Refundable Security Deposit Carrying Interest In Development Agreement Constitutes Financial Debt U/S 5(8) Of IBC: NCLAT New Delhi

The National Company Law Appellate Tribunal, Principal Bench, New Delhi comprising Shri Justice Ashok Bhushan (Judicial Member) and Shri Barun Mitra and Shri Arun Baroka (Technical Members), has held that Refundable Security Deposit carrying interest in development agreement constitutes under Section 5(8) of IBC since the development agreement has the effect of a commercial transaction. Background Facts Energy Properties Private Limited (“Corporate Debtor”) entered into a Development Agreement with Avani Towers Pvt. Ltd. (“Respondent”) dated 16.06.2008 wherein the Respondent was required to provide the refundable Security Deposit of Rs.12 Crores with option to add an extra Rs.3 Crores. The initial deposit of Rs.12 Crores would not accrue interest while any additional deposit up to maximum Rs. 3 Crores (increase to Rs.3.5 Crores mutually by the conduct between the parties) bear the interest at the rate of 18% compounded and payable quarterly. The additional amount advance of Rs. 3.5 Crores was to form part of Security Deposit. The repayment of refundable Security Deposit was also provided for in Part II of Third Schedule of Development Agreement. The development could not be carried out as per the development agreement. Thus, a Section 7 application was filed by the Respondent in September 2019 alleging a Financial Debt of 10,90,72,565/-. In the Section 7 application before the NCLT, the Respondent claimed that the Corporate Debtor obliged to pay quarterly interest on amount of Rs. 3.5 Crores in which payment the Corporate Debtor defaulted. The Corporate Debtor acknowledged the receipt of additional amount of Rs.3.5 Crores and admitted the same as unsecured loan in which the interest would be paid quarterly. However, a letter was written by the Corporate Debtor dated 31.03.2014 that since the project has not taken off for more than five and half years of signing Development Agreement, so it is not in the position to make provision for interest for the time being an amount of Rs. 3.5 Crores. The NCLT after hearing both the parties passed an order dated 20.03.2024 and admitted the Section 7 Application. NCLT held that the Development Agreement contains the details of transaction entered between the parties. The advance of Rs. 3.5 Crores carried interest of 18% which transaction falls within Financial Debt under Section 5(8). Thus the appeal was filed by Chintan Jhunjhunwala, one of the members of the Suspended Board of Directors of the Corporate Debtor (“Appellant”) before the NCLAT It was contended by the Appellant before the NCLAT that the additional amount advance of Rs. 3.5 Crores was to form part of Security Deposit. It was argued that the Respondent cannot claim for refund of Security Deposit without completing the development work under the Development Agreement. Since, development has not taken place, the refund of Security Deposit cannot take place and no default has been committed. Further, it was also argued that the respondent has classified the refundable Security Deposit together with the interest as the inventory in his books and so cannot claim it as financial debt. It was argued by the Respondent before the NCLAT that under the Development Agreement dated 16.06.2008, a refundable security deposit of Rs. 12 crores was specified. Additionally, the Rs. 3.5 crores advanced by the developers to the owners carried an 18% annual interest rate, compounded and payable quarterly, thus qualifying as financial debt. It was submitted that application under Section 7 was filed by the Financial Creditor only for the interest component. NCLAT Verdict It was observed by the tribunal that the Development Agreement is a transaction between the parties. As per Clause 8.1 of the agreement, Rs. 12 Crore amount has been referred as refundable deposit, which does not carry any interest was treated as Security Deposit. The clause also states that any additional amount up to Rs. 3 crores advanced by the developer is part of the security deposit and carries 18% annual interest, compounded quarterly. Thus, the further sum in addition to Rs. 12 Crores of Security Deposit was given a different treatment. The Interest of 18% payable quarterly was unrelated to the Security Deposit of Rs. 12 Crores. It was observed that the transaction has commercial effect of the borrowings. It relied on Global Credit Capital Limited & Anr. Vs. Sach Marketing Pvt. Ltd. & Anr. where the Supreme court held that the real nature of transaction has to be found out to find the nature of debt. In this case, it was also held that amount covered by the Security Deposit under the Agreement constitutes Financial Debt. It was held by the tribunal that the Agreement clearly contains the details of transaction entered between the parties which makes it clear that advance of Rs. 3.5 Crores carried interest of 18% which transaction falls within Financial Debt...

Refundable Security Deposit Carrying Interest In Development Agreement Constitutes Financial Debt U/S 5(8) Of IBC: NCLAT New Delhi

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Refundable Security Deposit Carrying Interest In Development Agreement Constitutes Financial Debt U/S 5(8) Of IBC: NCLAT New Delhi

Aditi Gupta

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