The Orator Saga: Validity of Interest-Free Loans as Financial Debt

By Ankur Mishra, Fourth Year Student at Institute of Law, Nirma University

On 26 July 2021, the Hon’ble Supreme Court in M/s. Orator Marketing Pvt. Ltd. v. M/s. Samtex Desinz Pvt. Ltd. analyzed the status of interest-free loans as financial debt. The SC categorically observed that an interest-free loan, which is advanced to finance the business operations of a corporate body, qualifies as financial debt under Section 5(8) of the Insolvency and Bankruptcy Code 2016 (the Code). The Court remarked that lenders of such debt would qualify as Financial Creditors and would be competent to initiate Corporate Insolvency Resolution Process (CIRP) against the defaulting debtors under Section 7 of the Code. This article seeks to analyse the Supreme Court’s judgment vis-a-vis the NCLT and NCLAT’s decision in the same case while highlighting the other significant rulings in this regard.

Background

M/s Sameer Sales Pvt. Ltd. (Original Lender) advanced a term loan of Rs. 1.60 crores to M/s. Samtex Desinz Pvt. Ltd. (Corporate Debtor/CD) to enable the company in meeting its working capital requirements. The Original Lender was a sister concern of the Corporate Debtor. The CD was able to repay some amount but eventually defaulted with an outstanding debt of Rs. 1.56 crores. The debt was later assigned to M/s. Orator Marketing Pvt. Ltd. (Financial Creditor/FC), who filed an application to initiate CIRP against the CD under Section 7 of the Code. However, the National Company Law Tribunal New Delhi (NCLT), vide its order dated  (23 October 2020), rejected the said application, holding that mere granting of a loan and an admission of its receipt does not qualify as ‘Financial Debt’ under Section 5(8) of the Code. For this, the NCLT relied on the Hon’ble National Company Law Appellate Tribunal’s (NCLAT) decisions in Vishwa Nath Singh vs. M/s. Visa Drugs & Pharmacaeuticals Pvt. Ltd. and B.V.S. Lakshmi vs. Geometrix Laser Solutions Pvt. Ltd.. The NCLT reasoned that since there was no provision in the loan agreement for payment of interest, the present transaction did not fulfil the criteria of time value of money and would therefore not qualify as Financial Debt. Aggrieved by this decision, the FC preferred an appeal with the appellate authority under Section 61 of the Code. The NCLAT upheld the impugned order and observed that interest-free loans do not render any consideration for the time value of money and hence, such loans could not be classified as financial debt. Resultantly, the FC filed an appeal before the Supreme Court under Section 62 of the Code.

Supreme Court’s Decision

The Apex Court observed that both NCLT and NCLAT had misinterpreted the definition of Financial Debt under Section 5(8) of the Code. Both tribunals had failed to consider the object and purpose of the Code while rendering their decisions. The Supreme Court remarked that it is crucial to take note of the legislative intent while interpreting a provision from any statute. The Court noted that Debt and Default have been given expansive and inclusive meanings under the scheme of the Code and held that the definition of Financial Debt did not expressly exclude interest-free loans advanced for financing day-to-day operations of a business. In doing so, the Court overruled the decisions of the NCLT and the NCLAT, holding that the lender of any interest-free loan will qualify as a Financial Creditor under Section 7 of the Code.

The Intent behind Section 5(8) of the Code

The Supreme Court has heavily relied on the legislative intent and scheme of the Code while deciding the present matter. The Court inferred through its previous decisions that the definitions of ‘Financial Creditor’ and ‘Financial Debt’ under the Code must be interpreted broadly and expansively. The Court added that these definitions cannot be read in isolation and without considering the definitions of claim, corporate debtor, creditor, debt, and default.

Understanding the definitions of ‘Debt’ and ‘Default’ under the Code is a prerequisite to understanding the intent behind the definition of Financial Debt. While ‘Debt’, defined under Section 3(11) of the Code, includes ‘Operational’ and ‘Financial’ Debt, ‘Default’ under Section 3(12) of the Code has been defined broadly as the non-payment of a Debt after it becomes due and payable. These interpretations have been adopted in NCLT, New Delhi’s decision in Brand Realty Services Ltd. vs. Sir John Bakeries Pvt. Ltd.,and the Supreme Court’s decision in Innoventive Industries Ltd. vs. ICICI Bank Ltd. As per the NCLAT’s decision in Krishna Enterprises vs. Gammon India Ltd. (Krishna Enterprises), where any interest is payable to the Financial Creditor, Debt under Section 3(11) of the Code would include such interest. However, where any interest is not payable, only the principal amount is to be treated as Debt. The author opines that this interpretation of Debt is also applicable to the definition of Financial Debt.

