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Noida Comes Under Operational Creditor And Not Financial Creditor: Sc, An Analysis

In the case of New Okhla Industrial Growth Authority vs. Anand Sonbhadra, the Supreme Court on Tuesday found that the NOIDA is an operating creditor under the Insolvency and Chapter Code, 2016. (IBC/Code) and not a Financial Creditor.

Case Analysis Of  Noida Vs Anand Sonbhadra
Case Name: New Okhla Industrial Development Authority Vs Anand Sonbhadra
Case No: Civil Appeal 2222 Of 2021 Combined With Civil Appeal 2367-2369 Of 2021
Corum: Justice Km Joseph And Justice Hrishikesh Roy.

Brief Background Of The Case:
The appeal filed by NOIDA against the judgment of the National Company Law Appellate Tribunal (NCLAT), which held that NOIDA is an operational creditor under the IBC and cannot be considered a financial creditor of the Corporate Debtor under the provisions of the code, was dismissed by the Bench of Justice KM Joseph and Justice Hrishikesh Roy.

In another case of NOIDA vs Manish Gupta & Anr,[1] the NCLT was in Favor of NOIDA and held it as a Financial Creditor. The NCLAT stayed that decision and held that NOIDA is simply an operational creditor and not a financial creditor in both cases.

NOIDA, enraged by the verdict, filed an appeal with the Supreme Court & SC amalgamate both of the decisions together and formed the main issue that:
"Whether the appellant (NOIDA) is entitled to be considered as a financial creditor under the IBC"

Ratio Decidendi:

The Supreme court after hearing both sides came to the contentions one by one and analyzed various provisions of the Insolvency Bankruptcy Code, 2016. NOIDA highlighted the provision mentioned in Part 5(8)(d) of IBC and put forth its argument that it qualifies as a Financial Creditor.

According to Part 5(8)(d):
"The amount of any legal liability in respect of any lease or rent-to-own contract that is regarded to be a finance or capital lease under the Indian Accounting Standards or such other accounting requirements as may be specified;"

By using this section Noida highlighted that Noida is a financial creditor as per the provisions of the Indian Accounting Standard (IAS). After this SC started to analyze every section of IAS mentioned by the Appellant NOIDA which defines the characteristics of the financial lease.
  1. RULE 61 of Indian Accounting Standards: Under Rule 61, the lessor is obliged to classify each of its leases as an operating lease or a finance lease. There is no case for the appellant-NOIDA, that it has been classified as a finance lease. it can be seen that while it is not shown as a finance lease as such, the transaction is characterized as a sale on the balance sheet. This makes rule 61 not in favor of Appellant Noida.
  2. RULE 62 & 65 of Indian Accounting Standards: The Supreme Court examined NOIDA's argument based on IAS Rule 62 and 65, which states that a lease can be classified as a financial lease if it transfers substantially all of the risks and rewards incidental to the ownership of the given asset, and held that NOIDA does not transfer all of the risks and rewards incidental to the ownership to the lessee, and thus the circumstances of Rule 62 and 65 do not meet in the current state of affairs.
  3. RULE 63 of Indian Accounting Standards: The Supreme Court cited IAS Rule 63, which provides that�"a lease is a finance lease if the lease period covers the majority of the economic life of the underlying assets, even if the title is not transferred". The Supreme Court determined that the lease in question is for 90 years and that the concept of the economic life of the land is inapplicable in this case s the economic life of the land cannot be calculated. After 90 years we cannot say that the land has DIED or is no more useful.

"�It will not be attainable to carry that the lease is for the most important a part of the financial lifetime of the land. It can't be mentioned that on the expiry of 90 years the land will stop being economically usable. Due to this fact, we can't settle for the argument of the appellant that after 90 years appellant wouldn't get the empty parcel of land and the land wouldn't be of any industrial use to the appellant after the expiry of the lease." (Part 73 of Judgement).

After clearing all the contentions and arguments of the appellants about the sections of the Indian Accounting Standard, the SC finally also take Section 5(8)(f) under its preview to examine it with the case of NOIDA.

