Deposit Of Security Under Memorandum Of Understanding Without Intention Of Commercial Effect Of Borrowing Cannot Be Categorised As Financial Debt: NCLAT

The National Company Law Appellate Tribunal (“NCLAT”) New Delhi bench of Justice Rakesh Kumar Jain (Judicial Member), Mr. Naresh Salecha (Technical Member) and Mr. Indevar Pandey (Technical Member) has held that the security amount deposited under a Memorandum of Understanding ('MoU') without any intention of commercial effect of borrowing and time value of money cannot be categorised as financial debt under section 5(8) of the Insolvency and Bankruptcy Code, 2016 (“Code”). Brief Facts: This appeal has been filed by Global Indian School Education Services Pvt. Ltd.(“Appellant”) against an order passed by the National Company Law Tribunal (“NCLT”). Housing Development and Infrastructure Ltd. (“Corporate Debtor”) entered into a Memorandum of Understanding ('MoU') with the appellant. As per the MoU, Corporate Debtor was required to construct “built to suit” school building on a land situated in Village Nahur, Taluka Kurla (“the said land”) for the appellant.The purpose of the 'MoU' was to create a school by the Corporate Debtor which could be operated by the Appellant for thirty years. A clause of the 'MOU' required the appellant to pay certain amount to the corporate debtor. The corporate debtor had to meet certain conditions precedent before transferring rights over the land and building. If these conditions were not met, the appellant could terminate the MOU by a written notice. After termination of the 'MOU', the corporate debtor will have to refund the entire amount paid within 30 days along with 9% annual interest. Contentions: The appellants submitted that the Respondent, through an email sent on September 1, 2020, unlawfully rejected the Appellant's claims and classified him as an Operational Creditor and directed the Applicant to resubmit its claim using Form B, which is designated for Operational Creditors. It was also argued that as per clauses of the MoU, the corporate debtor was obligated to return the amount with interest. Since the proposed never materialised, the amount constituted a financial debt as it involved borrowed funds with a commercial effect of borrowing. It was also submitted that the disbursement of the Amount was specifically for financing the construction of a building on the said land, and this amount was utilized by the Corporate Debtor as a means of finance for the said construction. The transaction, therefore, has a clear commercial effect of borrowing which clearly satisfies the requirements under Section 5(8) of the code. Per contra, the respondents contended that the 'MoU' does not specify that the monies paid were in consideration of the time value of money therefore the assertion that the amount constitutes a financial transaction based on the time value of money is without basis, as the clauses clearly outline that it is a security deposit subject to specific conditions. It was also argued that it is true that the Appellant disbursed an amount, the other two conditions stipulated in Section 5(8) of the Code have not been satisfied in this case and the transaction lacks a commercial effect of borrowing as there is no consideration for the time value of money. It was further submitted that the interest, payable upon termination, is characterized as liquidated damages and does not carry any profit motive. Therefore, the inclusion of this interest clause does not transform the 'security deposit' into a financial debt under the provisions of the Code. Reliance was placed on Budhpur Buildcon Pvt. Ltd. Vs. Abhay Narayan Manudhane, Resolution Professional (2022). It was argued that, since the Appellant has not terminated the MoU to date, the clause regarding the refund of the security deposit along with interest has not come into effect.The claim of the Appellant does not qualify as a financial debt under the Code. Observations: The question before the tribunal was whether the amount disbursed by the appellant to the corporate debtor was a financial debt. The tribunal noted that section 5(8) of the code provides that for a debt to be categorised as a 'financial debt', the amount should be disbursed against consideration of time value of money. The Supreme Court in Pioneer Urban Land and Infrastructure Ltd. v. Union of India (2019) laid down the essentials of the financial debt-there should be a disbursal, the transaction should have a commercial effect of borrowing and there must be a time value of money. Based on the above, it observed that for commercial effect, the intent between the lenders and the Corporate Debtor/ Borrower should be clear which indicate the purpose of such financial facilities. Such financial facilities/ loans are typical when the financial creditors lent money, stipulating the period for which money is lent, purpose for such money and also stipulate the returns on the financial debt in terms of interest, etc. It further added that ...

Deposit Of Security Under Memorandum Of Understanding Without Intention Of Commercial Effect Of Borrowing Cannot Be Categorised As Financial Debt: NCLAT

Mohd Malik Chauhan

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