Claim Of Refund Of Advance Payment- Whether An 'Operational Debt' Under The Insolvency & Bankruptcy Code, 2016

WHETHER AN 'OPERATIONAL DEBT' UNDER THE INSOLVENCY & BANKRUPTCY CODE, 2016

Introduction

Ever since the Insolvency and Bankruptcy Code, 2016 ("the Code") has come into effect, many vexed questions of law regarding the interpretation of various provisions of the Code have arisen, many of which have come to be settled by orders passed by the National Company Law Tribunals ("NCLT"), the National Company Law Appellate Tribunal ("NCLAT") as well as the Supreme Court. On the other hand, some issues are yet to be settled in a comprehensive manner by various NCLTs as well as the NCLAT as contradictory orders have been passed with regard to the same. In this paper, we seek to deal with one such issue, being, whether the claim for reimbursement of an advance amount by a creditor against a debtor (such claim can arise for a multitude of reasons, most commonly where the debtor is unable to or fails to provide the goods and services for which such advance payment was made) amounts to 'operational debt' under the Code and whether, by extension, the creditor becomes an 'operational creditor' of the debtor for the purposes of the Code.

The seeds of this fraught issue lie in the definitions of 'claim', 'debt', 'default', 'operational debt' and 'operational creditor' as defined in the Code itself, the definition of the aforesaid terms have been analysed in this paper. This paper commences with a brief look at how this issue was dealt with by the courts during the winding-up regime under the Companies Act, 1956, i.e., prior to the commencement of the Code. The paper then analyses the precedents in the IBC era delving into whether the issue has been answered satisfactorily by the NCLTs and the NCLAT.

On this note, it is pertinent to mention that the focus of this paper is on the cases where the main issue was whether an advance provided for the supply of goods or services only is an 'operational debt' within the meaning of the Code, as opposed to certain other cases where such advance payment may have been made for other purposes, such as for working capital requirements of the debtor company, etc.

Analysis

1. Precode Regime: Winding up petitions filed basis inability of the debtor to refund advance amount(s)

Prior to the promulgation of the Code, the recourse of a creditor against a debtor-company unable to pay a debt was to file a petition under Section 433(e) of the Companies Act, 1956^[1]. On being satisfied that the debtor-company was indeed 'unable to pay its debts' as alleged in the petition, the court could order the winding up of such debtor-company's affairs.

Upon a perusal of decisions rendered by various courts in the pre-Code regime where petitions were filed basis a claim of refund of advance amount against the debtor by the creditor, there remains no doubt that such claim could always be classified as a 'debt', the inability to repay which resulted in winding up of a company.

For example, in a case where a non-resident Indian paid an advance amount for subscription of certain shares in a company and thereafter demanded refund of such advance on finding out that such shares could only be subscribed to by a resident of India, the inability of the company to refund such advance amount resulted in an order of winding-up being passed against such company^[2].

The Delhi High Court also ordered the winding up of a company which took an advance from a person as part of consideration for a certain number of gold coins and thereafter failed to provide such gold coins or honour the customer's demand for return of such advance amount^[3].

It is therefore quite apparent that in the pre-Code regime where winding-up petitions were filed under the Companies Act, 1956, there was virtually no distinction between a claim for refund of the advance amount vis-à-vis other claims in a winding up petition to evince a debtor-company's inability to pay its debts.

The next section will examine the position pertaining to a claim for refund of advance amount in the regime under the Code.

 2.  A few relevant provisions of the Code:

Prior to embarking upon a discussion as to whether a claim for refund of advance is an operational debt under the Code or not, it will be apposite to note a few of the relevant provisions of the Code which may explain the genesis of this issue itself:

Section 3(6) of the Code defines a 'claim' as follows:

"(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured;

(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured."

Section 3(11) of the Code defines a 'debt' in the following manner:

"a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt."

Section 3(12) of the Code then goes on to define 'default' in the following manner:

"non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be."

Section 6 of the Code states that when a 'corporate debtor'^[4] commits a 'default' within the meaning of the Code, a financial creditor/ operational creditor/ corporate debtor itself may initiate a Corporate Insolvency Resolution Process ("CIRP") in respect of such corporate debtor in the manner provided in Chapter II of Part-II of the Code. Part-II of the Code contains the mechanism for the 'Insolvency Resolution and Liquidation of Corporate Persons'.

