This Blog Post analyses the judgment ofNew Okhla Industrial Development Authority v. Anand Sonbhadra, wherein the Supreme Court held that New Okhla Industrial Development Authority (NOIDA or the Appellant) is an operational creditor and not a financial creditor. The Supreme Court affirmed the decision of the National Company Law Appellate Tribunal (NCLAT) and the National Company Law Tribunal (NCLT), wherein both Tribunals held that NOIDA is an operational creditor. Further, the author revisits the criteria of “financial debt” and whether NOIDA, a public authority, satisfies the Court on this criterion based on a lease deed that NOIDA claims is of a financial nature. Lastly, this Blog Post studies the implications of this judgment and its benefits to homebuyers.

1. Introduction 

TheInsolvency and Bankruptcy Code, 2016 (the Code) lucidly distinguishes between financial and operational creditors. On the one hand, financial creditors enjoy certain powers such as voting, the power to appoint an Interim Resolution Professional, approve Resolution Plans and participate in the Committee of Creditors (CoC) decision-making process. However, on the other hand, operational creditors are put on a higher pedestal underRegulation 38 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, which states that the amount that is due to the operational creditors must be paid in priority to any financial creditors when a resolution plan is submitted by an interested applicant. In other words, operational creditors are to be given higher priority in the payment of dues in a resolution plan. The primary motivation for NOIDA to become a financial creditor was to safeguard its significant financial stake and to gain additional insight into the Corporate Insolvency Resolution Process (CIRP) and the Resolution Plans, which otherwise would tilt in favor of the homebuyers. In the present case, the Supreme Court concludes why NOIDA cannot be put on a similar footing as homebuyers (who are the financial creditors), and NOIDA was rightly categorized as an operational creditor by earlier Courts. 

A financial creditor is defined underSection 5(7) of the Code as any person to whom a financial debt is owed. Hence, it is paramount for NOIDA to prove that the lease deed entered between NOIDA (Lessor) and the Corporate Debtor (Lessee) falls under the definition of financial debt. NOIDA’s desire to become a financial creditor is evident from the fact that financial creditors are solely permitted to form part of the CoC who have leverage in approving the Resolution Plan binding on all creditors. Since the majority of the CoC were homebuyers, in this case, NOIDA asserted its claim to be a financial creditor to protect its interest and the significant sums of public money at risk.

2. Facts of the Case 

The Corporate Debtor and NOIDA entered into a lease deed to build residential flats that NOIDA had approved. The lease deed stipulated that 10% of the consideration was paid upfront, and the remaining 90% was to be paid over sixteen half-yearly installments (plus interest that accrued during the moratorium period that the lease deed specified). NOIDA initially filed Form “B” as an operational creditor for outstanding dues against the lease of plot granted in favor of the Corporate Debtor. Later, NOIDA filed a claim in Form “C” seeking the status of NOIDA to be recognized as a financial creditor. Thus, the main issue which arose before the NCLT, NCLAT, and the Supreme Court was: Whether NOIDA is entitled to be treated as a financial creditor under the Code?

3. Criteria to Qualify as a Financial Creditor 

The primary requirement to qualify as a financial creditor is the presence of default and financial debt. Unusually, the arguments of the NOIDA before the NCLAT and the Supreme Court diverge on legal points regarding its eligibility to be a financial creditor. In the NCLAT proceedings, NOIDA took the stance that the debt in the present case falls underSection 5(8)(d) of the Code. However, before the Supreme Court, NOIDA altered its stance, stating that the debt falls underSection 5(8)(d) andSection 5(8)(f) of the Code. Due to this, the Supreme Court needed to delve into the nature of the transaction to see whether the debt falls underSection 5(8)(d) andSection 5(8)(f) of the Code. 

Section 5(8) of the Code defines “financial debt” as a debt along with the interest that is disbursed against the consideration for the time value of money. Thus, prima facie, there are two significant limbs. First, the presence of financial debt, and second, this debt has been disbursed to the Corporate Debtor. 

InDr. B.V.S. Lakshmi v. Geometrix Laser Solutions Private Limited, NCLAT dealt with the concept of disbursement and held that the borrower must have raised funds directly or through other means, such as the issuance of bonds, notes, debentures, loan stock, or any other similar instrument if the Claimant asserts that he is a “financial creditor.” In such a case, the financial creditor must demonstrate that the debt is “due” and that the financial creditor has disbursed funds against the “consideration for the time value of money.” It is not essential to demonstrate that money has been “paid” to the Corporate Debtor to establish that debt was disbursed against the “consideration for the time value of money.” Any instrument can demonstrate that the payment was made with “respect to the time value of money.” The crux of NOIDA’s case before the Supreme Court was that it is not mandatory for a debt to be disbursed or outflow of money from NOIDA, i.e., the creditor, to the Corporate Debtor, and that any instrument can be relied upon as long as payment is made or “was to be made” against the time value of money. 

