Discerning 'time value of money' under IBC: A Tale of Muddled Jurisprudence
Anuj Dubey and Amay Bahri†
The Insolvency and Bankruptcy Code 2016 (“IBC” or “the Code”) was envisaged as a game-changer for the Indian economy. However, after 5 years since its enactment, the jurisprudence developed so far is lacking and incomprehensive. The problem is compounded by conflicting decisions by courts and tribunals which reflect the lack of clarity and consensus on the law. The understanding of ‘financial debt’ is one such highly litigated and contentious issue. Financial debt determines the financial creditors of the corporate debtor (“CD”), who in turn form part of the Committee of Creditors (“CoC”). CoC is instrumental in the insolvency resolution process as the authority to accept or reject the resolution plan vests in it.
Financial debt is defined under section 5(8) of the Code, and has ‘time value of money’ as one of its essential features. The phrase “time value of money” is not defined under the Code, however, a few decisions help in developing an understanding of the same. In this piece, we discuss the time value of money in the context of financial debt under IBC. The first part examines the decision of Pioneer Urban Land and Infrastructure Limited & Anr. vs. Union of India & Ors. (“Pioneer Urban'') and argues in favour of the Supreme Court’s (“SC”) interpretation of ‘time value of money’ (“TVM”). The second part analyses the recent ruling of Orator Marketing Pvt. Ltd. vs. Samtex Desinz Pvt. Ltd. (''Orator Marketing'') and argues that the SC’s approach in this case has distorted the meaning of financial debt.
Decision in Pioneer Urban
While the interpretation of financial debt remains a contentious and much litigated issue, attention is seldom paid to the understanding of TVM, specifically in the context of financial debt. Prior to the homebuyers' controversy regarding the inclusion of homebuyers as financial creditors under the Code, TVM was simply understood as being similar to regular or timely returns on investments (or interest on a loan).
The issue culminated in the SC's ruling in Pioneer Urban, wherein the SC upheld the constitutional validity of the amendments, thereby granting the status of financial creditors to the homebuyers. The SC clarified that the TVM is not only the regular or timely return received for the duration of the amount given but would also be the value gained when the buyer makes advance payments (allowing the developer to raise finances for construction of the property) instead of making a lump sum payment for a completed property. The cost the buyer would have to pay for a completed property would be far greater than the advance payments made for financing the construction, and the money saved in the process will be the time value of money.
The Pioneer Urban judgement is often criticised for broadening the scope of TVM. It is argued that TVM requires an amount, in addition to the principal, which would act as consideration for deferring the spending power of money, and the same is lacking as there is no repayment of any amount by the debtor. This is a restrictive interpretation of the phrase and borders on the implication that interest is essential to financial debt. A simple reading of the principal clause of section 5(8) would indicate that this implication is illogical and is clearly not the intention of section 5(8) as the provision uses the words “..interest, if any..”. In Pioneer Urban, SC clarifies that the TVM does not necessarily require an amount, in addition to the principal. What is required is some form of benefit accruing to the creditor as a return for providing money for a long duration. When the creditors are able to gain a certain benefit (in the form of discounted rate) by financing, rather than by paying a lump sum at a later date, the discount will be the value derived by the creditor.
The SC’s interpretation has offered a different perspective for understanding TVM in the context of financial debt under IBC. This decision significantly contributes and enriches the understanding of the often-overlooked aspect of TVM and points to the direction in which the understanding of financial debt will develop in the future. Hence, to the extent of interpreting TVM, the authors find the criticism of Pioneer Urban to be completely unfounded.
Decision in Orator Marketing
In July 2021, in Orator Marketing, the SC held that a lender advancing an interest-free loan to a corporate debtor would qualify as a financial creditor. To understand why this decision warrants scrutiny, we must first discuss the fundamentals of financial debt under IBC.
The opening words of the definition clause of Section 5(8) provide that a financial debt is a debt disbursed “against the consideration for the time value of money” and it includes the transactions enumerated in the subsequent sub-clauses. Further, in Nikhil Mehta v. AMR Infrastructures Ltd., which was one of the first decisions to delve into the understanding of time value of money, the NCLT and NCLAT referred to the Black’s Law Dictionary and defined TVM as “the price associated with the length of time that an investor must wait until an investment matures or the related income is earned.” Moreover, the Insolvency Law Report of 2018, which was heavily relied upon in Pioneer Urban, also understood ‘time value’ under Section 5(8) to mean “compensation or the price paid for the length of time for which the money has been disbursed.”
In Anuj Jain (RP) vs. Axis Bank Limited (“Anuj Jain”) the SC underscored the above point by succinctly observing that Section 5(8) could not be read so expansively that the core requirement of ‘disbursement’ against ‘the consideration for the time value of money’ is forsaken, thus allowing any form of transaction to qualify as financial debt. In other words, any transaction enumerated under sub-clauses (a) to (i) of Section 5(8) would qualify as financial debt only if the essential component of ‘disbursement’ against ‘the consideration for the time value of money’ stated in the principal clause is found in its genesis.