This brings us to the question, what is meant by an 'operational debt' and who is eligible to be an 'operational creditor'?

An 'operational creditor' has been defined at Section 5(20) of the Code as follows:

"a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred." (emphasis supplied)

The definition of 'operational debt', wherein lies the crux of our issue, is provided at Section 5(21) of the Code in the following manner:

"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."

From a perusal of the afore-mentioned definition of 'operational debt', it appears that there can broadly be two kinds of debts that may qualify to be an operational debt:

          1. A claim 'in respect of the provision of goods and services'; and

         2. A debt owed by the corporate debtor to the Central or any of the State governments or a local authority.

For the purposes of this paper, we are concerned with only the former kind of operational debt as stated hereinabove. It is not immediately clear from the term 'in respect of provision of goods or services' whether, for such claim to be an 'operational debt', the claim can only be one which is raised by the provider of the goods or services or if it can also be raised by the receiver of the goods and services. There is no doubt about the fact that a supplier of goods or services, upon not receiving due consideration for such goods or services, could have a claim against the receiver of such goods or services and such claim would fall under the definition of 'operational debt'. However, whether the provision be interpreted broadly to also include the claim of a receiver of goods or services against the supplier of the same, in the event the receiver might have paid an advance amount to the supplier but not ended up receiving the goods or the services which were promised?

The aforesaid question has been answered differently by the NCLTs, which has led to the confusion surrounding the issue which this paper aims to analyse and discuss. The Supreme Court, in its landmark judgment in Swiss Ribbons Private Limited v. Union of India^[5] ("Swiss Ribbons"), while not directly addressing this question, seems to have taken a narrow view of what can constitute an 'operational debt'. While discussing the difference between financial debts and operational debts, the Court observed the following:

"50. …Operational debts also tend to be recurring in nature and the possibility of genuine disputes in case of operational debts is much higher when compared to financial debts. A simple example will suffice. Goods that are supplied may be substandard. Services that are provided may be substandard. Goods may not have been supplied at all. All these qua operational debts are matters to be proved in arbitration or in the courts of law. On the other hand, financial debts made to banks and financial institutions are well-documented and defaults made are easily verifiable.

75. … On the other hand, operational creditors, who provide goods and services, are involved only in recovering amounts that are paid for such goods and services and are typically unable to assess viability and feasibility of business. The BLRC Report, already quoted above, makes this abundantly clear."

Therefore, it appears that the Supreme Court, in Swiss Ribbons (supra), considered that only those providing goods and services and having claims with regard to the unpaid amounts for the same could be operational creditors while non-supply of the agreed goods or services by the supplier to the buyer would be in the nature of a dispute with regard to such operational debt, which ought to be adjudicated in arbitration or civil courts. While in no way did the Supreme Court deal with the question whether a claim for refund of advance by the receiver of goods or services can also constitute as an 'operational debt' under the Code, the abovementioned observations in Swiss Ribbons (supra) certainly indicate a narrow interpretation of the aforementioned provisions.

Such narrow interpretation of the afore-mentioned provisions of the Code was also exhibited by the NCLTs as well as the NCLAT when certain homebuyers filed applications under Section 9 of the Code^[6] before the NCLTs, claiming that errant real estate developers have failed to deliver the apartments despite taking advances and thereafter failed to honour the homebuyers' claims for refund of such advance amounts, which made such homebuyers 'operational creditors' under the Code^[7].

While, eventually the homebuyers came to be recognized as 'financial creditors'^[8] under the Code after an amendment to that effect^[9], the treatment meted out to claims by buyers claiming to be operational creditors due to non-refund of advance amounts by suppliers of goods or services (other than real estate developers) is what we will analyse in the next section of this paper.

3. Some early cases dealing with whether a claim of refund of advance can be considered as 'Operational Debt'

Two of the earliest cases where a claim of refund of advance was recognised as an operational debt were the matters of Eknath K. Aher v. Royal Twinkle Star Club Limited^[10] and Sayali S. Rane v. Messrs. Cytrus Check Inns Limited^[11]. In both the aforesaid matters, the NCLT, Mumbai admitted two CIRP applications against two corporate debtors upon applications under Section 9 of the Code. The applications were instituted by individuals who had purchased holiday plan certificates from the corporate debtor companies and the said companies had defaulted in refunding a certain amount towards such purchase of holiday plan certificates by the applicants. It was held that such default had given rise to an 'operational debt' within the meaning the Code in favour of the applicants. However, it may be fair to indicate that, in both cases, the corporate debtors did not oppose the admission of the CIRP applications on the ground that the applicants were not 'operational creditors' within the meaning of the Code, and hence, this issue did not properly fall for consideration before the NCLT in these matters.

