Does Unsecured Loan with No Returns have the Effect of Time Value of Money and be Covered under the Commercial Borrowing under the IBC Code?

Recently, the Supreme Court of India in Orator Mktg. (P) Ltd. v. Samtex Desinz (P) Ltd.[1], held that disbursement of loan without having any assured rate of interest in return, will be covered within the definition of a financial debt under Section 5(8) of the Insolvency and Bankruptcy Code, 20162 (IBC Code) and the lender would be accredited at par with the status of financial creditor for initiating insolvency proceedings against the borrower the corporate debtor.

By interpreting Section 5(8) of the IBC Code, the view taken by the Supreme Court, is that the definition of financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money. That the return of interest is not sine qua non under Section 5(8) of the IBC Code for initiating the insolvency proceedings under Section 73 of the IBC Code, by the financial creditor against the corporate debtor in the event of default. That if any transaction does not contemplate assured rate of interest in return and not explicitly covered under clauses (a) to (e) of Section 5(8) of the IBC Code, the Court may refer to sub-clause (f) of Section 5(8) of the IBC Code, which means that amounts that are “raised” under “transactions” not covered by any of the other clauses of Section 5(8) of the IBC Code, would amount to a financial debt if they had the commercial effect of borrowing.

That certainly the Supreme Court rightly interpreted that the definition of financial debt means a debt along with the interest, if any, disbursed against the consideration of the time value of money. In a situation where no interest is payable on the loan, only the outstanding amount would qualify as a financial debt, by seeking reference under clause (f) of Section 5(8) of the IBC Code, in terms whereof “financial debt” includes any amount raised under any other transaction, having the commercial effect of borrowing.

However, the judgment of the Supreme Court, raises a question to the effect that if any transaction has no rate of return both in form of profit or discount, does that “transaction” still have the effect of “time value of money” or be covered under the “commercial effect of borrowing”?

As an example, where the advancement of a loan, without any assured rate of interest in return of profit or discount in any manner or form, would still qualify as a financial debt, having an effect of time value of money and be covered under the phrase “commercial effect of borrowing” under clause (f) of Section 5(8) of the IBC Code. This is the question that remained unanswered, which the author seeks to address upon in the present article.

Time value of money and commercial effect of borrowing

That there is no statutory definition of the terms “time value of money” or “commercial effect of borrowing” in the Code. The understanding of the above two terms, has been propounded by judicial precedents, that have been relied upon, to decipher the meaning of the said terms. In Nikhil Mehta & Sons (Huf) v. AMR Infrastructures Ltd.4, amounts raised by developers under assured return schemes, for monthly assured returns to the buyer, were held to have the “commercial effect of borrowing”, as it entails the element of profit in the nature of interest, which the buyer received for the value of money paid to the builder.

Though the current definition of “financial debt” under Section 5(8) of the IBC Code uses the word “includes”, the definition of financial debt is not exhaustive in nature. The phrase “disbursed against the consideration for the time value of money” has been the subject of interpretation only in a handful of cases under the Code. The Report of the Insolvency Law Committee dated 26-3-20185 has discussed the interpretation of the phrase “time value of money” which means compensation, or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money or factoring of a discount in the payment.

That in Pioneer Urban Land and Infrastructure Ltd. v. Union of India,6 Justice Nariman, while interpreting the concept of time value of money in Section 5(8) of the IBC Code, as applicable on the real estate builder stated that,

…the money that is disbursed by the allottee to the real estate developer, are utilised by them and they are legally obligated to give money’s equivalent back to the allottee, having used it in the construction of the project, and being at a discounted value so far as the allottee is concerned (in the sense of the allottee having to pay less by way of instalments than he would if he were to pay for the ultimate price of the flat/apartment.

Further Justice Nariman, referred to Collins English Dictionary & Thesaurus (2nd edn., 2000) for the meaning of the expression “borrow” and the meaning of the expression “commercial”.

  1. … borrow—vb 1. to obtain or receive (something, such as money) on loan for temporary use, intending to give it, or something equivalent back to the lender. 2. to adopt (ideas, words, etc.) from another source; appropriate. 3. Not standard. to lend. 4. (intr) Golf. To put the ball uphill of the direct path to the hole: make sure you borrow enough.

* * *

commercial. —adj. 1. of or engaged in commerce. 2. sponsored or paid for by an advertiser: commercial television. 3. having profit as the main aim: commercial music. 4. (of chemicals, etc.) unrefined and produced in bulk for use in industry. 5. a commercially sponsored advertisement on radio or television.

That relying upon the aforesaid definition, the Court further stated that:

“Commercial would generally involve transactions having profit as their main aim.”

