Licensing of premises is a ‘Service’ under insolvency law

Posted On - 29 July, 2022 • By - Souvik Ganguly

Under the Insolvency and Bankruptcy Code, 2016 (Code), a trade creditor may initiate corporate insolvency resolution process if there is an unpaid operational debt above INR 10 million. An ‘operational debt’ under the Code means a claim in relation to goods and services. The insolvency courts have provided divergent views on the issue of whether rental dues or license fees for use of premises would qualify as an ‘operational debt’ under the Code.

In January 2020, the National Company Law Appellate Tribunal (NCLAT) in M. Ravindranath Reddy v. G. Kishan (Ravindranath Reddy Case), held that the lease of immovable property cannot be considered as supply of goods or rendering any services and therefore, rents due cannot fall within the definition of ‘operational debt’ under the Code.

In October 2020, the NCLAT in Anup Sushil Dubey v. National Agriculture Co-operative Marketing Federation of India Ltd. (Anup Dubey Case) considered whether dues arising from a leave and license agreement are construed as ‘operational debt’ under the Code. The NCLAT noted that:

(i)  the Code has not defined ‘goods’ or ‘services’ and hence, general usage of these terms have to be relied on;

(ii)  the Code does not specify that essential goods and services mentioned under the regulations are those that fall under the ambit of ‘operational debt’; and

(iii)  since the premises was leased out for a commercial purpose, service tax is payable. Thus, the definition of ‘services’ under the Central Goods and Services Tax Act 2017 (CGST Act) can be referred which includes lease of a building for business or commerce as a supply of service.

Accordingly, the NCLAT held that lease rentals for commercial purposes are ‘operational debts’ under the Code. Pursuant to this order, it may be understood that ‘goods or services’ under the definition of ‘operational debt’ is not required to have a direct nexus with the input to the output produced by the corporate debtor in contrast to the Ravindranath Reddy Case.

Further, in November 2020, the question of whether arrears of rent are ‘operational debt’ was considered by the NCLAT in Promila Taneja v. Sundari Design Pvt. Ltd. In this case, the NCLAT concurred with the finding in Ravindranath Reddy Case that rent is not ‘operational debt’.

Order of the larger bench

Recently in March 2022, this issue of whether a license fee pertaining to immovable premises for running commercial activity will fall within the definition of ‘operational debt’ came up before the NCLAT in Jaipur Trade Expocentre Pvt. Ltd. v. Metro Jet Airways Training Pvt. Ltd. (Jaipur Trade Case). Considering the divergent views of the NCLAT in Ravindranath Reddy Case and Anup Dubey Case, this issue was referred to a larger bench of the NCLAT.

The larger bench of the NCLAT made the following observations:

(i)  the license agreement stipulates that the licensee must pay all taxes including goods and service tax (GST) over and above the license fee. The payment of GST is contemplated only for goods and services. Had this not been a service, there was no occasion to make the licensee liable to pay GST. Therefore, the definition of ‘service’ under the CGST Act is not irrelevant;

(ii)   the term ‘operating cost’ is defined as an expense incurred in the conduct of the principal activities of the enterprise under P Ramanathan Aiyar – Advanced Law Lexicon. ‘Operational debt’ under the Code is also a debt which incurred in the conduct of principal activities of the enterprise;

(iii)  the recommendations of Bankruptcy Law Reforms Committee (BLRC) regarding lease rentals being ‘operational debt’ can be used to understand the nature and content of ‘operational debt’.  BLRC’s observation that a lessor is an operational creditor is relevant;

(iv)  the observation of the NCLAT in Ravindranath Reddy Case that any debt arising without nexus to the direct input or output produced cannot be considered operational debt is contrary to the scheme of the Code.

In view of the above, the NCLAT held that license fee for use of premises for business purposes is an ‘operational debt’ and the decision in Ravindranath Reddy Case does not lay down the correct law.

Our thoughts

The NCLAT’s order in Jaipur Trade Case recognises the wide meaning intended to be provided to the term ‘services’ in the definition of ‘operational debt’ in line with the framework of the Code. Consequently, service providers such as a licensor will be classified as ‘operational creditors’. While the question on whether lease rentals of an immovable property are ‘operational debts’ is not specifically answered by the NCLAT, our view is that lease rentals will also be considered ‘operational debt’ pursuant to the Jaipur Trade case. Our earlier views on this issue can be accessed here.

Given the above, a creditor leasing or renting a property has recourse under the Code if there is a default in payment of above INR 10 million. However, such recourse must be judiciously opted being mindful that the Code is not a recovery tool. It may also be apposite to wait for the Supreme Court of India’s view on this issue which is currently under consideration.

 Authors: Souvik Ganguly, Akhil Ramesh and Shrishti Mishra

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.