An early example of a NCLT adopting a wide interpretation of the definition of 'operational debt' under Section 5(21) of the Code was in the matter of Renish Petrochem FZE v. Ardor Global Private Limited^[12]. In this case, the applicant had supplied certain goods to a company on the condition that the payment for the same was guaranteed by an associate entity of the buyer in case the buyer failed to pay the consideration sum. The applicant preferred the application under Section 9 of the Code against such associate entity and a question arose whether an operational debt can be claimed against a guarantor at all. The NCLT, Ahmedabad admitted the application and held as follows:

"Therefore, when the definition of the word 'claim' in Section 3 of the Code is inserted into the definition of 'operational debt' in sub-section (21) of Section 5, it includes the amount payable under the Guarantee Agreement also. No doubt, in case of 'financial debt', Section 8 Clause (i) specifically says about the liability in respect of any of the guarantee for any of the items referred to in sub-clause (a) to (h). There is no such specific clause in case of 'operational debt'. But, reading the definition of 'claim' into the definition of 'operational debt', it could only mean that the amount due from the buyer of the goods, and which is due to the seller of the goods and is guaranteed by the Guarantee Agreement, is also an 'operational debt'."

When NCLT, Chennai was faced with the issue of whether a claim of refund of advance, upon the provider of goods or services failing to provide the same as agreed, could qualify as an operational debt, it took a broad view of the provisions of the Code and allowed such application^[13], while observing as follows:

"7. The definition of "Operational Debt" refers to claim in respect of the provisions of goods or services or dues arising under any law. Therefore, we have to construe the term 'Operational Debt' with respect to purposive and contextual interpretation. Therefore, the petitioner's claim falls within the purview of 'Operational Debt'. In order to explain the same, the counsel for petitioner has given an example of the relationship between the client and the Law firm. If the Law firm is paid for rendering the services by a client and the Law firm fails to render such services, then the client can claim the money advanced on account of the services which were to be rendered by the Law firm. Similarly, in case the Law firm renders the services and the client has not paid, the Law firm can make the claim. Therefore, in both the ways, consideration is paid/agreed to pay, falls within the definition of 'Operational Debt'".

Even though the aforesaid order passed by NCLT, Chennai was set aside by the Madras High Court in a civil revision application under Article 227 of the Constitution of India^[14] on account of certain procedural improprieties on part of the operational creditor, which the NCLT had overlooked, the High Court did not have any observations on the merits of the aforesaid order of NCLT, Chennai.

Further, in the matter of Auspice Trading Private Limited v. Global Proserv Limited^[15], the applicant under Section 9 of the Code had placed orders for certain telecommunications equipment upon the corporate debtor and paid an advance as per commercial practice. Thereafter, the applicant cancelled the order and sought refund of the advance. Even though part of the advance was returned by the corporate debtor, the balance amount remained unpaid and, on that account, the applicant filed the application seeking admission of the corporate debtor into CIRP. The applicant was recognised by NCLT, Mumbai as an 'operational creditor' under the Code and such application was allowed.

The NCLT, Kolkata has, however, not adopted such a broad view of the terms 'operational debt' and 'operational creditor' with respect to the question of a claim for refund of advance amount. In Ranual Technology Private Limited v. Calprin Ads Private Limited^[16], an application under Section 9 of the Code was preferred by a creditor claiming that an advance amount of Rs. 10 lakhs (Rupees ten lakhs) had been provided as 'accommodation loan' to the corporate debtor and the corporate debtor had failed to liquidate such amount despite repeated reminders, and that such non-refund of the said sum amounted to an operational debt. The NCLT, Kolkata, refused to accept such contention of the creditor company and held that such advance amount could not be considered as an operational debt under the Code. The NCLT held as follows:

"12. Coming to the factual aspect of this case, the petitioner herein has neither supplied any goods nor has rendered any service so as to acquire status as an operational creditor. The payment owed by Calprin Ads could, therefore, not be considered as operational debt and the applicant could not be considered as Operational Creditor.

