Whether a Decree or an Arbitral Award or a Settlement Deed can Form the Basis of a Financial or Operational Debt under IB Code [Part III]

In the previous two columns, we had covered the position of law on whether a claim for an operational debt or a financial debt could be based on a decree by a court or an arbitral award. The rulings in Dena Bank v. C. Shivakumar Reddy[1], and G. Shivramkrishna v. Isgec Covema Ltd.[2] provide us with the guidance with respect to decree and/or an arbitral award being based on a financial debt and an operational debt respectively.

 

Now we will proceed with the third and final column in this three-part series.

 

The issue whether a settlement agreement is sufficient to constitute a financial or an operational debt has a long line of inconsistent rulings.


Settlement Agreement – As a Financial Debt


In Amrit Kumar Agrawal v. Tempo Appliances (P) Ltd.,[3] the financial creditor sought to base its claim of a financial debt against the corporate debtor/guarantor on a memorandum of understanding dated 22-9-2017 wherein the creditor had agreed to advance a loan of Rs 1,50,00,000 to one principal borrower along with with interest @18% per annum payable monthly. As per the MoU, the corporate debtor stood as a guarantor. However, when the cheques of the principal borrower had bounced, a settlement agreement was executed between the creditor and the corporate debtor. The corporate debtor, since was a guarantor had come forward to pay the outstanding amount of Rs 86 lakh with interest calculated at Rs 22 lakh and issued two cheques in consideration of such liability.

 

The creditor argued that their claim is based on the MoU and not the settlement agreement. The NCLAT (a) firstly held that as per the terms of the settlement agreement, the terms of the memorandum of understanding stood superseded. Then (b) it held that the obligation undertaken by the guarantor to pay Rs 86 lakh with interest calculated at Rs 22 lakh does not satisfy the ingredients of a financial debt, especially when no disbursement is made to the guarantor itself and the principal borrower was not a party to the settlement agreement.

It is submitted that the above ruling is an instance of a hyper-technical understanding of the provisions of the IB Code.

 

Previously in another ruling, when the debtor failed to comply with the terms of the master restructuring agreement, the appellant debtor pleaded that the terms of the debt stood altered and revised and therefore the element of default was missing. The aforesaid plea was rejected by the NCLAT and the order of admission was upheld.[4]

 

The position of law that a debt based on a consent decree will not be treated as a financial debt can also be found in context of real estate projects. In Arenja Enterprises (P) Ltd. v. Edward Keventer (Successors) (P) Ltd.,[5] the appellant and its associates entered into MoU about the land followed by two other supplementary MoUs. Later on, some dispute arose between the parties. The appellant, along with its associates filed a civil suit for specific performance along with other reliefs against the corporate debtor. Based on an amicable settled entered into between the parties, the civil suit was decreed where as per the settlement filed before the court, the corporate debtor had agreed to develop a group-housing complex on a plot of land measuring 22.95 acres. Out of this area, the applicant, along with another, was entitled to only 34,000 sq ft residential covered/built-up area along with proportionate super area. Given the terms of settlement if the sanction of plans is not obtained within a maximum period of 3 years from the date of signing of the settlement, in that event, further built-up area as well as liability of additional area would be imposed on the debtor.

 

Issue arose whether the terms of the consent decree tantamount to a financial debt. The NCLAT opined that in terms of Section 5(8)(f) of the IB Code, the appellant could claim a financial debt only when the amount raised from it as an “allottee” is used for a real estate project. Based on the facts and circumstances, the NCLAT firstly observed that no sum has been raised from an allottee under the real estate project. Then, it found that the financial creditor and its associates have not paid any money towards the allotment of built-up area and the entitlement of the appellant creditor is premised on the terms of settlement. In other words, in the light of the “consent decree and settlement terms”, the appellant had paid nothing in terms of money to the financial creditor and its associates. Resultantly, it was held that the appellant could neither be termed to be an “allottee” nor has any amount “being raised” from the appellant that could constitute to have the effect of a borrowing.

 

On the other hand, there is the ruling in Mahesh Kumar Panwar v. Neelam Singh[6], where the settlement agreement between the parties formed the basis of financial debt. One of the terms of the settlement agreement stipulated:

In terms of the clauses B and 8 of the earlier valid agreement dated 6-10-2008 entered between the same parties, the first party was to handover the vacant possession of space of about 2004 sq ft on 3rd floor in tower 1 in the proposed IT complex cum corporate hub to be constructed at Plot No. 02/02 situated at Sector – 154, in the name and style “the grid” of the unit duly completed in all respect by 30-6-2011.

It is ascertained and agreed by the first party that till date no construction work has started. Consequent upon the factual position both the parties have agreed for the amicable settlement.

*                                        *                                        *

Both the parties agreed and settled for a sum of Rs 1,34,00,988 (Rupees one crore thirty-four lakhs nine hundred eighty-eight only) which includes booking amount paid, compensation, commitment, services rendered, appreciation, etc.

