Revamping Corporate Lifelines: How the Companies Act Transforms Inter-Corporate Deposits in Insolvency

Introduction

Inter-corporate deposits, or ICDs, are short-term loans between businesses in which one business deposits money with another, usually at a specific interest rate and for a predetermined time. Unlike regular bank loans, ICDs are a flexible choice for businesses needing short-term cash because they are unsecured and do not demand collateral. ICDs play a crucial role in corporate financing by offering businesses a flexible and practical means of securing short-term funding. These deposits frequently result from business ties, such as joint ventures or strategic alliances.

Handling ICDs during insolvency proceedings under the Insolvency and Bankruptcy Code, 2016¹ (IBC) is paramount. Creditors and borrowers alike must comprehend how ICDs are managed under the IBC due to their distinct features in contrast to other types of debt. In circumstances of corporate distress, this approach impacts their total recovery, the framework of plans for bankruptcy resolution, and their priority in repayment.

Inter-corporate deposits and investments under the Companies Act, 2013: Key provisions and limitations

A company can provide loans and guarantees to other entities, including body corporates.² Specifically, a company may:

(i) Extend loans to other body corporates.

(ii) Offer guarantees or security in support of loans taken by other corporate entities.

(iii) Acquire securities of other body corporates, whether through purchase, subscription, or other means.

The total amount a company can lend, guarantee, or invest in securities is limited to the lesser of 60% of its paid-up share capital, securities premium account, and free reserves, or 100% of these amounts.³

Additionally, the Act restricts investments to no more than two layers of investment entities, subject to specific exceptions.⁴ These exceptions encompass the acquisition of companies established outside India, where such companies possess investment subsidiaries that exceed the initial two layers in compliance with local regulations. The acquisition of investment subsidiaries by a subsidiary company, provided such acquisitions meet the requirements established by applicable laws or rules in effect at the time.

Inter-corporate deposits: Key exceptions

The inter-corporate lending provisions under the Act do not apply to the following entities:⁵

(i) Banking companies, housing finance companies, and insurance companies

Banking institutions are subject to stringent oversight by financial authorities, encompassing their deposit-taking, lending, and investment activities. Housing finance companies operate under regulations specifically designed for housing finance, distinct from general corporate lending rules. Insurance companies are regulated by frameworks focused on financial stability and risk management, which differ from ICD regulations. Consequently, these entities are not bound by the ICD provisions due to their specialised regulatory environments.

(ii) Companies established for industrial finance or infrastructure development

Industrial finance companies focus on funding industrial projects, while infrastructure development companies finance and develop infrastructure projects. Their primary role is to support industrial and infrastructural growth rather than engaging in general inter-corporate lending.

(iii) Authorised non-banking financial companies (NBFCs) with a focus on equity investments

NBFCs specialise in investing in equity markets and managing stock investments. They operate under a regulatory framework designed for equity investment and capital markets. ICD provisions do not cover these companies because their core business revolves around equity investments rather than traditional corporate lending and borrowing.

Understanding inter-corporate deposit as a financial debt

To understand inter-corporate deposits (ICDs)⁶ examining their characteristics, risks, and regulatory aspects is essential as a form of financial debt. It is a well-established principle that inter-corporate deposits are financial debts; a relationship between the parties must exist for there to be a transaction involving a deposit of money or a loan; a simple transfer of funds from one account to another would not qualify as a loan or deposit unless the parties’ intentions⁷ are taken into account and supported by legitimate documentation.⁸ However, without supporting documentation, simply documenting the inter-corporate deposit transaction on the balance sheet would not be sufficient to demonstrate the financial debt.⁹

In contravention of the above judgment, the National Company Law Appellate Tribunal (NCLAT) has clarified that the financial support provided by one joint venture partner to another through an inter-corporate deposit to build a real estate project jointly cannot be interpreted as a financial debt¹⁰ under Section 5(8) of the Code.¹¹ To consider a debt as a financial debt, there must be a disbursement of the time value of money¹², money invested for profit cannot be treated as a financial debt.¹³

To qualify an inter-corporate deposit as a financial debt, it is essential to have a written agreement between the creditor and debtor or a formal Board Resolution from the financial creditor authorising the loan.¹⁴ A verbal agreement or an undocumented transaction, along with any resulting default, does not suffice to establish the debt as a financial liability. Proper documentation is imperative to substantiate the financial debt.¹⁵

Strategic considerations for inter-corporate deposits in insolvency

An ICD assigned to a third party must have its assignment deed registered under Section 17 of the Act.¹⁶ Even if the defect is curable, a claim filed by a financial creditor based on an unregistered deed cannot be deemed valid. Additionally, it is crucial to consider the assignor’s intent while assigning the inter-corporate deposit to a third party. Suppose a related party is prohibited from participating in the Committee of Creditors (CoC). In that case, the assignee of such a related party is similarly barred from gaining entry into the CoC indirectly.¹⁷

Once the debtor has fully repaid the principal amount of an inter-corporate deposit, initiating an application under Section 7 of the Code¹⁸, it is not permissible based solely on an outstanding interest claim.¹⁹ An application under Section 7 is maintainable only if the accrued interest meets or exceeds the threshold limit of the financial debt.²⁰ An application under Section 7 of the Code can be maintained for the interest component that has become due and payable, irrespective of whether the principal amount is due.²¹

When a creditor has disbursed an inter-corporate deposit to a debtor and the debt is overdue, the adjudicating authority must admit the claim if the debtor neither contests the debt nor presents valid reasons for its rejection.²² If the adjudicating authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete.²³

Conclusion

Effective management of ICDs in insolvency requires strict adherence to documentation and regulatory standards. To qualify as a financial debt, an ICD must involve the disbursement of the time value of money and be supported by formal agreements or Board Resolutions. Unregistered assignments and verbal agreements are insufficient. Additionally, once the principal is repaid, Section 7 of the Insolvency and Bankruptcy Code claims can only be pursued for due and payable interest if it meets the threshold limit. The emphasis on the time value of money and the exclusion of profit-driven investments as financial debts highlights a more precise approach to financial liabilities. These reforms foster a more transparent and structured insolvency process, safeguarding stakeholders’ interests and enhancing insolvency resolutions’ overall fairness and efficiency.