13. Ld. Counsel for the applicant also argued that the expression 'Corporate Debtor' means a person who owes debt to any person as per 3(5) of the IBC. It is further emphasized that the expression 'Debt' means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt. However, Part II specifically deals with "Insolvency resolution and Liquidation" and it has its own definition enumerated in section 5 of the IBC as is discussed in the preceding paragraph. Therefore, the definition as enumerated in section 5 of the IBC are to apply the expressions used in sections 7 and 9 of the IBC and therefore the expression used in section 3 of the IBC cannot be exclusively read to interpret various words used in section 5 of the IBC. Therefore, we find no merit in the aforesaid submission."

The NCLT, Kolkata, once again held a claim for advance amount as being unqualified to be an operational debt under Section 5(21) of the Code, in the matter of Daya Engineering Works Private Limited v. UIC Udyog Limited^[17] ("Daya Engineering Works"). However, the NCLT, Kolkata went a step further and observed that there was no agreement on record between the parties which enabled the buyer to claim refund of advance from the debtor in case of non-supply or shortfall in supply of the agreed quantity of goods. The relevant observation of the NCLT, Kolkata in this regard are as follows:

"… However, no provisions of contract brought to our notice so as to fall the claim under any one of the categories of the operational debt. The operational debt also not bear interest but a financial debt bears interest too. Here in this case the applicant claim refund of an advance with interest at 24% p.a. Admittedly there is no purchase agreement enabling the applicant to claim refund of advance in case of failure of supply of materials or in case of shortfall of materials received by the applicant on account of the purchase orders issued by the applicant. In light of above said discussions we are of the considered view that the claim of the applicant does not fall within the definition of operational debt and hence the applicant is not an operational creditor as alleged."

The aforesaid observation of the NCLT, Kolkata in Daya Engineering Works (supra) evinces the question whether the NCLT could have been persuaded otherwise, i.e. whether such claim of refund of advance would have been considered as an 'operational debt' had the contract(s) between the parties contained a clause that in case of non-supply or shortfall in supply of goods, such advance would have to be refunded? How the existence of such a contractual clause would have otherwise made the claim of refund of advance eligible to be an 'operational debt' (as the buyer would still not be the one providing the goods or services but receiving them) in the context of the narrow interpretation of Section 5(21) of the Code as adopted by the NCLT, Kolkata Bench, as discussed hereinabove, is confounding to say the least.

The NCLT, Kolkata, adopted a similar narrow view regarding claim of advance not falling within the definition of 'operational debt' under the Code, and was therefore pleased to dismiss the application of the creditor in Messrs. SHRM Biotechnologies Private Limited v. Messrs. VAB Commercial Private Limited^[18].

The NCLT, Mumbai also, in contrast to its earlier order in Auspice Trading (supra), inter-alia opined in its order in Tata Chemicals Limited v. Raj Process Equipments and Systems Private Limited^[19] ("Raj Process Equipments"), that an application under Section 9 of the Code, as far as refund of advance payment is concerned, could not be maintained as the corporate debtor was providing the goods and/ or services in such cases. The relevant observation of the NCLT in this regard is quoted hereinbelow:

25. The claim of the Operational Creditor is not based on the operational debt, because goods/services was to be rendered by the Corporate Debtor himself. It has been argued that the claim of the Operational Creditor is not relating to the goods/services including employment or the debt in respect of the repayment of the dues, but it is related to non payment of the advance money and claiming further compensation on account of the alleged loss incurred by the Operational Creditor. The same is not covered under the definition of the Operational Debt as provided under Section 5(21) of the Code."

4. The Kay Bouvet Case: NCLAT recognised claim of refund of advance amount as 'operational debt'

The NCLAT had the occasion to consider whether a claim for refund of advance by an errant supplier or provider of goods and services (in a non-homebuyer case) could be considered as an 'operational debt' under the provisions of the Code in the appeal preferred from the order of the NCLT, Mumbai in Overseas Infrastructure Alliance (India) Private Limited v. Kay Bouvet Engineering Limited ("Kay Bouvet")^[20]. In this case, the creditor, being the contractor, had advanced certain amounts to the debtor, being the sub-contractor, for the execution of the project. However, upon the project being cancelled, the creditor sought repayment of the advance from the debtor, which the debtor failed and/ or refused to pay. Thereupon, the creditor moved an application under Section 9 of the Code before NCLT, Mumbai, contending that such non-refund of the advance sums gave rise to an 'operational debt' and sought admission of the corporate debtor into CIRP. While NCLT, Mumbai did not go into the question of whether the debt could be considered as an 'operational debt' at all, the application was rejected on account of there being pre-existing disputes regarding the claim of the creditor.

