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Lease and Rentals: Are these Operational debts under the IBC?

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Lease and Rentals: Are these Operational debts under the IBC?

August 5, 2021

  • Introduction

“Lease rentals arising out of the use and occupation of a cold storage unit which is for a Commercial Purpose is an ‘Operational Debt’ as envisaged under Section 5 (21) of the Code.”[1] This was the National Company Law Appellate Tribunal’s (‘NCLAT’) holding in the case of Anup Sushil Dubey v. National Agricultural Co-operative Marketing Federation of India Ltd.[2], a decision that was a rather stark divergence from its earlier ruling in Mr. M Ravindranath Reddy v. Mr. G. Kishan & Ors.[3], wherein it had observed to the contrary that rental dues arising out of lease agreements were to be precluded from the scope of an ‘Operational Debt’ under the Insolvency and Bankruptcy Code, 2016 (hereinafter the ‘IBC’).

When it comes to the term ‘Debt’, there are several kinds that can be classified under different heads. However, when used in the context of the IBC, only two types of debts secure recognition, these are either ‘Financial Debts’ or ‘Operational Debts’. It is for this reason that importance is reserved for ascertaining the nature of a debt in a proceeding involving corporate insolvency, as under the Code a creditor may only have a claim and may only initiate an insolvency process, if he takes the position of a financial creditor or an operational creditor as provided for under Section 7 and 9 of the Code, respectively. Therefore, for a person holding a debt that falls outside the ambit of a ‘Debt” under the IBC, initiating proceedings against a corporate debtor would be an impossibility under the Code.

The debate surrounding the question of whether lease and rental dues can be treated as operational debts has been a legal quandary for creditors and debtors alike, with the benches of different NCLT’s evoking differing opinions on the matter, and in some instances even going as far as to evoke a contrarian view within the same NCLT, as had happened in the NCLT at Mumbai, wherein it had issued two opposing rulings to this question on the very same day, by holding arrears of rents to be operational debts in the case of Indiabulls Real Estate Company Pvt. Ltd. v. Crest Steel Power Pvt Ltd. on the one hand, and finding an unpaid amount towards rent to be a non-operational debt in Citicare Super Specialty Hospital v. Vighnaharta Health Visionaries Pvt. Ltd., on the other.[4] And, despite finding itself in the NCLAT on several occasions, the tribunal’s observations on this issue have always been divided, without offering any conclusivity to the members of the community as to the final stand. But, before we delve into how the position evolved in jurisprudence from here on, it is pertinent to first address the definition of an ‘operational debt’ under the IBC.

  •   What is an Operational Debt?

Section 5(21) of the Code breaks up the definition of an ‘operational debt’ into three components: (i) a claim in respect of the provision of goods or services; (ii) employment or a debt in respect of dues; and (iii) such repayment of dues which should arise under any law in force at that time. But, for the purposes of this paper and the question at hand, we shall solely address the scope of ‘services’ provided under the first component to include within its ambit, lease and rentals which have not been expressly specified for, in the Code, therefore compelling jurisprudence to develop on its own, through precedents, the bounds of the definition.

The long standing conflicting views on the matter of lease and rentals and their qualification as operational debts, has plagued the various benches of the different NCLTs with some holding in their favor and others against – a clear sign of the lack of uniformity in the jurisprudence encompassing the matter. Take for instance, cases filed before the NCLTs – Mahesh Madhavan v Black N Green Mobile Solutions Pvt. Ltd.[5] before the Chennai Bench, Sarla Tantia v. Nadia Health Care Ltd.[6] before the Kolkata Bench, and Saiom Developers Pvt. Ltd. v. R Square Shri Saibaba Abhikaran Pvt. Ltd.[7] before the Ahmedabad Bench. All these suits arose out of petitions filed under Section 9 of the IBC for the initiation of Corporate Insolvency Resolution Proceedings (CIRP) against the Corporate Debtors on account of inability to repay sums owed towards arrears of rent for the use of leased premises. With all three benches addressing the same question of whether the recovery of arrears of rent can be claimed as operational debts within the meaning of Section 3(11) of the Code, and in all three cases answering in the affirmative, holding the petitions filed under Section 9 as maintainable and arrears of rents as “Operational Debts” within the meaning of the Code. With the NCLTs placing reliance on the Supreme Court’s judgement in Mobilox Innovations Private Ltd vs Kirusa Software Private Ltd.[8] that held arrears of rent to be operational debt and the act of letting out a premise on lease to be the provision of a service as per Section 2 of  the Central Goods & Services Tax Act, 2017. 

