LSI Insight

Ambit of ‘Financial Debt’

Under IBC

Ambit of ‘Financial Debt’ Under IBC

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Background:

‘Financial Debt’ has an inclusive definition given u/s

5(8) of the IBC, which defines it as a debt along with

interest, if any, which is disbursed against the

consideration for the time value of money. Further,

Section 5(7) of the IBC defines ‘financial creditor’ as

any person to whom a financial debt is owed and

includes a person to whom such debt has been legally

assigned or transferred to. Since the definition of

‘financial debt’ is non-exhaustive, the Judiciary has the power to interpret what can or cannot

be considered as a ‘financial debt’.

Several rulings have been passed by the Supreme Court and Tribunals in respect of what

constitutes a ‘financial debt’ under IBC. Vide a recent noteworthy judgment, the Apex Court

had held that interest free loans would fall under the definition of ‘financial debt’. In another

significant ruling, SC ruled that for a debt to become ‘financial debt’ for Part II of the Code,

the basic elements are that it ought to be a disbursal against the consideration for the time

value of money. It is crucial to understand the meaning of ‘time value of money’ to

understand the elucidation of ‘financial debt’. Black’s Law Dictionary has defined the term

‘Time Value’ as the price associated with the length of time that an investor must wait until

an investment matures or the related income is earned.

Furthermore, NCLAT in certain other matters ruled that

‘Security deposit carrying interest, made with Corporate

Debtor’, ‘Deposit’, ‘Collective Investment Scheme’

qualifies as ‘financial debt’. Moreover, this issue has also

been considered by different NCLT benches while

adjudicating on admission/rejection petitions seeking

insolvency initiation. Interestingly, in one case NCLT had

rejected an insolvency application owing to failure in

paying MoU dues, on the ground that the same does not constitute a ‘financial debt’. In

another matter, NCLT ruled that an ‘Investor’ cannot be treated as a ‘financial creditor’. As

jurisprudence in the IBC domain is still at its blooming phase, cases in subsequent times will

further polish the evaluation of this term.

In this context, we bring to you a bunch of noteworthy rulings rendered by the Supreme Court,

NCLAT and various NCLT benches with regard to what qualifies, what doesn’t qualify as

‘financial debt’.

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Ambit of ‘Financial Debt’ Under IBC

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What qualifies as ‘Financial Debt’

Sr.

No.

Headline LSI Citation Summary

Supreme Court Rulings

1. SC: Interest-free

loans to finance

Corporate Debtor’s

business

operations, within

‘financial debt’

ambit

[LSI-559-SC-2021(NDEL)] Highlighting that the definition of

‘Financial Debt’ u/s Sec. 5(8) of

IBC does not expressly exclude an

interest free loan, SC ruled that

“‘Financial Debt’ would have to

be construed to include interest

free loans advanced to finance

the business operations of a

corporate body.” Accordingly, SC

set aside NCLAT order [LSI-310-

NCLAT-2021(NDEL)] dismissing

insolvency application u/s 7 of IBC

filed by the assignee of the original

lender to the Corporate Debtor for

non-payment of a loan that was

interest free.

NCLAT Rulings

2. NCLAT: Security

deposit carrying

interest, made with

Corporate Debtor,

qualifies as

‘financial debt’

[LSI-812-NCLAT-2021(NDEL)] NCLAT set aside the NCLT order

upholding RP’s decision to treat

Appellant’s claim as an

operational debt. Observing that

the Corporate Debtor had

accepted the ‘Security Deposit’

from the Appellant and credited

the interest for some time against

such amounts, NCLAT held that

the said security deposit qualifies

as ‘financial debt’.

3. NCLAT: Guarantee

given by Corporate

Debtor for group

entity’s loan,

[LSI-511-NCLAT-2021(NDEL)] NCLAT opined that, on the basis of

Corporate Guarantee given by

Corporate Debtor for the loan

provided by Respondent 2 to a

group concern of the Corporate

Ambit of ‘Financial Debt’ Under IBC

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qualifies as

‘financial debt’

Debtor, Respondent 2 is a

financial creditor in CIRP. Thus

upheld the NCLT order directing

RP to constitute the CoC.

