Lessor as an Operational Creditor – What is the Position under IBC? – By Pratyush Singh

Lessor as an Operational Creditor – What is the Position under IBC?

Authored by:
Pratyush Singh
National Law School of India University, Bangalore

Introduction

The Insolvency and Bankruptcy Code (“the Code”) recognizes three kinds of creditors, which are: financial creditors, operational creditors, and other creditors. The classification helps in delineating the different kinds of rights under the Code. For example, the application to initiate the corporate insolvency resolution process (“CIRP”) against the corporate debtor can only be filed by the financial creditor, operational creditor or the corporate debtor themselves. The rationale for this structure is that the majority of the creditors fall under these categories and the claims put forward by other creditors would not be of enough substance to attract the initiation of the CIRP.

A financial creditor is an entity that has disbursed a debt in consideration for the time value of money whereas an operational creditor is an entity to whom a debt is owed in terms of goods and services. So, if a creditor does not squarely fall within either definitions, then they can only put forth their claims after the initiation of CIRP. It is in this context that the Hon’ble National Company Law Tribunal (“NCLT”) Mumbai in Bharat Doshi v. Autobahn Automotive Private Limited (2022) ibclaw.in 529 NCLT ruled that debt arising out of rent or lease cannot be considered as ‘Operational Debt’ under the Code and hence the lessor would not be granted the rights of an operational creditor.

Input-Output Test

One of the first times wherein a bench dealt with this issue was in Parmod Yadav & Anr. v. Divine Infracon Pvt. Ltd. In this case, NCLT Delhi put forth the input-output test under which a person would only be categorized as an operational creditor if the goods or services being provided by them have a direct nexus to the ‘output’ or business operations of the corporate debtor. This meant that if a company merely used the premises of the creditor for storage purposes that had no direct relationship with the output of the business of the debtor, then they would not have the option of approaching NCLT for a remedy.

The input-output test was used by the counsel in Sarla Tantia v. Nadia Health Care (P) Ltd. [CP(IB) No. 108/KB/2018 and CA(IB) No. 119/KB/2018 to argue that rent would not constitute operational debt. However, the tribunal relied on the Supreme Court judgment in Mobilox Innovations (P) Ltd. v. Kirusa Software (P) Ltd. [2017] ibclaw.in 01 SC to state that lease rent would come under the ambit of operational debt. It is pertinent to note that the Supreme Court in Mobilox Innovations did not actually make any such observation but had only reproduced excerpts from the Viswanathan Committee Report on Bankruptcy Law to discuss another issue altogether. It was only coincidental that a part of those excerpts referred to lease and rent.

Contrary Verdicts by the NCLAT

There was a shift in position on this subject matter in M. Ravindranath Reddy v. G. Kishan [2020] ibclaw.in 95 NCLAT. In this case, the full bench of the National Company Law Appellate Tribunal (“NCLAT”) Delhi made two arguments to rule that an entity granting a lease would not be termed as an operational creditor. Firstly, the Parliament has not incorporated every suggestion of the Viswanathan Committee Report. ‘Operational Debt’ is only defined in respect of the provision of goods or services and no references to lease or rent have been made. And secondly, since the statute has not defined ‘services’, reference has to be made to ‘essential goods and services’ under Regulation 32 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulation 2016 which only includes electricity, water, telecommunication services, and information technology services.

There was a split in jurisprudence where in Anup Sushil Dubey v. National Agriculture Coop. Mktg. Federation of India Ltd. (2020) ibclaw.in 293 NCLAT, the division bench of NCLAT Delhi ruled contrary to M. Ravindranath(supre). The NCLAT in the instant case relied on the definitions of ‘service’ under the Consumer Protection Act 2019 and the Central Goods and Services Tax Act 2017 to rule that since the site was leased for a ‘commercial purpose’, its dues would come under the ambit of ‘operational debt’ under the Code.

