NCLAT: Lease and Rental dues do not constitute Operational Debt under the Insolvency and Bankruptcy Code

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This declared by the NCLAT in the case of  Ravindranath Reddy v. G. Kishan. In this case, an appeal before the National Company Law Appellate Tribunal (NCLAT) was filed by Mr. Ravindranath Reddy, the director of M/S Walnut Packaging Pvt. Ltd (Corporate Debtor) against the order of the National Company Law Tribunal (NCLT), to initiate Corporate Insolvency Resolution Process (CIRP) against the corporate Debtor (CD).

Facts

Facts leading to the application before the NCLT:

The Appellant’s Company (Corporate Debtor) and the respondent entered into a lease agreement in July 2011. The CD’s defaulted in paying the rent instalment after January 2017. Post the occurrence of default, a notice under Section 108 of the Transfer of Property Act (TOPA) was issued by the respondent, ordering the CD to vacate the property.  On the CD’s ignorance, a notice demanding the payment of rent was issued by the respondent under Section 8 of the Insolvency and Bankruptcy Code (IBC). On the CD’s rejection of claims mentioned under the notice, respondent’s petition to initiate CIRP under Section 9 of the IBC was made before the NCLT.

Facts leading to the appeal before the NCLAT:

The CD claimed before the NCLT that the amount claimed by the applicant included the yearly enhancements in the claimed rent. Due to financial distress in the CD’s business parties, according to the CD, entered into a verbal agreement putting a cap on the yearly enhancements in rent. Due to the lack of proof, this claim was rejected by the NCLT. Challenging the order of the NCLT, an appeal before the NCLAT was filed by the CD.

Issues before the NCLAT

Apart from the claims raised before the NCLT, the major claim before the NCLAT included the following:

Treatment of rental dues arising out of a lease agreement under the definition of “operational debt” under section 5(21) of the IBC

The appellant contended that dues arising out of defaults in payment of rental dues arising out of a lease agreement do not fall under the category of ‘operational debt’ provided under Section 5(21) of the IBC. The appellant emphasised that, as provided under section 3(11) (definition of debt) and 3(12) (definition of default) of the IBC, a default arising out of a ‘financial’ or an ‘operational’ debt is to be proven as a sin qua non before an adjudicating authority.

He pointed out that in order to prove a debt as an ‘operational debt’, three criteria’s are required to be fulfilled; (a) claim in respect of provision for goods and services; (b) employment or debt in respect of dues; and (c) such repayment of dues should arise under any law in force at that time.

The term ‘goods and service’, hasn’t been directly defined under the IBC. However, a similar reference to ‘essential goods and services’ is made under section 14(2) of the IBC. The detailed list of items falling under the ambit of the term ‘essential goods and services’ is provided under Regulation 32 of the (Insolvency Resolution Process for corporate person) Regulations 2016. This list, according to the CD did not provide for rental dues under it.

Thus, according to the CD, any such debt arising without nexus to the direct input to the output produced or supplied by the CD, cannot, in the context of the IBC, be considered an ‘operational debt’.

Effect of the ‘pre-existing dispute’ between the parties on the maintainability of the petition.

The CD contended that since there was a verbal agreement between the parties, the claimed dues by the creditors, which included the amount of annual enhancement of rental dues should not be treated as default.

Effect of ‘pre-existence’ of disputes amongst the parties on the maintainability of the petition.

According to the CD, the notice issued under Section 106 of the TOPA was a clear indication of pre-existence of disputes between the parties. And thus, the petition under the IBC is not maintainable before the adjudicating authority.

Judgment and Reasoning

These were the facets of the judgement rendered by the NCLAT:

Treatment of lease and rental dues as ‘operational debt’ under the IBC.

The NCLAT held that dues arising out of lease agreements do not constitute ‘operational debt’ under the IBC. Going beyond the arguments mentioned by the CD, the NCLAT quoted the definition of ‘operational debt’ given by the Bankruptcy Law Reforms Commission (BLRC). Quoting the BLRC, the phrase where it mentioned “Enterprises have ….. operational creditors such as employees, rental obligations, utilities payment, and trade credit.”. Thus, according to the NCLAT, the BLRC suggested the inclusion of lease and rental obligations under the definition of the Operational debt, however, in the definition adopted by the legislature, while omitting this portion, only the claims pertaining to the ‘goods and services’ were included under the definition of operational debt.

To support the assertion put forth, the NCLAT made reference to the case of  Parmod Yadav & Anr. V. Divine Infracon (P) Ltd., where the NCLT Delhi, referred to the dictionary meaning of the word ‘operation’, and defined it as something which is ‘ready for use, or able to be used’. On this definition of the term ‘operation’ the NCLAT held that there must be a direct nexus between the debt and the input to the output produced or supplied by the CD.

The NCLAT made further reference to the case of Jindal Steel & Power Ltd. v. DCM International Ltd., where it was mentioned by the Supreme Court that making any claim apart from those arising in respect of the provisions pertaining to the ‘goods and services’ and with respect to the repayment of dues to the CG or SG cannot be constituted to be ‘operational debt’ under Section 5(21) of the IBC.

Maintainability of the petition:

The NCLAT propounded that the sending of notice to vacate the property under Section 106 of the TOPA is an indicative of ‘pre-existing’ dispute between the parties. The NCLAT directed the parties to approach any competent court having jurisdiction to adjudicate such dispute.

NCLAT’s Analysis

The judgment rendered by the NCLAT indicates mere reliance on the pre-existing standards, without the issuance of any justification for the same. The NCLAT at first got confused between the ‘goods and services’ and the term ‘essential goods and services’. As rendered by the NCLAT in the Umang Realtech case, the list of goods and services mentioned under Regulation 36 of the IBC (Insolvency resolution process for corporate persons) Regulations merely mentions the list of goods and services, whose supply cannot be terminated during the course of CIRP. Thus, there is no sound reason to believe that goods ‘essential goods and services’, who’s supply has to be maintained during the course of CIPR, and the goods and services mentioned under Section5(21) are the same.

Further, this dichotomy in the two terms indicate that the definition of ‘goods and services’ under the IBC is still unclear. Thus, giving a literal interpretation to such term would be against the basic objectives of the IBC.


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