MOOT QUESTION, WHETHER CLAIMS TOWARDS OUTSTANDING RENT IS OPERATIONAL DEBT AS DEFINED UNDER IBC. 

Ashutosh Gupta and Gaurav Rana 

This article deals with the most mooted question(s) of the recent past i.e. whether claims towards outstanding rent is operational debt as defined under Insolvency Bankruptcy Code, 2016 (“Code” or “IBC”); whether landlord falls under the definition of Operational Creditor and can approach National Company Law Tribunal (“NCLT” or “Adjudicating Authority”) under Section 9 of the IBC for rent outstanding; whether lessor falls under definition of Operational Creditor and can approach Adjudicating Authority under Section 9 of the IBC for lease outstanding; and whether licensor falls under the definition of Operational Creditor and can approach National Company Law Tribunal (“NCLT” or “Adjudicating Authority”) under Section 9 of the IBC for license fee outstanding (“Moot Question”).

Recently National Company Law Appellate Tribunal (“Appellate Tribunal”), has dealt with the Moot Question in the matter of Mr. M. Ravindranath Reddy Vs. Mr G. Kishan & Ors. Company Appeal (AT) (Insolvency) No. 331 of 2019, an appeal filed against the order passed by the Adjudicating Authority Hyderabad Bench and has clarified the law which appeared cloudy due to different verdicts on the same question by different Benches of NCLT. While, NCLT Mumbai and New Delhi had held that the said question in negative and declined to accept the claim arising from outstanding rent as Operational Debt. On the other hand, NCLT Kolkata held that, rent outstanding is operational debt and thus petition under Section 9 of the IBC claiming outstanding rent is maintainable.

On similar lines NCLT, Hyderabad, on January 21, 2019 (“Impugned Order”) and had admitted a Section 9 insolvency petition filed against the Corporate Debtor, M/S. Walnut Packaging Private Limited. The petition was preferred by the Lessors of the Corporate Debtor with respect to a piece of land measuring about 1667 sq. Yards in Hyderabad. Being aggrieved by the Impugned order shareholders/promoter challenged the same in an appeal titled as Mr. M Ravindranath Reddy (Supra) before NCLAT wherein NCLAT has set aside the Impugned Order.

Before adverting to rationale and findings of the NCLAT in Mr. M Ravindranath Reddy (Supra), it is relevant to discuss the facts leading to the Impugned Order.

1. Facts of the case:

The tenancy was yearly in nature and the rent payable for the period from July 2011 to June 2017 was Rs. 85,67,290. The Corporate Debtor was stated to have made “part payments” of the lease rent from July 2011 until December 2016, totalling to Rs. 49,96,728, after deduction of Rs. 5,55,192 as TDS.

It was the Lessor’s grievance that the Corporate Debtor stopped making payments from January 2017 and by the end of June 2017 as per enhanced rent rate the Corporate Debtor was in default of Rs. 30,15,370. Thereafter, the Lessor issued a legal notice to the Corporate Debtor to handover the property but the property was not vacated. Subsequently, an eviction suit was filed against the Corporate Debtor before the jurisdictional Civil Court.

Finally, in January 2019, the Lessor served a Demand Notice under Section 8 IBC for a sum of Rs. 49,51,605 including interest @ 18%. The Corporate Debtor contended that it had paid the rent until December 2017, and no amount was due. It was further added that due to slowdown in the operations of the Corporate Debtor during the period from April 2012 to July 2012, it was agreed that there would be a moratorium for no yearly enhancement of rent for six years.

Since there was no documentary proof on acceptance of moratorium, the NCLT concluded that the Corporate Debtor failed in making payment of rents and admitted the insolvency petition.

2. ISSUES FRAMED AND DISCUSSED:

1. Whether a landlord by providing lease, will be treated as providing services to the corporate debtor, and hence, an operational creditor within the meaning of Section 5(20) read with Section 5(21) of the ‘Insolvency and Bankruptcy Code, 2016?

2. Whether the petition filed U/S 9 of the Insolvency and Bankruptcy Code 2016 is not maintainable on account of ‘pre-existing dispute’?

3. RATIONALE AND FINDINGS

NCLAT while considering the first issue, relied upon Jindal Steel & Power Ltd. v. DCM International Ltd. Company Appeal (AT)(Insolvency) No 288/2017 wherein it was held that:

“Admittedly, the Appellant is a tenant of the Respondent- Even if it is accepted that a Memorandum of Understanding has been entered between the parties in regard to the premises in question, the Appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and the debt in respect of the repayment of dues does not arise under any law for the time being in force payable to the Central Government or State Government, we hold that the Appellant tenant do not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-Section (21) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to  ‘I&B Code’) for triggering Insolvency and Bankruptcy Process under Section 9 of the ‘I&B Code’”

In short in Jindal Steel & Power Limited (supra,) Hon’ble NCLAT held that tenancy does not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-section (21) of Section 5 of the IBC.

