Supreme Court Clarifies Operational Creditor Definition under IBC: Consolidated Construction Consortium Ltd. vs. Hitro Energy Solutions Pvt. Ltd. (2022)

Introduction

Date of the Judgment: 04 February 2022

Citation: 2022 INSC 114

Judges: Dr. Justice Dhananjaya Y Chandrachud, J, Surya Kant, J, and Vikram Nath, J. The judgment was authored by Dr. Justice Dhananjaya Y Chandrachud.

Can a company that has made an advance payment for goods or services be considered an operational creditor under the Insolvency and Bankruptcy Code (IBC)? The Supreme Court of India recently addressed this question, clarifying the scope of “operational debt” and “operational creditor” under the IBC. This case revolves around a dispute over an advance payment for light fittings, and whether the company that made the payment can initiate insolvency proceedings against the supplier.

The Supreme Court, in this judgment, clarified that an operational debt can arise not only when a party provides goods or services but also when a party receives goods or services, thereby broadening the scope of who can be considered an operational creditor under the IBC. This decision has significant implications for businesses and their ability to initiate insolvency proceedings when owed money for undelivered goods or services.

Case Background

The case involves M/s Consolidated Construction Consortium Limited (Appellant), which was executing a project with Chennai Metro Rail Limited (CMRL). As part of this project, the Appellant placed orders with a Proprietary Concern, Hitro Energy Solutions (Proprietary Concern), for the supply of light fittings through three purchase orders dated 24 June 2013.

The Proprietary Concern requested an advance payment of Rs 50,00,000. CMRL issued a cheque of Rs 50,00,000 in favor of the Proprietary Concern, with the condition that the delivery of the light fittings should be in compliance with the schedule provided by the Appellant.

On 2 January 2014, CMRL terminated the project with the Appellant. The Appellant claims to have informed the Proprietary Concern on the same day, which the Proprietary Concern denies. The Proprietary Concern deposited the cheque and withdrew the amount. CMRL deducted the amount from the dues payable to the Appellant. The Appellant then paid the amount to CMRL and requested the Proprietary Concern to return the money.

In the interim, M/s Hitro Energy Solutions Private Limited (Respondent) was incorporated on 28 January 2014, with one of its main objectives being to take over the Proprietary Concern. Despite this, the Proprietary Concern did not return the amount.

The Appellant requested the Proprietary Concern to refund the amount on 23 July 2016, which was refused. The Proprietary Concern stated that it would return the amount directly to CMRL if insisted upon. A joint meeting was held on 4 August 2016, where the Proprietary Concern refused to return the amount. The Appellant obtained a letter from CMRL on 27 December 2016, confirming the payment was made on the Appellant’s request. Despite this, the Proprietary Concern did not return the amount.

The Appellant then sent a demand notice on 27 February 2017, which was also refused. Subsequently, the Appellant initiated insolvency proceedings against the Respondent under Section 9 of the IBC.

Timeline:

Course of Proceedings

The National Company Law Tribunal (NCLT), Chennai, admitted the Appellant’s application under Section 9 of the IBC, ruling that the Respondent’s Memorandum of Association (MOA) proved that it had taken over the Proprietary Concern and was liable for its debts. The NCLT declared a moratorium and appointed an Interim Resolution Professional (IRP).

However, the National Company Law Appellate Tribunal (NCLAT) reversed the NCLT’s decision, dismissing the Appellant’s application. The NCLAT held that the Appellant was a ‘purchaser’ and not an ‘operational creditor’ as defined under the IBC, as it had not supplied any goods or services to the Proprietary Concern/Respondent. The NCLAT also stated that there was no evidence to suggest that the Respondent had taken over the Proprietary Concern. Additionally, it noted that the application was barred by limitation.

Legal Framework

The Supreme Court examined the following key provisions of the Insolvency and Bankruptcy Code, 2016 (IBC):

• Section 5(20) of the IBC: Defines an “operational creditor” as a person to whom an operational debt is owed, including any person to whom such debt has been legally assigned or transferred.

• 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 re-payment of dues arising under any law.

• Section 3(6) of 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; or 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 8 of the IBC: Outlines the procedure for an operational creditor to initiate the insolvency resolution process by delivering a demand notice to the corporate debtor.

