NON-PAYMENT OF LEASE RENTALS IS AN OPERATIONAL DEBT UNDER THE INSOLVENCY AND BANKRUPTCY CODE

The insolvency resolution process in India has in the past involved the simultaneous operation of several statutory instruments. Broadly, the Sick Industrial Companies Act, 1985 (hereinafter referred to as ‘SICA’), the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (hereinafter referred to as ‘SARFAESI’), Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (hereinafter referred to as ‘RDDBI) and the Companies Act, 2013 provided for a disparate process of debt restructuring and asset seizure and realization in order to facilitate the satisfaction of outstanding debts. The multiplicity of statues offering insolvency and liquidation remedies gave rise to immense confusion in the legal system and thus, there was a crucial need to overhaul the insolvency laws as the nation was beholding a huge piling-up of NPA[1]s and creditors waiting for years at end to recover their debts.
Thus, the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as ‘Code’) is an effort at a comprehensive reform of the fragmented regime of corporate insolvency framework, in order to allow credit to flow more freely throughout the nation by withholding the confidence of investors by quick disposal of their claims.
The Code is applicable to any company incorporated under the Companies Act, 2013; any other company governed by any special act, any limited liability partnership incorporated the Limited Liability Partnership Act, 2008; such other body incorporated under any law for the time being in force as the Central Government may, notify in this behalf; partnership firms and individuals on relation to their insolvency, liquidation, voluntary liquidation or bankruptcy.[2]
In the event, a debtor is unable to discharge its debts due to its creditors, the Code provides the creditors the means to trigger Corporate Insolvency Resolution Process (hereinafter referred to as ‘CIRP’) against such debtor. Unlike the preceding legislations, the new Code categorizes creditors as Financial Creditor[3] and Operational Creditor[4] categorically on the basis of nature of debt[5] owed to the debtor.
The Code is a new dynamic legislation evolving on a daily basis either by clarificatory amendments by the legislature or by new judicial pronouncements by the Supreme Court, National Company Law Appellate Tribunal (hereinafter referred to as ‘NCLAT’) and the National Company Law Tribunal (hereinafter referred to as ‘NCLT’) defining the scope and ambit of the Code.
In view of the above, the present article serves as a litmus test to adjudicate whether non-payment of lease rental by the corporate debtor to the creditor is an operational debt and whether such creditor qualifies as an operational creditor under the Code.
An Operational Creditor means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred[6]. In order to ascertain as to who is an operational creditor it is imperative to point out as to what would qualify as an operational debt. An operational debt means ‘a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment 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’[7].
The transaction to provide the service of lease and/or furnishing of premises for commercial/retail purposes in lieu of monthly rent duly qualifies as ‘Operational Debt’ as defined under the Code. The term ‘goods or services’ used in the definition of operational debt has a direct correlation between the input to the output produced or supplied of the debtor. In this regard it is pertinent to refer to the decision rendered by the Hon’ble National Company Law Tribunal, Single Bench, New Delhi in Pramod Yadav & Others v. Divine Infracon Pvt. Ltd.[8] wherein the Adjudicating Authority has held that the transaction in relation to immovable property cannot be considered as a transaction falling under the term ‘operation’ and ‘operational debt’ unless such a transaction has a correlation of direct input to the output produced or supplied by the Corporate Debtor.
It is now trite to highlight the legal scope of operational debt in connection with non-payment of lease rentals under the Code. The mere act of non-payment of a debt (whether whole or any part) which is due and payable by the debtor and is not paid becomes an act of default[9] under the Code. Therefore, a default occurs when the debtor fails to discharge a debt which has become due and payable by it for the provision of services. It can be discerned that the term debt[10] has been given a wide amplitude and it also signifies the intention of the legislature to name two kinds of debt specifically i.e. ‘financial debt’ and an ‘operational debt’. Thus, the definition of ‘debt’ under the Code is an inclusive definition and should be interpreted widely and purposively to include other kinds of debt as well.
