Refund of Advance- Does it constitute Operational Debt under IBC, 2016?

It has become a habitual and customary practice to collect advance money from consumers before
providing any kind of goods or services to them. The consumers, therefore, tend to face a constant
risk of not being able to recover the advance amount in the event the provider of goods or services
abruptly ceases operations and fails to supply the goods or services.

Interpretation of terms Operational Debt, Operational Creditor and Debt of the Insolvency
and Bankruptcy Code, 2016

Section 3(11)i defines a ‘debt’ as a means a liability or obligation in respect of a claim which is
due from any person and includes a financial debt and operational debt. Further, the term ‘claim’
is enumerated as the right to payment, whether or not such right is reduced to judgment, fixed,
disputed, undisputed, legal, equitable, secured or unsecured.

From that, Section 3(21)ii define ‘operational debt’ 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

Section 3(20)iii "operational creditor" means a person to whom an operational debt is owed and
includes any person to whom such debt has been legally assigned or transferred;

A combined reading of the above definitions will clearly establish that unless a person falls within
the definition of an Operational Creditor and 'debt' be classified as an 'Operational Debt', even
though, there may be an existence of debt/ claim by a person against the other, however, cannot
file in relation to a claim as an 'Operational Debt' and as an Operational Creditor.

Refundable Advance-

The National Company Law Tribunal (hereinafter, “NCLT”) and the National Company Law
Appellate Tribunal (hereinafter, “NCLAT”) have been reluctant to interfere and expand the
definition in Section 5(21) of the IBC. For instance, in the case of Satish Mittal v. Ozone Builders
& Developers Pvt. Ltd., the NCLAT observed that if the Operational Creditor has not rendered
any services or provided any goods or is not in debt in respect of payment of dues arising under

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any law due to him, an insolvency application cannot be admitted.iv
It has been recognised that a refundable advance does not amount to an operational creditor as the
provision of goods and services has to flow in one direction only, ie., from the Operational Creditor
to the Corporate Debtor.v

In the case of SHRM Biotechnologies Private Ltd. v. VAB Commercial Private Ltd., the question
for consideration was whether return of advance comes under the purview of operational debt.vi
The NCLT, Kolkata held that the claim of the Operational Creditor does not fall within the ambit
of the IBC as the Operational Creditor did not provide goods or services. The same was observed
in the case of Daya Engineering Works Pvt. Ltd. v. UIC Udyog Ltd.vii

The IBC does not contemplate the repayment of debts grounded in equity

The definition of ‘debt’ in the IBC contemplates only a financial debt and an operational debt. It
has been observed that there is no legislative intent showing that there are more than two kinds of
debts.viii

Furthermore, by way of the fact that operational creditors and financial creditors are not at par in
the Committee of Creditors (clearly contrary to principles of equity), it is contended that the IBC
is not subject to equitable practices.ix

Lastly, taking recourse to Bankruptcy Law in the USA, it is contended that the equities of
bankruptcy are not the same as those of common law. The equities of bankruptcy may affect the
grant of equity otherwise available under state law.x

The scope of IBC, therefore, does not entertain an equitable claim.

In TATA Chemicals Ltd. v. Raj Process Equipments and Systems Pvt. Ltd.xia similar factual matrix

arose where the Petitioner terminated the contract and filed under sec. 9 for refund of advance

money rendered the Court held:

“Refund of advance money is not in connection with the goods/services including

employment or a debt in respect of repayment of dues. Corporate Debtor has taken order
from the petitioner for supply of goods. The contract/order has been terminated by the

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 Petitioner. Therefore, refund of advance amount, which has been taken by the Corporate
Debtor, is not on account of goods/services or employment.”

Thus, to claim a ‘debt’ under IBC, the same has to be in course of operation i.e. there has to either
be a seller-buyer or service provider-service recipient relationship between the operational creditor
and the corporate debtor. In such cases of security deposits or advance monies, there is no service
which would have been rendered by the operational creditor and in fact, service if any, is given by
the corporate debtor to the operational creditor.

Concluding Remarks

The emphasis on the term “Operational Debt” clarifies that it is a “claim in respect of any kind of
provision of goods or services”. The basic definition gives rise to arguments and it can be
contended that the definition of “Operation Debt” is ambiguous on two counts.

Firstly, with regard to the direction of flow of provision of goods or services, the provision does
not specify that the provider of goods or services shall be the creditor and the recipient shall be the
corporate debtor. An operational debt is only a claim “in respect of provision of goods or services”.
Hence, there might be instances where the party paying advances may be considered as a creditor,
and the party to provide goods or services is then regarded as debtor against the advance amount.

Secondly, the section is hazy as to whether the provision of goods and services should have already
taken place on the date of filing of claim, or on the date of making the application, as the case may
be, or whether such a provision of goods and service may be for the future as well.

Considering the aforementioned, it is quite possible to arrive at alternative interpretations of the

definition. In fact, in Auspice Trading Private Limited v. M/s Global Proserv Limitedxii, a creditor,
being aggrieved due to the non-repayment of advance, approached NCLT, Mumbai under section
9 of the IBC. The application was admitted by NCLT, initiating corporate insolvency resolution
process against the debtor.

To further substantiate, there are potentially three types of claims: financial, operational and others.
It is also pertinent to mention that the erstwhile section 271(1)(a) of the Companies Act, 2013 for
failure to pay money has been deleted, leaving no scope for a winding up application by creditors.

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In essence, the only remedy seems to be the IBC. While it is true that the IBC is not a proper
remedy for commercial claims which are otherwise undisputed, there may be a case of inability to
pay or discrete insolvency. But the interpretation of the word “claims”, and the distinction between
financial and operational debt should not be given a narrow interpretation. It is certainly acceptable
to construe the term “financial debt” with a precise meaning so as to include financial facilities
only; however, the word “operational debt” should be interpreted widely so as to minimise the
third category, other claims, which is only a claim without a right. Such a remediless claim, must
be minimised.

i
Section 3(11), Insolvency and Bankruptcy Code, 2016
ii
Section 3(21), Insolvency and Bankruptcy Code, 2016
iii
Section 3(20), Insolvency and Bankruptcy Code, 2016
iv
Satish Mittal v. Ozone Builders & Developers Pvt. Ltd., Company Appeal (AT) (Insol.) No. 75 of 2017.
v
Jindal Steel and Power Ltd. v. DCM International Ltd, Company Appeal (AT) (Insolvency) No. 288 of 2017.
vi
SHRM Biotechnologies v. VAB Commercial Pvt. Ltd., C.P. (I.B.) No. 799/KB of 2018.
vii
Daya Engineering Works Pvt. Ltd. v. UIC Udyog Ltd., C.P. (I.B.) No. 547/KB of 2017.
viii
Chitra Sharma v. Union of India, (2017) 143 SCL 680 (SC).
ix
Swiss Ribbons Pvt. Ltd. v. Union of India, (2019) 4 SCC 17.
x
Superintendent of Ins. V. Ocks, 377 F3d. 209, (2d Cir, 2004).
xi
Tata Chemicals Limited. v. Raj Process Equipments and Systems Private Limited., CP 21/I&BP/NCLT/MAH/2018.
xii
Auspice Trading Private Limited v. M/s Global Prosery Limited, (2017) MANU 5611