 (Supreme Court of India)
  • Re: Rogers Pyatt Shellac Co. v. The Secretary of State for India in Council, AIR 1925 Calcutta 34 (Calcutta High Court)
  • The Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai and Co., Bombay, AIR 1950 SC 134 (Supreme Court of India)
• Books:
  • Dictionary of Accounting & Finance by R. Brockington
  • Lease Financing & Hire Purchase by Dr. J.C. Verma
  • Salmond on Jurisprudence, 12th Edition
  • Black’s Law Dictionary, 11th Edition
  • Collins English Dictionary & Thesaurus (2nd Edn., 2000)
  • ACT Borrower’s Guide to the LMA’s Investment Grade Agreements by Slaughter and May (5th Edn., 2017)
  • Dictionary of Banking Terms (2nd Edn.) by Thomas P. Fitch
• Legal Provisions:
  • Section 5(8) of the Insolvency and Bankruptcy Code, 2016
  • Section 3(11) of the Insolvency and Bankruptcy Code, 2016
  • Section 3(6) of the Insolvency and Bankruptcy Code, 2016
  • Section 5(21) of the Insolvency and Bankruptcy Code, 2016
  • Section 3(33) of the Insolvency and Bankruptcy Code, 2016
  • Section 6 of the Uttar Pradesh Industrial Area Development Act, 1976
  • Section 7 of the Uttar Pradesh Industrial Area Development Act, 1976
  • Section 105 of the Transfer of Property Act, 1882
  • Section 108 of the Transfer of Property Act, 1882
  • Section 9 of the Uttar Pradesh Apartment Owners Act, 2010
  • Rules 61 to 67 of Indian Accounting Standards
  • Section 2(ha) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993
  • Section 2 (ma) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

Authority Treatment Table

Judgment

The Supreme Court analyzed the submissions of both parties and concluded that NOIDA did not qualify as a financial creditor under the IBC.

How each authority was viewed by the Court?

• The court followed Pioneer Urban Land and Infrastructure Limited and Another vs. Union of India (UOI) and Others [CITATION] on the definition of debt and claim but distinguished it on facts, holding that the homebuyer’s case involved a disbursement of funds, which was absent in NOIDA’s case.
• The court referred to Swiss Ribbons Private Limited and Another v. Union of India and Others [CITATION].
• The court followed Orator Marketing Private Limited v. Samtex Desinz Private Limited [CITATION] on the point that interest is not essential for a financial debt.
• The court followed Asea Brown Boveri Ltd. v. Industrial Finance Corporation of India and Others [CITATION] on the interpretation of financial lease.
• The court referred to Mohd. Noor and Others v. Mohd. Ibrahim and Others [CITATION] on the concept of ownership.
• The court followed Aneeta Hada v. Godfather Travels and Tours Private Limited [CITATION] on the interpretation of ‘deemed’.
• The court followed State of Orissa and Another V. M/S. Chakobhai Ghelabhai and Company [CITATION], State of Tamil Nadu V. Binny Ltd., Madras [CITATION] and M/s. Shroff and Co. v. Municipal Corpn. of Greater Bombay and Another [CITATION] on the interpretation of ‘incidental’.
• The court followed Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited and Others [CITATION] on the requirement of disbursement for financial debt.
• The court referred to Union of India and Others v. R.C. Jain and Others [CITATION] on the definition of local authority but distinguished it on facts.
• The court referred to New Okhla Industrial Development Authority v. Chief Commissioner of Income Tax and others [CITATION] on NOIDA not being a local authority but distinguished it on facts.
• The court distinguished Housing Board of Haryana v. Haryana Housing Board Employees’ Union and Others [CITATION] and Commissioner of Income Tax, Lucknow v. U.P. Forest Corporation [CITATION] on the definition of local authority.
• The court followed State of Orissa v. State of A.P. [CITATION] on the interpretation of ‘similar instrument’.
• The court approved Re: Rogers Pyatt Shellac Co. v. The Secretary of State for India in Council [CITATION] and The Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai and Co., Bombay [CITATION] on the meaning of ‘arises’.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

The court emphasized the importance of a strict interpretation of the term ‘financial debt’ under the IBC. The court was not persuaded by the argument that the lease had the ‘commercial effect of borrowing’ as it was not a traditional lending transaction.

Fact:Law

The court’s decision was more influenced by legal interpretation rather than factual aspects of the case.

Logical Reasoning

The following flowchart demonstrates the Supreme Court’s logical reasoning in deciding the issue:

Final Verdict

The Supreme Court dismissed the appeal filed by NOIDA. The court held that NOIDA’s dues under the lease agreement did not qualify as a financial debt under Section 5(8) of the IBC.

Implications

This judgment has significant implications for development authorities and the interpretation of ‘financial debt’ under the IBC:

• Development Authorities: Development authorities like NOIDA cannot claim the status of financial creditors simply based on lease dues. They will be treated as operational creditors, which have a lower priority in the resolution process.
• Financial Debt Definition: The judgment reinforces the strict interpretation of ‘financial debt’ under Section 5(8) of the IBC. It clarifies that a transaction must involve a disbursement of funds or have the commercial effect of borrowing to qualify as a financial debt.
• Lease Agreements: Lease agreements, by themselves, do not create a financial debt unless they fulfill the criteria of a financial lease or have the commercial effect of borrowing.
• Operational Creditors: The judgment highlights the difference between operational and financial creditors and the importance of maintaining the distinction under the IBC.
• Precedence: This judgment sets a precedent for future cases involving similar issues, providing clarity on the status of development authorities and the interpretation of financial debt under the IBC.

Conclusion

The Supreme Court’s judgment in the NOIDA case provides crucial clarity on the interpretation of ‘financial debt’ under the IBC. It establishes that lease dues of a development authority do not qualify as financial debt unless they meet the specific criteria outlined in Section 5(8) of the IBC. This ruling ensures that the distinction between financial and operational creditors is maintained and that only genuine financial transactions are treated as financial debts under the IBC. The judgment serves as a significant precedent for future cases involving similar issues and reinforces the importance of a strict interpretation of the IBC.