The Insolvency and Bankruptcy Code, 2016 (IBC) has consolidated laws that govern corporate restructuring and insolvency for individuals, partnerships, and sole proprietors. The primary purpose was to expedite the resolution of corporate insolvency. Both financial and operational obligations were defined in the IBC and a categorisation was drawn up.
DEBT
Debt is the amount due by a borrower to the lender which was borrowed for a fixed period of time and then repaid with interest.
FINANCIAL DEBT
A financial debt is any loan, interest included, given in return for consideration of the time value of money, according to Section 5(8) of the IBC. It is indicated by interest paid at a rate that is mutually agreed upon. Consequently, for non-payment of accrued interest, insolvency procedures may be started under Section 7 of the IBC.
OPERATIONAL DEBT
If the creditor is claiming the debt from the corporate debtor for rendering of a ‘service’, then the debt would be considered an operational debt, which involves money owed for day-to-day operational expenses such as a salaries, utilities, or inventory purchase, which are necessary for running a business.
WHEN DOES DEBT BECOME FINANCIAL DEBT & OPERATIONAL DEBT UNDER IBC?
In its recent ruling, Global Credit Capital Limited & Anr. v. Sach Marketing Pvt. Ltd. & Anr (2024) SC 340, the Apex Court elaborated on the difference between ‘financial debt’ and ‘operational debt’ under IBC.
BACKGROUND OF THE CASE
· A security deposit of Rs. 53,15,000 was deposited by the creditor to the corporate debtor.
· The corporate debtor had to pay Rs. 4,000 per month for services related to beer promotion to the creditor.
· There was also an obligation on the corporate debtor to refund the security deposit with an interest rate of 21% per annum.
LEGAL ISSUE
· Whether the security deposit should be classified as a ‘financial debt’ or ‘operational debt’?
KEY POINTS OF THE JUDGEMENT
· A ‘financial debt’ refers to a disbursement based on the time value of money. In the case at hand, the security deposit amount that the corporate debtor was required to refund, along with an annual interest rate of 21%, is considered as a financial obligation it represents the commercial effect of borrowing.
· On the other hand, ‘operational debt’ refers to requests for payments for goods or services. In the case at hand, the corporate debtor’s monthly payment of Rs. 4,000 to the creditor for promotion services was classified as operational debt because it is directly related to the services provided.
COURT FINDING’S
· Monthly service payments of Rs. 4,000 were deemed as operational debt.
· The security deposit, due to the obligation of refund with interest, was classified as a financial debt.
· Supreme Court highlighted the importance of examining the transaction’s substance and the actual terms of written agreements to ascertain the true nature of the debt.
OUTCOME OF THE CASE
· Supreme Court through this the case of Global Credit (Supra) has provided clarity on the interpretation of ‘financial debt’ and ‘operational debt’ under the IBC.
· The Supreme Court affirmed the NCLAT’s decision, which treated as the creditor’s security deposit as a financial debt due to the corporate debtor’s obligation to repay it with the interest.
· As a result, the creditor was deemed a financial creditor, entitled to initiate the Corporate Insolvency Resolution Process (CIRP) under the IBC.