• Section 3(12) of the IBC: Defines “default” as the non-payment of debt when the whole or any part of the amount of debt has become due and payable and is not re-paid by the debtor.

• Section 9 of the IBC: Specifies the process for an operational creditor to file an application for initiating a corporate insolvency resolution process.

The Court also referred to Rule 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules 2016, which provides the manner in which the demand notice under Section 8(1) has to be delivered, and Regulation 7 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016, which provides the manner in which the claims by operational creditors can be proved.

Additionally, the Court considered Sections 4, 10, and 13 of the Companies Act, 2013, which relate to the Memorandum of Association (MOA) of a company and its alteration.

Arguments

Appellant’s Submissions:

• The Respondent’s MOA states that one of its main objectives is to take over the Proprietary Concern. Therefore, the NCLAT’s finding that there is no evidence of the Respondent taking over the Proprietary Concern is incorrect.

• The Appellant made the payment of Rs 50,00,000 to CMRL, and it thus becomes due from the Respondent to the Appellant.

• The Appellant is an operational creditor under the IBC because the purchase orders for light fittings were related to its operational requirements.

• The application under Section 9 of the IBC is not barred by limitation.

Respondent’s Submissions:

• The Appellant’s dealings were only with the Proprietary Concern, not the Respondent. Although the Respondent’s MOA stated an intention to take over the Proprietary Concern, this intention was changed through a subsequent Board resolution. The Proprietary Concern still exists as a separate entity.

• There is no privity of contract between the Appellant and the Respondent, as the Appellant’s contract was with the Proprietary Concern, and the payment was made by CMRL.

• The Appellant is not an operational creditor because it did not provide any goods or services to the Respondent, but only availed of them from the Proprietary Concern. Also, the debt, if any, is with CMRL, which has not legally transferred it to the Appellant.

• The application is barred by limitation since it was filed more than three years after the date of default.

• The Appellant is misusing the IBC to recover its dues.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the Appellant is an operational creditor under the IBC, even though it was a ‘purchaser’.

2. Whether the Respondent took over the debt from the Proprietary Concern.

3. Whether the application under Section 9 of the IBC is barred by limitation.

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:

The Court also considered the following legal provisions:

• Section 5(20) of the IBC: Defines an “operational creditor”.

• Section 5(21) of the IBC: Defines “operational debt”.

• Section 3(6) of IBC: Defines “claim”.

• Section 8 of the IBC: Outlines the procedure for an operational creditor to initiate the insolvency resolution process.

• Section 3(12) of the IBC: Defines “default”.

• Section 9 of the IBC: Specifies the process for an operational creditor to file an application for initiating a corporate insolvency resolution process.

• Rule 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules 2016: Provides the manner in which the demand notice under Section 8(1) has to be delivered.

• Regulation 7 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016: Provides the manner in which the claims by operational creditors can be proved.

• Sections 4, 10, and 13 of the Companies Act, 2013: Relate to the Memorandum of Association (MOA) of a company and its alteration.

Judgment

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

How each authority was viewed by the Court?

✓ The court relied on Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 SCC 17* to understand the difference between financial and operational creditors and the objectives of the IBC.

✓ The court relied on Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416* to highlight the differences between home buyers and operational creditors, and the nature of operational debts.

✓ The court relied on Innoventive Industries Ltd. v. ICICI Bank, (2018) 1 SCC 407* to understand the process for an operational creditor to trigger the CIRP.

✓ The court relied on Mobilox Innovations (P) Ltd. v. Kirusa Software (P) Ltd., (2018) 1 SCC 353* to understand the procedure for an operational creditor to initiate CIRP and the meaning of “dispute”.

✓ The court relied on Kay Bouvet Engg. Ltd. v. Overseas Infrastructure Alliance (India) (P) Ltd., (2021) 10 SCC 483* to reiterate the concern that operational creditors may initiate insolvency proceedings for small amounts of debt.

✓ The court relied on Phoenix ARC (P) Ltd. v. Spade Financial Services Ltd., (2021) 3 SCC 475* to purposively interpret Section 21(2) of the IBC.

