Lease and Rent as an Operational Debt


A. Introduction


The IB Code differentiates between financial creditors and operational creditors. Financial creditors are those having a relationship with the corporate debtor that is purely a financial contract, such as a loan or a debt security. Whereas, operational creditors are those who have due from the debtor on account of transactions made for the operational working of the debtor.[1]

 

For the purposes of the definition of the term “goods”, the Sale of Goods Act, 1930 can be referred to; whereas, the definition of the term “services” is still not concretely defined. A claim on operational debt may be on account of breach of an agreement or a decree of a court of law; still the same must relate to the supply of goods and services.

 

Now issue arises as to the status of lease dues forming an “operational debt”. The question has two aspects, namely, one whether the landlord could claim to be an operational creditor against the tenant for the rental dues outstanding; and two whether a tenant while using the tenanted premise, if suffers any damages, could claim to be an operational creditor.

 


B. Landlord claiming to be an Operational Creditor


The Bankruptcy Law Reforms Committee Report that formed the basis of the IB Code illustratively suggested that the definitions of “operational creditor” and “operational debt” include wholesale vendors of spare parts whose spark plugs are kept in inventory by the car mechanic and who gets paid only after the spark plugs are sold, thus making them operational creditors. Similarly, the lessor who rents out space to an entity is an operational creditor to whom the entity owes monthly rent on a three-year lease.[2] Operational creditors, in other words, maybe employees, rental obligations, utilities payments and trade credit.[3]

 

While the landlord certainly could claim to be an operational debtor in light of what the Bankruptcy Law Reforms Committee seems to suggest, however, in Annapurna Infrastructure (P) Ltd. v. SORIL Infra Resources Ltd.[4], such an issue was left open by the NCLAT to be decided by the NCLT. In this case, the landlord had initiated proceedings under Section 9 against the tenant on the basis of an arbitral award which awarded rent due towards the landlord on the part of the tenant. The NCLAT, however, left this contention unaddressed and remitted the matter on other grounds.

 

In Sarla Tantia v. Nadia Health Care (P) Ltd.,[5] the question before the NCLT was whether the recovery of arrears of rent can be claimed as operational debt within the meaning of Section 5(21) of the IB Code. The counsel for the corporate debtor i.e. Nadia Health Care relied on the input output test arguing that the operational debt are only those debts that have “a correlation of direct input to output produced or supplied by the corporate debtor”. However, the NCLT herein relied on the observations from the decision of the Supreme Court in Mobilox Innovations (P) Ltd. v. Kirusa Software (P) Ltd.,[6] to conclude that the Supreme Court in the affirmative settled the issue of lease dues being an operational debt.

 

It is submitted that the same is erroneous because (i) the Supreme Court in Mobilox Innovations[7] did not discuss the issue of lease deeds in its own observations. The court had merely reproduced paragraphs from the report of the Bankruptcy Law Reforms Committee, a part of which had also touched upon rental and lease dues as a type of operational debt; and (ii) to begin with, the issue was not the subject-matter of dispute before the Supreme Court at all.

Therefore, the opinion of the NCLT in Sarla Tantia[8] may not be on strong footing.

 

Split in jurisprudence

A split in the jurisprudence before the NCLAT is found in the two rulings rendered by the NCLAT in M. Ravindranath Reddy v. G. Kishan,[9] on one side and Anup Sushil Dubey v. National Agriculture Coop. Mktg. Federation of India Ltd.[10] on the other.

 

In Ravidranath, the specific query was addressed by the NCLAT on whether a landlord by providing lease could be treated as operational creditor. The same was held by the Full Bench of NCLAT to not fall within the ambit of the definition of the term “operational debt”.[11] The NCLAT in Ravidranath[12] opined that the recommendation of the Bankruptcy Law Reforms Committee pertaining to the treatment of lessors/landlords as operational creditors, was not adopted by the legislature and only the claim in respect of goods and services were kept in the definition of operational creditor and operational debt under Sections 5(20) and 5(21) of the IB Code. Resultantly, it was concluded that the definition of an operational debt and operational creditor could not be interpreted to include rent dues as operational debt. Therefore, non-payment of rent does not amount to an operational debt.