In R.M. Investment and Trading Company Pvt. Ltd. v. Boeing Company and Anr[11], while dealing with the expression ‘commercial’, the Apex Court has opined that the expression ‘commercial’ should be construed broadly having regard to the manifold activities which are integral part of international trade today. Thus, when a debtor takes a premise for commercial purpose, it is basically to sub serve the cause of facilitating commerce, business and promoting the same. Therefore, there can be no trace of doubt that an element of value addition is involved and once there is a value addition, there is an element of service. Thus, the leasing service being rendered by a creditor owning the premise is for facilitating commercial and business activities of the debtor which in turn essentially brings value addition thereby involves an element of service.
Notably, service tax liability on renting of immovable property was introduced under the provisions of Section 65(90a), Section 65(105) (zzzz) and Section 66 of the Finance Act, 1994 as amended by Finance Act, 2007, with effect from 1.06.2007. Renting of immovable property for use in the course or furtherance of business or commerce was made taxable under Section 65(105) (zzzz) of the Finance Act 1994. The phrase “in the course or furtherance of business or commerce” for the purposes of this clause included “use of immovable property as factories, office buildings, warehouses, theaters, exhibition halls and multiple-use buildings”[12].
The Hon’ble High Court of Delhi in the matter of Home Solutions Retails (India) Ltd. v. Union of India and Ors.[13], while defining the meaning of Service held that:
“65. Every building or premises cannot be utilized for commercial or business purposes. When a particular building or premises has the “effect potentiality” to be let out on rent for the said purpose, an element of service is involved in the immovable property and that tantamount to value addition which would come within the component of service tax. To further clarify, an element of service arises because a person who intends to avail the property on rent wishes to use it for a specific purpose.”[14]
That the imposition of service tax under Section 65(105)(zzzz) read with Section 66 of the Finance Act, 1994; taxed an activity, and the activity denotes the letting or leasing with a purpose, and the purpose is fundamentally for commercial or business purpose and its furtherance. Thus, there is “effect potentiality” in the premises let out on lease for the commercial/retail purpose, an element of service is involved in the immovable property and therefore, the same falls within the ambit of operations and thereby construes as an operational debt and as such the creditor as an Operational Creditor.
The Hon’ble Punjab and Haryana High Court has further reiterated the aforesaid view in the matter of Shubh Timb Steels Limited v. Union of India (UOI) and Anr.[15] and has categorically stated that:
“22. It cannot be held that renting of property did not involve any service as service could only be in relation to property and not by renting of property. Renting of property for commercial purposes is certainly a service and has value for the service receiver”[16].
Therefore, in view of the above mentioned decisions of Home Solutions and Shubh Timb Steel, it is rightful to conclude that the activity of renting premises for commercial/retail purposes is a service.
Reliance shall also be placed on the report of the Bankruptcy Law Reforms Committee (hereinafter referred to as ‘BLRC’) as presented to the Government of India particularly at paragraph 5.2.1, which is produced for ready reference as below –
‘5.2.1. Here, the Code differentiates between financial creditors and operational creditors. Financial creditors are those whose relationship with the entity is pure financial contract, such as a loan or a debt security. Operational creditors are those whose liability from the entity comes from transaction on operations. Thus, the wholesale vendor of spare parts whose spark plugs are kept in inventory by the car mechanic and who gets paid only after the spark plugs are sold is an operational creditor. Similarly, the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease. The Code also provides for cases where a creditor has both a solely financial transaction as well as an operational transaction with the entity. In such a case, the creditor can be considered a financial creditor to the extent of the financial debt and an operational creditor to the extent of the operational debt’[17].
Thus, the aforesaid paragraph from the BLRC reinforces the transaction of lease of premises by a creditor and will fall within the term ‘services’ as defined under Section 5(21) of the Code.