That in Shailesh Sangani v. Joel Cardoso7, the shareholder of the company granted an unsecured loan, without any interest in return to the company. On default, the shareholder, initiated insolvency proceedings against the company under Section 7 of IBC Code. The company took a defence, that the transaction does not have an effect of commercial borrowing to qualify as financial debt under clause (f) of Section 5(8) of the IBC Code. The NCLAT held,

  1. … that money advanced by a promoter, director or a shareholder of the corporate debtor as a stakeholder to improve financial health of the company and boost its economic prospects, would have the commercial effect of borrowing on the part of corporate debtor notwithstanding the fact that no provision is made for interest thereon. Enhancement of assets, increase in production and the growth in profits, share value or equity ensures to the benefit of such stakeholders and that is the time value of the money constituting the consideration for disbursement of such amount raised as debt with obligation on the part of company to discharge the same.

Similarly, in Kolla Koteswara Rao v. S.K. Srihari Raju,8 the question arouse was whether parties which had agreed to one-time settlement can claim that there exists no element of profit and the transaction will fall out the contour of clause (f) of Section 5(8) of the Code. The NCLAT held that,

  1. As regarding the argument of the learned appellant counsel that there was no “profit” involved, it is only because of the one-time settlement entered into between the lender bank and the “corporate debtor”, that the “corporate debtor” had benefited in terms of waiver of interest, payment of a lesser amount of Rs 11.70 crores as against the ledger outstanding amount of Rs 16.72 crores and therefore it has to be safely construed that the “corporate debtor” has benefited/profited from the said transaction.

In cases, where the promoters of the company give interest free loans to the company, it certainly exists the element of foreseeable profit to be secured at a later stage, by providing financial stability to the company, means to expand the company business, etc. Though, at the first glance it may look that it is an unsecured loan without any interest, but it certainly carries a motive of making profit in future, which relates to the concept of time value of money and effect of commercial borrowing.

That the disbursement of money by the lender to the borrower, must have an element of profit or factor of discount in return, to have the effect of time value of money and commercial borrowing, to qualify as a financial debt under Section 5(8) of the IBC Code. Certainly, the intent of the legislature is evidently clear when they use the terms like “time value of money and commercial effect of borrowing” which impliedly shows the nexus in between the transaction and the motive behind it for making profit or factoring of discount, by more than one form and manner, through that transaction.

IBC is not intended to be substituted to a recovery forum

That the objective of the Code is to introduce a unified legal regime for effective and timely resolution of the insolvency and bankruptcy of a corporate entity, to attain maximisation of value of assets of the company, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders. That the intent of the Code, is to safeguard the interest of the company and its creditors, by providing maximum realisation of assets to the creditors of company, while the company will remain a going concern. That the primary focus of the Code, is to ensure revival and continuation of the corporate debtors, by bringing it back on feet, and not being the mere recovery legislation for creditors.

That the IBC Code is bifurcated into two forms of creditors, firstly financial creditors and secondly operational creditors. In the case of financial creditors, the financial debt is disbursed against the consideration for the time value for money. In the case of operational creditors, where the operational debt would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local authority.

That the difference between the financial creditors and operational creditors is that the former will firstly attempt to preserve the corporate debtor as a going concern, while ensuring maximum recovery for all creditors as being the objective of the Code, while the later concerns are limited to the recovery of their outstanding dues against the supply of goods and services to the corporate debtor.

That the element of return of profit in the transaction, certainly accedes to the interest of the financial creditor, as they are in the business of money lending, banks and financial institutions, whose primary focus is reviving and restructure the liabilities of the corporate debtor, so that it can continue to remain a going concern. On the other hand, operational creditors, who are limitedly concerned for the recovery of their outstanding dues against the supply of goods and services to corporate debtor.

That if an amount is disturbed as a loan, not against the time value of money, having no effect of commercial borrowing, then the financial creditor rather than having any interest in the revival of corporate debtor, will only seek to recover the said loan amount by pushing the otherwise health company in the shackles of insolvency proceedings, which is not the intent of the IBC Code. That the primary focus of the IBC Code is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation. The IBC Code is a beneficial legislation which puts the corporate debtor back on its feet, not intended to be substituted by a recovery forum.

Conclusion

Under the IBC Code, the unsecured loan without any interest, must have an effect of time value of money and commercial effect of borrowing, to qualify as the financial debt under clause (f) of Section 5(8) of the IBC Code. For transaction to qualify as a financial debt under the IBC Code, it must have the element of profit or factoring discount, to give it an effect of time value of money and commercial effect of borrowing. Though, the profit or discount may not always materialise in monetary benefits, but it should entail benefit of such a nature, that the money advanced against loans, has a potential earning capacity and furthers the intent of the financial creditors seeking profits.


Associate, PSL Advocates and Solicitors.

†† Partner, PSL Advocates and Solicitors.

[1] 2021 SCC OnLine SC 513.

2 <http://www.scconline.com/DocumentLink/w93pA9Ln>.

3 <http://www.scconline.com/DocumentLink/K60PW5A6>.

4 2017 SCC OnLine NCLT 219.

5 <http://www.scconline.com/DocumentLink/sYKPTj8e>.

6 (2019) 8 SCC 416, p. 513-514.

7 2019 SCC OnLine NCLAT 52.

8 2021 SCC OnLine NCLAT 110.

One comment

  • It is really a helpful blog to find some different source to add my knowledge.

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