 

There is a qualification added to the ruling in M. Ravindranath[13], when the NCLAT in Sanjeev Kumar v. Aithent Technologies (P) Ltd.[14] distinguished the former. In Sanjeev Kumar, the relationship between the creditor landlord and the debtor tenant was found to be not merely of the one to that of a landlord tenant but was held to also include certain provision of services such as electricity, diesel, sewer and water charges amongst others given to the debtor tenant. In such cases once the dues were found to be more than the pecuniary threshold, the debt was held to fall under the definition of an operational debt and an application under Section 9 of the Code was admitted.[15]

 

On the other hand in Anup Sushil Dubey[16] the NCLAT held that lease and licence agreements fall within the ambit of Section 5(21) of the IB Code. The NCLAT here noted that the appellants had leased out the premises for “commercial purpose” and the same fell within the meaning of term “service” under Section 5(21) of the IB Code. Then the NCLAT found the definition of “service” under the Consumer Protection Act, 2019 to be of relevance, which defines a service in the following manner :

(42) “service” means service of any description which is made available to potential users and includes, but not limited to, the provision of facilities in connection with banking, financing, insurance, transport, processing, supply of electrical or other energy, telecom, boarding or lodging or both, housing construction, entertainment, amusement or the purveying of news or other information, but does not include the rendering of any service free of charge or under a contract of personal service.

 

The NCLAT similarly referred to the provisions of the Central Goods and Services Tax Act, 2017, which under the Schedule II lists down the activities that are to be treated as supply of goods or services, and in Para 2 of the Schedule stipulates as follows:

(a) any lease, tenancy, easement, licence to occupy land is a supply of services;

(b) any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is a supply of services.

 

On the basis of the above, taking into account that the premises were leased out for a commercial purpose, it was held that the dues claimed by the creditor squarely fell within the ambit of the definition of “operational debt” as defined under Section 5(21) of the Code.

 

It is essential to note that while M. Ravindranath[17] was a decision by a Full Bench of the NCLAT, the ruling in  Anup Sushil Dubey[18] was by a Division Bench. Furthermore, the NCLAT in Anup Sushil Dubey[19] while noted that the corporate debtor appellant before it, cited the ruling in M. Ravindranath[20]; the NCLAT however did not render any findings on the reference to M. Ravindranath[21].

 


C. Tenant claiming to be an Operational Creditor


On the other hand, as regards the claim of a tenant in its tenant landlord relationship is concerned, the position seems to be settled in Jindal Steel & Power Ltd. v. DCM International Ltd.[22] wherein it was held that tenants do not come within the meaning of “operational creditor” as defined under Sections 5(20) and (21), IB Code. In this case, the tenant sought to recover the security deposit on account of the termination of the lease agreement with the landlord. The NCLAT upheld the order of the NCLT rejecting the application filed under Section 9 by the tenant holding that the tenant does not come within the meaning of the term “operational creditor”.

 

It must also be noted here that while in Sarla Tantia,[23] the NCLT had referred to the Schedule II of the CGST Act, 2017[24] which in context of land and buildings, classifies “any lease, tenancy, easement, licence to occupy land” as a supply of services. Here in Jindal Steel[25], the NCLT held that the definition of “service” in the fiscal statutes has no bearing because the purpose of fiscal statutes is to generate revenue for the Government in the form of taxes, whereas the purpose of the IB Code is to consolidate and amend the laws relating to reorganisation and insolvency resolution.

 

Similar position was maintained in  D & I Taxcon Services (P) Ltd. v. Vinod Kumar Kothari,[26] where a tenant filed a claim on account of suffering damage in the tenanted premises due to a fire incident. The NCLAT clarified that the claim of the tenant does not constitute any operational debt since by using the demised premises as a tenant, the appellant could not be said to have been providing any “services”.