4. NCLAT: Collective

Investment

Schemes qualify as

‘financial debt’;

Directs NCLT to

admit insolvency

application

[LSI-100-NCLAT-2021(NDEL)] Observing that “…the essence of

any debt to be mentioned as

‘financial debt’ is the ‘time value

of money’, as borrowing money is

for monetary transaction.”, NCLAT

set aside NCLT order dismissing an

Investor’s (‘Appellant’) Sec. 7

application, on finding that the

Corporate Debtor had committed

to pay the investors, a return on

the investment for the ‘time value

of money’ based on the amount

of investments made, and held

that the Appellant qualifies as a

‘financial creditor’.

5. NCLAT: 'Deposit' a

'financial debt';

Quashes NCLT

order rejecting

insolvency petition

[LSI-86-NCLAT-2021(NDEL)] NCLAT set aside NCLT order

rejecting Appellant’s Sec. 7

application for initiation of CIRP

against the Corporate Debtor, on

finding that Appellant comes

within the definition of ‘financial

creditor’ and the deposit is a

‘financial debt’ as defined under

IBC. Inter alia observed that

Corporate Debtor had accepted

certain amounts from the

Appellant and credited the

interest in a consistent manner

against such amounts, thus,

bearing in mind that payment of

interest on amounts borrowed by

Corporate Debtor is nothing but a

consideration for time value of

money.

6. NCLAT: Amount

loaned by Director

to ease Corporate

Debtor’s liquidity

[LSI-445-NCLAT-2020(NDEL)] Upholding NCLT order admitting

Respondent’s Sec. 7 application

for initiation of CIRP against the

Corporate Debtor, NCLAT ruled

that “…the amount deposited by

Ambit of ‘Financial Debt’ Under IBC

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crunch, a ‘financial

debt’

the respondent No.1 in the

account of GNIDA to save the

corporate debtor on account of

financial crunch to save the

allotment made in the name of

corporate debtor falls within the

ambit of ‘financial debt’.”

7. NCLAT: Advance

paid for

construction

qualifies as

‘financial debt’ on

project becoming

unviable

[LSI-212-NCLAT-2019(NDEL)] NCLAT held that the debt in

question w.r.t. advance money

paid by Appellant pursuant to an

agreement whereby the

Respondent was to construct a

residential building, got

transformed into a ‘financial debt’

on the project becoming

commercially unviable, falling

within the purview of Sec. 5(8) of

IBC, making Appellant’s status

that of a ‘financial creditor’. Thus,

set aside the NCLT order

erroneously holding the Appellant

as an ‘operational creditor’.

NCLT Rulings

8. NCLT: Amount

invested by

Corporate Debtor’s

ex-Directors

qualifies as

‘financial debt’

[LSI-680-NCLT-2021(MUM)] NCLT admitted the petition filed

by Investors/Ex-Directors

(‘Petitioners’) who had extended

financial support to the Corporate

Debtor at numerous occasions, for

initiation of CIRP against the

Corporate Debtor, on observing

that the nature of debt in question

is a ‘financial debt’ as defined u/s

5(8) of IBC.

9. NCLT: Advance

payment having

commercial effect

of borrowing, a

‘financial debt’

[LSI-136-NCLT-2020(NDEL)] NCLT ruled that RP had rightly

treated one of the creditors of the

Corporate Debtor as a Financial

Creditor, on finding that the

advance paid by the creditor to

the Corporate Debtor was a debt

disbursed against the

consideration of time value of

money under Sale Agreement,

Ambit of ‘Financial Debt’ Under IBC

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having the commercial effect of

borrowing, and thus, qualifies as a

‘financial debt’.

What doesn’t qualify as ‘Financial Debt’

Sr.

