India: Does Payment Of Interest Constitute A Financial Debt?

Last Updated: 11 December 2018
Article by Nikhil Khurana, Malavika Menon and Nisarg Mehta

The National Company Law Appellate Tribunal, New Delhi ("NCLAT") in the case of Sanjay Kewalramani vs. Sunil Parmanand Kewalramani & Ors. vide order dated 12th July, 2018 held that the mere fact that a company has paid interest on an unsecured loan for a certain period of time (i) cannot be a ground to hold that the debt comes within the meaning of "Financial Debt" as defined under Section 5 (8) of the Insolvency and Bankruptcy Code, 2016 ("Code"); and (ii) cannot be termed as 'disbursement of an amount for consideration for the time value of money'.

  • Facts

Mr. Sunil Parmanand Kewalramani ("Petitioner 1"), for himself and on behalf of Mr. Parmanand Kewalramani ("Petitioner 2") and Mr. Madhu Kewalramanj ("Petitioner 3") (collectively referred to as "Petitioners") had filed a petition to initiate corporate insolvency resolution proceedings under Section 7 of the Code against Medilux Laboratories Private Limited ("Company") for claims amounting to (i) Rs.18,18,793/- (Rupees Eighteen Lakhs Eighteen Thousand Seven Hundred and Ninety Three); (ii) Rs. 95,20,444/- (Rupees Ninety-Five Lakhs Twenty Thousand Four Hundred and Forty-Four) and Rs. 1,97,256/- (Rupees One Lakh Ninety-Seven Thousand Two Hundred and Fifty-Six), respectively (collectively "Outstanding Amounts"). In accordance with the ledger entries in the books of accounts of the Company, interest was paid on the unsecured loans advanced by the Petitioners at a rate of 12% per annum for the years ending 2007-2008 to 2012-2013. However, after the year ending 2012-2013, no interest was paid by the Company to the Petitioners. Further, the annual report of the Company for the year 2015-2016 recorded an outstanding amount in the name of Petitioners.

The Petitioner 1 (as the director of the Company) had also executed a deed of guarantee ("Guarantee") wherein the Petitioner 1 undertook inter alia that he will not prove in bankruptcy or insolvency or winding up of the Company.

The Petitioner 1 was authorized by the Petitioner 2 and Petitioner 3 to initiate legal proceedings against the Company under a general power of attorney and subsequently the Petitioner 1 for himself and on behalf of the Petitioner 2 and Petitioner 3 issued a demand notice dated 28th August 2017 calling upon the Company to pay the Outstanding Amounts.

Upon the Company failing to repay the Outstanding Amounts as stated in the demand notice, the Petitioner 1 filed an application under Section 7 of the Code before the National Company Law Tribunal, Ahmedabad ("NCLT") for initiation of corporate insolvency proceedings.

Pursuant to the aforesaid, the NCLT by an Order dated 2nd February 2018 held that the petition for initiation of corporate insolvency resolution process filed by Petitioner 1 against the Company was not maintainable since the Petitioner 1 had executed the Guarantee wherein the Petitioner 1 had specially agreed to refrain from initiating such proceedings against the Company and was thus estopped. The NCLT held that the application for initiation of corporate insolvency resolution process filed by the Petitioner 1 on behalf of the Petitioner 2 and Petitioner 3 was maintainable in view of the fact that the Petitioner 2 and Petitioner 3 were not the parties to the Guarantee and there was no restriction against them from initiating insolvency proceedings against the Company.

Mr. Sanjay Kewalramani, aggrieved by the said impugned Order dated 2nd February 2018 filed an appeal with the NCLAT inter alia praying not to treat Petitioner 2 and Petitioner 3 as 'Financial Creditor' as defined in the Code.

  • Key Observations of the NCLAT
  1. The Explanation to Section 7 of the Code states that a Financial Creditor in whose case no default has taken place may also file a petition for initiation of corporate insolvency resolution process under Section 7 of the Code for default along with other creditors joined with him. In the present appeal, since the Petitioner 1 was not eligible to file an application in the capacity of a Financial Creditor as held by the NCLT, the joint petition at the instance of Petitioner 2 and Petitioner 3 was also not maintainable.
  1. Further, there was nothing on the record to suggest that the Petitioner 2 and the Petitioner 3 had given loans to the Company which could be deemed to be a 'disbursement of an amount for consideration for the time value of money' which is the first essential requirement to fall within the ambit of the definition of the term "Financial Debt" under Section 5(8) of the Code. Thus, the Petitioners failed to satisfy the requirements of a "Financial Debt" i.e. the loan granted by the Petitioner 2 and Petitioner 3 does not comply with the substantive definition of "Financial Debt" under the Code.
  • Held

The mere fact that the Company paid interest at the rate of 12% per annum during a certain period cannot be the ground to hold that the 'debt' shall be deemed to be a "Financial Debt" in terms of the Code and further that the said loans cannot be termed as "disbursement of an amount for consideration for the time value of money" which is a necessary requirement for the debt to be construed as a 'Financial Debt' enabling the Petitioners to initiate proceedings in their capacity as 'Financial Creditors' under the Code.

  • Conclusion

The order of the NCLAT lays down a critical distinction between a "debt" and a "Financial Debt". In accordance with Section 5(8) of the Code, the essential requirement of a 'Financial Debt' is that in order for a debt to be construed as a Financial Debt, the debt should have been disbursed against the consideration for the time value of money. The meaning of the term financial debt and time value has been deliberated upon by the NCLAT in the following matters:

  1. In the matter of B.V.S Lakshmi v. Geometrix Laser Solutions Private Limited, the NCLAT held that the definition of 'Financial Debt' under Section 5(8) of the Code uses the word 'includes', meaning that the kinds of financial debts illustrated in the definition are not exhaustive.
  1. In Nikhil Mehta and sons (HUF) v. AMR Infrastructures, the NCLAT interpreted that the word 'Financial Debt' is ordinarily used in the context for a sum of money received today to be paid over a period of time in a single or series of payments in future. A 'Financial Debt' may also be a sum of money invested today to be repaid over a period of time in a single or series of instalments to be paid in future. Further, the meaning of the term 'time value'" as defined in Black's Law Dictionary (9th Edition) is the price associated with the length of time that an investor must wait until an investment matures or the related income is earned.

The inference one may draw from the ratio of the NCLAT in the matter is that in a situation where the creditor is unable to prove that the loan has been disbursed for a stipulated period with sight of the date when repayment of the loan is to be made, the loan would not meet the requirements of a "Financial Debt".  Any lender disbursing such loan may be compelled to seek recourse in the civil courts since the remedies under the Code are available only to Financial Creditors and Operational Creditors. This highlights the importance of having crystallized terms in respect of any lending in the absence of which a creditor may possibly not have recourse under the Code. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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