LEASE RENT - AN OPERATIONAL DEBT?

[Mr. M. GOVINDARAJAN]

Corporate insolvency resolution process by operational creditor

Section 9 of the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short) provides for the initiation of corporate insolvency resolution process by an operational creditor against the corporate debtor for non settlement of debts the operational creditor after fulfilling the procedure contained in Section 8 of the Code.

Operational debt

Section 3(11) of the Code defines the term ‘debt’ as a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt. 

The expression ‘operational debt’ is defined under section 5(21) of the Code as a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.

Issue

In many cases the dues could not be proved as an operational debt and in such cases the Adjudicating Authorities rejected the application filed by the operational creditor for initiation of corporate insolvency resolution process under section 9 of the Code.  In this article the issue to be taken up is as to whether the licence fee amounts to operational debt with reference to decided case law.

Case laws

In M. RAVINDRANATH REDDY VERSUS G. KISHAN - 2020 (2) TMI 56 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL, NEW DELHI, the NCLAT, Principal Bench, New Delhi held that the debt on account of purported enhanced rate of leasehold properties does not fall within the definition of operational debt.

In M/S SMARTWORKS COWORKING SPACES PRIVATE LIMITED VERSUS M/S TURBOT HQ INDIA PRIVATE LIMITED - 2023 (5) TMI 979 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL , PRINCIPAL BENCH, NEW DELHI the appellant is engaged in the business of coworking and/or providing flexi office space, a working arrangement where different corporate bodies come together to work for a single business center run and maintained by the appellant.  The appellant entered into an agreement with Turbot HQ India Private Limited (‘respondent’) called as ‘Service Providers Agreement’.  The features of the said agreement are as below-

• The period of agreement was from 01.10.2018 to 30.09.2021.
• The agreement does not create any right or title or interest in the property immovable or movable.
• The monthly office fees is Rs.3,52,000/-.
• There is a lock-in-period for 36 months.

The respondent in terms of agreement began to use the said premises.  The respondent wanted to end the agreement with the appellant and therefore gave an email to the appellant on 04.06.2019 indicating his intention to end the contract by 01.09.2019. The appellant informed the respondent that there is a lock-in-period of 36 months ending on 30.09.2021.  Therefore the respondent has to pay unpaid balance amount to the appellant.  The respondent stopped using the premises with effect from 01.10.2019.

The appellant sent notice to the respondent for the payment of remaining unpaid amount to the tune of Rs. 1,05,32,126/-.  Since no payment has been made the appellant issued a notice under Section 8 of the Code to the respondent, as a Corporate Debtor (now the respondent changed to ‘Corporate Debtor) on 18.08.2020 claiming an operational debt of Rs.1,28,95,402/-.  The Corporate Debtor denied the claim and replied accordingly to the appellant.  The appellant, as an operational creditor, filed an application under Section 9 of the Code before the Adjudicating Authority for initiation of corporate insolvency resolution process against the Corporate Debtor. 

The Corporate Debtor filed a reply to the Adjudicating Authority contending that the office service agreement is a lease agreement, containing all essential elements of lease prescribed under section 105 of the Transfer of Property Act, 1882.  Rent is not an operational debt for the purposes of admitting the application under section 9 of the Code.  The Adjudicating Authority framed the following issues for its consideration-

• Whether, the amount claimed by the petitioner for the locking period amounts to operational debt?
• Whether, the agreement dated 17th August, 2018 is compulsorily registerable Instrument under the Registration Act 1908?
• Whether, the agreement dated 17.08.2018 was originally engrossed on an unstamped paper?

The Adjudicating Authority held that the amount claimed by the operational creditor for the lock in period is not an operational debt.  The agreement dated 17.08.2018 was originally engrossed on an unstamped paper.  The same is required to be registered.  Therefore the Adjudicating Authority rejected the application filed by the operational creditor.

The operational creditor filed an appeal before the National Company Law Appellate Tribunal (‘NCLAT’ for short), Principal Bench, New Delhi, against the order of Adjudicating Authority.    The appellant submitted the following before the NCLAT-

• The agreement entered with the Corporate Debtor had a lock-in-period of 36 months, during which period the agreement cannot be terminated by the Corporate Debtor.
• The termination is in breach of the agreement for which the appellant is entitled for the claim within the meaning of Section 3(6) of the Code.
• The Adjudicating Authority committed error in holding that the licence fee is not an operational debt.
• The claim of the appellant arises out of the breach of contract which is a ‘debt’ within the meaning of the Code.
• The agreement does not require for registration since no right was created in any immovable property in favor of the Corporate Debtor.
• West Bengal Stamp Duty on document does not provide for license as chargeable with duty.
• Since there is a debt and default the Adjudicating Authority ought to have admitted the application filed by the applicant.

