Provider of Services and Goods – Advance Payment made for Procuring Goods and Services - Whether an Operational Debt

Recently, the Supreme Court in Consolidated Construction Consortium Ltd. v. Hitro Energy Solutions (P) Ltd.[1] settled on a crucial issue of defining the contours of the terms “operational creditors” and “operational debt” and expanded the same to include even the acquirer of such services and goods within its ambit.

 

In this column post, we will discuss on whether an advance payment made by one party to acquire the service or goods of the other party, entitles the former to claim an operational debt when such service or good is not provided or supplied by the latter.

Introduction

Generally, operational creditors are those who have due from the debtor on account of transactions made for the operational working of the debtor.[2] 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.

 

The problem in classifying advance payments made by one party to acquire the services or goods from the other party is that the inherent meaning of the term “operational creditor” and “operational debt”. The party which is giving the advance sum is generally the acquirer, not the provider of goods and services, hence such party cannot be the creditor who is providing any services or supplying any goods towards the operations of a company.

 

The same seems to be case when one peruses the Bankruptcy Law Reforms Committee Report that formed the basis of the Insolvency and Bankruptcy Code, 2016 (IB Code). The report 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.[3] Operational creditors, in other words, maybe employees, rental obligations, utilities payments and trade credit.[4]

 

Judicial Discourse on the Issue of Advance Payment

Section 5(21) of the IB Code defines an “operational debt” as:

 “operational debt” means 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.

 

For the present article, it is the scope of the phrase “a claim in respect of the provision of goods or services” which decides and spins the interpretation on the subject-matter.

 

Earlier, the position of law seemed to be clear on the issue that if an entity has provided goods or services, then only such a person could raise an issue that it must be paid its debt since such debt could be paid in terms of money. However, on the other hand, if a person claims that it has paid in advance for securing the services or seeking supply of goods, then the question arose whether such a person could claim that the goods or services grant such payer the status of an “operational creditor” holding a claim of an “operational debt” against the corporate debtor. Even additionally, whether repayment or reimbursement of money paid in advance could be taken to show that an “operational debt” is due.

 

The NCLAT has consistently maintained that in such cases, such payers of advance money either for receiving a supply of goods[5] or for procuring the services[6] could not claim to be operational creditors and such payment is not an operational debt.[7] While such a person is no doubt a creditor, but the payer is not an operational creditor. Consequently, such a person neither can file an application under Section 9 against its corporate debtor nor could stake any rights under the IB Code that are given to an operational creditor.[8] Even if the advance money is to be refunded by the corporate debtor, still the refund does not constitute an operational debt.[9]

 

In B. Karthikeyan v. Nonstop Courier & Cargo (P) Ltd.[10], the NCLAT took note of the fact that the appellant neither supplied any goods nor provided any services and had merely deposited money for securing franchisee rights and resultantly, held that the debt could not be termed as an operational debt.

 

However, opposite conclusion was reached in Overseas Infrastructure Alliance (India) (P) Ltd. v. Kay Bouvet Engg. Ltd.[11], where the NCLAT reached the opposite conclusion. It was held that a claim for refund of advance is an “operational debt”. The creditor, who was the contractor, had advanced funds to the debtor, who was the sub-contractor, for the completion of the project. The creditor pursued recovery of the advance from the debtor after the project was terminated, but the debtor failed and/or refused to pay. While the NCLT did not decide on this issue, the NCLAT specifically held that “the appellant having advanced 10% of the contract value to respondent — sub-contractor as advance payment had a claim in respect of provision of goods or services bringing him within the definition of ‘operational creditor’, to whom an ‘operational debt’ was owed by the respondent – ‘corporate debtor’ “. (emphasis added)

 

The NCLAT here opted for an expansive interpretation of the phrase “a claim in respect of the provision of goods or services” in the definition of the term “operational debt” under Section 5(21) of the IB Code.

 

However, when the case went for appeal in the Supreme Court, it was observed that there was a genuine pre-existing dispute and the appeal was dismissed on that ground only. Therefore, the question whether non-repayment of advance payments amounted to an operational debt or not was left undecided.[12]

 

It was this phrase of an operational debt being “a claim in respect of the provision of goods or services” that became the subject matter of discussion in the decision of the Supreme Court in Consolidated Construction Consortium[13] where the Court held that a creditor seeking refund of the advanced money can stake the claim for being an operational creditor since such creditor had advanced money to the debtor in respect of provision of goods or services. In other words, it is not material as to who was the acquirer or provider of the goods or services; what was material is that the debt arose in respect of goods and services. Since an acquirer had paid advance money to the service or goods provider to procure and secure the goods and services from such provider, the same was sufficient to cloth the person who paid the advance money with the status of an “operational creditor”.