Upon appeal, the NCLAT, prior to deciding, whether there existed disputes which merited the rejection of the application under Section 9 of the Code, dealt with the contention of the respondent-debtor that the creditor was not an 'operational creditor' and the debt was not an 'operational debt' within the meanings of Sections 5(20) and 5(21) of the Code respectively. The NCLAT, in this case, in stark contrast to the narrow interpretation of such provisions of the Code adopted by some NCLTs as discussed hereinabove, held that such claim was indeed an operational debt and held as follows:

"8. … Having glanced through the terms of Tripartite Agreement, we have no doubt in mind that the same made provision for rendering of services in the nature of execution of works related to construction, installation and commissioning of the 'Sugar Plant' with clear stipulation for supply of goods including equipment towards execution of work. It is expressly stipulated in the Tripartite Agreement that the Appellant has paid 10% of the contract value to the sub-contractor (Respondent) as advance payment. Therefore, there should be no difficulty in holding that the Tripartite Agreement provided for supply for goods and rendering of services and the Appellants claim was in respect of such provision of goods and services. Viewed in this perspective, it can be stated without any hesitation 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'…. The Adjudicating Authority declined to address this issue on the ground that the matter was sub-judice before the Hon'ble High Court ignoring its own observation that the suit filed by the Appellant sought the relief of specific performance of contract. The reluctance on the part of Adjudicating Authority to address the issue whether non-refund of the amount paid by the Appellant to Respondent, as advance amount, in terms of the Tripartite Agreement gave rise to a claim in respect of provisions of goods and services cannot be appreciated as the nature of relief claimed in the suit was distinct and same could not operate as bar for seeking remedy in the nature of triggering of Corporate Insolvency Resolution Process within the ambit of I&B Code. Admittedly, the issue whether the debt in question qualifies as an 'Operational Debt' and the Appellant was covered by definition of 'Operational Creditor' was not sub-judice before the Hon'ble High Court."

The NCLAT went on to allow the appeal and remitted the matter to the NCLT for admission of the operational creditor's application under Section 9 of the Code. It is evident from the aforementioned observation of the NCLAT that it has adopted a much wider interpretation of the definition of 'operational debt' as contained at Section 5(21) of the Code and has construed the phrase 'a claim in respect of the provision of goods or services', as contained in such definition, broadly enough to not only include claims by a supplier who has not received agreed upon consideration from the buyer of its goods or services but also claims by a buyer/receiver who has not received the agreed upon goods or services despite payment of advance sums towards the same.

Unfortunately, even after the judgment in Kay Bouvet (supra) by the NCLAT, there was no settled resolution to the issue whether an advance amount provided by the buyer/ receiver for the provision of goods and services qualifies as an operational debt or not, and contradictory orders in this regard continued to be passed even thereafter by the various NCLTs and even by the NCLAT. In fact, the NCLAT's judgment in Kavita Anil Taneja v. ISMT Limited^[21] ("Kavita Anil Taneja") contains contradictory observations to that in Kay Bouvet (supra), thereby muddying these waters further, even though the fact situation in Kavita Anil Taneja (supra) was slightly different, and the advance was held to be an amount not only for supply of goods but contribution towards establishment of a joint venture, and thereby could qualify as a 'financial debt'. However, in this judgment, passed barely a month after the Kay Bouvet (supra) judgment, the NCLAT seems to have retracted from its wide interpretation of Sections 5(20) and 5(21) of the Code through the following observation:

"4. Section 5(20) defines 'Operational Creditor' which is r/w Section 5(21) which defines 'operational debt'. In the present case, it is clear from the work order that the amount of Rs. 2,60,00,000/- was advanced by the respondent 'M/s. ISMT Limited to the 'corporate debtor' for supply of 10,000 Metric Tons of Indonesian Thermal Coal. From the aforesaid fact, we find that the respondent had not supplied any goods nor provided any services and, therefore, it does not come within the meaning of 'operational creditor'."