Since M. Ravindranath was a full bench of NCLAT, it has been treated as the position of law by the benches that have subsequently considered this matter such as the NCLAT Aurora Accessories (P) Ltd. v. Ace Acoustics & Audio Video Solutions (P) Ltd. [2020] ibclaw.in 155 NCLAT and most recently by NCLT Mumbai in Bharat Doshi (2022) ibclaw.in 529 NCLT. However, owing to the conflict in the two NCLAT judgments, the matter has been referred to the Supreme Court in Promila Taneja v. Surendri Design (P) Ltd. (2021) ibclaw.in 02 SC. To that end, the next section argues why the approach taken by M. Ravindranath is correct.

Finance lease or Operating lease?

Before we began analysing the position of law on this subject matter, it is important to understand the two kinds of lease. Section 5(8)(d) of the Code states that a ‘finance lease’ as recognized under the Indian Accounting Standards would be understood as ‘financial debt’. The Indian Accounting Standard 19 distinguishes between ‘finance lease’ and ‘operating lease’ on the basis of the risks and rewards arising out of the leased asset. Hence, if a substantial amount of risk and rewards are transferred, then it will constitute a finance lease, while if a lease does not transfer substantial risks and rewards, then it would be termed as an ‘operating lease’. In the recent judgment of New Okhla Industrial Development Authority v. Anand Sonbhadra (2022) ibclaw.in 38 SC the Supreme Court undertook a similar analysis wherein it relied on facts such as the lease agreement not envisioning a transfer of ownership and that the allottees had virtually no ownership rights over the concerned piece of land, to rule that there was no substantial transfer of risks and rewards and hence it would not constitute a ‘finance lease’.

Thus, it is noted that while the definition of ‘financial debt’ includes finance lease, no reference to an operating lease has been under the definition of ‘operational debt’ under the Code. This can be treated as a deliberate decision on part of the legislature, keeping in mind that the Viswanathan Committee Report does make a reference to the lessor as an operational creditor.[1] Hence, operational debt should not be read in a way to include operating lease into it when it has been consciously left out by the legislature. Moreover, as already stated above, the reference to ‘lease’ in the Mobilox Judgment was a mere iteration of the Viswanathan Committee Report and the Supreme Court expressed no opinions of its own.

Definition of Services

In Anup Dubey, the argument of only ‘essential services’ constituting ‘services’ under ‘operational debt’ was rejected as the Code does not provide for such a restrictive definition. While this is a valid point, the NCLAT went ahead to place reliance on the definition of ‘services’ under other statutes. This is an erroneous application of the law. The Supreme Court in Bangalore Turf Club Limited v. Regional Director, Employees’ State Insurance Corporation had observed that one cannot simply superimpose the definition of one act onto another unless the statute specifically provides for such an application.

Coming to the Code, unlike the Mobilox Judgment, the Supreme Court in M/s Consolidated Construction Consortium Limited v. M/s Hitro Energy Solutions Private Limited (2022) ibclaw.in 09 SC did make an observation after citing the Viswanathan Committee Report. While emphasising on the line of the Report that said “…the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease”, Justice Chandrachud stated that any transactions pertaining to goods and services that are required for the operation of the enterprise, would be covered under operational transactions. This point was then later substantiated in the judgment wherein it was held that the main requirement for a ‘claim’ to constitute ‘operational debt’ would be to “bear some nexus with a provision of goods or services”. Thus, it was concluded that as long as the debt is related to the operation of the business in some way, it would be treated as operational debt. Thus, premises leased out for facilitating any aspect of the business (manufacturing, storing or selling) should come under operational debt if there is a default in payments.

It must be kept in mind that in K. Kishan v. M/S Vijay Nirman Company Pvt. Ltd. [2018] ibclaw.in 01 SC, the Supreme Court had observed that operational creditors cannot use CIRP under the Code to circumvent the processes contained under other statutes. Hence, even if lessors are considered to be ‘operational creditors’, they would not be able to seek remedy under the Code if there is a pre-existing dispute under another statue. For example, Section 106 of the Transfer of Property Act, 1882 provides for terminating of lease agreements by giving a notice.

Conclusion

As we can see, there is a conflict in the position of law regarding the treatment of lessors as operational creditors and there is argument to be made from both sides. Hence, a judgment by the Supreme Court in Promila Taneja would help clarify the position of law on this issue. Till that time, M. Ravindranath continues to remain the binding precedent on all tribunals.

Reference:

[1] Page 77 of the Report states that “[T]he lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease”.

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