The Corporate Debtor submitted the following before the NCLAT-

• The rent as per the agreement cannot be treated as an operational debt.
• For the breach of contract the appellant was required to claim compensation in the competent Civil Court.
• The agreement is not engrossed on stamp paper and therefore it is not admissible before the Court of law.
• Clause 1.12 of the agreement provides for arbitration to settle the dispute.
• The appellant could not provide services as per agreement and failed to the terms of the agreement, necessary uses and customs.
• The Adjudicating Authority rightly rejected the application since it is not an operational debt.

The NCLAT heard the submissions put forth by the parties to the present appeal and also perused the records.  The NCLAT analyzed the provisions of the agreement dated 17.08.2018.  The NCLAT observed that there was a lock in period for 36 months from 01.10.2018 to 30.09.2021.  The amount payable for the first 6 months is Rs.2,72,000/- plus taxes and thereafter @ Rs.3,52,000/- plus taxes.  The agreement creates no right, title or interest in the immovable and movable properties.  The agreement is in person to the client and is non inheritable and cannot be transferred or assigned to anyone else.  The agreement also provides for the cancellation of agreement by giving 30 days notice in advance without assigning any reason after the lock-in-period.  However, the provider has no right to terminate the agreement during the validity of the agreement except in the circumstances of material breach of any of the terms of this agreement or the client is in default as more specifically mentioned.

The NCLAT further observed that the Corporate Debtor, on 04.06.2019 sent an email to the operational creditor intimating that their management decided to quit to their own premises and requested to accept their appeal to quit from the premises of the operational creditor.  The operational creditor replied that the agreement cannot be cancelled during the lock-in-period and insisted the Corporate Debtor to honor the agreement and requested to pay the balance amount remaining unpaid. 

The NCLAT observed that as per clause 1.4 of the agreement the Corporate Debtor can terminate the contract after giving 30 days notice only after the lock-in-period of 36 months.  Since the Corporate Debtor terminated the contract during the lock-in-period against the clause 1.4 of the agreement the case will be in favor of the appellant.  In section 9 Application, the Operational Creditor has in part-IV of the Application mentioned all details of transaction and details of operational debt giving details of correspondence between the parties and the details of the operational debt which accrued on account of pre-mature termination of the agreement by the Corporate Debtor.

The High Court held that the Adjudicating Authority has committed an error in holding that the debt claimed by the operational creditor was not operational debt.  The debt claimed by the Appellant is clearly a claim within the meaning of the Code  and on default being committed by the Corporate Debtor the debt became due and Appellant was fully entitled to initiate proceedings under Section 9 of the Code.

The NCLAT then considered the second point determined by the Adjudicating Authority as to whether the agreement is liable to be registered.  In this regard the NCLAT found that according to the nature of the agreement there is no claim on the moveable and immovable properties except the services run by the appellant. The NCLAT referred to Section 17(b) of Registration Act,

The NCLAT held that it is clear that agreement does not purport or operate to create, declare, assign, limit or extinguish any right, title or interest in immovable or movable property. The Agreement was clearly not required to be compulsorily registered under Section 17(b).

The NCLAT then considered the third issue decided by the Adjudicating Authority that the agreement was originally engrossed on unstamped paper.  The NCLAT observed that according to the Corporate Debtor the agreement was written on the paper.   Both the parties have signed but on the paper where stamp paper was mentioned there was no signature of the Corporate Debtor.  The Corporate Debtor did not deny execution of the agreement between the parties.  The Agreement was termed by the Corporate Debtor as a lease agreement.  The Corporate Debtor in pursuance of the Agreement took the possession of the premises and also paid monthly office fee up to July 2019 which clearly indicate that the agreement dated 17th August, 2018 was given effect to.

The NCLAT held that when Agreement was admittedly executed between the parties, signed by both the parties and acted upon, mere fact that it not being engrossed on stamped papers shall have no adverse consequence on the claim of the Operational Creditor.  The Adjudicating Authority erred in determining the third point against the operational creditor.  The appellant has proved that debt claimed by the Appellant in Section 9 Application was operational debt. Further the agreement dated 17th August, 2018 was not compulsorily registrable and agreement having not been executed on Rs. 100 Stamp Paper was inconsequential, the agreement having been acted upon and the Corporate Debtor having entered into possession of the premises in pursuance of the Agreement.

The NCLAT allowed the appeal and set aside the order of the Adjudicating Authority.  The NCLAT further directed the Adjudicating Authority to pass order of admission under section 9 of the Code within one month from the date of receipt of the order.  The parties to the appeals are at liberty to arrive at a settlement, if any.