Lease Rentals as Operational Debt: Clearing the Air

Shalin Ghosh*

The Insolvency and Bankruptcy Code, 2016 [“IBC”] has been one of the most comprehensive and significant laws governing insolvency and credit recovery matters in India. The legal framework, which the IBC outlines for initiating Corporate Insolvency Resolution Process [“CIRP”] against a corporate debtor, makes a clear distinction between two kinds of debts- financial and operational. A financial creditor or an operational creditor can initiate CIRP under Section 7 and Section 9 of the IBC respectively.

Initiating CIRP under Section 9 must involve an operational debt. Section 5 (21) of the IBC defines an operational debt as— “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”. The term ‘service’ in the aforementioned definition has not been defined in the IBC. This ambiguity has been a major bone of contention in recent judgments dwelling on whether or not lease rentals could be considered as ‘operational debt’ for the purposes of initiating CIRP under Section 9 of the IBC. This issue has been a stiffly contested one with various judgments of the National Company Law Tribunal [“NCLT”] and National Company Law Appellate Tribunal [“NCLAT”] offering contrarian viewpoints on the matter.

A recent full bench judgment of the NCLAT in Jaipur Trade Expocentre Pvt Ltd v. Metro Jet Airways Pvt Ltd [“Jaipur Trade”] largely clarifies the conundrum by including lease rentals within the scope of ‘operational debt’ as defined in Section 5 (21) of the IBC, while also commenting on the soundness of certain precedents, which were commonly cited in relation to the contentious point. This article analyses the aforementioned judgment.

Brief facts and Judgment

The corporate creditor [“Appellant”] entered into a five-year licensing agreement with the corporate debtor [“Respondent”] granting the latter to use a building for commercial purposes at an agreed licensing fee. A few years later, the Respondent issued two cheques to the Appellant which were subsequently dishonoured. The Appellant sent a demand notice to the respondent under Section 8 of the IBC which was left unanswered by the Respondent. Consequently, the Appellant initiated CIRP against the Respondent under Section 9 of the IBC. This application was rejected by the Adjudicating Authority reasoning that since a claim emerging from a license granting to use an immovable property does not come within the purview of ‘goods and services’, the amount in question, claimed under Section 9 cannot be considered as an unpaid operational debt. This matter was referred to a larger bench on appeal.

The NCLAT made two arguments to fill up the void created by the absence of a definition for ‘service’. Firstly, it noted that the term ‘operation’ is derived from ‘operate’ and ‘operating cost’ refers to expenses incurred while conducting an enterprise’s principal activities. Therefore, an operational debt is also a debt spent in lieu of the principal activities of an enterprise. Thus, the NCLAT concluded that due to the license agreement taken by the corporate debtor, any outstanding fee would be payable to the operational creditor. Secondly, the NCLAT referred to the Bankruptcy Law Reforms Committee Report, as an aid to interpret the IBC, which explicitly stipulates that a lessor can be considered an operational creditor.

An important aspect of this judgment is the NCLAT’s observations on two judgments cited by the Respondents. In Mr. M Ravindranath Reddy v. Mr. G. Kishan & Ors [“Ravindranath Reddy”], the NCLAT had to decide whether a landlord leasing space would be considered as providing a ‘service’ to the corporate debtor, so as to be categorized as an ‘operational creditor’ within Section 5 (21) of the IBC. In this case, the NCLAT observed that a debt emerging without nexus to the direct input to the output produced or supplied by the corporate debtor, will not be an ‘operational debt’. Considering this rationale, the NCLAT held that lease of immovable property cannot be considered an ‘operational debt’ because it does not involve supplying any goods or rendering any service. The NCLAT in Jaipur Trade held that such a wide observation goes beyond the pale of the IBC and is not supported by its scheme. It also held that Ravindranath Reddy, by relying on the narrower Section 14 (2) for interpreting ‘service’, does not consider the expansive interpretation of the word under Section 5 (21) and consequently lays down an incorrect legal position. It added that the word ‘service’ under Section 5 (21) is both conceptually and contextually different from Section 14 (2) which deals with ‘essential goods and services’.

