Investment On Profit-Sharing Basis Does Not Qualify As Financial Debt : NCLT Delhi Reaffirms

The National Company Law Tribunal at New Delhi has recently reaffirmed that an investment made on a profit-sharing basis does not constitute a financial debt under Section 5(8) of the Insolvency and Bankruptcy Code and therefore cannot be used to initiate insolvency proceedings under Section 7. The ruling came in a case where Modern Solar Private Limited sought to treat Rs 20 lakh advanced to Claro Energy Private Limited in 2013 as a loan carrying interest.

A coram of Judicial Member Mahendra Khandelwal and Technical Member Anu Jagmohan Singh examined the emails exchanged between the parties and held that “the amount in question was merely an investment made on a profit-sharing basis. In terms of Section 5(8), an amount must be disbursed against the time value of money, which is absent in the present case as transaction being Investment Transaction.”

Modern Solar said Claro Energy had approached it for goods and services for a project of the Public Health Engineering Department in Sitamarhi, Bihar, and that it transferred Rs 10 lakh on March 2, 2013 and another Rs 10 lakh on March 19, 2013 as a loan. It relied on the emails dated October 3, 2013 and February 6, 2014, the latter enclosing a calculation sheet showing interest at 18 percent, and on cheque dated February 22, 2014 which was later dishonoured.

Claro Energy argued that the transfers were not a loan. It relied on the applicant's own email dated October 4, 2013 stating that “it was always understood that the investment is on the basis of profit sharing.” It also referred to its email dated March 8, 2014, stating, “This money was an investment from Modern Solar, and the capital was committed till the completion of the project… at no point would we be in a position to borrow money at higher cost, so as to not only give back your principal amount of Rs. 20 lakhs but also an interest @18%.”

The tribunal said the October 4 email “explicitly records that the Applicant itself treated the transaction as an investment” and found that the February 2014 email relied on by the applicant “only indicates discussions regarding restructuring of the investment transaction.” It added that the emails dated October 4, 2013, March 8, 2014 and April 18, 2014 demonstrates that the said sum was advanced as working capital towards an investment on a profit-sharing basis.

Referring to the NCLAT's ruling in Jagbasera Infratech Private Ltd. v. Rawal Variety Construction Ltd., the tribunal concluded the amount advanced was an investment on profit sharing and therfore does not fall within the definition of financial debt. The insolvency plea was therefore dismissed.