Solve the problem of interest and insolvency
JThe interest component has played an important role in admitting a business into bankruptcy when the required monetary threshold is not partially met. The question that arises in these situations is whether the interest component can be added to the total debt to calculate the threshold value for admitting a company into insolvency.
Given that the Insolvency and Bankruptcy Code, 2016 (IBC), makes a clear distinction between financial debt and operational debt, the question is whether interest can be included in these two types of debt for admission of a business into insolvency under the IBC.
The Code provides the definition of financial debt under Article 5(8), where “financial debt” means debt together with interest, if any, that is disbursed in return for the time value of the silver. The situation is therefore clear in terms of financial debt, interest should be added for the calculation of the threshold. However, Article 5(21) of the CIB defines operating debt as “a debt relating to the provision of goods or services, including employment, or a debt relating to the reimbursement of contributions”, which makes the hazy situation.
The main bench of the National Companies Law Appellate Tribunal (NCLAT) faced a similar issue in the Prashant Agarwal case, where the operational debt claimed amounted to INR 9.78 million (USD 122,900), which was less than at the minimum threshold of INR10 million as per section 4 of the code. However, the inclusion of the interest component meant that insolvency could be initiated under the code. The National Company Law Tribunal (NCLT) admitted the insolvency case, citing another of its judgments in Pavan Enterprise, which said that in terms of any agreement, the debt would include any interest.
The NCLAT said that to include interest, consistent with the definition of “operational debt” as well as “debt”, the code makes it necessary to have a liability/liability in respect of a claim, which is owed by every person. The definition of claim under Article 3(11) states that “claim” includes, inter alia, a right to payment.
The NCLAT concluded that since late payment interest was clearly stated on an invoice and therefore would give rise to the “right to payment” under IBC Article 3(6) and, by therefore, would form part of the “debt” in accordance with Article 3(11) of the Code. The company could be admitted into bankruptcy in accordance with the provisions of the code.
The NCLAT also noted that there had been differing opinions taken by various NCLTs. In one case, the Chandigarh bench of the NCLT refused to include the interest component when calculating the threshold, stating that the bills were a unilateral act of the creditor and the creditor’s claim could not stand. Moreover, since the interest rate was not fixed, the court had no obligation to determine the rate.
However, the matter may become trickier, as the code does not allow the NCLT to undertake a detailed examination of the evidence, which is confusing. In another slightly different decision, in Steel India v Theme Developers, the NCLAT held that the amount of accrued interest could only be claimed if mutually agreed to by the parties. Thus, similar disputes are expected to continue to arise unless the issue is resolved by the Supreme Court or the IPC is amended to allow for detailed review.
Meanwhile, it can be concluded from the precedents that where there are clear agreements on the interest rate, the interest claim can be added to the total debt to meet the insolvency criteria.
In light of this, the appeal was upheld and the judgment and order of the Orissa High Court, as well as the appointment of the sole arbitrator, were set aside. The court had no power to consider the claim made under section 11(6) of the law regarding the contractual arrangement. Furthermore, the defendant had filed an interim application in the High Court of Andhra Pradesh under Section 9 of the Act. Therefore, the request for the appointment of the arbitrator could only be considered by the High Court of Andhra Pradesh.
The Dispute Summary is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi and Mumbai. Authors can be contacted at [email protected] Readers should not act upon this information without seeking professional legal advice.