Section 5(8) of the Code defines Financial Debt as a debt coupled with an interest, if any, which has been disbursed against the time value of money and includes money borrowed against the payment of interest under Section 5(8)(a) of the Code. Simply put, when a loan has been disbursed, Financial Debt under Section 5(8) would include the outstanding principal amount with interest, if any is payable thereon. The NCLT and NCLAT judgments not only overlooked the words “if any” as if it did not serve any purpose, but also overlooked Clause (f) of Section 5(8) in terms of which, Financial Debt includes any amount raised which has the commercial effect of borrowing. The Apex Court noted that sub-clauses (a) to (i) of Section 5(8) of the Code were illustrative and not exhaustive and must thus be given a likewise interpretation.

The Conundrum of “Time Value of Money”

In Dr. B.V.S. Lakshmi vs. Geometrix Laser Solutions Pvt. Ltd., the NCLAT held that for a debt to qualify as financial debt under Section 5(8) of the Code, a claimant has to prove firstly, that there exists a debt that had been disbursed, and secondly, that such disbursement was made against the “consideration for the time value of money”. Similarly, in K.N. Mahesh Prasad vs. Medinnbelle Herbalcare Pvt. Ltd., the NCLT rejected the application of the creditor and reasoned that a simple loan agreement, devoid of any element of the time value of money will not qualify as financial debt. While interpreting what constitutes time value of money, the NCLAT in Nikhil Mehta & Sons (HUF) & Ors. vs. M/s. AMR Infrastructure Ltd. had inferred that time value of money means the price that is paid as compensation to the investor for the time it takes for an investment to mature. The Supreme Court had also interpreted this phrase in Pioneer Urban Land and Infrastructure Ltd. vs. Union of Indiaas the compensation for the duration for which the money has been disbursed and such compensation could be in the form of interest paid on the money. A similar interpretation was taken in Narendra Kumar Agarwal vs. Monotrone leasing Pvt. Ltd.,wherein the payment of interest had satisfied the component of the time value of money.

However, in Sanjay Kewalramani vs. Sunil Parmanand Kewalramani, the NCLAT had observed that the mere grant of loan and the admission of taking such loan will not render the transaction as Financial Debt if the essentials of Sections 5(8) and 7 are not satisfied. The NCLAT clarified that this will be true even if interest was paid on such a transaction for a certain period. Separately, in Shailesh Sangani vs. Joel Cardoso (Shailesh Sangani), the NCLAT held that interest was not a sine qua non for a debt to be classified as Financial Debt as long as the element of time value of money was satisfied in any other way. The Appellate Tribunal further observed that any amount advanced by a Promoter, Director, or Shareholder of the CD which has been raised to improve the financial health of the Company and to boost its economic prospects will have the commercial effect of borrowing, irrespective of any provision for interest thereon. Resultantly, such a transaction will qualify as Financial Debt under Clause (f) of Section 5(8) of the Code which deals with transactions having the commercial effect of borrowing.

In the present case, the NCLAT had refused the petitioner’s application, observing that how the CD uses the money could not be treated as the consideration for time value of money. The Supreme Court’s decision primarily focussed on the scheme of the Code and failed to provide adequate reasoning as to how the transaction in question has satisfied the requirement of time value of money. It is the author’s view that the NCLAT’s decision in Shailesh Sangani applies to the present factual matrix. The debt in the present case was advanced by Mr. Sameer Bhardwaj, a founding director of CD, through the Original Lender to facilitate the development of CD’s business and would, thus, have the commercial effect of borrowing as per Shailesh Sangani. The transaction will, consequently, come under the purview of Clause (f) of Section 5(8) of the Code and will qualify as Financial Debt under the Code.

Conclusion

The Apex Court’s decision in the present matter enlarges the definitions of Financial Debt and Financial Creditor under the Code. The decision is a welcome step in the right direction and provides additional protection to the creditors. Despite the wide ramifications this decision is bound to have, the reasoning provided by the Court in the present matter is certainly not adequate. The Court has acknowledged that consideration against the time value of money is an essential element for a debt to qualify as Financial Debt under Section 5(8) of the Code. However, it has failed to provide adequate reasoning to show that this element has been fulfilled in the present case. This lack of clarity could serve as a major impediment in understanding a substantial element of financial debt.

The author opines that the interpretation of debt to comprise solely the principal amount in the absence of interest, as laid down in Krishna Enterprises must be applicable to Financial Debt as well since the scheme of the Code does not bar such interpretation. Alternatively, even if such interpretation is not accepted, the transaction in the present case falls under the purview of Clause (f) of Section 5(8) of the Code by virtue of the NCLAT’s decision in Shailesh Sangani.