NCLAT further noted judgments passed by various benches of NCLT, holding moot question in negative and dismissed the petition, which were about arrears of rent. For instance C.P. No.567/IB/2018 Citicare Super Speciality Hospital v. Vighnaharta Health Visionaries Pvt. Ltd. Dated 11th March 2019, NCLT, Mumbai Bench, Parmod Yadav &Anr v. Divine Infracon (P) Ltd., 2017 SCC OnLine NCLT 11263 New Delhi Bench, Col. Vinod Awasthy v. AMR Infrastructure Ltd. New Delhi Bench, and CP/IB/61/9/HDB/2019 Manjeera Retail Holdings Pvt. Ltd. v. Blue Tree Hospitality Pvt. Ltd. Hyderabad Bench and held that  If the claim by way of debt does not fall under any of the three categories as mentioned in Section 5(21) of the IBC, the claim cannot be categorised as an operational debt, even though there may be a liability or obligation due from the corporate debtor to the creditor, and hence, such a creditor was disentitled from maintaining an application for initiation of corporate insolvency resolution process (CIRP) of the corporate debtor.

In addition to above NCLAT also noted that The Bankruptcy Law Reforms Committee (BLRC), in its report dated November 2015 stated that:

“The law has not gone into defining goods or services – hence, one has to rely on general usage of the terms so used in the law, with due regard to the context in which the same has been used. Simultaneously, it is also relevant to understand the intention of the lawmakers. The Bankruptcy Law Reforms Committee (BLRC), in its report dated November, states that “Operational creditors are those whose liability from the entity comes from a transaction on operations”. While discussing the different types of creditors, the Committee points out that “enterprises have financial creditors by way of loan and debt contracts as well as operational creditors such as employees, rental obligations, utilities payment and trade credit.” Further, while differentiating between a financial creditor and an operational creditor, the Committee indicates “the lessor, that the entity rents out space from, is an operational creditor to whom the entity owes monthly rent on a three-year lease”. Hence, the BLRC recommends the treatment of lessors/landlords as operational creditors.”

Interestingly NCLAT held that Legislature has not completely adopted the BLRC Report, and only the claim in respect of goods and services are kept in the definition of operational creditor and operational debt u/s Sec 5(20) and 5(21) of the IBC. The definition does not give scope to interpret rent dues as operational debt. Thus rental obligations cannot be read into the definition as the definition does not give scope to for such interpretation.

Further to evaluate whether the non-payment of outstanding rent/lease/license fee tantamount to Operational Debt, the reliance was also placed on the interpretation of the term “Operational Debt” and definition of “essentials goods or services” under Regulation 32 IBBI (Insolvency Resolution Process of Corporate Person) Regulation, 2016 (“Regulations”).

In order to determine the meaning of “Operational Debt” NCLAT has, also relied on the order of the New Delhi Bench (“Tribunal”) in the matter of Parmod Yadav &Anr v. Divine Infracon (P) Ltd., wherein same question was considered that whether rent outstanding falls under definition of Operational Debt. Notably, Tribunal held that the word “operation” is not defined anywhere in this Code, therefore the Tribunal consider the dictionary meaning of the term in its literal sense and defined as “ready for use or able to be used”. It was further specified that in the Code the term Operational Debt is used in connection with goods and services to categories a Creditor as “Operational Creditor”. According to the Tribunal, the definition of Operational Debt only includes the debt arising from provision of goods, services or the debt arising from statute and payable to the government. Thereafter, Tribunal opined that the said debt must have aroused with a nexus of direct input to the direct output produced. Therefore, according to Tribunal lease/rent/license fee arising from immovable property cannot be considered as ‘Operational Debt’, as the said services has no nexus with direct input to direct output produced by the Corporate Debtor. 

NCLAT went further and opined that in case of rent/lease/license of immovable property, default can be determined by examination of evidence only. As the NCLT cannot entail investigation and conduct trial, as proceedings under IBC are summary proceedings, NCLT cannot give any finding regarding rental dues as the same require further investigation and trial. Therefore, NCLAT held that as there is dispute in respect of moratorium on enhancement of rent, same could not have been adjudicated by the NCLT due to its aforesaid facet.   

4. ORDER

In the light of the above, NCLAT held that lease of immovable property cannot be considered as supply of goods or rendering of any services and this, cannot fall within the definition of ‘Operational Debt’.

Further as there was plausible dispute, in terms of Mobilox Innovations (P) Ltd. V/s Kirusa Software (P) Ltd. reported in 2018 (1) SCC 353, raised by the Corporate Debtor hence impugned order was set aside and Corporate Debtor was freed from all the rigours of IBC. Hence first issue was answered negative and second issue affirmative.