Similarly, the NCLAT, in its judgments in Roma Infrastructures India Private Limited v. A.S. Iron & Steel (I) Private Limited^[22] ["Roma Infrastructure"] and Andal Bonumalla v. Tomato Trading LLP^[23], relied on its aforementioned judgment in Kavita Anil Taneja (supra) and held that in cases where advance payment had been made for supply of goods and thereafter the supplier failed to supply whole or part of the agreed upon quantity of goods, the claim for refund of the advance amount or balance advance amount, as the case may be, would not be covered within the definition of 'operational debt' within the meaning of Section 5(21) of the Code.

This uncertainty regarding whether an advance payment for supply of goods or services qualifies as operational debt continued in the NCLTs as well, as apparent from the various contradictory judgments passed by them in this regard. NCLT, Amaravati, without even going into an analysis of the precedents in this regard, held that such advance could not be operational debt in terms of the Code in its order in Mironda Trade and Commerce Private Limited v. Sai Lakshmi Tulasi Ferros Private Limited^[24]. A similar view was expressed by NCLT, Mumbai, where the corporate debtor failed to install the ghee manufacturing plants for which it had taken advance payment from the applicant and did not refund such advance^[25]. In passing such order, the NCLT, Mumbai relied on its earlier order in Raj Process Equipments (supra) as well as the abovementioned order of NCLT, Kolkata in SHRM Biotechnologies (supra). However, the judgment of the NCLAT in Kay Bouvet (supra) was not taken into consideration in such order either. In yet another case, NCLT, Mumbai relied on Roma Infrastructure (supra) to reject a claim for refund of advance amount for undelivered goods as an operational debt^[26].

On the other hand, NCLT, Chennai, in Messrs. Christy Friedgram Industry v. Messrs. Shree Ambika Sugars Limited^[27], held that the failure of the corporate debtor to refund advance amount after failing to supply the agreed upon quantity of goods to the applicant amounted to an operational debt under Section 9 of the Code and was pleased to admit such application, albeit without referring to any of the contradictory precedents in this regard.

Further, NCLT, Hyderabad, in Venkatesh Biosciences LLP v. Genomelabs Bio Private Limited^[28], held that a claim for refund of amount that was advanced for certain services, was to be construed as an operational debt upon such services not having been provided by the receiver of such amount. It was held by NCLT, Hyderabad as follows:

"17. … In other words, the Operational Creditor agreed to give Rs. 7.5 lakhs in connection with expenditure incurred by the Corporate Debtor towards work orders under MSA. No doubt the money was given towards rendering services and therefore it is a debt and Petitioner is an Operational Creditor. The money so given to the Corporate Debtor was in connection with rendering services by Corporate Debtor to Operational Creditor. In other words, Corporate Debtor agreed to execute the work which is four task orders. Thus, money was given for rendering services. It comes within the meaning of operational debt and Petitioner is an Operational Creditor."

Furthermore, NCLT, Mumbai, admitted two applications under Section 9 of the Code, basis the claim for refund of advance paid for goods not delivered by the corporate debtor, in Dinesh Sharma v. Peerless Fabrikerne (India) Limited^[29] and Ada Cellworks Wireless Engineering Private Limited v. Global Rural Netco Limited^[30], though it must be mentioned here that the applications were virtually uncontested, and this legal issue was not traversed in much detail by the NCLT in these two orders.

It is interesting to note that in Mphasis Limited v. Strategic Outsourcing Services Private Limited^[31], where the applicant had made a claim for refund of an advance amount as a financial creditor under Section 7 of the Code, the NCLT, Bengaluru, held that such claim cannot be considered to be a 'financial debt' within the meaning of the Code, and observed as follows:

"13. And moreover, the advance payment is not covered in the definition of Financial Debt and it is covered under the Operational Debt. Hence, the Petition deserves to be rejected, and accordingly, C.P.(IB) No. 233/BB/2018 is hereby rejected, and the Registry is directed to communicate the Order to the Applicant and the Corporate Debtor."

5. The Sunteck Realty case-where amount is advanced by the service provider itself:

In the matter of Sunteck Realty Limited v. Goodwill Theatres Private Limited^[32], ("Sunteck Realty") NCLT, Mumbai was faced with a case with slightly peculiar factual circumstances wherein an application was preferred under Section 9 of the Code on the basis of non-refund of advance, however, the applicant-creditor was itself the service provider in this case as opposed to the previous cases where the applications were preferred by an applicant who had not been provided with the promised goods or services after payment of the advance amount.

