Ashmi Mohan Vatsala Pandey September 20 2022 Earnest money for purchase of land does not constitute "financial debt" under Insolvency and Bankruptcy Code Clasis Law | Litigation - India Ashmi Mohan, Vatsala Pandey Litigation FactsSubmissionsDecisionThe National Company Law Appellate Tribunal (NCLAT), in its recent judgment(1) in S Chandriah v Sunil Kumar Agarwal, Resolution Professional of Digjam Limited,(2) has clarified whether the payment of earnest money for the purchase of land falls under the category of financial debt under section 5(8) of the Insolvency and Bankruptcy Code 2016 (the Code).FactsOn 14 September 2018, S Chandriah (the appellant) sent a letter to Digjam Ltd (the respondent), offering to purchase the surplus land available at the respondent's mill premises at Jamnagar, Gujarat. Subsequently, the appellant made a payment of 70 million rupees as earnest money to the respondent.In the meantime, an application under section 9 of the Code was admitted and a corporate insolvency resolution process (CIRP) was initiated against the respondent. The appellant filed a claim under Form-C as a financial creditor. However, the resolution professional rejected the appellant's claim on the ground that the sum of 70 million rupees constituted an interest-free advance to be adjusted against the sale consideration for the proposed land sale.The appellant then filed an application before the National Company Law Tribunal (NCLT), Ahmedabad Bench, seeking to direct the resolution professional to adjudicate the claim and admit the appellant as a member of the committee of creditors (CoC). On 7 February 2020, the NCLT dismissed the appellant's application. Thereafter, on 27 May 2020, the CoC approved a resolution plan submitted by M/s Finquest Financial Solutions Pvt Ltd.Feeling aggrieved, the appellant filed two appeals before the NCLAT, challenging the NCLT's dismissal of his application and the CoC's approval of the resolution plan.SubmissionsIn the proceedings before the NCLAT, the appellant raised the following contentions, among others:The NCLT had committed an error in rejecting his claim as a financial creditor as he had paid a sum of 70 million rupees to the respondent. A receipt with respect to the transaction had been issued to the appellant and the respondent had not disputed the payment.The resolution professional had wrongly classified the appellant's claim as "other creditors", despite the earnest money being classified as "other financial liability" in the respondent's annual financial reports.The CoC had approved the resolution plan without taking into consideration the interests of all the stakeholders. No amount had been earmarked for the appellant – his claim had been classified as "other creditors", and the plan envisaged no payments to "other creditors". Thus, the plan was not in accordance with the provisions of section 30(2)(e) and section 30(2)(f) of the Code.The resolution plan failed to state how the interests of all the stakeholders had been dealt with in compliance of Regulation 38(1-A) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 (the CIRP Regulations).While refuting the arguments raised by the appellant, the respondent made the following submissions, among others:The appellant's claim was rightly classified in the category of "other creditors" as the appellant was not a financial creditor. There was no contract between the appellant and the respondent for the sale of any land and the appellant had advanced the earnest money on his own.The NCLT had been correct in holding that the essential conditions for holding a debt to be "financial debt" within the meaning of section 5(8) of the Code were not present in this matter. Therefore, no error had been committed in not accepting the claim of the appellant as a financial creditor.The appellant, as part of the category of "other creditors", was not entitled to payment of any amount as per the provisions of the Code.The main issue for the NCLAT's consideration was whether the appellant's payment of earnest money of 70 million rupees to the respondent constituted a financial debt within the meaning of section 5(8) of the Code.DecisionThe NCLAT referred to section 5(8) of the Code, as well as the following judgments:Pioneer Urban Land and Infrastructure Ltd v Union of India;(3)Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v Axis Bank Limited and Ors;(4) andSach Marketing Pvt Ltd v Resolution Professional of Mount Shivalik Industries Ltd.(5)The NCLAT observed that: "For a debt to be financial debt, [the] essential condition to be proved is that the debt is disbursed against the consideration for the time value of money and has a commercial effect of borrowing."Accordingly, it held that the disbursement made by the appellant to the respondent was only a payment of earnest money, which was to be adjusted in the sale of the land, and the disbursement was not in consideration for the time value of money. It was also clarified that the acknowledgment of the liability of earnest money as a financial liability in the annual returns was not akin to admitting it as a "financial debt".The NCLAT, relying on the judgment of Essar Steel India Ltd Committee of Creditors v Satish Kumar Gupta,(6) also observed that its powers of judicial review were limited to seeing whether, while approving the resolution plan, the CoC had taken into account:the fact that the respondent needed to be kept as a going concern;the need to maximise the value; andwhether the interests of all the stakeholders had been taken care of.In the present case, there was no violation of the section 30(2) of the Code or Regulation 38 (1-A) of the CIRP Regulations. The resolution plan did not contravene any of the provisions of the Code and in fact dealt with all the stakeholders' concerns adequately. In its commercial wisdom, the CoC had decided to offer nothing to the "other creditors", which had been approved by the NCLT and with which the NCLAT did not need to interfere.Accordingly, the appeals were dismissed.For further information on this topic please contact Ashmi Mohan or Vatsala Pandey at Clasis Law by telephone (+91 11 4213 0000) or email ([email protected] or [email protected]). The Clasis Law website can be accessed at www.clasislaw.com.Endnotes(1) Judgment dated 22 July 2022.(2) Company Appeal Insolvency Nos. 21-22 of 2022.(3) (2019) 8 SCC 416.(4) (2020) 8 SCC 401.(5) Company Appeal Insolvency No. 180 of 2021.(6) (2020) 8 SCC 531.