However, in contrast to these aforementioned decisions, the very same question was found in the negative, in rulings of the NCLTs in the cases of Parmod Yadav & Anr. vs Divine Infracon Pvt. Ltd.[9]Vinod Awasthy v. AMR Infrastructure Limited[10] and Jindal Steel and Power vs DCM International Limited[11] before the New Delhi Bench, M/s Citicare Super Speciality Hospital vs Vighnaharta Health Visionaries Pvt. Ltd.[12] before the Mumbai Bench and M/s Manjeera Retail Holding Private Limited vs M/s Blue Tree Hospitality Private Limited[13] before the Hyderabad Bench. Wherein, they opined that if claims by way of a debt do not fall within any of the three categories as mentioned under Section 5(21) of the Code, those claims cannot be categorized as an operational debt, and even though there may be a liability due from the Corporate Debtor, such creditors would be disentitled from maintaining an application under Section 9 for initiation of CIRP against the Corporate Debtor, thus ruling out a landlords act of leasing out a premises as a provision of a service. Furthermore, by placing reliance on the decision in Parmod Yadav, the NCLTs in the latter cases held after a detailed discussion that transactions of immovable property cannot be considered as a transaction falling under the term’s operation or operational debt, unless such transactions have a correlation to direct input to output produced, which were not apparent from the facts of the above cases.

  • The Jurisprudence on the Matter

This legal quandary first came up for consideration at the NCLAT in the case of Ravindranath Reddy. The tribunal in interpreting the scope of an operational debt under the IBC was posed with the question of whether ‘provision of services’ in the definition, could be construed broadly enough to bring within its purview a landlords act of leasing or renting out a space to a corporate debtor, and consequently afford him the position of an operational creditor within the meaning of Section 5(20) of the Code. 

Thus, the tribunal first analyzed the meaning of a financial creditor and an operational creditor, under the Bankruptcy Law Reforms Committee Report, which while distinguishing the two, found that a lessor from whom an entity rents out a space from, and owes a monthly rent to, on a three-year lease, is an operational creditor. However, despite taking note of the Reform Committee Report’s recommendations that stipulated that while lease dues could be part of the operational debt, and similarly a lessor could be an operational creditor, the NCLAT could not take these into consideration as the legislature has not included the same within the purview of the IBC. Only claims that were in respect to goods or services could find themselves within the meaning of an ‘operational debt’ and consequently an ‘operational creditor’ under the Code. 

Therefore, taking a strict interpretation on the basis of the statutory provisions, the NCLAT found only the three components under Section 5(21) to be a part of an operational debt, which as it happens does not afford any scope to incorporate rental dues within its ambit. On these lines, the NCLAT rejected the appellant’s contentions on the matter and held that, just as lease and rental dues cannot form a part of the operational debt, a lessor or a landlords act of leasing/ renting out a space would not be considered a provision of a service that could afford them the position of an operational creditor.

However, the following year saw a decision from the NCLAT in the Anup Sushil Dubey case on the very same issue, that deviated from its ruling in Rabindranath Reddy, by holding to the contrary that lease rentals arising out of the use of a cold storage unit for a commercial purpose could be construed as an operational debt and the lessor as an operational creditor under the IBC.

In examining the meaning of a ‘service’ under the definition of an operational debt under the Code, the adjudicating authority rightly differentiated between ‘essential goods and services’ and ‘goods and services’ as the former would only comprise of those goods or services whose supply would not be terminated during the Corporate Insolvency Resolution Proceedings. Moreover, there was nothing in the Code that mentioned that ‘goods and services’ under Section 5(21) were the same as ‘essential goods and services’ under Section 14(2). Thus, the tribunal relied on the definition of a ‘service’ as provided for under Section 2(42) of the Consumer Protection Act, 2019 (CPA) and the list of activities considered as ‘goods and services’ in Schedule II of the Central Goods and Services Tax Act, 2017 (CGST) and found that leasing a premise for activities of a commercial purpose would bring it within the meaning of a ‘service’ under Section 5(21) of the IBC. Furthermore, contrary to the case of Rabindranath Reddy, the tribunal had also chosen to rely on the Supreme Court’s judgment in Mobilox Innovations Private Ltd vs Kirusa Software Private Ltd.[14]whose decree was pronounced on the basis of the Bankruptcy Law Reform Committee Report’s recommendations that supported the inclusion of lease rentals within the purview of an operational debt.

Hence, in its conclusion, the tribunal while coupling the definition of a service alongside the Supreme Court’s ruling in the Mobilox case, held lease/rent to be a service and thereby an operational debt within the meaning of the Code. 

But this was not the end to the NCLAT’s conflicting views, as the case that followed Anup Sushil Dubey only served to further deepen the conundrum posed by this legal quandary, by once again delivering a ruling that reversed an earlier decision and thereby the position of the law. 