In this case, the corporate debtor, being the owner of certain immovable property, appointed the applicant, a noted real estate developer in the city of Mumbai, to develop the said property commercially (which was the service to be provided by the applicant) and a term sheet was executed between the parties in this regard. As per the terms of the term sheet, the applicant was to make an advance payment of a certain sum to the corporate debtor towards such transactions. However, if the development agreement could not be finalized and signed between the parties, the term sheet would stand cancelled automatically and the advance payment had to be returned by the corporate debtor, along with interest as specified in the term sheet. Upon the non-fructification of the development agreement between the parties and the failure of the corporate debtor to refund the aforementioned advance, the applicant preferred the said application under Section 9 of the Code. The NCLT observed that it was apparent from a perusal of the term sheet that the intention of the parties was to engage the applicant's services for certain works, as specified therein, and further, the advance amount was a token amount which was part of the services provided by the applicant to the corporate debtor. The relevant observations of the NCLT in this regard are reproduced hereinbelow:

"15…(g) In the instant case, intention of parties while executing the binding Term Sheet clearly indicate that the Petitioner was engaged to perform the services in relation to the project as an agent / contractor on behalf of the owner and the Project Manager to accept engagement to undertake, provide and carry out such services subject to payment of Development Management Agreement fees by the Corporate Debtor. The scope of services of the Petitioner is well defined and the payment of fees under the project to the Petitioner is also well defined. The mutual obligation and covenants as detailed in the binding Term Sheet and thus demonstrates that this is the service which was required to be provided by the Petitioner to the Corporate Debtor and hence, this is construed to be an Operational Debt within the meaning of Section 5(21) of the Code read as follows:

Therefore, the binding Term Sheet dated 2nd August, 2018 clearly stipulates the obligation of the Petitioner to pay the money to the Corporate Debtor at the time of execution of the Term Sheet and hence, the liability of refund of such monies paid is well defined in the case of termination of the Term Sheet. Therefore, the Corporate Debtor is liable to refund the token amount to the Petitioner which is part of the services provided to the Corporate Debtor."

While it must be admitted that the decision of NCLT, Mumbai in the Sunteck Realty (supra) adopts a wider definition of 'operational debt' as compared to the instances where tribunals have held that an application under Section 9 of the Code is filed on the basis of a claim of non-refund of advance is not maintainable at all, however, the said decision must be seen in the perspective of its unique factual circumstances.

6. The NCLAT recognizes a claim for refund of advance amount for services not performed as an 'operational debt:

In its recent judgment in Jospeh Jayananda v. Navalmar (UK) Limited^[33] ("Navalmar Limited"), the NCLAT was called upon to decide an appeal preferred by an aggrieved director of the corporate debtor, admitted into CIRP by NCLT, Bengaluru. The creditor in this case had appointed the corporate debtor as its agent for providing various merchant shipping services in India and an agreement had been executed between the parties in this regard. Pursuant to the termination of such agreement, the creditor, among other claims against the corporate debtor, sought refund of certain amounts that had been advanced by it to the corporate debtor, which the corporate debtor failed and/ or refused to refund.

Faced with the question whether such claim for refund of advance amount could be classified as 'operational debt' within the meaning of the Code, the NCLAT relied on the judgment of the Supreme Court in Pioneer Urban Land and Infrastructure Limited v. Union of India^[34], ("Pioneer") wherein it had been observed as follows:

"42. … One other important distinction is that in an operational debt, there is no consideration for the time value of money—the consideration of the Debt is the goods or services that are either sold or availed of from the operational Creditor. Payments made in advance for goods and services are not made to fund manufacture of such goods or provision of such services. Examples given of advance payments being made for turnkey projects and capital goods, where customisation and uniqueness of such goods are important by reason of which advance payments are made, are wholly inapposite as examples vis-à-vis advance payments made by allottees."