5. ANALYSIS OF THE JUDGEMENT

NCLAT also opined that definition of ‘Operational Debt’ did not leave room for interpretation and to include any other transactions other than as specified under the IBC. However said definition of ‘Operational Debt’ is inclusive in nature and not exclusive or exhaustive and leave sufficient room of inclusion of other transaction as, same can be examined from the definition itself which goes as follows :

“5(21) “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;”

(emphasis supplied)

That the phrase “inclusive” used in the definition just after the “goods and services” clearly suggest that the definition is prima facie extensive and other transactions falling under the meaning of ‘goods and services’ can also be imputed under the said definition. Thus, legislature in its wisdom used inclusive definition to serve the purpose and meet the dynamic nature of commercial transactions and therefore, legislature provided sufficient scope of interpretation to judiciary to include the goods and services meeting the requirement of IBC.

Though NCLAT admitted that the words and phrases not defined under IBC should bear its meaning in terms of their usage in general parlance, but it did not consider the definition of “goods and service” under Central Goods and Services Tax , 2017 (“GST”). It is relevant that Schedule II of GST list down the activities that are to be treated as supply of goods or services and 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.”

(c) construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration has been received after issuance of completion certificate, where required, by the competent authority or after its first occupation, whichever is earlier”.

That the aforesaid definition sufficiently held rent or lease or license as supply of goods and services. However, NCLAT did not examine the said aspect in its judgment.

Further NCLAT in its order also endorsed order of Parmod Yadav &Anr (Supra) and invented a touch stone for adjudication of Section 9 petition and held that unless claim /debt has nexus to the direct input to the output produced by the Corporate Debtor, same cannot be treated as Operational Debt. Thus, as per NCLAT any debt arising without nexus to the direct input to the output produced or supplied by the corporate debtor, cannot, in the context of Code, be considered as an operational debt, even though it is a claim amounting to debt.

That the aforesaid rider or touch stone of NCLAT would make the adjudication of claim pre CIRP period and during CIRP period a cumbersome and contentious task, as the NCLT or Resolution Professional, as the case may be, has to segregate claims/debt having nexus to the direct input to the output produced by the Corporate Debtor from claims /debts not having so. For instance claims of managerial staff or administrative staff or marketing staff would be debarred from section 9 of the IBC and only claim of workman and employees working in factory would be considered under Section 9 of the IBC as they have nexus to the direct input to the output produced or supplied to the Corporate Debtor. That the said list will only increase with coming days if the touch stone is not set aside or diluted.

Further NLCAT opined that legislature has not adopted the BLRC report in complete and only ‘goods and services’ and ‘employees’ are followed in the definition i.e. Section 5(21) of the IBC. Hence ‘rental obligation’ cannot be read into the definition clause as there is no room left for it. Notably, along with ‘rental obligation’, ‘trade credit’ and ‘utilities payment’ are also not included or adopted under the Section 5(21) of the IBC and thus, from the same coin said transactions should also not be included under the definition of ‘Operational Creditor’, but hopefully said view is not yet been taken by NCLT benches or by NCLAT itself.

Due to the present order of NCLAT, there is no remedy available to the Petitioner claiming rental obligation under IBC. The other options to the aggrieved party are either to; invoke the Arbitration Clause (if any in the Lease/Rent Agreement) for recovery of arrears or File a Civil Suit for Recovery of Money before the competent Court.

Authors are advocates in New Delhi and Managing Partner & Partner respectively at Indo Legal Services a Boutique Law Firm in New Delhi.  

Relevant # for search: #Rent #Lease #Tenancy #OperationalCreditor #IBC #InsolvencyBankruptcyCode #NCLT #NCLAT

Author Bio

Qualification: LL.B / Advocate
Company: Indo Legal Services LLP
Location: New Delhi, New Delhi, IN
Member Since: 18 Feb 2020 | Total Posts: 8
MR. GAURAV RANA(Advocate, CS) Mr. Rana, Advocate is a member of Bar Council Association of Delhi High Court, India and an Associate member of Institute of Company Secretaries of India. He has extensive experience in commercial litigation, arbitration and regularly argues at various fora. He advises View Full Profile

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2 Comments

  1. RAJESH GUPTA says:

    Hello Gaurav, saw your article on “Whether Claims towards Outstanding Rent is Operational Debt under IBC”. I think the NCLAT’s view is highly restrictive while considering the definition of operational debt. Has anyone gone in Supreme Court so far on this issue?

    1. Gaurav Rana says:

      Hi Rajesh Ji, hope you are doing good in this difficult time.
      Absolutely, I agree with you NCLAT relied on technical and mechanical aspect of this question. Further I have not come across any order of SC on this aspect, hope to see one soon.

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