Promila Taneja vs. Surendri Design Pvt Ltd.[15], was another case before the NCLAT, wherein a landlord had filed an application under Section 9 of the IBC, that was dismissed by the authority on the grounds that dues that took the form of rent of an immovable property would not fall under the head of an operational debt as defined under the IBC. Thus, upholding its observation in the Rabindranath Reddy case. The tribunal’s rationale for this decision base themselves mainly on two grounds. The first being, its plain interpretation of the verbatim in Section 3(37) of the IBC, which stated that for words and expressions used but not defined in the Code, but defined in the other Acts provided therein, they shall have the meanings assigned to them by those Acts. But, given that the CPA and the CGST Act that were used in Anup Sushil Dubey to define the terms ‘service’ and ‘activities’ were not in the list of Acts provided in Section 3(37), they could not be used to do the same. The second reason that pushed the NCLAT to take a conflicting view to its earlier decision is its interpretation of Section 5(8)(d) of the IBC, which read “financial debt means a debt….in respect of any lease…. which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;”, meaning lease/rent dues, if any would be classified as a financial debt and not an operational debt under the IBC. Thus, given these reasons the NCLAT concluded, by supporting the preclusion of rental and lease dues from the purview of an operational debt.

  • Would the non-payment of utility bills/maintenance charges along with non-payment of lease attract section 9 of IBC?

For a debt to be an operational debt in this context, there are two essential elements that require to be fulfilled; (i) it must be a claim; and (ii) it should be in relation to the provision of a service. And, only if a person holds a debt that takes the form of an ‘operational debt’ under Section 5(21) of the IBC, would he be considered as an ‘operational creditor’ as per Section 5(20) and would consequently be able to initiate Corporate Insolvency Resolution Proceedings (CIRP) through Section 9 of the Code.

There have been several judgments from different benches of the NCLT that have indicated this position of law, by holding that for an applicant to initiate insolvency proceedings under Section 9, he had to have supplied goods or rendered services. The decision of the Kolkata NCLT in the case of Ranual Technologies Private Limited v Calprin Ads Private Limited [16] and the New Delhi NCLT in Rahul Sayal v S.S Conbuild [17] are some such instances. 

Therefore, if non-payment of utility bills/maintenance charges along with the non-payment of lease is to attract Section 9 of the IBC, then it must first be recognized as a debt in the nature of an operational debt. However, given the position of law on the matter of lease and rentals as operational debts as established in the paper above, the NCLAT’s ruling in Rabindranath Reddy and even the most recent decision in Promila Taneja point to their exclusion from the purview of ‘service’ under the Code, and naturally their nature as a financial debt. Thus, given that there is no rendering of any service and that it is not an operational debt for that matter, any dues arising from them would certainly not attract Section 9 of the Code.

  • Conclusion

This issue has certainly posed a dilemma to members of the community, due to the lack of any conclusively on the matter, with the NCLT’s and the NCLAT taking conflicting views time and time again, constantly changing the position of law. Leaving us with, but two options, either accept the findings of the larger bench, as per the principle of comity of courts, which is to accept the ruling in Ravindranath Reddy that was delivered by a three-member bench making for greater precedential value, unlike Promila Taneja and Anup Sushil Dubey that were both delivered by a two-member bench. Or to wait for the Apex Court to clarify the ambiguity in the appeal put forth to it, following the Promila Taneja case in hopes of finally putting the matter to rest.

Author: Abhishek Gupta, Senior Associate.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at abhishek@samistilegal.in


[1] Company Appeal (AT) (Insolvency) No. 229 of 2020

[2] ibid.

[3] Company Appeal (AT) (Insolvency) No. 331 of 2019

[4] Bishwajit Dubey and others, “Lease and Rentals: Are these Operational Debt under the IBC?”, (Cyril Amarchand Mangaldas, June 14, 2021), https://corporate.cyrilamarchandblogs.com/2021/06/lease-and-rentals-are-these-operational-debt-under-the-ibc/#_ftnref13.

[5] 2017 SCC OnLine NCLT 13134

[6] C.P. (IB) No. 335/KB/2018

[7] TP/ MP/ 30 of 2019 in CP (IB) 510 of 2018.

[8] [2018] 1 SCC 353

[9] [2017] SCC OnLine NCLT 11263

[10] C.P No. (IB)-10(PB)/2017

[11] C.P No. (IB) -200/ND/2017

[12] C.P. No. 567/IB/2018

[13] CP IB No. 61/9/HDB of 2019

[14] (n 8)

[15] Company Appeal (AT) (Insolvency) No. 459 of 2020

[16] CP (IB) No. 212/KB/2018

[17] CP (IB) No. 100/PB/2017

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