The NCLAT thereafter went on to hold that while the advance made by the creditor to the corporate debtor did not involve any time value for money (and hence could not be classified as a 'financial debt'), the same was in the nature of an amount paid for services to be delivered in the future by the corporate debtor, and thus the same has to be classified as 'operational debt'. The relevant observation of the NCLAT in this regard is reproduced hereinbelow:

"1.4 In the instant case, the monies advanced by the R-1 to the Corporate Debtor were advance payment for work to be done in the future. Admittedly, the work was to be done in terms of the General Agency Agreement between the parties. The Corporate Debtor referred to these amounts as advance payment in its audited accounts and the objection filed by it before the NCLT. It even claimed that the said amount was "adjusted towards various cost and expenses incurred by the Respondent Company in the course of business, without raising any doubt about the nature of the Debt. Hence the amounts referred to as above cannot be treated as anything but Operational Debt under the Code. Further, in case of Pioneer (supra) Hon'ble Supreme Court has clearly held that in Operational Debt there is no consideration for the time value of money. The consideration of the Debt is the goods or services that are either sold or availed of from the Operational Creditor. Payments made in advance for goods and services are not made to fund the manufacture of such goods or the provision of such services. The advance payment being made for turnkey projects and capital goods, where customisation and uniqueness of such goods are important by reason of which advance payments are made. The liability or obligation in respect of a claim which is due from any person is defined as Debt under Section 3 (11) of the Code. It provides that the Debt includes Financial Debt and Operational Debt. Further, the term' Financial Creditor' and 'Financial Debt' is defined under Section 5 (7) & 5(8) of the Code. Section 5 (20) defines the term 'Operational Creditor' as a person to whom an Operational Debt is owed and includes any person who has been legally assigned or transferred. Section 5 (21) defines 'Operational Debt' as a claim in respect of the provision of goods or services including employment or a debt in respect of 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.

1.5 … Since the Corporate Debtor was an agent and service provider of the Operational Creditor, the amounts due under the transactions would fall within the ambit of Operational Debt as defined under Section 5 (21) of the Insolvency and Bankruptcy Code 2016."

While such a broad interpretation of Sections 5(20) and 5(21) of the Code by the NCLAT once again following the Kay Bouvet (supra) judgment is certainly welcome, it appears that the NCLAT has failed to clarify whether this is an overarching standard to be adopted in all cases where the buyer/ recipient has not been provided with the goods/ services by the supplier/ provider despite payment of advance, or only in certain cases where the advance has not been made in order to fund the manufacture of goods or provision of services but because the goods/ services to be provided are unique in nature requiring their own customisation, in line with the aforementioned example of the NCLAT cited from the Supreme Court's judgment in Pioneer (supra). It is hoped that this will be clarified in the future judgments of the NCLAT as well as NCLTs, where they are called to deal with situations involving 'operational debts' based on claims of non-refund of advance amounts.

Concluding Remarks

The question of whether homebuyers or entities which have paid certain advance amounts with regard to transactions involving immovable property would be eligible to claim a cause of action for operational debt under the Code has been thankfully settled with homebuyers being brought into the ambit of 'financial creditors' under the Code^[35].

However, whether a claim regarding refund of advance where goods or services have not been provided by a party, despite receipt of such advance, can be considered as 'operational debt' under the Code cannot be said to be conclusively settled, with the NCLTs see-sawing between both ends of the spectrum at different points in time. At this juncture, the wide interpretation of the provisions of the Code by the NCLAT acknowledging such a claim as an operational debt, in its aforesaid judgments in Kay Bouvet (supra) and Navalmar Limited (supra) becomes extremely critical. However, as discussed hereinabove, the said judgments of the NCLAT have also failed to conclusively settle the issue and contradictory orders are still being passed by the NCLTs and in fact by the NCLAT itself in this regard.

In this connection, it is pertinent to mention that the phrase 'a claim in respect of the provision of goods or services' is capable of being construed widely enough to bring into its ambit such claims regarding reimbursement of advance amounts by buyers/ service recipients who have parted with such sums but have not received the goods or services from the supplier as agreed upon. In fact, keeping with the growth of commerce in the country, a broad interpretation of Sections 5(20) and 5(21) of the Code is perhaps what is called for at this stage. Needless to say, such an approach should also come with the necessary checks and balances so that the Code is not used as a mechanism of recovery or as an arm-twisting tactic by buyers against suppliers where the issue of refund of advance amounts is disputed or where the supplier i.e., the debtor is a solvent company and such amounts can be recovered through civil suits or arbitrations or other modes under the law of the land.

It will therefore be interesting to see what approach the Supreme Court takes in deciding the appeal from the Kay Bouvet (supra) judgment as well as any other matter, as the Supreme Court's view in this regard will hopefully settle this controversy finally.

This paper has been written by Pooja Chakrabarti (Partner) and Somdutta Bhattacharyya (Principal Associate).

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