No.

Headline LSI Citation Summary

Supreme Court Rulings

1. SC: Shares pledged

by Corporate

Debtor absent

undertaking to

discharge liability,

not ‘financial debt’

[LSI-53-SC-2021(NDEL)] SC dismissed appeal challenging

NCLAT order upholding NCLT’s and

RP’s rejection of Appellant’s claim

as ‘financial creditor’ of the

Corporate Debtor u/s 5(8) of IBC, on

holding that shares pledged by

Corporate Debtor absent

undertaking to discharge liability, is

not ‘financial debt’. SC affirmed

NCLAT’s observation that pledge of

shares in question does not amount

to “disbursement of any amount

against the consideration for the

time value of money” and thus

won’t fall under the meaning of

‘financial debt’.

2. SC: Collusive

transactions with

Corporate Debtor

don’t qualify as

‘financial debt’

under IBC

[LSI-45-SC-2021(NDEL)] SC set aside NCLAT order, inasmuch

as it refers to Respondents as

financial creditors, while holding

that “Since the commercial

arrangements between Spade and

AAA, and the Corporate Debtor

were collusive in nature, they would

not constitute a ‘financial debt’.

Hence, Spade and AAA are not

financial creditors of the Corporate

Debtor.”

Ambit of ‘Financial Debt’ Under IBC

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NCLAT Rulings

3. NCLAT: Affirms

NCLT order holding

default in payment

of interest, not

‘financial debt’

[LSI-816-NCLAT-

2021(NDEL)]

NCLAT affirmed NCLT order

dismissing Appellant’s application

for initiation of insolvency process

against the Corporate Debtor for

default in payment of interest,

holding that the same is not

maintainable on grounds that

default of payment of interest is not

covered under the definition of

‘financial debt’ u/s 5(8) of IBC and

the Appellant does not fall within the

ambit of ‘financial creditor’.

4. NCLAT: Mere

obligation to pay

under Settlement

Agreement, not

‘financial debt’

[LSI-47-NCLAT-

2020(NDEL)]

NCLAT upheld NCLT order rejecting

Appellant’s application u/s 7 of IBC

for initiating CIRP and ruled

that “Mere obligation to pay under

a Settlement Agreement would not

amount to disbursal of amount for

consideration against the time

value of money and breach thereof

would not entitle the Appellant in

the instant case to trigger Corporate

Insolvency Resolution Process

against the Respondent.”

5. NCLAT: Debt once

converted into

capital cannot

trigger CIRP;

Upholds NCLT order

rejecting

insolvency petition

[LSI-630-NCLAT-

2020(NDEL)]

Dismissing appeal against NCLT

order rejecting Appellant’s Sec. 7

application for initiation of CIRP,

NCLAT ruled that “…once the

‘Debt’ is converted into “Capital” it

cannot be termed as ‘Financial

Debt’ and the Appellant cannot be

described as ‘Financial Creditor’.”

6. NCLAT: Cannot

initiate insolvency

process for breach

of contract

involving reciprocal

rights

[LSI-568-NCLAT-

2020(NDEL)]

NCLAT held that the “…Application

seeking initiation of CIRP by one

partner of JDA against the other,

only jeopardizes the interests of the

allottees… the Joint Development

Agreement… is a contract of

reciprocal rights and

obligations… and for any breach of

terms of contract, Section 7

Ambit of ‘Financial Debt’ Under IBC

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Application is not maintainable as

the amount cannot be construed as

‘Financial Debt’…”.

NCLT Rulings

7. NCLT: Money

advanced by seller

to associate

supplier doesn’t

qualify as ‘financial

debt’

[LSI-776-NCLT-2021(MUM)] NCLT dismissed an insolvency

application filed by a Financial

Creditor (a Govt. of India Enterprise

under Ministry of Commerce and

Industry), holding that an advance

given to the associate supplier to

supply goods on behalf of the seller

i.e. the Financial Creditor, to the

foreign buyer, doesn’t qualify as

‘financial debt’.

