Last week, we had published an exclusive analysis of The Insolvency and Bankruptcy Code (2nd Amendment) Bill, 2019 by Mr. Gaurav Gaur, a seasoned Insolvency professional and advocate which you can read here - https://bit.ly/2v6IFPn. Today, we are publishing an in-depth article jointly written By CA Jugraj Singh Bedi and CS Shruti Mittal on a simple word – ‘Operational’ or ‘Operation’ which has not been defined anywhere in the I&B Code and how it creates disputes.

By CA Jugraj Singh Bedi & CS Shruti Mittal 

The Insolvency and Bankruptcy Code (“Code”) recognises two types of debt to enable the creditors to make an application for initiating insolvency proceedings against the corporate debtor- financial debt and operational debt. If there is a debt, other than a financial debt or an operational debt, the creditor will not qualify to apply under Sections 7 or 9, as the case may be. Hence, the determination of the nature of claim/debt is an important step while filing the petition under the code.

The word “operational” or “operation” has not been defined anywhere in the Code. The General Clauses Act, 1897, also does not define the term. The dictionary meaning of “operational” is given as “of or relating to operation”

Section  5(20)  of  the  Code,  defines  an  “operational  creditor”  to  mean  “a  person  to  whom  an operational debt  is owed and includes any person  to whom such debt  has been  legally assigned or transferred.”

In turn, Section 5(21) defines an “operational debt”  to mean “a claim in respect  of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government,  any State Government  or any local authority.”

Therefore, an operational debt is essentially a claim in respect of the following: (a) provision of goods;

(b) provision of services, including employment; or

(c) a debt arising under any statute and payable to Government/local authority.

If the claim by way of debt does not fall under any of the three categories as mentioned above, the claim cannot be categorised as an operational debt, even though there may be a liability or obligation due from the corporate debtor to the creditor, and hence, such a creditor disentitled from maintaining an application for initiation of corporate insolvency resolution process (CIRP) of the corporate debtor.

The law has not gone into defining goods or services – hence, one has to rely on general usage of the terms  so  used  in the  law,  with  due  regard  to  the  context  in which  the  same  has  been  used. Simultaneously, it is also relevant to understand the intention  of the lawmakers. The Bankruptcy Law Reforms Committee (BLRC), in its report  dated  November 20151, states  that  “Operational  creditors are those  whose liability from the entity comes from a transaction on operations”. While discussing the different  types of creditors,  the Committee points out that  “enterprises have financial creditors by  way  of  loan  and  debt  contracts   as  well as  operational  creditors  such  as  employees,   rental obligations,  utilities payments  and trade  credit.”  Further,  while differentiating  between a financial creditor  and an operational creditor,  the  Committee indicates “the lessor, that  the entity rents  out space from 10 is an operational creditor to whom the entity owes monthly rent on a three-year lease”. Hence, the BLRC recommends the treatment of lessors/landlords as operational creditors.  However, the Legislature has not completely adopted the BLRC Report, and only the claim in respect  of goods and services are kept in the definition of operational creditor and operational debt u/s Sec 5(20) and 5(21) of the Code. The definition does not give scope to interpret rent dues as operational debt.

The Code provides that for an amount  to be classified as an Operational  Debt under I&B Code, 2016 the alleged claim should fall in the definition of: -

3(6) "Claim" means - (a) a right to payment,  whether  or not such right is reduced to judgment,  fixed, disputed, undisputed, legal, equitable, secured or unsecured; (b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment,  whether  or not  such  right  is reduced  to  judgment,  fixed, disputed,  undisputed,   legal,  equitable,  secured  or unsecured;

3(11)"debt"  means  a liability or obligation  in respect  of a claim which is due from any person  and includes a financial debt and operational debt;

3(12)"default" means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not [paid] by the debtor or the corporate debtor, as the case may be;

The Legislature did not include here the reference to rent dues of property. Thus, it is clear that a claim in respect of the provision of goods or services is covered under the operational debt. There seems to be some rationale in restricting only to operational creditors for initiation of CIRP, other than financial creditors. Default committed to operational creditors about payment of their debt connotes that the corporate debtor is not even in a position to service the regular payments and operational expenses, as required in the day-to-day functioning of the corporate debtor, which provides a clear indication to its insolvency, warranting the resolution process being put in place.

What constitute essential goods and services are provided under Regulation 32 (Insolvency Resolution Process for corporate persons) Regulation 2016 wherein it is provided that; the essential goods and services referred to in Sec 14(2) shall mean:

• Electricity
• Water
• Telecommunication Services
• Information Technology Services

To the extent, these are not a direct input to the output produced or supplied by the corporate debtor. Thus, any debt arising without nexus to the direct input to the output produced or supplied by the

Corporate debtor, cannot, in the context of Code, be considered as an operational debt, even though

it is a claim amounting  to  debt.  However,  without  going into  the  aspect  whether an immovable property in itself constitutes stock- in- trade of the corporate debtor and has a direct nexus to its input- output, being an integral part  of its operations, the  Bench held that  lease  of immovable  property cannot  be considered  as a supply of goods or rendering  of services, and thus, cannot  fall within the definition of operational debt.

In a case, Jindal Steel (supra) and Citicare (Supra) NCLT Hyderabad also, in the case of CP/IB/61/9/HDB/2019 Manjeera  Retail Holdings Pvt. Ltd. v. Blue Tree Hospitality Pvt. Ltd., held that the petitioner claiming default in payment of rent of the premises leased out cannot be treated as an operational creditor, and the amount  involved cannot be treated as an operational debt.