In M/s Prasad Production Pvt. Ltd. v. M/s Diksat Transworld Ltd.[18], the petition filed by the petitioner therein was transferred from the Hon’ble High Court of Madras on 09.11.2016 to National Company Law Tribunal, Division Bench, Chennai and was dealt with under Section 9 of the Code. The said petition was filed on account of outstanding arrears of rent to be paid by the corporate debtor. The same was admitted by the Hon’ble National Company Law Tribunal, Division Bench, Chennai considering the arrears of rent as Operational debt and accordingly, moratorium was declared.
Similar view was taken by Hon’ble National Company Law Tribunal, Division Bench, Chennai, in Lakshmi Vilas Bank Limited v. Orchid Pharma Limited[19], wherein the Hon’ble Adjudicating Authority categorically considered letting out premises on rent is nothing but providing services and therefore, the same is an operational debt and the petitioner therefore is an operational creditor, accordingly, the same was admitted by the Hon’ble Adjudicating Authority and moratorium was commenced.
In M/s Seth Thakurdas Khinvraj Rathi v. M/s Cals Refineries Ltd.[20], the Hon’ble National Company Law Tribunal, Bench – II, New Delhi, admitted the petition filed under Section 9 of the Code against unpaid debt arising out of a Leave & License Agreement as well as License & Hire Charges Agreement for both dated 10.03.2008 for use and occupancy of immovable property. The Hon’ble Tribunal held that the liability stands crystallized and is therefore, admitted. Thus, the unpaid amount arising out of a Leave & License Agreement as well as License & Hire Charges Agreement for use and occupancy of immovable property was held to be Operational Debt and the petitioner therein was Operational Creditor.
In Mahesh Madhavan v. M/s Black N Greem Mobile Solutions Pvt. Ltd.[21], the Hon’ble National Company Law Tribunal, Single Bench, Chennai, held that the lease rents due to a lessor would come under the ambit of operational debt as evidenced by a decision. Thus, the transaction in relation of immovable property resulting in lease rents due to a lessor would come under the ambit of operational debt.
In Sarla Tantia v. Nadia Health Care Private Limited[22], the Hon’ble National Company Law Tribunal, Kolkata Bench, has categorically held that the letting-out of premises for rental income is services and service tax is payable on the income from the same. The view opined by the Hon’ble Adjudicating Authority is an uti furi of the findings made by the Hon’ble Apex Court in the case of Mobilox Innovations Pvt. Ltd vs Kirusa Software Pvt. Ltd.[23], wherein it was held that , “The report of the Bankruptcy Law Reform Committee Volume I, Rational and Design dated November, 2015 at 5.2.1 under the heading “Who can trigger the IRP” also provides that the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three years lease” [24] and the provisions of section 2 of Central Goods & Services Tax Act, 2017.
It seems that there is no conformity or clarity on the aforesaid issue of whether letting out of an immovable property to a debtor is an operation or not the New Delhi Bench and the Kolkata Bench differ in their view of whether letting out an immovable property falls under the domain of a claim in respect of the provision of goods or services as provided in the definition of operational debt. The NCLT Delhi views the transaction relating to immovable property will not fall under the term ‘operations’ and therefore dues arising out of letting out of an immovable property is not an ‘operational debt’ and therefore, application under section 9 will not be maintainable. On the contrary the NCLT Kolkata placing reliance on the decision of Hon’ble Supreme Court has held that the dues arising out of letting-out of an immovable property will fall under the definition of operational debt and will fall under the purview of the Code and therefore, an application under section 9 is maintainable.
Though the Adjudicating Authorities across the nation have conflicting views on non-payment of lease rentals and there is dire need to settle this question of law for larger benefit of many creditors.
Upon perusal of the aforesaid findings of the judicial forums it is affirmative to conclude that non-payment of lease rental by the corporate debtor to the creditor is an operational debt and such creditor qualifies as an operational creditor under the Code.