Under the Insolvency and Bankruptcy Code, 2016 (the Code), a financial creditor can initiate a Corporate Insolvency Resolution Process (CIRP) by filing an application before the jurisdictional National Company Law Tribunal (the NCLT) upon the occurrence of a default in the payment of its financial debt under section 7 of the Code. Before making an application, the financial creditor shall ascertain that his dues are more than INR 1,00,000/- (Indian Rupees One Lakh only), to be eligible to make an application. The paramount question that arises is what can be included as ‘Financial Debt’. The term Financial Debt is defined under Section 5 (8) of the Code, which means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes: (a) money borrowed against the payment of interest; (b) any amount raised by acceptance under any acceptance credit facility or its dematerialized equivalent; (c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument; (d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as finance or capital lease under the Indian Accounting Standards or any other Standards as may be prescribed; (e) receivables sold or discounted other than any receivables sold on non-recourse basis; (f) any amount raised under any other transaction including any forward sale or purchase agreement, having the commercial effect of a borrowing; (g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account; (h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution; (i) the amount of any liability in respect of any of the guarantee or indemnity or any of the items referred to above; The opening words of Section 5(8), i.e. the definition clause indicates that a financial debt is a debt along with interest which is disbursed against the consideration for the time value of money and it may include any of the events enumerated in sub-clauses (a) to (i). The above mentioned (a-i) are instances of a mere inclusive definition and the judiciary has powers to interpret other situations which can be considered as financial debt. A Financial Creditor is a person who has the right to a financial debt. The key feature of financial transaction as postulated by section 5(8) of the Code is its consideration for the time value of money. In Black's 12 Law- Dictionary (9th edition) the expression 'Time Value' has been defined to mean the price associated with the length of time that an investor must wait until an investment matures or the related income is earned. In both the cases, the inflows and outflows are distanced by time and there is a compensation for the time value of money. A bare reading of the provision gives an impression that the financial transaction should be in the nature of debt and no equity has been implied by the opening words of Section 5(8) of the Code. Also, the NCLT order in the Nikhil Mehta & Sons (HUF) v. M/s AMR Infrastructures Limited (AMR) case has provided “...that the financial transaction should be in nature of debt and no equity has been implied by the opening words of clause 5(8) of the IBC”. Even though this order has been superseded by the NCLAT order on the merits of the case, it is expected that the intent of the legislation is clear to exclude all equity transactions from the purview of financial debt in the spirit of “Verba intentioni, non e contra, debent inservire” which means that the words of the statute should serve its intentions, not the reverse. In Nikhil Mehta & Sons (HUF) Vs. M/s AMR Infrastructures Limited (AMR) the NCLAT held that in order to qualify as a “Financial Creditor”, first the essential requirements of “Financial Debt” has to be satisfied as the key feature of a financial transaction is its consideration for the time value of money. Initially, the NCLT had denied the applicant’s petition stating that his contractual right under an MOU with AMR, whereby AMR had assured ‘assured/committed returns’ to him, from the date of execution of the MoU till the handing over of the physical possession of the unit(s) was an agreement for mere sale and purchase of a piece of property and not a financial debt as the transaction did not have consideration for the time value of money. On appeal, the NCLAT had reversed the decision of the NCLT and held that the promise of the ‘assured return’ makes the applicant analogous to a ‘Financial Creditor’ or an ‘investor’ that has chosen ‘committed return plan’. The above judicial interpretation of 'the time value of money' in the context of financial debt has opened up a Pandora’s box and put forth the question of whether the treatment of other complex debt instruments (debt-like instruments such as redeemable preference shares, put and call options on securities) whose returns are linked to parameters observed in equity transactions as financial debt. It can be logically argued that to satisfy clause 5 (8) of the Code, the claim should be in nature of a debt, to begin with. However, it is true that there are complex financial instruments which may not provide an easy answer to decipher the true nature and meaning of a transaction as either debt or equity. There may be instances wherein debt instruments/hybrid instruments in investment transactions may come with the option of assured returns within a prescribed timeframe for the investors. It would be interesting to watch if these will now be covered under the broad umbrella of financial debt. Another area of concern is whether damages awarded in instances of breach to the investor may also be categorized as “Financial Debt” under IBC. This discussion is relevant especially since various courts in judgments such as Cruz City v. Unitech’  and ‘NTT Docomo v. Tata Sons’ have ruled in favor of foreign investors and have provided that any pre-determined rate of exit claimed by such foreign investors in nature of damages would be valid and enforceable in India. The Courts in these cases have held that any assured exit formulae in lieu of damages would not be violative of Foreign Exchange Management Act, 1999 (FEMA) as FEMA prohibits any and all assured return to foreign investors . A right/option of assured returns can be termed as illegible instruments in accordance with RBI guidelines (RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013). And Circular dated 14.07.2014 (A.P. (DIR Series) Circular No. 3 The Court opined that the RBI circular which bars exit at pre-determined returns would not apply, in cases where the option is exercised for making good for a breach. Thus, any pre-determined exit exercisable in the event of a breach of obligations is not necessarily an assured return but a mere downside protection. This interpretation is important as the RBI circular itself does not account for distinction on grounds of breach or non-breach for prohibiting a pre-determined exit price but merely puts a blanket restriction on the exit of foreign entities at a pre-determined price. One can draw an analogy of these judgments to Nikhil Mehta’s case as discussed above as even in the Nikhil Mehta’s case, the court held the constructor liable for payment in the instance of a breach. Thus, even pre-determined exit clauses for foreign investors tailored in nature of breach may also fall within the domain of financial debt. In such instances, foreign investors may approach the NCLT under the Code and initiate a request for an insolvency process of Indian companies. Even though these provisions may seem as investor friendly and boost investor confidence in the Indian judicial system, such broad interpretations may flood the gates of IBC with suits wherein investors approach under the garb of financial creditor and will be entitled to trigger the CIRP against the Corporate Debtor. If so, then all investors (even including holders of convertible instruments) may fall under the ambit of “financial creditors” as their investment in the company may be treated as a downside protection or assured return by virtue of the transaction documents. This would aggravate the very purpose and intent of the Code as a statute was a quicker and faster way to protect creditors interests and not that of the shareholders. Nikhil Mehta and Sons v AMR Infrastructure Company Appeal (AT) (Insolvency) No. 7 of 2017 (July 21, 2017).  MANU/DE/0965/2017  MANU/DE/1164/2017  A right/option of assured returns can be termed as illegible instruments in accordance with RBI guidelines (RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013). And Circular dated 14.07.2014 (A.P. (DIR Series) Circular No. 3
Co-authored by: Ashwin Bhat (Junior Partner) and Ayushi Singh (Associate) at NovoJuris Legal.