The Code also states that a lease can be considered as financial or capital according to the Indian Accounting Standards.Section 5(8)(d) of the Code lays down that “financial debt” means and includes the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed. Thus, the question arises: whether NOIDA satisfied the criteria mentioned above to be classified as a financial creditor?

4. Classification of NOIDA: Financial Creditor or Operational Creditor? 

Indian Accounting Standard 17 (Ind AS 17) identifies two kinds of leases, i.e., financial and operational. Paragraph 4 of Ind AS 17 defines a financial lease as “A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred”. To put it simply, “transfer of all the risks and rewards incidental to ownership” simply means the transfer of control of all the assets linked to the title of the asset. In the present case, the underlying asset is land. Consequently, the issue of whether the current lease is a financial lease arose. Paragraphs 7 to 19 of Ind AS 17 are required to be followed to classify a lease as a financial lease underSection 133 of the Companies Act, 2013. According toParagraph 8 of Ind AS 17, a lease is classified as a financial lease when it transfers all risks and rewards incidental to ownership. Paragraph 10 states that the classification depends on the substance of the transaction and not on the form of the contract.Paragraph 12 says that if the lease does not substantially transfer all risks and rewards incidental to ownership of an underlying asset, the lease is to be classified as an operating lease. Lastly, according toParagraph 13, the lease must be classified as financial or capital by the Lessor since the lease’s inception date. The inception date is the date of the agreement or date of commitment by parties, whichever is earlier. In the present case, NOIDA had not classified the lease as a financial lease from its inception. Further, the lease was not recognized as a financial lease on NOIDA’s balance sheet as prescribed underParagraph 20 of Ind AS 17. Failure of initial recognition and classification of the lease as a financial lease by NOIDA violated these provisions of Ind AS 17. 

Another important aspect of proving that the current lease is a financial lease is the transfer of all risks and rewards incidental to ownership as prescribed under Paragraph 8 of Ind AS 17. Transfer of “risks” indicates considering all possibilities of a loss, such as a change in economic conditions, change in circumstances, technological obsolescence, and cessation of operations, while “reward” means profit and economic benefits generated from the lease. While it is paramount to prove this transfer of risks and rewards, it must be a transfer incidental to the ownership of the asset, which means the transfer of the control of the asset. Now, this does not necessarily mean that only the owner or the Lessor of the asset will constitute the control, including taking all the risks involved in the lease. Most lease agreements are drafted to safeguard the Lessor from taking risks. As a result, the risks are transferred to the Lessee. However, not every risk and reward is associated with ownership is transferred, only some are, and it is essential to identify which one plays a key role in controlling the lease and who is exercising this control by taking these risks to ensure the lease agreement is executed accordingly. Thus, only a substantial transfer of risks and rewards incidental to the ownership of the asset from the Lessor to the Lessee will indicate the nature of the lease as financial. 

Hence, it is essential to satisfy the two prongs: transfer of all risks and rewards and ownership. Two axes support NOIDA’s contention that there is a transfer of risks and reward. Firstly, the Lessee can fix the price for the dwelling units and is free to appropriate the profits. Secondly, since the Lessee was given the authority to transfer the flats, the ownership of the land has been transferred to the Lessee. Thus, it may appear that there has been a transfer of all risks and rewards and ownership to the Lessee (Corporate Debtor) by the Lessor (NOIDA). However, on these two points, the Court observed the following. Firstly, profits generated from commercial activities by selling units by the Lessee could not be considered a reward incidental to ownership. Secondly, there is no sale of land in the present case as it is a lease by which almost all rights are controlled by the Lessor (NOIDA). 

The Appellant argued that the underlying asset in this lease deed is the residential flats to be sold along with the land. However, the Court observed that the underlying asset is the plot of land, not the residential flats to be constructed. As the Lessee constructs the residential flats in the present case, which it will sell to sub-Lessees/apartment-owners/homebuyers, the title will directly flow from the Lessee to the sub-Lessee and not to NOIDA. Further, the Court noted an absence of an ownership transfer clause in the lease deed. Thus, the current lease does not give the title to the Appellant, and the title is the primary ingredient to prove ownership. Additionally, since ownership did not belong to the Appellant, naturally, substantial risks and rewards were not attached to NOIDA but to the Corporate Debtor (Lessee)/sub-Lessees. 