"5(8)(f): any quantity raised beneath every other transaction, together with any ahead sale or buy settlement, having the industrial impact of a borrowing;
This section of the Code identifies a creditor as a monetary creditor in the event of a debt of any financial borrowing specifically to anyone to whom such debt has been lawfully transferred or conveyed.

Before the bench, the question was whether renting or paying premiums influenced financial borrowing. However, the bench after careful examination of this case states that "the lessee's obligation to pay the rental and premium cannot be treated as a quantity raised by the lessee from the appellant and hence cannot come under the Financial Dept, this is only an operational debt." (Para- 138, 144)

The Supreme Court Dismissed the Appeals filed by the NOIDA for the decision of NCLAT and held the decision of NCLAT stand faultless.
The Parties to bear their own cost.

Why Noida Was So Reluctant To Be A Financial Creditor And Not An Operational Creditor?

Various clauses of the IBC, as well as the Uttar Pradesh Industrial Area Development Act, 1976, under which 'NOIDA' was constituted, were thoroughly scrutinized by the Supreme Court while giving the ruling.

"It is undeniably true that, under the design of the IBC, Section 21 of the IBC anticipates the formation of the Committee of Creditors," the Court wrote in its decision. The Committee of Creditors will be made up of all of the corporate debtor's financial creditors. The Committee of Creditors has the authority to appoint and remove the Interim Resolution Professional from his or her position as Resolution Professional. The Committee of Creditors, which would consist only of financial creditors, would have the power to replace a Resolution Professional under Section 27 of the IBC."

"By being a Committee member of Creditors, the appellant will have the right to place its perspective," the Court continues. It would have the chance to persuade the other Committee of Creditor's members to adopt, reject, or amend a Resolution Plan."

The Bankruptcy Law Reforms Committee distinguished between financial and operational creditors in paragraph 5.2.1 of its final report. It reads:
"The Code distinguishes between financial and operational creditors in this case. Financial creditors are those who have a pure financial contract with the entity, such as a loan or debt security. Operational creditors are people who owe the firm money because of a business transaction... The Code also addresses situations in which a creditor has both a financial and an operational relationship with the company. The creditor might be classified as a financial creditor for the financial debt and an operational creditor for the operational debt in this situation."      

What is The Waterfall Mechanism For Liquidation?
The waterfall mechanism under the Insolvency and Bankruptcy Code gives priority to secured financial creditors over any other creditors.

The mechanism says that if a company is being liquidated, these secured financial creditors must be first paid the full extent of their admitted claim before any sale proceedings are distributed to any other unsecured creditor or Operational Creditor. This is why a Company or NOIDA in this case tries hard to prove itself as a financial creditor and not an operational creditor.

To effectively launch a corporate insolvency resolution proceeding against a debtor, it is essential to show that the creditor is within the scope of the IBC's definitions of "Financial Creditor" as defined in Section 5(7) or "Operational Creditor" as defined in Section 5(20).

With this Judgment, the Supreme Court has clearly taken its stance on one of the most important aspects and conflicts of IBC. Hardly six years old, the Insolvency and Bankruptcy Code continues to be a fertile ground to spawn litigation. Born in the year 2016, the IBC this time around has given rise to the question as to whether the appellant would be a financial creditor and entitled to be so treated in the Corporate Insolvency Resolution Process commenced against the corporate debtor under the IBC.

Financial creditors are given higher priority since they are members of the creditor's committee and have voting power, whereas operational creditors are not. The main issue is that some operational creditors are treated unfairly since the legislation protects the rights and interests of financial creditors. This is backed by the fact that when operational creditors file an application, the corresponding class has no authority to make any proposals during the creditor's committee meeting.

The Judgment which is supporting the decision of the NCLAT will emerge as a precedent where it will highlight on what grounds an Entity or a person will be called a financial creditor.

  1. Civil Appeal No. 2367-2369 OF 2021
Written By: Ketan Aggarwal: National Law University, Lucknow

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