 The first party has handed over post dated Cheque No. 617815 dated 1-2-2015 amounting to Rs 29,61,261 and Cheque No. 617818 amount to Rs. 1,04,39,727 both drawn at Corporation Bank, Noida total amounting to Rs 1,34,00,988 (Rupees one crore thirty-four lakhs nine hundred eighty-eight only) to the second party in discharge of his liability and post-dated cheques for interest of deferred payment applicable as per the agreement reckoning from 1-6-2014 as per details hereunder:

*                                        *                                       *

Noting the above-mentioned terms, the NCLAT had concluded that there was a disbursal of a sum of Rs 1,34,00,988 which was against the “consideration of time value of money” i.e. interest @12.5% per annum payable from 1-6-2014.

 

Similarly, in Ludhiana Scrips (P) Ltd. v. K.C. Land & Finance Ltd.[7], the adjudicating authority had dismissed an application under Section 7 of the IB Code on the ground that the creditor did not bring on record the books of accounts with any entry showing any debit of interest in the account of the corporate debtor. The NCLAT, however, overruling the order referred to the settlement agreements[8] entered into between the parties to conclude that the interest element was very much present and the condition of time value of money stood satisfied. Consequently, the NCLAT held that the earlier compromise agreement dated 20-5-2017 and the subsequent agreement dated 15-6-2018 clarify the nature of the transaction and show that the appellant is a financial creditor to whom the respondent owes financial debt, and which is in default.

Clearly, the jurisprudence on this issue is diverging and conflicting.

 


Settlement Agreement – As an Operational Debt


With respect to an operational debt, the issue came up in Brand Realty Services Ltd. v. Sir John Bakeries India (P) Ltd.,[9] as to whether default of installments under a settlement agreement could be considered as an operational debt under the IB Code. In this case, the debtor had approached the creditor seeking investment and consultancy services and an agreement dated 28-11-2014 was entered into by the parties to that effect. Subsequently, a settlement agreement dated 15-6-2018 was entered into wherein the debtor undertook to clear the dues of the creditor.

 

Issue arose when the dues were not cleared. The NCLT in this case, firstly opined that the application under Section 9 was filed on account of breach of the terms of the settlement agreement dated 15-6-2018. The NCLT categorically rendered the findings that the claim of the creditor is not based on the invoices raised on account of the agreement dated 28-11-2014.

 

Consequently, the NCLT then referring to several precedents, including the ruling in Delhi Control Devices (P) Ltd. v. Fedders Electric and Engg. Ltd.[10], held that the debt due in terms of a settlement agreement cannot be considered as an operational debt in terms of Section 5(21) of IB Code and hence unpaid installments under the settlement agreement do not suffice to trigger resolution process against a corporate debtor.

 


Conclusion


From the three-part series discussion, it is crystal clear that: first, the decree-holder cannot be excluded from the definition of a financial or operational debt; second, an arbitral award may also be sufficient to constitute a financial or operational debt; third, the underlying debt must be based on a transaction that fulfills the criterion of a definitions laid down of financial debt and an operational debt. Lastly, the position with respect to a settlement agreement constituting a financial or an operational debt is still divergent and conflicting.


± Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is the author of the commentary “Insolvency and Bankruptcy Code – Law and Practice.

[1] (2021) 10 SCC 330.

[2] 2020 SCC OnLine NCLAT 909.

[3] 2020 SCC OnLine NCLAT 1202.

[4] Esther Malini Victor v. Oriental Bank of Commerce, 2019 SCC OnLine NCLAT 1107.

[5] 2020 SCC OnLine NCLAT 1188.

[6] 2018 SCC OnLine NCLAT 596.

[7] 2019 SCC OnLine NCLAT 355.

[8] Ludhiana Scrips (P) Ltd. v. K.C. Land and Finance Ltd., 2019 SCC OnLine NCLAT 355, para 9 reproduces one of the agreements dated 15-6-2018 wherein one of the clauses of the agreement purported:

A company winding petition was filed before the Punjab and Haryana High Court by Part 1 against Part 2 which is pending adjudication.

There after it was agreed between the parties that Part 2 i.e. K.C. Land & Finance Ltd will pay Rs 4.40 crores as principal amount and Rs 1.60 crores as interest. An agreement was executed between the parties on 20-5-2017 and various post dated cheques were issued.

… Part 2 i.e. M/s K.C. Land and Finance Ltd. undertakes and assures that all these cheques will be honoured in the event of default Part 1 will be at liberty to enforce this agreement by way of initiating legal proceedings against Part 1 and the amount recoverable will be with interest @18% from the date of default till the realisation of the full amount. (emphasis added)

[9] 2020 SCC OnLine NCLT 6066.

[10] 2019 SCC OnLine NCLT 8030.

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