CONTRACTUAL CLAIMS AS OPERATIONAL DEBT UNDER IBC

Several legislations relating to liquidation and reorganisation of companies, partnerships and other firms have been consolidated and amended by The Insolvency and Bankruptcy Code, 2016 (hereinafter, “IBC”) which seeks to facilitate insolvency proceedings in a time bound manner. Under the Code, Corporate Insolvency Resolution Process (hereinafter, “CIRP”) can be initiated against a corporate person by either a ‘Financial Creditor’ or an ‘Operational Creditor’ as opposed to the Companies Act, 2013 which failed to make any such classification. Section 5(20) defines an operational creditor as any person to whom an operational debt is owed. The term ‘operational debt’ is defined by Section 5(21) as:

"a claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment 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".


The scope of the term has been further elaborated by the Bankruptcy Law Reforms Committee as liabilities arising from any transaction on operations. This article seeks to analyse scope of the term ‘operational debt’ as to include contractual claims for refund of advance under its ambit. It discusses a situation where an agreement to provide goods and services to the creditor has been breached by the debtor and the creditor seeks a refund of the sum paid in advance for the same and financial damages accruing thereto.

A claim as per the Code includes a claim arising from breach of a contract, whether reduced in form of a judgment or not. However, for this claim to fall under the ambit of operational debt, the contract must be for the purpose of providing goods or services. Most cases decided by the tribunals relating to operational debt have been primarily adjudicated upon the issue of what amounts to ‘goods and services’ under Section 5(21). The National Company Law Tribunal (hereinafter, “NCLT”) has on several occasions observed that the expression ‘operational debt’ is not intended to include all claims which do not satisfy as financial debt since it is confined only to four categories as specified in Section 5(21) of the IBC. In the case, Col. Vinod Awasthy v. AMR Infrastructure Limited,[1] the Tribunal held that the debt owed to a flat purchaser was associated with possession of immovable property and it did not arise from any goods, services, employment or dues which were payable to the Government or local bodies. The Tribunal followed a restricted approach to the interpretation of the term ‘goods or services’ and dismissed the insolvency petition.


The National Company Law Appellate Tribunal (NCLAT) in a recent judgement of Pr. Director General of Income Tax (Admn. & TPS) v. M/s. Synergies Dooray Automotive Ltd. & Ors.,[2] heard along with other petitions, decided that statutory dues such as income tax, sales tax, value added tax and other taxes fall within the definition of operational debt as these claims arise out of operation of the company and the goods or services are essential for the company as a going concern. The NCLAT gave the definition the widest possible interpretation in holding that statutory authorities claiming the tax dues will be treated as operational creditors under the Code. Hence, it can be inferred that the Tribunal gives due consideration to the question whether the claim is directly related to provision of ‘goods or services’.

After determination of whether existence of a claim in relation to ‘good or services’, the second question that arises is whether the ‘provision’ of goods or services must necessarily flow from the creditor to the debtor. The phrase ‘in respect of provision’ may be interpreted narrowly to mean a claim of the provider of goods or services or widely to include any claim arising out of or in relation to a contract for provision of goods or services, including the claim of the person in receipt of the goods or services. The narrow approach assumes existence of a constant state of affairs and the ideal situation where the parties discharge their obligations in accordance to the contract. The wider interpretation takes into account such exceptions of non-performance or voidable nature or the contract. It may be concluded that the language of the Code intended to cover such exceptions as Section 3(6) includes claims arising out of breach of contract.


The NCLAT, in its decision in the case Overseas Infrastructure Alliance (India) Pvt. Ltd v. Kay Bouvet Engineering Ltd.[3] applied the latter interpretation of the definition of operational debt and settled the position of law that a claim for refund of advance amount paid by the creditor in pursuance of a contract to provide service will amount to operational debt, irrespective of the direction of flow of such goods and services.


The NCLT, Chennai has also preferred the above interpretation of the definition of operational debt in a case before it, M/s Nupower Renewables Pvt. Ltd. v. Cape Infrastructure Pvt. Ltd.[4] The Tribunal gave a purposive and contextual interpretation to the definition and elucidate that operational debt includes a claim in respect to dues arising under any law.

The third question that arises is whether the claim for damages against breach of contract for provision of goods and services would amount to operational debt. The NCLT, Mumbai in a recent case, TATA Chemicals Limited v. Raj Process Equipment's and Systems Private Limited,[5] has settled the position of law that such claim for damages does not amount to operational debt and imposed heavy cost upon the Petitioner for attempting to initiate CIRP against the corporate debtor with ulterior motives under Section 65 of IBC. In the said case, the Petitioner made an advance payment against the purchase order for industrial equipment. The corporate debtor failed to fulfil the order as per the agreed terms, owing to which the Petitioner terminated the Purchase Order and further claimed damages for financial loss and interest accruing to that amount.


Section 73 of the Contract Act, 1872, provides that a party who suffers from breach of contract is entitled to receive compensation for any loss or damage caused to him from the party in fault. The NCLT found that in the present case, the Petitioner has raised claims of INR 5,00,000 per day for loss of production, which is not only in nature of consequential damages, but also completely arbitrary and baseless, and which cannot be relied upon in absence of adjudication.


The Tribunal relied on the cases of E-City Media Private Limited v. Sadhrta Retail Limited[6] and Union of India v. Raman Iron Foundry[7] and observed that until the claim for financial damages is assessed and adjudicated upon by a competent authority in law, it would not amount to operational debt.


The NCLAT has made it absolute that when an application is made before it for default of operational debt, it will first look into the nature of such debt and also at the contract or agreement under which it arose. Only when it is satisfied that there was a flow of goods and services settled upon will it admit the application. The caution is crucial and cannot be undermined- companies may use the pretence of operational debt to initiate CIRP for recovery of damages and other unrelated unliquidated claims.


Footnotes [1] Col. Vinod Awasthy v. AMR Infrastructure Limited (C.P. No. (IB)10(PB)/2017). [2] Director General of Income Tax (Admn. & TPS) v. M/s. Synergies Dooray Automotive Ltd. & Ors. (Company Appeal (AT) (Insolvency) No. 205 of 2017). [3] Overseas Infrastructure Alliance (India) Pvt. Ltd v. Kay Bouvet Engineering Ltd. (Company Appeal (AT) (Insolvency) No. 582 of 2018). [4] M/s Nupower Renewables Pvt. Ltd. v. Cape Infrastructure Pvt. Ltd. (TCP/3(IB)/CB/2017). [5] TATA Chemicals Limited v. Raj Process Equipment's and Systems Private Limited (CP 21/I&BP/NCLT/MAH/2018). [6] E-City Media Private Limited v. Sadhrta Retail Limited (CP No.367 of 2009). [7] Union of India v. Raman Iron Foundry (1974 AIR 1265).

Submitted by,

Kanika Jain,

Symbiosis Law School, Pune.

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