IFMS and Financial Debt: Examining NCLAT’s interpretation of Section 5(8)

The National Company Law Appellate Tribunal (NCLAT) recently ruled on whether Interest-Free Maintenance Security (IFMS) qualifies as a “financial debt” under the Insolvency and Bankruptcy Code, 2016 (IBC) in ILD Owners Welfare Association v. M/s. ALM Infotech City Pvt. Ltd [Company Appeal (AT) Insolvency No. 2198/2024]. While the Appellate Tribunal acknowledged the deeming provision in Section 5(8)(f) inserted through an Explanation to the said Section, it failed to address the deeming provision or provide a reason for disregarding the same, leaving a crucial legal question unanswered.

This raises serious concerns about how insolvency law is being interpreted, particularly in real estate transactions where homebuyers and associations often struggle to recover funds from faltering promoters. By narrowly focusing on whether IFMS involved “time value of money”, NCLAT overlooked the broader commercial reality of real estate transactions, especially with respect to the treatment of monies raised by developers from the allottees. Pertinently, multiple amendments in IBC have been made specifically to deal with and empower allottees in real estate projects, especially the 2^nd Amendment in 2018.  

Section 5(8) of the IBC defines “financial debt” and includes within its ambit debts that are disbursed against the consideration for the time value of money. Clause (f) extends this definition to cover transactions that have “the commercial effect of a borrowing”. The Explanation to this clause, as inserted by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, further states that “any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing." This deeming fiction was inserted to address the financial nature of obligations arising out of real estate transactions, particularly in cases where developers raised funds from homebuyers under the guise of advances or security deposits.

The Hon’ble National Company Law Tribunal (“NCLT”), in an earlier matter initiated by a registered Residents Welfare Association (RWA) involving IFMS, passed an order dated July 12, 2021 in the case titled Vipul Greens Residents Welfare Association v. Vipul Limited (bearing Case No. IB-541/ND/2019), wherein it recognized IFMS as a financial debt, reinforcing that such amounts, when raised from allottees, should be deemed to have the commercial effect of a borrowing.

However, in 2023 and thereafter, the view taken by NCLT changed and various benches of NCLT across India ruled that IFMS was not ‘financial debt’ as per IBC as the same did not involve ‘time value of money’. The said view was taken in Innova Premises Co-operative Society Limited v. Marathon Nextgen Realty Limited C.P. (IB) No. 1042/MB-IV/2020 by NCLT Mumbai bench; in Vasathi Anandi Owners Welfare Association v. Vasathi Housing Limited C.P. (IB) No. 50/7/HDB/2020 by NCLT Hyderabad bench and thereafter it was followed by NCLT Delhi bench in The Verandas Apartment Owners Association v. M/s. Saluja Construction Company Ltd IB-1097/(PB)/2019. NCLT’s decision in the Verandas matter was challenged before NCLAT in Company Appeal No.902/2023, involving issues in relation to the qualification of the IMFS as financial debt, within the ambit of Section 5(8) of the IBC. The said appeal was admitted and is still pending for final disposal.

During the pendency of the appeal in Verandas, NCLAT decided a similar question in ILD Owners Welfare Association v. M/s. ALM Infotech City Pvt. Ltd. (supra) wherein it rejected the claim that IFMS constitutes financial debt, primarily on the ground that it was not disbursed for the “time value of money." However, this interpretation seems legally flawed for the reasons discussed below.

It is our understanding that the Explanation to Section 5(8)(f), added specifically to counter the aforesaid view, unequivocally states that “any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing.” This provision creates a legal fiction whereby such amounts are automatically considered financial debt, irrespective of whether they were advanced explicitly as a loan or not. By merely mentioning this provision but failing to apply it, the NCLAT sidestepped a critical aspect of the case. The judgment does not offer any reasoning as to why the deeming fiction should not apply to IFMS, despite its collection from allottees in a real estate project.

The NCLAT’s ruling rests on the premise that financial debt must necessarily involve a disbursal against “time value of money." However, this approach is inconsistent with established jurisprudence. The Supreme Court in Pioneer Urban Land and Infrastructure Ltd. v. Union of India (2019) 8 SCC 416 clarified that funds raised from homebuyers are deemed financial debt, even though they are not traditional loans. Similarly, Orator Marketing Pvt. Ltd. v. Samtex Desinz Pvt. Ltd. (2023) 3 SCC 753 held that even an interest-free loan qualifies as financial debt under Section 5(8). By disregarding these precedents, the NCLAT’s decision appears to be inconsistent with settled legal principles.

The NCLAT also failed to account for the economic reality of IFMS. This amount is collected from allottees, retained by the corporate debtor, and was meant for future maintenance. The said amount is required to be transferred to registered RWAs of the concerned project as an operation of law as the same is mandated by state legislatures such as the Uttar Pradesh Apartment (Promotion of Construction, Ownership and Maintenance) Act, 2010 and the Haryana Apartment Ownership Act, 1983. However, the funds were neither transferred to a maintenance agency nor refunded to the allottees, effectively making it an unauthorized form of finance raised from the public.

The fundamental question is whether IFMS had the “commercial effect of a borrowing.” Since the corporate debtor held the funds for an extended period without utilizing them for the intended purpose, the transaction bore the characteristics of a financial debt. By failing to recognize this, the tribunal’s ruling is detached from the commercial realities of the transaction.

The NCLAT’s failure to apply or even distinguish the deeming fiction of Section 5(8)(f) results in an erroneous dismissal of the Section 7 application. The tribunal ignored well-established Supreme Court jurisprudence, misapplied the concept of “time value of money”, and failed to recognize the financial nature of IFMS.

Given the clear legislative intent behind Section 5(8)(f) and the broader objectives of the IBC, the NCLAT’s decision appears legally unsound. If left uncorrected, this judgment may set a problematic precedent by allowing corporate debtors in real estate projects to evade financial obligations under the guise of non-financial transactions. A review by the Supreme Court would be warranted to rectify this misinterpretation and ensure consistency in insolvency jurisprudence.

About the authors: Gagan Narang is a Partner and Urvi Syal is an Associate at Triumvir Law.

Disclaimer: The opinions expressed in this article are those of the authors. The opinions presented do not necessarily reflect the views of Bar & Bench.

If you would like your Deals, Columns, Press Releases to be published on Bar & Bench, please fill in the form available here.