A Case of Concern for The Financial Creditors vis-à-vis Saraf Chits Private Limited & Anr. v. KAD Ho
The Delhi Bench of the National Company Law Tribunal (“NCLT” & “the Tribunal”), has recently passed their judgement in Saraf Chits Private Limited & Anr. v. KAD Housing Private Limited. The Tribunal was required to interpret Section 7 along with the definition of ‘debt’, ‘financial debt’ and ‘claim’ from the Insolvency and Bankruptcy Code, 2016 (“IBC”). On careful observation of the aforementioned provisions, the Tribunal held that IBC does not grant the financial creditor, the power to initiate Corporate Insolvency Resolution Process (“CIRP”) when the principal amount of his financial debt has been discharged and only the amount towards the interest portion is unpaid.
The judgement by the division bench of the Tribunal seems like a rigid and somewhat questionable interpretation of the provisions of IBC. The following article aims to analyse and argue against the approach adopted by the Tribunal while interpreting various provisions of IBC. Furthermore, this article seeks to question the judicial precedent upon which the members of the Tribunal have relied upon while passing this judgement.
The Question of Interpretation
Section 7 of IBC allows the financial creditor within the meaning of Section 3(10) to file an application with the tribunal to initiate CIRP. A financial creditor simply put, is any person to whom financial debt is owed. IBC defines financial debt under Section 5(8) as a debt that includes interest and is paid back with any applicable consideration for time worth of money.
The stance of the tribunal while interpreting the definition of financial debt was that the debt amount would per se not include the amount of interest. Interest according to the Tribunal, can only be claimed when the principal amount towards the financial debt remains un-paid. Consequently, an application to start CIRP would be dismissed when the full amount towards the principal amount would be paid by the corporate debtor.
This definition of financial debt could be interpreted in two ways. The first interpretation would be to consider usage of the words “along with” in the definition of financial debt in a strict sense and in isolation with the wordings of the remaining section. Such an approach would lead us to an interpretation similar to the one adopted by the Tribunal in this case.
The second approach, and a more liberal and practical one would be to consider Section 5(8) holistically. As the provision lays emphasis on disbursement of debt against consideration for time value of money, in all commercial transactions, the usual consideration for time value of money is the interest amount. This approach of harmonizing the wordings of the complete provision, would have allowed the Tribunal to safeguard interests of the financial creditors.
The following arguments will highlight why the tribunal should have adopted the latter approach.
Golden Rule v. Literal Rule
The two most employed rules while interpretating any statues are the literal rule and the golden rule. As the name suggests, the literal rule posits that words or phrases in a statue are to be interpreted as their plain, simple and literal meaning. The legislative intent has to be inferred from a word’s literal or generally accepted meaning.
The golden rule of interpretation is the alternative approach which allows a shift from the ordinary meaning of a word(s) if the overall content of the document demands it. The Golden rule is usually adopted to suit the contemporary needs of the law.
In an earlier judgement in M/s Orator Marketing Pvt Ltd v M/s Samtex Desinz Pvt. Ltd, the NCLT erred in interpreting financial debt by applying the literal rule.
The question before the Tribunal was whether a loan advanced without interest would be considered as financial debt? The Tribunal in an attempt to strictly interpret Section 5 (8), held that for a debt to be considered as a financial debt, there has to be an element of interest involved.
The Tribunal again focused on the Section’s use of the phrase “along with” to reach the conclusion that a financial debt has to necessarily be a debt along with” interest. The National Company Law Appellate Tribunal (“NCLAT”) also upheld this interpretation by the NCLT.
A positive approach of safeguarding the interest of the creditors and at the same time keeping in mind the legislative intent and the principles of IBC, was shown by the Supreme Court.
The Supreme Court reversed the judgement of the NCLAT and observed after dwelling on the overall intent of Section 5(8) and the IBC, that an interest-free loan would also classify as a financial debt and a Section 7 application can be filed by the financial creditor for initiation of CIRP for recovering such a debt.
This reasoning of Apex Court shows that the definition of financial debt does not have to be interpreted in a sense where debt has to be necessarily present along with interest.
