Unpaid license fees – An “operational debt” under the Insolvency and Bankruptcy Code 2016

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Introduction

In an effort to provide relief to licensors whose license fee payments are in arrears, the National Company Law Appellate Tribunal (“NCLAT”) see order of July 7, 2022 (“Order”) held that debt arising from unpaid license fees qualifies as ‘operational debt’ under section 5(21) of the Insolvency and Bankruptcy Code 2016 (“Coded”).

The said order was made in the case of Jaipur Trade Expocentre Pvt. ltd. vs. M/s Metro Jet Airways Training Pvt. ltd. (“Jaipur Trade”) by a bench of 5 (five) members of the NCLAT reversing previous decisions of the NCLAT in the cases of MM Ravindranath Reddy v. MG Kishan & Ors. (“Ravindranath Reddy“) and Promila Taneja v Surendri Design Pvt. ltd. (“Promila Taneja”). In the said order, the NCLAT observed that Ravindranath Reddy and Promila Taneja (which reiterated the position taken by the NCLAT in Ravindranath Reddy) failed to consider the breadth and scope of the expression” service” used in section 5(21) of the Code. Moreover, the nature of the royalties in both cases was that of real estate rental, whereas the present case concerns unpaid license fees arising from a license granted for the use of certain premises under a license agreement which expressly provides for the payment of goods and the service tax (“GST”). Since the debt arose from a license granted for a particular type of service, namely the management of an educational institution, the unpaid fee is fully covered by the scope of ‘operating debt under section 5(21) of the Code.

Summary of the decree of 7e July 2022

Facts of the case:

  1. The appellant/operational creditor issued a notice of formal notice under Article 8 of the Code for a total amount of rupees. 1,31,20,788/- (rupees one crore thirty one lakhs twenty thousand seven hundred eighty eight only) against the respondent/corporate debtor. Said debt included unpaid license fees under a license agreement dated April 15, 2017 signed by and between the parties. The debtor company failed to respond to the content of the formal notice; conversely, the debtor company filed a civil suit in the Sanganer court in Jaipur.
  2. Simultaneously, the appellant filed a motion under section 9 of the Code which was opposed by the debtor company. In accordance with the order of March 4, 2020, the Appellant’s request was dismissed on the grounds that the unpaid license fees do not constitute an “operating debt” within the meaning of the Code. Injured by the said order, the Appellant preferred to appeal to the NCLAT, which was then seized and judged by a bench of five members of the NCLAT.

Results:

The main issues that were raised for determination by the five-member bench of the NCLAT were:

  • that the judgment of Ravindranath Reddy reflects the correct position of the law?

Answering this question in the negative, the NCLAT ruled as follows:

  1. The facts in Ravindranath Reddy involved a request for an increased license fee and were therefore distinct.
  2. The NCLAT in Ravindranath Reddy failed to consider the scope and scope of the term “services” under section 5(21) of the Code and incorrectly relied on section 14(2) ) of the Code which has a very restrictive scope. Section 14(2) of the Code deals with the provision of essential goods or services to the corporate debtor and is unrelated to the extent and expenditure of “operating debt” within the meaning of Section 5(21) of the Code.
  3. “Operating debt” as defined in section 5(21) of the code has a much broader meaning than essential goods and services and the court in Ravindranath Reddy erred in judging that “any debt arising unrelated to the direct contribution to the production produced or supplied by the debtor company cannot, within the framework of the Code, be considered as an operating debt, even if it is a debt equivalent to a debt‘ – a much broader observation that is not supported by the economy of the code.
  • Whether or not the claim for unpaid royalty for the use and occupation of real estate for business purposes is classified as an “operating debt” under Article 5(21) of the Code ?

Answering in the affirmative, the NCLAT ruled as follows:

  1. Article 5(21) of the Code defines an “operating debt” as a debt relating to the supply of goods or services. Except for this definition of “operating debt” as it appears in Article 5(21), the term has not been explained in any other provision of the Code. The Bankruptcy Law Reform Committee report dated June 4, 2015 cites examples such as unpaid rent qualifying as operational debt under the Code.
  2. In Anup Sushil Dubey v National Agriculture Co-operative Marketing Federation of India Ltd. & Anr., the Operational Creditor and the Debtor Company had entered into a Leave and License Agreement for the use of a cold store. The NCLAT considered that the rent associated with the use and occupancy of the cold storage unit was considered an operating debt. Likewise, in Sanjeev Kumar vs. Aithent Technologies Pvt. ltd. & Anr., where the Operating Creditor had leased certain premises to a Debtor Company, the Contracting Authority admitted the claim of the Operating Creditor as an unpaid debt which falls under Article 5(21). Subsequently, the NCLAT also upheld this order. Another case that involved the issue of unpaid operating debt arising from a furlough and license agreement was the case of Sarla Tantia v. Ramaani Hotels & Resorts Pvt. ltd. & Anr. In this case, the NCLAT was of the view that the application under Section 9 of the Code merited admission. Therefore, a prima facie analysis demonstrates that since the granting of a license to use and occupy premises for commercial purposes appears to be an operational transaction, the unpaid license fees must be considered an operational debt.
  3. The term “services” within the meaning of Article 5(21) has nowhere been defined in the Code. In this regard, the NCLAT relied on the rules of statutory interpretation and observed that the term “service” can be used to refer to any type of service that is made available to potential users and includes the provision of facilities.
  4. Interestingly, while referring to the facts of the case, the NCLAT observed that the debtor company was liable for GST under the license agreement and therefore the appellant was supplying services by licensing respondent/debtor company to use and occupy premises . Section 3(37) of the Code provides that words and expressions which have been used but not defined by the Code, but which may be defined by other laws, have the same meaning given to them in those laws. Section 3(37) lists a specific set of laws, such as Companies Act, Indian Contracts Act, etc. However, this does not include the Central Goods and Services Tax Act 2017 (“CGST‘).
  5. Relying on section 3(37) of the Code, the NCLAT dealt with the observation in Promila Tanejawhere the Tribunal held that since the Consumer Protection Act 2019 and the Central Goods and Services Tax Act 2017 have not been expressly covered by section 3(37) of the Code, the definition of services in these laws cannot be imported based on Article 3(37) of the Code. The NCLAT denied the argument in Jaipur trade since the license contract itself provides for the payment of GST for the services rendered under the contract. Thus, the definition of “services” within the meaning of the CGST cannot be rendered devoid of purpose. Further, where a term has not been legally defined, its meaning must be established from the general usage and application of the term.

Conclusion

The judgment rendered by the NCLAT in Jaipur Trade has the effect of extending the scope of Article 5(21) of the Code to include debts relating to unpaid license fees. By setting aside the order made in Ravindranath Reddy and hence Promila Taneja, the judgment establishes the final legal position on the matter which will prevail unless challenged by the debtor company by way of appeal to the Supreme Court of India.

The judgment is a welcome move for landlords/licensors seeking to evade old tenancy laws that govern tenuous landlord-tenant/licensor-licensee disputes, given the arduous litigation one would otherwise face in court. civil even if the debt is a At the same time, it should be considered whether the inclusion of debts which are likely to be strongly disputed and contested should be brought before the National Company Law Courts, which are statutorily bound to adjudicate summarily on applications filed under the Code.

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