India - Lease And Rentals: Are These Operational Debt Under The IBC?
Legal News & Analysis - Asia Pacific - India - Dispute Resolution
14 June 2021
The Insolvency and Bankruptcy Code, 2016 (‘Code’) recognises two types of debts — financial and operational– to enable the creditors to make an application for initiating insolvency proceedings against a corporate debtor. A financial creditor and an operational creditor can initiate a Corporate Insolvency Resolution Process (‘CIRP’) under Section 7 and Section 9 of the Code, respectively. If there is a debt, other than a financial debt or an operational debt, the creditor will not qualify to apply under Sections 7 or 9 of the Code, as the case may be. Therefore, it becomes important to determine the nature of debt/claim while considering the application of an admission under the Code.
In the recent past, the insolvency courts have been debating whether or not lease and rentals dues can be treated as operational debt. The issue has evoked different opinions from different benches of the National Company Law Tribunal (‘NCLT’). For instance, NCLT Delhi and NCLT Hyderabad have held that lease rent dues are not operational debt while NCLT Chennai, NCLT Kolkata and NCLT Ahmedabad have taken a contrarian view, maintaining such dues would qualify as operational debt and a landlord can be counted as an operational creditor under the Code for providing the lease that can be treated as providing ‘services’ to the corporate debtor. The NCLT Mumbai gave two rulings on the same day by upholding claim towards arrears of rent to be operational debt in Indiabulls Real Estate Company Pvt. Ltd. v. Crest Steel Power Pvt Ltd. and ruling that unpaid amount towards rent/license fees did not amount to an operational debt under the Code in the matter of Citicare Super Specialty Hospital v. Vighnaharta Health Visionaries Pvt. Ltd. (‘Citicare’). An appeal was subsequently preferred before the NCLAT in Citicare, however, the same was dismissed. In fact, as has been dealt with in this blog, even the Hon’ble National Company Law Appellate Tribunal (‘NCLAT’) has had multiple occasions to deal with the issue; unfortunately, the jurisprudence that has evolved is far from being conclusive.
Before getting into the jurisprudence that has evolved through case laws, it is important to understand what is an ‘operational debt’. An operational debt has been defined in Section 5(21) of the Code and it is essentially a claim in respect of the following:
Provision of goods;
Provision of services, including employment; or
A debt arising under any statute and payable to government/local authority
APPROACH OF THE NCLAT
The issue regarding treatment of rent arrears as operational debt came up for consideration before the NCLAT in the matter of Mr. M Ravindranath Reddy v. Mr. G. Kishan & Ors(‘Ravindranath Reddy’) where the NCLAT had to decide whether a landlord’s act of leasing/renting out space will be treated as providing services to the corporate debtor, and hence, he/she becomes an operational creditor within the meaning of Section 5(20) read with Section 5(21) of the Code. In order to answer the question, the NCLAT deciphered the intention of the lawmakers by analysing the Bankruptcy Law Reforms Committee Report (‘BLRC Report’) in which the BLR Committee, while differentiating between a financial creditor and an operational creditor, indicated that “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,” While noting the BLRC’s recommendation of treating lessors/landlords as operational creditors, The NCLAT clarified that the Legislature has not completely adopted the BLRC report, and only the claims in respect of goods and services has been kept in the definition of operational creditor and operational debt under Section 5(20) and 5(21) of the Code. The NCLAT held that the definition does not give scope to interpret rent dues as an operational debt. By giving a strict interpretation to Section 5(21) of the Code, the NCLAT held that only when a claim by way of debt falls within one of the three categories mentioned in Section 5(21) will it be categorised as an operational debt. It further held that for a debt to qualify as operational debt, the debt must have arisen with a nexus of direct input to the direct output produced. Based on the above reasoning, the NCLAT held that lease of immovable property cannot be considered as a supply of goods or rendering of any services and thus, cannot be considered as operational debt.
Subsequently, the NCLAT in the case of Anup Sushil Dubey vs. National Agricultural Co-operative Marketing Federation of Indian Limited & Ors. (‘Anup Sushil Dubey’) was once again faced with the question of deciding whether dues arising from leave and licence agreement would qualify as operational debt and the court answered in the affirmative. The NCLAT lifted the definition of “service” and “activities” to be treated as supply of service from the Consumer Protection Act, 2019 and the Central Goods and Services Tax Act, 2019 and held that when premises are leased out for ‘commercial purpose’ it would fall within the meaning of ‘service’ for the purpose of Section 5(21) of the Code. The NCLAT deviated from its judgment in Ravindranath Reddy and placed reliance on the judgment of Supreme Court in Mobilox Innovations Private Limited vs. Kirusa Software Private Limited,(‘Mobilox’). The NCLAT noted that the Supreme Court in paragraph 5.2.1 of the judgment observed that ‘lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease,’ and thus held that lease rentals arising out of use and occupation of a cold storage unit which is for commercial purpose will qualify as operational debt.
Recently, the NCLAT in Promila Taneja v. Surendri Design Pvt. Ltd. (‘Promila Taneja’) had another occasion to deal with the issue. The NCLAT taking note of the conflicting judgments on the issue, and after analysing the available jurisprudence on the matter, upheld the view taken in Ravindranath Reddy. The NCLAT made reference to Section 3(37) of the Code, which provides that if the undefined words and expressions used in the IBC can be found defined in the Acts mentioned in the Section, they can be directly imported. The NCLAT held that the definition of “Service” and “Activities” cannot be imported from the Consumer Protection Act, 2019 and the Central Goods and Services Tax Act, 2019 as both the Acts do not find a mention in Section 3(37) of the Code. Further, on the parameter of interpretation of statutes, the NCLAT analysed Section 5(8)(d) of the IBC, which while defining financial debt says that it includes “the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standard or such other accounting standards as may be prescribed;” Accordingly, the NCLAT held that a perusal of the above definition makes it clear that the legislature was conscious of liabilities arising from lease and made specific provision to club it under a financial debt, but no such provision was made for operational debt.
For the above-mentioned reasons, the NCLAT upheld the judgment in Ravindranath Reddy.
It is important to note here that the judgment in Anup Sushil Dubey and Promila Taneja was delivered by a two-Judge Bench of the NCLAT, while in Ravindranath Reddy, it was delivered by a three-Judge Bench of the NCLAT.
A perusal of the decisions by NCLAT and various benches of the NCLT highlights the diverse views on the subject matter. The issue has now travelled up to the Supreme Court by way of an appeal filed before it in the case of Promila Taneja and the Apex Court has issued notice in the matter. Considering, the conflicting stands taken by various benches, it has become imperative for the Supreme Court to consider the larger issue of claims arising due to the use of immovable property and other connected services and finally put to rest the question of rent arrears qualifying as operational debt.
For further information, please contact:
Bishwajit Dubey, Partner, Cyril Amarchand Mangaldas
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