Interestingly, the lease agreement was drafted in a manner where it came across as NOIDA controlled most of the aspects of the lease, transferring most of the risk to the Lessee except the right to sell the flats once they were constructed. NOIDA was in-charge of the lease and played a massive role in supervising the lease, including aspects of the mortgage, payment schedule, interest, and other similar aspects. As a result, while some of the risks were transferred to the Lessee, they were not risks associated with ownership since NOIDA did not have a title to the residential flats which were to be constructed by the Lessee. Hence, the Supreme Court concluded that NOIDA did not satisfy the criteria of transfer of all the risks and rewards incidental to ownership of an underlying asset as these risks and rewards must stem directly from rights of ownership and not rights of the Lessee. Additionally, there was no disbursement of money in the present case from NOIDA to the Corporate debtor. The Court observed that a disbursement is a pre-requisite to satisfySection 5(8)(d) of the Code and that it should flow from the creditor to the debtor. Consequently, the absence of disbursement and NOIDA’s failure to classify the lease deed as financial or operational worked against NOIDA’s claim to be a financial creditor. Further, the lack of transfer of risks and benefits associated with ownership prevented NOIDA from meeting the requirements ofSection 5(8)(d) of the Code. 

While NOIDA did not meet the requirements underSection 5(8)(d), it sought further protection underSection 5(8)(f) of the Code, stating that the current lease is a financial transaction falling underSection 2(33) of the Code. Section 2(33) would include any agreement for the transfer of funds that may also occur from the Corporate Debtor to the creditor or from the creditor to the debtor. Due to this, the Supreme Court also considered whether the lease in the present case qualifies as a transaction for Section 5(8)(f) of the Code?

5. Does NOIDA’s Lease fall under Section 5(8)(f) of the Code? 

Section 5(8) of the Code states that “any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing” is a financial debt under the Code. UnderSection 5(8) of the Code, NOIDA put forth its argument that a disbursement is not always a requirement and that a lease (such as the one in the present case) is raising funds under the lease deed and, therefore, it falls underSection 5(8)(f) even though there is no actual disbursement. NOIDA contended that the lease in question acts as a tool of financing and is a mode of upfront payment to the Lessee even if there is no actual disbursement of money from the Lessor to the Lessee. NOIDA supported its argument by relying onPioneer Urban Land and Infrastructure Limited v. Union of India, wherein homebuyers were considered financial creditors on the payment of advances and installments in return for the flats. In this case, it was held that like other financial creditors such as banks and financial institutions, all persons who have advances monies to the Corporate Debtor should be considered financial creditors since they have a vital interest in their funds invested for the completion of their projects. Therefore, they have the right to be on the Committee of Creditors. NOIDA relying on the Pioneer case, contended that while an operational creditor merely seeks to realize its dues, NOIDA cannot be treated as an operational creditor since NOIDA is similarly situated to a homebuyer or a financial institution. Since the Lessee in the present case is obliged to pay the balance of 90% of the lease premium. The Appellant draws a comparison with a situation as in the Pioneer case wherein the Lessee would borrow/receive money from the bank/allottee/homebuyer if it wanted to purchase the property or needed funds to complete the project. In such a case, the Lessee would be obliged to repay the bank/allottee/homebuyer. Similarly, the Lessee is raising funds in the form of this advance payment as provided in the lease deed and is obliged to repay the Appellant. Therefore, NOIDA contended that the transfer of funds, in this case, is the mode of advance payment of 10% of the premium paid by the Corporate Debtor to the Appellant and the balance of 90% of the lease premium is the amount raised in this transaction thus, falling underSection 5(8)(f).

However, the Supreme Court rejected the argument that the advance payment of 10% of the premium paid by the Corporate Debtor to the Appellant is the transfer of funds. The Supreme Court held that this advance payment does not represent a substantial amount of the fair value of the asset. Further, there is no disbursement of any money or advances being paid from NOIDA to the Corporate Debtor. In this regard, the Supreme Court observed that, in the case of homebuyers, there is generally an actual transfer of funds to the Corporate Debtor/real estate developer. In the absence of any transfer of funds from the creditor to the debtor or in the absence of any advances to the Corporate Debtor, the law laid down in the Pioneer case does not apply. Therefore, NOIDA was classified as an operational creditor since the lease was not a financial transaction, and NOIDA did not satisfy the conditions mentioned above to be recognized as a financial creditor.

6. Implications of the Judgment 

This decision was welcomed since it aims to safeguard and maintain homebuyers’ interests during the Corporate Debtor’s Insolvency Resolution Process. It stops NOIDA from impeding the Corporate Debtor’s revival. 