 

In Consolidated Construction Consortium[14], the appellant — Consolidated Construction Consortium Limited entered into a contract to supply light fittings to Chennai Metro Rail Limited (CMRL). The appellant had placed purchase orders for light fittings with Hitro Energy Solutions (proprietary concern) pursuant to the contract with CMRL. On behalf of the appellant, CMRL issued a cheque for INR 50 lakh to the proprietary concern, but afterwards cancelled its contract with the appellant when the project on which CMRL was working was terminated. While the appellant cleared the dues towards the CMRL by returning Rs 50 lakh, it itself was unable to recover the stated sum from the proprietary concern on account of some facts and circumstances. While the NCLT decided in favour of the appellant – advance payer, the NCLAT decided against it and dismissed the application filed under Section 9 of the IB Code.

 

When the creditor went into appeal before the Supreme Court, it first considered the relevant provisions, rules and regulations, the legislative history of the IB Code in order for a better understanding of the issue in hand.  Consequently, the Supreme Court observed that the term “operational debt” under Section 5(21) of the IB Code is defined as “claim in respect of the provision of goods and services”. Resultantly, it was opined that the definition does not restrict the claim to only those who supply goods and services, but it requires that “the claim must bear some nexus with a provision of goods or services, without specifying who is to be the supplier or receiver”.

 

With respect to the observations from the report of the Bankruptcy Law Reform Committee (noted above in the column post), the Supreme Court stated that the report also “specifies that operational debt is in relation to operational requirements of an entity”.

 

It is submitted that the judgment may have overstepped the core idea behind the inclusion of operational creditors, especially when such creditors are allowed to initiate insolvency process against a corporate debtor. The idea is that the corporate debtor is ailing financially to such an extent that even its own suppliers and employees are not getting paid.

 

Conclusion

The ruling of the Supreme Court in Consolidated Construction Consortium[15] is significant because it has resolved the controversy over the legality of forward payment for goods and services, as well as the ambiguity caused by various judgments of NCLTs and the NCLAT. However, whether the interpretation opted for by the Supreme Court truly conforms to the idea behind the definition of an operational debt and an operational creditor is still unclear. Nonetheless, the ruling of the Supreme Court is another step toward narrowing conflicting positions of law in the IB Code.


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.

[1] 2022 SCC OnLine SC 142.

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

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

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

[5] Andal Bonumalla v. Tomato Trading LLP, 2020 SCC OnLine NCLAT 624; N.S. Rangachari v. Consolidated Construction Consortium Ltd., 2019 SCC OnLine NCLAT 1424; Kavita Anil Taneja v. ISMT Ltd., 2019 SCC OnLine NCLAT 512; Roma Infrastructures India (P) Ltd. v. A.S. Iron & Steel (I) (P) Ltd., 2019 SCC OnLine NCLAT 822.

[6]  Bhadreshwar Vidyut (P) Ltd. v. Maheshwari Handling Agency (P) Ltd., 2020 SCC OnLine NCLT 1224; Hitachi India (P) Ltd. v. Prime Infrapark (P) Ltd., 2018 SCC OnLine NCLAT 1044; P.R. Earnarst v. Ajantha Flat Owners Assn., 2019 SCC OnLine NCLAT 247, para 4.

[7]  Co. Jegannathan v. Spring Field Shelters (P) Ltd., 2018 SCC OnLine NCLAT 107.

[8] See, Ss. 24(3)(c), 24(4) and 30(2)(b) for the rights that an operational creditor is granted under the IB Code.

[9] Andal Bonumalla v. Tomato Trading LLP, 2020 SCC OnLine NCLAT 624.

[10] 2019 SCC OnLine NCLAT 873.

[11] 2018 SCC OnLine NCLAT 873.

[12] Kay Bouvet Engg. Ltd. v. Overseas Infrastructure Alliance (India) (P) Ltd., (2021) 10 SCC 483.

[13] 2022 SCC OnLine SC 142.

[14] 2022 SCC OnLine SC 142.

[15] 2022 SCC OnLine SC 142.

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