The National Company Law Appellate Tribunal (NCLAT), Principal Bench, New Delhi, has held that an amount paid as part of the consideration for a share purchase does not automatically become a financial debt merely because the recipient later records it as an unsecured loan, credits interest and deducts tax at source.
The three-member bench of Justice Sharad Kumar Sharma (Judicial Member), Arun Baroka and Indevar Pandey (Technical Members), dismissed an appeal seeking to initiate corporate insolvency proceedings over a payment of ₹1.39 crore made under a share purchase arrangement.
The tribunal found that the payment was originally made as part of the price of a proposed share acquisition. The appellant had failed to establish its claim that the parties subsequently entered into an oral agreement converting the amount into an interest-bearing loan.
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The NCLAT also directed its registry to forward a copy of the judgment to the jurisdictional Principal Commissioner of Income Tax for such action, if any, as considered appropriate. It made clear that it had expressed no opinion on any income-tax liability.
Background of the case
Catalyst Refinery Services Private Limited, the appellant, had entered into a tripartite memorandum of understanding (MoU) dated August 27, 2014, with Ganpati Global Private Limited and its shareholders.
Under the arrangement, the shareholders agreed to sell their entire shareholding in Ganpati Global for a total consideration of ₹7.70 crore. The agreed consideration was to be applied towards the company’s term loans, unsecured loans and other current liabilities, with the balance going towards the purchase of shares.
Pursuant to the MoU, Catalyst Refinery Services transferred ₹1.39 crore to Ganpati Global through six cheques issued between August 29 and August 31, 2014.
The proposed transaction did not go through. The parties blamed each other for its failure: the appellant said the company and its shareholders did not fulfil their obligations, while the respondent maintained that the appellant had failed to pay the full consideration.
The appellant contended that, after the share deal reached a stalemate, the parties orally agreed that the amount already paid would continue as an unsecured loan, carrying interest at 11% per annum and repayable on demand.
It acknowledged that no formal loan agreement had been executed. However, it relied on Ganpati Global’s financial records, which showed the amount as an unsecured loan, as well as balance confirmation letters and tax deducted at source on interest.
According to the appellant, a demand-cum-legal notice was issued in February 2019, but the amount remained unpaid. It subsequently filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC), claiming ₹2.73 crore, comprising the principal of ₹1.39 crore and interest of approximately ₹1.34 crore up to August 31, 2021.
The National Company Law Tribunal (NCLT), Jaipur Bench, dismissed the application on October 19, 2022. The appellant challenged that order before the NCLAT.
The central question before the appellate tribunal was whether the ₹1.39 crore constituted a financial debt under Section 5(8) of the IBC, making the appellant a financial creditor entitled to seek initiation of the Corporate Insolvency Resolution Process.
The NCLAT examined the original MoU and found that it dealt with the price of the shares and the manner in which the consideration would be applied. It did not require the respondent company to repay the amount to the appellant or provide for interest or another return for the use of money over time.
The tribunal noted that the appellant itself had described the payment as part of the consideration for acquiring shares. It concluded that, when the cheques were issued, the money was paid as part of a share purchase price, rather than disbursed against consideration for the time value of money.
The bench rejected the argument that money paid to a company by a prospective share purchaser could only be share application money or an unsecured loan. The MoU was a tripartite arrangement, and payment to the company was the agreed method of applying part of the purchase consideration towards its liabilities.
The NCLAT said the appellant had not stated when the alleged oral agreement was made, identified who represented each company in reaching it, or shown any board resolution or other authority for it.
The resolutions relied upon by the appellant predated the MoU and therefore could not establish an oral agreement said to have been reached after the proposed share transaction failed. No document signed or accepted by both parties setting out the interest rate, tenure or repayment date was produced.
The tribunal clarified that an oral agreement can support a claim of financial debt. Its finding was that, on the evidence in this case, the appellant had not established that the alleged agreement was made or proved its terms.
A disputed oral agreement whose existence and terms depended on one party’s account against the other’s could not be tried in the summary proceedings contemplated under Section 7, the bench held.
The appellant relied on the respondent’s balance sheets, which described the amount as an unsecured loan, and on balance confirmation letters dated June 30, 2015, and June 15, 2017. The respondent had also credited interest and deducted TDS under Section 194A of the Income Tax Act.
The NCLAT accepted that a balance sheet can amount to an acknowledgment of debt for the purposes of limitation. However, it distinguished an acknowledgment that money is owed from proof that the amount qualifies as a financial debt under the IBC.
An entry made by one party in its books, the tribunal said, could not by itself change the nature of a payment originally made for a different purpose. Similarly, describing an amount as an unsecured loan did not automatically establish the relationship of financial creditor and corporate debtor.
On TDS, the bench observed that deduction under Section 194A showed that the debtor had treated a payment or credit as interest. By itself, it did not prove that the principal was lent for a return or that the parties had agreed on interest.
The NCLAT also noted that, apart from the tax deducted at source, no interest had actually been paid to the appellant. It treated that as a relevant circumstance in assessing the nature of this particular transaction.
At the same time, the tribunal acknowledged the Supreme Court’s ruling in Orator Marketing Pvt. Ltd. v. Samtex Desinz Pvt. Ltd. that payment or stipulation of interest is not an essential element of every financial debt. The absence of actual interest payment was relevant here because the character of the transaction itself was disputed.
The bench held that the ₹1.39 crore was not proved to be a financial debt under Section 5(8), and that the appellant was therefore not a financial creditor in respect of that amount. It agreed with the NCLT that the Section 7 application was not maintainable.
The tribunal said the question of whether the appellant could recover the money, and any interest on it, depended on the MoU, the parties’ subsequent conduct and evidence requiring a full trial. Those issues could not be decided in the Section 7 proceedings.
While dismissing the appeal, the NCLAT allowed the appellant to approach the appropriate legal forum for relief. It left the parties’ rights and contentions open and expressed no view on the merits of a recovery claim or on limitation.
The bench also clarified that it had not decided the respondent’s other objections concerning company-law requirements, the alleged interest rate or whether a default had occurred. The appeal failed because financial debt had not been established.
The tribunal took note of the respondent’s accounting treatment: it had retained the ₹1.39 crore for years, shown the amount as an unsecured loan, credited interest and deducted TDS, while no interest had been paid to the appellant.
The NCLAT said whether that treatment was consistent with the Income Tax Act was a matter for the income-tax authorities. It directed the registry to forward the judgment to the Principal Commissioner of Income Tax having jurisdiction over the respondent, without expressing any opinion on tax liability.
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