In the current environment, it is crucial to consider the interests of every person — such as homebuyers, governmental authorities, and Corporate Debtors — in a way that advances the Code’s object, i.e., the speedy revival of the Corporate Debtor. While it is undeniable that NOIDA, in the specific case, had a legitimate worry regarding its public funds and that if it is not present in the CoC, no person will protect NOIDA’s interest. However, at the same time, it is essential to weigh the possible hindrances that may be caused in the CIRP if NOIDA becomes the financial creditor. Considering that NOIDA is a public entity, and if it became a member of the CoC, there would be a reasonable probability that NOIDA would be more rigid and resistant in accepting haircuts to approve a strategy that would otherwise guarantee the Corporate Debtor remaining a going concern. NOIDA, in its interest, might prefer voting against every Resolution Plan put forth by the Resolution Applicant. This would ultimately result in the Corporate Debtor being liquidated by frustrating the CIRP. This will severely impact the homebuyers and other individuals involved in the real estate project because most of their hard-earned money will be at risk, and they will receive very little in return for their investment. On the contrary, there are good chances of reviving the Corporate Debtor and finishing the real estate project if the public authority (NOIDA) is excluded as a financial creditor in this case. Due to this, when the project is finished, the homebuyers will be able to receive their apartments, thereby fulfilling the primary goal of their investment. 

This judgment is laudable as it protects the Corporate Debtor from creditors who have a minority stake in the deal or substantially have disbursed less or none of the principal amount. Creditors with a minority stake believe that their interest is lost in the process of reviving the Corporate Debtor since they have less influence and authority in the CoC, and as a result, in the CIRP. Therefore, they would prefer to liquidate the Corporate Debtor and recover their debts to protect their dues as much as possible. By restricting such creditors from being part of the CoC, this judgment prevents disrupting the CIRP and gives only those creditors a seat at the table (CoC) who genuinely must have a say in the process. 

According toSection 6 of the U.P. Industrial Area Development Act, 1976, the purpose of the Industrial Development Authority shall be to secure the planned development of the industrial development area. The Supreme Court observed that NOIDA could not simultaneously assert that the lease deed is covered by bothSection 5(8)(f) of the Code, which is a general provision, andSection 5(8)(d) of the Code, which is a specific provision relating to finance leases. These debts towards the Corporate Debtor qualify as statutory dues under the Code and, therefore, they cannot be sought with the motive of seeking a greater value or profit. A public authority entering into an agreement such as a lease deed cannot have a commercial effect of borrowing as “commercial effect” would mean to earn profit or that the primary purpose of the deed is profitability. The motive to earn profit or seek greater value in dues is incompatible with a public authority’s duty to secure development as it is not a commercial entity but a public one. 

The Supreme Court noted that a lease deed entered into by a Development Authority intending to redevelop the township and the necessity to regulate house construction is legitimate and just. A local/public/statutory authority cannot be permitted to join the CoC if the lease is not financial and it does not adhere to the Indian Accounting Standards. Therefore, the Supreme Court ensured that authorities do not try to escape or circumvent the Standards laid down and change the lease’s nature to protect its interest conveniently.

7. Conclusion 

In India, leasing is quite common, particularly among real estate developers, governmental authorities, and homebuyers. When dividing creditors into operating and financial and determining who has a say in the CIRP, it becomes crucial to comprehend the nature of the lease. 

The Apex court correctly distinguished NOIDA’s situation from that of homebuyers, mainly that, in the case of homebuyers, the transaction generally consists of a transfer of funds to the Corporate Debtor. However, in this case, there was no transfer of funds. Hence, homebuyers having a better claim, considering there is an actual disbursement of money to the Corporate Debtor, continue to be treated as financial creditors. NOIDA’s designation as a financial creditor would have the effect of thwarting the Corporate Debtor’s CIRP as NOIDA would be less inclined to accept Resolution Plans from Resolution Applicants in the current situation because the project includes a sizeable amount of public funds in the lease agreement and NOIDA would want to seek its dues through liquidation. 

Homebuyers’ claims and decision-making power are now protected, and they have the freedom to divert the CIRP from its losses in order to receive their apartments/flats as agreed. Additionally, the Corporate Debtor is lifted out of its downfall and can continue operating, which is the primary goal of the Code. Therefore, declaring NOIDA as an operational creditor is a big boost for real estate projects in NOIDA that were stuck in CIRP, as the CIRP for the revival of the Corporate Debtor will now be much quicker.

About the Authors 

Ms. Vanshika Shroff is a Paralegal at Crawford Bayley & Co.

Editorial Team 

Managing Editor: Naman Anand 

Editors-in-Chief: Jhalak Srivastav and Muskaan Singh 

Senior Editor: Pushpit Singh 

Associate Editor: Harshita Tyagi

Junior Editor: Parishti Kaushik

Preferred Method of Citation  

Vanshika Shroff, “Analysis of the New Okhla Industrial Development Authority v. Anand Sonbhadra Judgment vis-à-vis its Impact on Homebuyers” (IJPIEL, 27 July 2022) 


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