Lease Rental Arrears – Operational Debt?

NCLAT, Delhi in Company Appeal (AT) (Insolvency) No. 331 of 2019

CP (IB) No. 134/09/HDB/2018 [Arising out of Order dated 21st January 2019 passed by NCLT, Hyderabad in]

Mr. M. Ravindranath Reddy
Versus
Mr G. Kishan & Ors.

Lately, the issue of lease rental arrears being considered as operational debt has been hogging the limelight. This is more due to varying views on the same issue been taken by various benches of the NCLT across the country. While the NCLT Mumbai and Delhi have declined to accept the lease rental arrears as operational debt, NCLT Kolkata ruled that lease rental arrears are operational debt and therefore petition is maintainable u/s 9 of the IBC, 2016.

In January 2019, the NCLT bench in Hyderabad passed an order admitting a petition filed by Lessor against the Corporate debtor who failed to pay lease rental.

Aggrieved, the Corporate debtor filed an appeal before the NCLAT Delhi.

Two key issues relating to lease rental arrears arose – (i) a landlord providing lease will not be treated as operational creditor within the meaning of section 5(20) read with 5(21) of the IBC, 2016 and (ii) petition filed u/s 9 of the IBC, 2016 is not maintainable if there is a pre-existing dispute.

On 17th January 2020 the NCLAT, Delhi passed the below judgment on key issues. A look at the latest ruling based on the facts of the case.

Facts of the case

  1. M/s Walnut Packaging Private Limited, (Corporate debtor) took on lease industrial premises land measuring about 1667 sq. Yards whose owner is Mr. G. Kishan (Lessor).
  2. The tenancy was yearly in nature from July 2011 to June 2017. The amount payable was approximately Rs. 85.67 lakhs.
  3. It was alleged by the Lessor that the Corporate debtor had made part payments of upto Rs. 49.96 lakhs. The corporate debtor stopped making payments from January 2017.
  4. The outstanding dues by the corporate debtor was Rs. 30. Fifteen lakhs after the agreed lease period.
  5. The Lessor issued a notice in June 2017 to the corporate debtor to hand over the property (back to the Lessor). The corporate debtor failed to that within the stipulated time. Hence the Lessor issued an eviction notice against the Corporate debtor before a jurisdictional Civil Court. Thereafter a notice u/s 8 of the IBC, 2016 was issued to the Corporate debtor.
  6. The Corporate debtor contended that after the said period the parties agreed to a moratorium period where the corporate debtor would not pay enhanced rent due to slowdown in business operations.
  7. The counsel of the corporate debtor objected to the fact that a lessor cannot be considered as operational creditor under the IBC, 2016.
  8. The Corporate debtor also alleged that since there was a pre-existing dispute before the jurisdictional civil court, the application u/s 9 of IBC 2016 is not maintainable.

Issues

Two key issues emerge of this case-

  1. When a lessor provides lease and there are lease rental arrears (outstanding to be paid to the Lessor), can the Lessor be considered as “operational creditor” within the meaning of Section 5(20 )read with Section 5(21) of the Insolvency and Bankruptcy Code, 2016?
  2. Whether the petition filed U/S 9 of the Insolvency and Bankruptcy Code 2016 is not maintainable on account of ‘pre-existing dispute’?

NCLT judgment in January 2019

In original order passed by NCLT Hyderabad on 19th January 2019, the Bench took a view that Lease rental arrears were to be considered as operational debt. Consequently, a Lessor was to be considered Operational creditor.

The NCLT observed that since there is no express definition of “goods or Services” under IBC, one must rely on general usage of the terms used in the law with reference to context of such usage. Alongside the Bankruptcy Law Reforms Committee (BLRC), states that “Operational creditors are those whose liability from the entity comes from a transaction on operations”. The BLRC observed that an enterprise has financial creditors (loan and debt) as well as operational creditors such as employees, rental obligations, utilities payment and trade credit.”

The BLRC recommendations were not fully adopted though. The legislature did not include reference to rent dues of property. Thus it is clear that claim in respect of provisions of goods & services is covered under operational debt.

The NCLT was of the view that if the Lessor didn’t provide commercial space, then the corporate debtor couldn’t have carried out its daily commercial business transactions. Unless the space was provided the commercial operations of the corporate debtor could not have been carried out. So, there exists a quid pro quo relationship between the Operational Creditor and Corporate Debtor. The term Lease comes under the purview of ‘service’ within the meaning of Section 2(102) of Central Goods and Services Act, 2017. And the invoices raised by the Petitioner also falls within the meaning of services as provided by the Operational Creditor to the Corporate Debtor and hence, the petitioner is an Operational Creditor within the meaning of Section 5 (20) of IBC, 2016.

Appeal against NCLT judgment

On appeal by the Lessor against the order, before the NCLAT Delhi, it relooked the meanings of “Operational Creditor” and “Operational debt” under section 5(20) & 5(21) respectively of the IBC, 2016.

The NCLAT reasoned that transactions relating to the immovable property could not be considered as a transaction falling under the term ‘operation’ as well as ‘operational debt’ unless, such a transaction having a correlation of direct input to the output produced or supplied by the Corporate Debtor. Thus, the Lessor could not be considered as an operational creditor, nor the claim would come under the ambit of operational debt. Consequently the Lessor could not be considered as Operational Creditor.

Under the Code, Section 5(2) defines “Operational Creditor” to mean “any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.”

Section 5(21) defines “Operational Debt” have been defined which is: “a claim in respect of the provisions 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.”

On the issue of admitting a petition u/s in face of a pre-existing dispute, the NCLAT held that that once an operational creditor has filed an application which is otherwise complete the Adjudicating Authority must reject the application U/S 9(5)(2)(d) if notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility, the Adjudicating Authority is to see whether there is a plausible contention which requires further investigation and the “dispute” is not a patently feeble legal argument or an assertion of fact, unsupported by evidence. It is important to separate the grain from the chaff and to reject a spurious defence which is mere bluster.

In the case in hand, the Lessor has filed the petition for realization of enhanced rent from the Corporate debtor. Thus understanding for not increasing the rent of a period for a moratorium period of 6 years is a question of fact, which requires further investigation. Thus in the present case, there was a pre-existing dispute, which is proved by the issuance of notice under Section 106 of the TP Act, much before the issuance of demand notice, under Section 8 of the I&B Code. Based on the above, the application filed under Section 9 of the I&B Code could not have been
admitted.

NCLAT Judgment

The NCLAT opined that lease of immovable property could not be considered as a supply of goods or rendering of any services and thus, could not fall within the definition of ‘Operational Debt’. Consequently, NCLT (Hyderabad Bench) Order dated 21st January 2019 treating the lease of immovable property as a supply of goods or rendering services within the purview of ‘Operational Debt’ has been set aside by NCLAT.

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