From the discussion hereinabove, it is clear that the element of disbursal against the consideration for TVM is a prerequisite for a debt to qualify as financial debt. In Orator Marketing, the NCLAT and NCLT emphasized precisely the same point - they highlighted how the requirement of consideration against TVM was not satisfied in the dispute before them since the loan was disbursed without any interest. The SC, in its analysis, failed to engage with this point and did not determine whether the consideration for TVM was present in the case. While the SC correctly held that interest is not essential to financial debt, it erred in relying on the rule of expansive interpretation to justify the inclusion of interest-free loans under financial debt. The SC highlighted that the usage of the term “includes” within Section 5(8) signifies that the provision allowed expansive interpretation, observing that “where the word is defined to include something, the definition is prima facie extensive.” Consequently, the SC held that interest free term loan would constitute financial debt since the transaction had a “commercial effect of borrowing”.
Notwithstanding the extent to which the provision permits wide interpretation, the essential components of the provision cannot be forsaken and overridden. As observed in Anuj Jain, if the transaction lacks the essential features under the principal clause, expansive interpretation cannot come to its rescue. Hence, while expansively interpreting Section 5(8), the SC forsook the core requirement of disbursal against the consideration for TVM. In this context, the SC’s conclusion that any transaction having commercial effect of borrowing is financial debt, appears illogical and the same is evident by a simple reading of the principal clause of section 5(8) with section 5(8)(f) - any amount can be financial debt as long as it has the commercial effect of borrowing, provided that it is disbursed against the consideration for time value of money. Thus, the SC’s interpretation in Orator Marketing effectively increases the scope of section 5(8) to cover transactions merely falling under any of the sub clauses (a) to (i) of section 5(8), thereby rendering the aspect of TVM superfluous.
Characterisation as ‘other creditor’
The term loan in Orator Marketing was granted without any interest or benefit accruing to the creditor. The CD only had to return the borrowed principal amount after a period of 2 years. Therefore, the disbursal of the loan was not against the consideration for TVM, and, hence, it could not have constituted financial debt and the lender could not have been classified as a financial creditor. The SC could perhaps have classified the creditor under “other creditors”, a third class of creditors introduced by the 2017 amendment to Regulation 9 of the CIRP Regulations. Although these creditors do not have the same rights as financial and operational creditors - they cannot institute CIRP - they can only submit claims during the corporate insolvency resolution process. Thus, the lender in this case would have been able to submit its claim during a CIRP already ongoing against the CD.
Implications of Orator Marketing
The increase in the ambit of ‘financial debt’ is a double-edged sword. On one hand it gives a desirable outcome as it permits a wider class of creditors to take recourse under IBC and initiate the insolvency resolution process early; thereby raising alarms about troubled businesses, which would in turn increase the chances of the CD getting back on its feet. On the other hand, this decision will open the floodgates for debts without time value of money, but having the commercial effect of borrowing, to qualify as financial debt and come within the ambit of IBC.
Further, by failing to discuss whether creditors with interest-free loans are classified under “other creditors” the decision leads to dilution in the strict demarcation of operational, financial and other creditors under the Code. This approach creates confusion with regards to the constitution of the CoC which only consists of financial creditors. The instrumental role played by the financial creditors as the sole participants of the CoC cannot be understated and the commercial wisdom of the CoC is seldom questioned because it is essential to the resolution process of the CD. The differential treatment meted out to operational creditors and financial creditors in the context of CoC was justified and upheld in Swiss Ribbon Pvt. Ltd. vs. Union of India wherein the SC observed that financial creditors are better placed to evaluate a resolution plan, and decide on the viability of the same. The muddled understanding of financial debt in Orator Marketing will lead to other types of creditors participating in the CoC, thus disrupting the resolution process of the CD. By muddling the interpretation of financial debt in order to characterize the creditor in this case as a financial creditor, the SC appears to have attempted to fit a square peg in a round hole.
From the aforesaid discussion, it is clear that the understanding of financial debt under IBC is unrefined. This is further compounded by the inconsistent approach of the SC leading to a muddled jurisprudence on financial debt. In Pioneer Urban, the SC correctly interpreted that ‘time value of money’ would mean compensation or the price paid for the length of time for which the money has been disbursed. However, the recent decision of the SC in Orator Marketing has diverged and distorted the meaning of financial debt. It sets a dangerous precedent where the SC has completely disregarded the aspect of time value of money from the analysis of financial debt. As explained above, such a precedent will have wide repercussions as it impacts the decision-making process of the CoC, and sets IBC on the path of debt recovery mechanism. There is a need for clarity and a consistent view on financial debt, given the fact that it is one of the fundamental pillars on which the legal framework of IBC stands.
† Anuj Dubey and Amay Bahri are final year students at National Law University, Delhi.