8. NCLT: ‘Refundable

security deposit’

arranged by Joint

Developer through

third-party cannot

constitute

‘financial debt’

[LSI-862-NCLT-2021(MUM)] NCLT rejected insolvency

application filed by the Financial

Creditor against the Corporate

Debtor, ruling that refundable

security deposit arranged by the a

Joint Developer (‘Petitioner’)

through a third entity cannot

constitute a ‘financial debt’ owed

by the Developer to the Petitioner as

per Sec. 5(8) of the IBC.

9. NCLT: Investor

cannot be treated

as ‘Financial

Creditor’, dismisses

insolvency

application

[LSI-503-NCLT-2021(CHE)] NCLT ruled Applicant being an

Investor cannot be and need not be

treated as a ‘Financial Creditor’ and

that “…an Investment Agreement

which is subsequently converted

into a Settlement Agreement with a

payment schedule between the

parties fails to fall within the

definition of a ‘financial debt’ and

the Applicant herein is not a

“Financial Creditor” as per the

provisions of the IBC.”

10. NCLT: Rejects

insolvency

application filed for

claiming MoU dues,

[LSI-203-NCLT-2021(AHM)] NCLT ruled that the nature of claim

based on a MoU entered between

the parties is not falling under the

Ambit of ‘Financial Debt’ Under IBC

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not being ‘financial

debt’

definition of Financial Debt as

defined u/s 5(8) of IBC.

11. NCLT: Transaction

governed by High

Seas Sale

Agreement cannot

be re-christened as

“Financial Debt”

[LSI-341-NCLT-2021(CHE)] NCLT dismisses an insolvency

application filed u/s 7 of the IBC,

holding that Applicant cannot be

treated as “Financial Creditor” since

the nature and characteristics of

transaction between the parties

were governed by a High Seas Sale

Agreement and such transaction

cannot be ‘re-christened’ as

Financial Debt.

12. NCLT: Forward

Purchase

Agreements

lacking

commercial effect

of borrowing, not

‘financial debt’

[LSI-116-NCLT-2021(MUM)] NCLT set aside IRP’s decision to

admit Respondents’ claims as

financial creditors, on finding that

the transactions between the

Corporate Debtor and Respondents

were essentially simple agreements

of sale and purchase and did not

have the commercial effect of

borrowing, held that “The same

would not come within the definition

of ‘financial debt’ under section

5(8)(f)…”.

13. NCLT: Amount

disbursed in

Debtor’s favour

absent ‘time value

of money’ not

‘financial debt’

[LSI-901-NCLT-2020(ALLD)] Remarking that “significance of

Section 5(8) is that, the financial

transaction should be the nature of

debt, and further, the Financial

Creditor is a person who has a right

to financial debt”, NCLT dismissed

the insolvency application while

holding that the Applicant failed to

show that the amount of Rs. 3 Cr.

was disbursed in Corporate Debtor’s

favour against the consideration for

time value of money.

14. NCLT: Amount

advanced to

intermediary,

Company’s

Director not

[LSI-502-NCLT-2020(ALLD)] NCLT dismissed Sec. 7 petition filed

by the Petitioner for initiation of CIRP

on holding that the debt in the

present case doesn’t qualify as

‘financial debt’ under IBC as the

Petitioner failed to prove that the

Ambit of ‘Financial Debt’ Under IBC

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‘financial debt’

under IBC

amount transferred to the personal

account of an intermediary as well

as Respondent’s Director’s account

was given as loan to the

Respondent.

15. NCLT: Monies

advanced for

rendering services

outside the purview

of ‘financial debt’

[LSI-58-NCLT-2018(CHE)] NCLT held that monies advanced to

Corporate Debtor by firms engaged

by it for rendering services in relation

to Corporate Debtor’s business and

management don’t fall within the

purview of the term ‘financial debt’

under IBC, as the monies advanced

weren’t against time value of

money.

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