 

However, sub-tenants cannot be treated as a corporate debtor even if part of the payment is made directly by such sub-tenants to the operational creditor since the same will not create any relationship of operational creditor and debtor.[27]


Conclusion


On account of the differing viewpoints expressed by the NCLT and NCLAT, the issue on whether a landlord could claim to be an operational creditor remains unresolved.

 

Since different types of creditors are granted distinct rights under the IB Code framework, it is necessary to determine to which category, a creditor belongs to. In this context, it is possible that, in the future, a leasing agreement may not fall within either of the two categories of creditors who can file for initiating a corporate insolvency resolution process (CIRP), namely, financial and operational creditors, and that they will have to make a claim as other creditors. Categorisation as such would also lead to a significant loss of rights as such creditors would have no participatory role (whatsoever) in the CoC working.

The issue is now pending before the Supreme Court in Promila Taneja.[28]

 

Given the ambiguity surrounding the problem, the Supreme Court must evaluate the larger issue of claims resulting from the use of immovable property and other associated costs, and eventually resolve the question of whether rent arrears constitute as operational debt.

 

To sum up, unless the existing gaps in the Code regarding lease transactions, their treatment as secured creditors, the right to relinquish, and other factors discussed above are addressed, the true devil will lie in the strategically drafting of lease agreements, which will essentially make or break the rights available to the lessor.


Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is also a visiting faculty at the National Law University, Mumbai and the author of the commentary Insolvency and Bankruptcy Code – Law and Practice.

“The author gratefully acknowledge the research and assistance of Sh. Priyanshu Fauzdar, pursuing law at NLU, Assam in writing this article.”

[1] The Report of the Bankruptcy Law Reforms Committee, Volume 1: Rationale and Design (Nov. 2015), Ch. 5.2.1, available online at HERE .

[2] The Report of the Bankruptcy Law Reforms Committee, Volume 1: Rationale and Design, (Nov. 2015), Ch.

5.2.1.

[3] The Report of the Bankruptcy Law Reforms Committee, Volume 1: Rationale and Design, (Nov. 2015), Ch.3.2.2.

[4] 2017 SCC OnLine NCLAT 380.

[5] 2018 SCC OnLine NCLT 16726.

[6] (2018) 1 SCC 353.

[7] (2018) 1 SCC 353.

[8] 2018 SCC OnLine NCLT 16726.

[9] 2020 SCC OnLine NCLAT 84.

[10] 2020 SCC OnLine NCLAT 674.

[11] The ruling in M. Ravindranath case, 2020 SCC OnLine NCLAT 84 has been followed subsequently in Aurora Accessories (P) Ltd. v. Ace Acoustics & Audio Video Solutions (P) Ltd., 2020 SCC OnLine NCLAT 527; Promila Taneja v. Surendri Design (P) Ltd., 2020 SCC OnLine NCLAT 1105.

[12] 2020 SCC OnLine NCLAT 84.

[13] 2020 SCC OnLine NCLAT 84.

[14] 2020 SCC OnLine NCLAT 734.

[15] 2020 SCC OnLine NCLAT 734.

[16] 2020 SCC OnLine NCLAT 674.

[17] 2020 SCC OnLine NCLAT 84.

[18] 2020 SCC OnLine NCLAT 674.

[19] 2020 SCC OnLine NCLAT 674.

[20] 2020 SCC OnLine NCLAT 84.

[21] 2020 SCC OnLine NCLAT 84.

[22] Jindal Steel & Power Ltd. v. DCM International Ltd., 2017 SCC OnLine NCLAT 441 upholding the order of the NCLT in Jindal Steel and Power Ltd. v. DCM International Ltd., 2017 SCC Online NCLT 989.

[23] 2018 SCC OnLine NCLT 16726.

[24] Central Goods and Services Tax, 2017, Schedule II read with S. 2(a).

[25] 2017 SCC Online NCLT 989.

[26] 2020 SCC OnLine NCLAT 878.

[27] Rahul Gupta v. Mahesh Madhavan, 2018 SCC OnLine NCLAT 263.

[28] Promila Taneja v. Surendri Design (P) Ltd., Civil Appeal No. 4237 of 2020, order dated 28-1-2021. (SC)

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