Unpaid lease rentals qualify as operational debt under IBC, rules NCLAT

Should lease rentals dues arising from the ‘Leave and Licence Agreement’ be categorized as an operational debt under the Insolvency and Bankruptcy Code (IBC)?

The National Company Law Appellate Tribunal (NCLAT) in a recent order said that lease rentals arising out of use and occupation of immovable property for commercial purpose is an Operational Debt.

The appellate tribunal was hearing an appeal by corporate debtor Umarai Worldwide (P) Ltd, in which the petitioner has argued that the Agreement entered into with NAFED, the operational creditor, is a Leave and Licence Agreement and rental on immovable property does not amount to operational debt as defined under Section 5 (21) of the IBC.

Corporate debtor’s appeal was against the National Company Law Tribunal (NCLT) allowing admission of NAFED’s claim as operational debt.

To buttress its point, the corporate debtor cited observation made by NCLAT in M. Ravindranath Reddy V/s. G Kishan, [Company Appeal (AT) (Ins) No. 331 of 2019 wherein it was observed by the tribunal that the appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and debt in respect of repayment of dues does not arise under any Law for the time being in force payable to the Central Government or State Government.

Arguing against the appeal, the operational creditor (NAFED) contended that receiving any consideration by way of licence fee falls within the purview of providing services and falls within the definition of ‘operational debt’ as held by NCLAT in Sarla Tantia V/s. Nadia Healthcare Pvt. Ltd. [Company Appeal (AT) (Ins) No. 513 of 2018] and also in Jindal Steel and Power Pvt. Ltd. V/s. DCM International Ltd. [Company Appeal (AT) (Ins) 288 of 2017.] It also cited Supreme Court in Mobilox Innovations Private Limited V/s. Kirusa Software Private Limited (2018) 1 SCC 353, where the apex court noted that any consideration by way of rent, Leave and Licence, while letting out premises would fall within the ambit of Section 5(21) of the IBC.

Section 5 (21) defines operational debt under IBC.

The NCLAT in its observation said that in order to prove a debt as an operational debt, the criteria that needs to be met is as follows — (a) Claim in respect of provisions for goods and services (b) Employment or debt in respect of dues and (c) Such repayment of dues which should arise under any law in force at that time.

It said that the law has not gone into defining goods or services – hence, one has to rely on general usage of the terms so used in the law, with due regard to the context in which the same has been used. Simultaneously, it is also relevant to understand the intention of the lawmakers, said the tribunal in its order.

It also cited the Bankruptcy Law Reforms Committee (BLRC), which in its report in November 2015 indicates “the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease”.

The NCLAT, therefore, concluded that the BLRC recommends the treatment of lessors/landlords as Operational Creditors.

Though, it admitted that in the definition adopted by the legislature, only claims relating to ‘Goods and Services’ were included within the definition and purview of ‘Operational Debt’. It, therefore, also cited the Supreme Court in Mobilox Innovations Private Limited V/s. Kirusa Software Private Limited (2018) 1 SCC 353 in Para 5.2.1, where it has observed that the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease.

On the contention of Umarai Worldwide (P) Ltd that lease rentals are not a Service and do not fall within Regulation 32 (Insolvency Resolution Process for Corporate persons, Regulation 2016) read  with Section 14 (2) which defines essential goods or services as Electricity, Water, Telecommunication Services and Information Technology Services To the extent, these are not direct input to the output produced or supplied by the Corporate Debtor, the NCLAT said that the provisions of the Central Goods and Services Tax Act 2017, Schedule – II of the Act lists down the activities that are to be treated as supply of goods or services, and paragraph 2 of the Schedule stipulates any lease, tenancy, easement, licence to occupy land is a supply of services, any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is a supply of services.

Therefore, based on these observations, the NCLAT concluded that dues claimed by NAFED squarely falls within the ambit of the definition of ‘Operational Debt’ as defined under Section 5 (21) of the Code.