NCLAT Clarifies: Security Deposit Refunds Do Not Qualify as Operational Debt Under IBC

Introduction

The National Company Law Appellate Tribunal, Delhi (‘NCLAT’), ruled in the matter of Carestream* *Health India Private Limited v. Seaview Mercantile LLP[i] that a refund of a security deposit, contingent upon executing an agreement does not qualify as operational debt (‘OD’) under the Insolvency and Bankruptcy Code, 2016 (‘IBC’).

Brief Facts

• The Appellant and the Respondent, i.e., Carestream Health India Pvt. Ltd and Seaview Mercantile LLP, respectively, entered into a ‘without-prejudice letter of intent’ (WP-LOI) for leasing a building, pursuant to which the Appellant paid a security deposit of Rs. 25.6 Lakhs approximately.

• The Appellant subsequently discovered that the aforementioned premises were not eligible for IT/ITES/STPI registration. Consequently, the Appellant sought to terminate the WP-LOI and requested a refund of the security deposit.

• The Appellant issued several notices and reminders, including a notice under s. 8 of the IBC, to the Respondent and sought a refund of the security deposit.

• Subsequent upon filing the s. 8 application, the Respondent replied and disputed the Appellant’s claims. The Respondent asserted their right to forfeit the security deposit on the ground that the Appellant failed to execute the licence agreement. Aggrieved by the forfeiture of the security deposit, the Appellant filed a petition for the corporate insolvency resolution process (‘CIRP’) under s. 9 of the IBC on 20.02.2020.

• The NCLT, however, dismissed the above petition on the ground that the Appellant did not qualify as an operational creditor within the meaning of the IBC. Thus, the security deposit forfeited did not qualify as an OD under s.5(8) of the IBC. Hence, the same was not defaulted under s.3(12) of the IBC. Aggrieved by the NCLT order, the Appellant filed an appeal before the NCLAT, contending, ‘whether the claimed amount qualifies as an OD under the IBC?’

Held

Upholding the decision of the NCLT, Mumbai, the NCLAT dismissed the appeal and made the following observations:

• The security deposit did not qualify for a refund as operational debt since it was tied to a conditional contractual obligation, contingent upon executing a leave and license agreement, and unrelated to the provision of any goods or services.

• Additionally, a pre-existing dispute over the contract's termination and other issues constituted a 'genuine dispute,' rendering the application under s. 9 of the IBC redundant.

Our Analysis

This judgment provides insight into what constitutes an OD under the IBC. The NCLAT held that the security deposit does not constitute an OD under IBC as defined by s.5(21) of the IBC, as it does not arise from providing goods or services. S. 5(21) delineates OD as a claim in respect of the provision of goods or services, including employment, or a debt arising under any law for the time being in force.

The Appellant’s claim for refund of the security deposit did not pertain to the provision of goods or services; instead, it was linked to a conditional contractual arrangement and not to the actual provision of goods or services. Despite the WP-LOI contemplating a future license agreement, the security deposit was not directly linked to any service rendered by the Respondent. To qualify as OD, a claim must have borne some nexus with providing goods or services.

Even if the NCLAT were to consider the security deposit an OD, established legal precedent that CIRP proceedings could not be initiated solely to recover dues, especially when a pre-existing dispute exists, would still preclude the maintainability of a CIRP petition under s. 9 of the IBC. This precedent underscores that the presence of a genuine dispute alone is sufficient to invalidate the initiation of proceedings under s. 9 of the IBC.

End Note

[i] 2024 SCC OnLine NCLAT 684

Authored by Shreya Manchanda, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.