For an amount to be classified for an operational debt under I&B Code, 2016, it is provided:

Firstly, the amount falls within the definition of "claim" as defined under Section 3(6) of the Code; Secondly, such a claim should claim within the confines of the definition of a 'debt' as defined under

Section 3(11), meaning it should be by way of a liability or obligation due from any person;

Thirdly, such a "debt" should fall strictly within the scope of an "Operational Debt" as defined under

Section 5(21) of the Code, i.e. the claim should arise in respect of

(i)         Provision of goods or services including employment or

(ii)         (ii) A debt in respect of the repayment of dues arising under any law for the time being in force and payable either to the Central Government,  any State Government or any local authority.

The word “in relation to Government” or local authority and the dues owed to it, has been given a wide platform.  It is important to see whether persons other than the Government or local authority can claim the benefit, that any debt owed should be construed as an 'operational debt' other than those classified as 'financial debt'.

Thus, only if the claim by way of debt falls within one of the three categories as listed above, can be categorised as an operational debt.  In case if the amount claimed does not fall under any of the categories mentioned as above, the claim cannot be categorised as an operational debt, and even though there might be a liability or obligation due from one person,  namely  Corporate Debtor to another, namely Creditor other than the Government or local authority, such a creditor cannot categorise itself as an "Operational  Creditor" as defined under  Section 5(21) of the I&B Code, 2016.

Therefore, we are of the considered opinion that lease of immovable property cannot be considered as a supply of goods or rendering of any services and thus, cannot fall within the definition or 'Operational Debt. In case of lease of immovable property, Default can be determined, on the basis of evidence.

Recently in one of the Judgements passed by the National Company Law Appellate Tribunal in the matter of Mr. M Ravindranath Reddy versus Mr. G. Kishan & Ors. also set aside the matter as an appeal filed by Mr. M Ravindranath  Reddy, director of Corporate Debtor M/s Walnut Packaging Private Limited against the order passed by the NCLT. The Tribunal ordered that in the present case, there was a pre-existing dispute,  which is proved by the issuance of notice under Section 106 of the TP Act, much before the issuance of demand notice, under Section 8 of the I&B Code. Based on the above, the application filed under Section 9 of the I&B Code could not have been admitted. We are of the considered opinion that the alleged debt on account of purported enhanced rent of leasehold property does not fall within the definition of the operational debt in terms of Section 5(21) of the Code. On the above basis, it is clear that appeal deserves to be allowed.

Facts of the case: The application is being filed against the Corporate debtor (M/s Walnut Packaging Private Limited) Operational  Creditor (Mr. G. Kishan & Ors)  under  Section 9 of the  Insolvency and Bankruptcy Code,2016. The creditor stated the facts that the creditor has given his Hyderabad property on rent to the corporate debtor on a yearly basis and the rent payable for the period from July 2011 to June 2017 was Rs. 85,67,290/- and the Corporate Debtor is stated to be making part payments of lease rent from July 2011 until December 2016, totaling to Rs. 49,96,728/-, after deduction of Rs. 5,55,192/- as TDS.

The aggregate credit to the Corporate Debtor's account was Rs. 55,51,920/-. The  Corporate  Debtor stopped making the payment from  January  2017,  after the last part payment was made,  which was adjusted towards rental dues. 

The dues against the Corporate Debtor at the end of June 2017 was Rs. 30,15,370/-. After that, the creditor issued a legal notice dated 15-06-2017 to handover the property back to the Petitioners, but the Corporate Debtor failed to vacate the property. 

After that, an eviction suit was filed against the Corporate Debtor before the jurisdictional Civil Court.

On which the Corporate Debtor responded that he had paid the rent until December 2017, and no amount is due to the Petitioner.  It is further stated that due to slowdown in the Operations of the  Corporate  Debtor during the period from  April 2012 to  July 2012 Petitioner agreed on a moratorium for no yearly enhancement of rent for six years.

The  Adjudicating  Authority held that the  Corporate  Debtor had taken the property of the Petitioners on rent and they were paying rent up to June 2017. But the Corporate Debtor failed to pay the rent from July 2017onwards. Therefore, the Adjudicating authority after considering the facts has admitted the application stating:

"The main issue in the matter is as to whether the Petitioners accepted a moratorium for no enhancement of rent for six years or not? Though the Corporate Debtor says so, there is no documentary proof filed to that effect. In the absence of any documentary proof about accepting the moratorium, the submissions of the Corporate Debtor are to fail. It is deemed that the Corporate Debtor has failed in making payment of rents as no substantial document is placed on record to show the existence of moratorium between the parties regarding the Rent. Therefore, I am inclined to admit the Petition".

The following question arises for NCLT consideration:

1. Whether a landlord by providing lease, will be treated as providing services to the corporate debtor, and hence,  an operational creditor within the meaning of Section  5(20 )read with Section 5(21) of the 'Insolvency and Bankruptcy Code, 2016?

2.  Whether the petition filed  U/S  9  of the Insolvency and  Bankruptcy  Code  2016  is not maintainable on account of 'pre-existing dispute'?

With this order, the director of the corporate debtor has filed an appeal before the Hon’ble Tribunal and the tribunal has set aside the order of NCLT.

(The writers are associated with JS Bedi & Associates, a prominent Insolvency and Bankruptcy Professional’s firm based in Delhi-NCR. Contact -  jb@jsba.in )

Disclaimer: The opinions expressed in this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of Indian Observer Post and Indian Observer Post does not assume any responsibility or liability for the same.

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