The NCLT ought to have adopted the golden rule of interpretation in the Saraf case as well. Interest is the biproduct of debt which has been disbursed by any creditor for realizing the time value of his money. Moreover, the legislative intent of the IBC is to (a) provide a mechanism for insolvency resolution of corporates in a time bound fashion, (b) still focus on maximisation of value of assets and (c) promote availability of credit in the market. This order by the Tribunal negatively impacts the availability of credit aspect of the legislative intent as it shakes the confidence of the lenders.
Mis-application of Judicial Precedent
The Tribunal while dealing with this case, primarily relied on the ratio in S. S. Polymers v. Kanodia Technoplast Ltd.The application was pursued for realisation of the interest amount by the operational creditor in this case. Since the debt is an operational debt within the meaning of Section 5(21), the same interpretation cannot be blindly adopted while interpreting ‘financial debt’.
Operational debt is defined under Section 5(21) of the IBC as a claim for the provision of goods or services, including employment, or a debt for the payback of fees owed to the Central Government, any State Governments, or any local authorities under any current laws.
The point of differentiation here is that, as opposed to financial debt which is premised on the consideration of time value of money, there is no mention of either interest or of time value of money within Section 5(21).
In this carefully drafted structural reform i.e., IBC, the drafters have carefully chosen employees’ fee, professional fee, payment towards goods/service, etc., to be included as part of operational debt and purposefully chose to omit interest from being part of the operational debt. Such an interpretation cannot be translated to the case at hand, therefore, the precedent that the NCLT has relied upon, is not relevant for this case.
The Tribunal in this case, admitted the application under Section 7 even when the amount of remaining financial debt was 64 lakhs while the permissible limit for filing a Section 7 application is 1 crore rupees.
The applicant brought to the attention of the Tribunal that the amount of 64 lakh was the sum towards the interest while the principal of Rs.1.5 crores was repaid during the pendency of the application.
Therefore, in light of the above, an application for CIRP could very well be admitted by the NCLT even when the amount of debt is below the permissible limit due to payment of principal amount of debt during the pendency of the application.
This stance of the NCLT is somewhat contradictory to what they took in CBRE South Asia (P) Ltd. v. United Concepts and Solutions (P) Ltd. and by the Kolkata bench in M/s Plastofab v. Electroteknica Switchgears Private Limited The Tribunal in the said cases held that the amount of interest will not be added to the amount of operational debt when an application is filed for initiation of CIRP under Section 9 of the Act.
This differential treatment in admission of operational debt and financial debt on the basis of interest, furthers the argument that interest is an extremely crucial part of financial debt which is why it should also be solely recoverable.
The industry practice is to adjust the amount received towards repayment of debt against the component of interest initially and subsequently against the principal. An argument that can be made here is that the amount towards repayment of financial debt would ipso facto be adjusted against the interest and then against the principal when the interest has been paid off in full. If the said approach is adopted, despite this Order, the financial creditor will have a recourse to recover his debt under the IBC.
The legislative intent, the overall wording of Section 5(8) and the differentiation between operational debt and financial debt make it clear that un-paid interest can be claimed solely as financial debt.
While the ratio in Saraf Chits is likely to be challenged, the status quo which remains in Delhi is problematic. An application for initiation of CIRP will not be entertained by the Tribunal even in cases where the amount of un-paid interest is surpassing the minimum permissible limit of filing an application under Section 7 but the principal amount of the financial debt has been paid by the corporate debtor.
 Saraf Chits Private Limited & Anr. v. KAD Housing Private Limited, (IB)-255(ND)/2021.  Supra note 1.  M/s Orator Marketing Pvt Ltd v M/s Samtex Desinz Pvt. Ltd, AIR 2021 SC 4040.  S. S. Polymers v. Kanodia Technoplast Ltd, (IB)-121/ND/2019.  CBRE South Asia (P) Ltd. v. United Concepts and Solutions (P) Ltd, CP (IB) No. 797/(ND)/2021.  M/s Plastofab v. Electroteknica Switchgears Private Limited, CP(IB) No. 62 /KB/2021  Supra note 1.