Equity Investment Made through Commercial MoU does not Convert Underlying Claim into Operational Debt: NCLT [Read Order]

The National Company Law Tribunal( NCLT), Hyderabad Bench has held that an equity investment made through Commercial memorandum of understanding (MoU) doesn't convert the underlying claim into operational debt. An equity investment, does not relate to the provision of goods or services, and hence does not fall within the meaning of “operational debt” under the Insolvency and Bankruptcy Code, 2016 (IBC).

The Application has been filed by Mrs Neeta Zanvar, (Operational Creditor/OC/Applicant) under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC) read with Rule 6 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, seeking initiation of the CorporateInsolvency Resolution Process (CIRP) against M/s. Filatex Fashions Limited, (Corporate Debtor/CD /Respondent) on account of an alleged operational debt amounting to ₹2,75,56,134/.

The Applicant entered into a Memorandum of Understanding (MoU) dated 13.12.2017 with the Respondent, whereby the Applicant agreed to provide financial assistance to the Respondent through investment. In consideration thereof, the Respondent agreed to issue shares to the Applicant as security. Pursuant to the said MoU, the Applicant invested a sum of ₹1,00,00,000/- (Rupees One Crore only), against which 20,00,000 (Twenty Lakh) equity shares of ₹5/- each were allotted by the Respondent.

As per the terms of the MoU, the Respondent undertook to provide an assured exit to the Applicant with returns/profit on the investment. It was specifically agreed that in the event the Respondent failed to provide the promised returns, it would be liable to repay the principal amount along with interest at the rate of 24% per annum. The MoU stipulated that the transaction was to be completed within a period of 16 (sixteen) months from the date of execution. However, the Respondent failed to adhere to the terms and conditions of the MoU despite multiple reminders.

A second MoU dated 30.06.2023 was executed, wherein the Respondent acknowledged and agreed that a total sum of ₹2,75,56,134/- was due and payable to the Applicant, inclusive of interest and incidental charges. The date of default was mutually set as 30.09.2023 in case of nonpayment. Upon failure of the Respondent to make payment, the Applicant issued a demand notice under Section 8 of the IBC on 26.12.2023, demanding payment of ₹2,75,56,134/-.

The applicant argued that issuance of shares was merely a security mechanism. The dominant intent of the transaction was financial assistance, which falls within the scope of “debt” under Section 3(11) and “default” under Section 3(12) of the IBC. The claim also qualifies as an “operational debt” under Section 5(21) of the IBC. The pendency of a separate Section 7 application by the Applicant’s husband cannot be grounds for dismissal. Both parties acted independently in their individual capacities, based on distinct transactions.

The core issue before this Adjudicating Authority is whether the claim made by the Applicant constitutes an “operational debt” and whether there exists an “operational default” within the meaning of Sections 5(21) and 3(12) of the Insolvency and Bankruptcy Code, 2016, respectively.

Section 5(21) of the IBC defines "operational debt" as: "a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law... payable to the Central Government, any State Government or any local authority."

The tribunal found that the investment made by the Applicant was towards acquisition of equity shares and not towards any supply of goods or services. The MoU contemplated an exit strategy based on market performance, with profits to be shared equally after deducting the Applicant’s capital contribution.

The promise of returns or refund in case of non-performance does not alter the nature of the arrangement. No goods were supplied, nor services rendered by the Applicant to the Respondent. The entire foundation of the claim rests upon a commercial MoU governing investment and share exit strategies, and therefore, lacks the character of an operational relationship.

The tribunal comprising Mr. Rajee Bhardwaj (Member-Judicial) and Mr. Sanjay Puri (Member-Technical) viewed that the existence of a mere investment or commercial arrangement, without such disbursement, does not satisfy the statutory test. It was found that the transaction clearly falls outside the ambit of Section 5(21). The present transaction, being an equity investment, does not relate to the provision of goods or services, and hence does not fall within the meaning of “operational debt” under the Code.

The entire dispute stems from a commercial investment for profit with fallback clauses, and not from an operational relationship involving supply of goods or services. It is clarified that the mere fact that the Applicant’s husband has filed a separate Section 7 application based on similar documents and grounds does not bar the present adjudication. The Applicant and her husband are distinct legal persons, each having entered into separate contracts with the Respondent.

The Tribunal held that the alleged claim does not constitute an "operational debt" under Section 5(21) of the Code.

commercial MoU investment

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