Solving the problem of interest and insolvency

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The component of interest has played a significant role in the admission of a company into insolvency where the required monetary threshold is partially unmet. The question that arises in these situations is whether the component of interest can be added to the total debt to calculate the threshold value for admission of a company into insolvency.

As the Insolvency and Bankruptcy Code, 2016 (IBC), clearly differentiates between financial debt and operational debt obligations, the question becomes whether interest can be included in both these types of debt for the admission of a company into insolvency under the IBC.

The code provides the definition of financial debt under section 5(8), where “financial debt” means a debt along with interest, if any, which is disbursed against the consideration for the time value of money. Therefore, the position is clear in terms of the financial debt, the interest should be added for calculating the threshold. However, section 5(21) of the IBC defines operational debt as “a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment of dues”, which makes the situation unclear.

The principal bench of the National Companies Law Appellate Tribunal (NCLAT) was presented with a similar issue in the case of Prashant Agarwal, where the operational debt claimed amounted to INR9.78 million (USD122,900), which was below the minimum threshold of INR10 million as per section 4 of the code. However, inclusion of the interest component meant insolvency could be initiated under the code. The National Company Law Tribunal (NCLT) admitted the case for insolvency, citing another of its judgments in Pavan Enterprise, which stated that in terms of any agreement the debt would include any interest.

The NCLAT stated that to include interest, as per the definition of “operational debt” as well as “debt”, the code makes it necessary to have a liability/obligation in respect of a claim, which is due from any person. The definition of claim under section 3(11) states “claim” means a right to payment, among other things.

The NCLAT concluded that since interest on delayed payment was clearly stipulated in an invoice and, therefore, this would entitle the “right to payment” under section 3(6) of the IBC and, therefore, form part of “debt” as per section 3(11) of the code. The company could be admitted into insolvency as per the code’s provision.

The NCLAT also noted that there have been divergent views taken by various NCLTs. In one instance, the NCLT’s Chandigarh bench declined to include the interest component while calculating the threshold, stating that the invoices were a unilateral act of the creditor and the claim by the creditor could not be sustained. Furthermore, as the rate of interest was not determined, there was no obligation on the tribunal to determine the rate.

However, the question can become trickier, as the code does not permit the NCLT to undertake detailed examination of evidence, leading to confusion. In another slightly differing ruling, in Steel India v Theme Developers, the NCLAT held that the amount of accumulated interest could be claimed only if it was mutually agreed to by the parties. Thus, similar litigation is expected to keep popping up unless the issue is settled by the Supreme Court, or the IBC is amended to permit detailed examination.

Meanwhile, it can be concluded from precedents that where there are clear agreements on the rate of interest, the claim of interest can be added to the total debt to meet the criteria for insolvency.

In light of this, the appeal was allowed, and the judgment and order of the Orissa High Court, as well as the appointment of the sole arbitrator, were quashed. The court lacked the authority to consider the application made in accordance with section 11(6) of the act with regard to the contract agreement. In addition, the respondent had filed an interim application with the High Court of Andhra Pradesh in accordance with section 9 of the act. Therefore, the application for the appointment of the arbitrator could only be considered by the High Court of Andhra Pradesh.

The dispute digest is compiled by Numen Law Offices, a multidisciplinary law firm based in New Delhi & Mumbai. The authors can be contacted at support@numenlaw.com. Readers should not act on the basis of this information without seeking professional legal advice.