✓ The court relied on B.K. Educational Services (P) Ltd. v. Parag Gupta & Associates, (2019) 11 SCC 633* to hold that the Limitation Act applies to applications filed under Sections 7 and 9 of the IBC.

The Supreme Court held that the Appellant is an operational creditor under the IBC. The Court reasoned that the definition of “operational debt” under Section 5(21) of the IBC is broad enough to include debts arising from contracts for the supply of goods or services, irrespective of whether the party is the supplier or the receiver. The Court stated that the phrase “in respect of” in Section 5(21) has to be interpreted in a broad and purposive manner in order to include all those who provide or receive operational services from the corporate debtor, which ultimately lead to an operational debt.

The Court also held that the Respondent was deemed to have taken over the Proprietary Concern, as stated in its MOA. The Court noted that no valid amendment was made to the MOA, and therefore, the Respondent was liable for the debts of the Proprietary Concern.

Regarding the issue of limitation, the Court clarified that the limitation period starts from the date of default, which is the date when the debt becomes due and is not paid, not when the debt was initially incurred. In this case, the default occurred when the Proprietary Concern refused to repay the amount, and therefore, the application under Section 9 was not barred by limitation.

The Court emphasized that the IBC is not merely a recovery legislation for creditors but a beneficial legislation aimed at reviving corporate debtors.

The Court quoted from the judgment:

“…the phrase “in respect of” in Section 5(21) has to be interpreted in a broad and purposive manner in order to include all those who provide or receive operational services from the corporate debtor, which ultimately lead to an operational debt.”

“…the MOA of the respondent still stands and the presumption will continue to be in favor of the appellant. Thus, it can be concluded that the respondent took over the Proprietary Concern and was liable to re-pay the debt to the appellant.”

“…limitation does not commence when the debt becomes due but only when a default occurs. As noted earlier in the judgment, default is defined under Section 3(12) of the IBC as the non- payment of the debt by the corporate debtor when it has become due.”

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the need to provide a purposive interpretation of the IBC, ensuring that it serves its intended goal of resolving insolvency while also protecting the interests of various stakeholders. The court emphasized that the definition of operational debt should be interpreted broadly to include all transactions related to the supply of goods and services, regardless of whether one is the supplier or the receiver. This approach ensures that the IBC does not become a tool for unscrupulous debtors to avoid their obligations.

The court also focused on the factual matrix of the case, noting that the debt arose from a genuine commercial transaction, and the Respondent’s attempt to evade liability based on technicalities was not acceptable. The court also took into account the importance of the MOA of a company as a founding document and the legal implications of not amending it properly.

The court’s reasoning also reflected a concern with ensuring that the IBC does not become a mere recovery mechanism, while at the same time, it should not allow debtors to use technicalities to evade their liabilities. The court’s decision was a balanced approach, ensuring that the IBC serves its intended purpose of resolving insolvency in a fair and equitable manner.

Implications

The Supreme Court’s judgment in Consolidated Construction Consortium Ltd. vs. Hitro Energy Solutions Pvt. Ltd. has significant implications for businesses and the legal landscape under the IBC:

• Broadening the Scope of Operational Creditor: The judgment clarifies that a party that has made an advance payment for goods or services can be considered an operational creditor if the goods or services are not delivered. This broadens the scope of who can initiate insolvency proceedings under the IBC.

• Protection of Purchasers: It protects purchasers who have made advance payments but have not received the goods or services, allowing them to initiate insolvency proceedings against defaulting suppliers.

• Liability of Companies Taking Over Other Entities: The judgment highlights the importance of the MOA of a company and the legal implications of taking over another entity. Companies must ensure that any changes in their objectives are properly documented and reflected in their MOA.

• Limitation Period Clarification: The judgment clarifies that the limitation period for initiating insolvency proceedings starts from the date of default, not the date when the debt was initially incurred.

• Emphasis on the Purpose of IBC: The judgment emphasizes that the IBC is not merely a recovery mechanism but a beneficial legislation aimed at reviving corporate debtors.

This judgment serves as a landmark decision by the Supreme Court, clarifying the scope of operational debt and creditor under the IBC, and ensuring that the legislation is interpreted in a manner that promotes its intended objectives.