In the second judgment cited by the Respondents, Promila Taneja v. Surendri Design Pvt. Ltd [“Promila Taneja”], the NCLAT upheld the view made in Ravindranath Reddy reasoning that the interpretation of ‘service’ cannot be deduced from the Consumer Protection Act, 2019 and the Central Goods and Services Tax Act, 2017 [“CGST Act”] as neither of them are mentioned in Section 3 (37) of the IBC. This section contains a list of legislations from which the meanings of undefined words in the IBC can be directly imported. However, the bench made an important observation on the applicability of this rule in Jaipur Trade. The NCLAT held that the reasoning in Promila Taneja will be inapplicable to Jaipur Trade as the latter involves an agreement that clearly contemplates the payment of GST on the services rendered under the agreement thereby holding that the interpretation of ‘service’ under the CGST Act can be extended to the present case. All these observations led the NCLAT to conclude that Section 5 (21) of the IBC would include lease rentals.

Analysis    

The question of including lease rentals within ‘operational debt’ has been a tricky one for the tribunals. There has been a glaring inconsistency even in the views taken by various branches of the NCLT. While NCLT Hyderabad and NCLT Delhi have excluded lease rentals from the scope of ‘operational debt’, NCLT Ahmedabad and NCLT Chennai have taken a diametrically opposite stand, ruling that rentals come within the purview of ‘operational debt’ and that a landlord leasing a property would be considered as an ‘operational creditor’ providing a ‘service’ to the corporate debtor. Even the rulings pronounced by the same tribunal are contradictory and inconsistent. In Citicare Super Specialty Hospital v. Vighnaharta Health Visionaries Pvt Ltd., NCLT Mumbai opined that rent arrears would not come within the purview of ‘operational debt’ while, on the other hand, ruling in Indiabulls Real Estate Company Pvt Ltd. v. Crest Steel Power Pvt Ltd. that rent dues will not be considered as an ‘operational debt’ for the purposes of the IBC.

The confusion has been compounded by judgments like Ravindranath Reddy and Promila Taneja, two commonly cited precedents, excluding rent dues/outstanding license fees from the scope of ‘operational debt’. This is a view that goes against several notable NCLAT judgments like Anup Sushil Dubey v. National Agricultural Co-operative Marketing Federation of Indian Limited & Ors and Sanjeev Kumar v. Aithent Technologies Pvt Ltd (both were cited by the Appellants) ruling otherwise. The NCLAT’s ruling in Jaipur Trade acts as an authoritative precedent for the NCLTs. More importantly, the NCLAT’s categorical observation that Ravindranath Reddy and Promila Taneja lay down incorrect legal positions, significantly streamlines the view at the NCLAT level, bringing some uniformity and reducing the prevailing confusion.

A narrow interpretation of ‘operational debt’ would lead those creditors to hardship who had already entered into the settlement process and risked a reduction in the debt’s value as they would be prohibited from initiating CIRP as operational creditors against a defaulting debtor. The NCLAT’s distinction between the connotations of ‘service’ under Section 5 (21) and 14 (2) and its observation favouring the word’s expansive interpretation under the former while ascertaining whether lease rentals constitute an ‘operational debt’ prevents such an undesirable outcome.

It is pertinent to note that the judgment, while not applying the rule laid down in Promila Taneja, did not make any exceptions to it. This is concerning as it is unfeasible for the IBC to exhaustively include all the legislations under Section 3 (37) from which the meanings of undefined words could be imported. Therefore, being unable to take recourse to Section 3 (37) to discern a word’s interpretation merely because it does not include a particular legislation is problematic. A word’s interpretation depends on the facts and circumstances of a case. The judgment’s failure to carve out exceptions might lead to future claims being challenged on similar grounds.

An appeal in Promila Taneja is currently pending before the Supreme Court. The real test of the Jaipur Trade rationale will depend on the Court’s observation of its validity. A judgment of the apex court on the appeal will further clarify the confounding problem and greatly contribute to the issue’s evolving jurisprudence.       

*The author is a first year student at Maharashtra National Law University (MNLU), Mumbai.