Recharacterization of Debt under IBC: Party Autonomy vs. Regulatory Safeguards in the Context of Financial vs. Operational Debt

The decisions of the NCLAT in Minions Ventures Pvt. Ltd. v. TDT Copper Ltd. and the NCLT in IPK Exports Pvt. Ltd. v. HSB Home Solutions Ltd. highlight an increasingly critical and technical issue in insolvency jurisprudence: whether and to what extent parties to a commercial transaction can, by mutual agreement or subsequent restructuring, recharacterize an operational debt as a financial debt, particularly with the intent to avail themselves of the special rights and privileges conferred on financial creditors under the IBC.

The IBC draws a clear and functional distinction between “financial debt” [Section 5(8)] and “operational debt” [Section 5(21)], and correspondingly between “financial creditors” [Section 5(7)] and “operational creditors” [Section 5(20)]. This distinction is not merely definitional, but central to the architecture of the Code, influencing voting rights in the Committee of Creditors (CoC), access to resolution proceedings, and the hierarchy of distribution under a resolution or liquidation process.

Under Section 5(8)(e), receivables sold or discounted are generally included as financial debt except when sold on a non-recourse basis. In Minions Ventures (P) Ltd. v. TDT Copper Ltd.( Company Appeal (AT) (Ins) No. 572 of 2022 & I.A. No. 1530 of 2022 with Company Appeal (AT) (Ins) No. 780 of 2022 Decided on 28th March, 2023), the National Company Law Appellate Tribunal (NCLAT) upheld the Adjudicating Authority’s order rejecting a Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC) application filed by financiers who had discounted invoices through the ‘KredX’ platform. The financiers had funded the seller (M/s Ashoka Creations Pvt. Ltd.) by paying the invoice amount, which extinguished the liability of the Corporate Debtor (TDT Copper Ltd.) to the seller, with the seller assigning its receivables to the financiers. The NCLAT held that the financiers merely stepped into the shoes of the operational creditor and had not disbursed any amount to the Corporate Debtor for consideration of time value of money. Therefore, they do not qualify as ‘financial creditors’ under Sections 5(7) and 5(8)(e) IBC but may pursue remedy under Section 9 IBC as ‘operational creditors’ in light of Sections 5(20) and 21(5). Thus, in the light of clear provisions of Section 5(8)(e) IBC, the NCLAT rightly held that discounting of invoices on a non-recourse platform such as KredX did not involve disbursement for the time value of money to the corporate debtor, and the financiers merely stepped into the shoes of the seller. As such, the claim remained operational in nature, despite assignment.

In a recent case, the National Company Law Tribunal (NCLT), New Delhi Bench-IV, in its decision in the case of IPK Exports Pvt. Ltd. v. HSB Home Solutions Ltd. (CP (I.B.) NO. 771 OF 2024), dated 08 July 2025, dismissed a company petition filed under Section 7 of IBC by IPK Exports Pvt. Ltd. against HSB Home Solutions Ltd., holding that the debt in question did not qualify as a “financial debt” as the original disbursement was clearly made as an advance for supply of goods and not as financial debt.

The origin of the dispute lay in the advance of INR 2.18 crore made by the Applicant during the financial year 2011–2012 to the Corporate Debtor towards supply of materials. However, the Corporate Debtor failed to fulfill its contractual obligation of delivering the goods and, over the years, acknowledged its liability through various letters between 2012 and 2022, requesting additional time to either repay the amount or fulfill the supply obligations. In 2022, acknowledging its continuing inability to supply the materials or refund the amount, the Corporate Debtor and the Applicant entered into a Loan Agreement dated 15.04.2022, whereby the outstanding advance was re-characterized as a loan of INR 2.15 crore, repayable by 30.06.2022 with interest at the rate of 24% per annum. However, the Corporate Debtor defaulted on this restructured obligation as well. The Applicant then issued a notice of default in July 2022, followed by reminders in November 2022 and August 2023.

The Tribunal extensively analyzed the nature of the transaction and framed the key issue: whether the amount advanced by the Applicant could be considered a “financial debt” under Section 5(8) of the IBC. It acknowledged that although the parties had entered into a Loan Agreement in 2022 re-characterizing the earlier advances as a loan, the original disbursement was clearly made as an advance for supply of goods. Therefore, the nature of the debt at the time of its origin was of critical importance. Citing Section 5(21) of the IBC, which defines “operational debt” to include claims arising out of provision of goods or services, the Tribunal held that the amount in question originated as an operational advance and thus, even if subsequently converted into a loan by mutual agreement, the essential character of the transaction remained that of an operational debt. It further relied on the principle laid down in Swiss Ribbons Pvt. Ltd. v. Union of India and the NCLAT ruling in Minions Ventures Pvt. Ltd. v. TDT Copper Ltd., which had held that such recharacterization cannot convert an operational debt into a financial debt merely through a subsequent agreement.

The Tribunal was also cautious about potential misuse of the IBC process, observing that allowing such conversions would defeat the legislative distinction between financial and operational creditors and could open floodgates for similar recharacterizations. It expressed concern over the genuineness of the loan agreement, hinting at possible collusion and noting the lack of substantive terms that would indicate an independent financial transaction.

While the NCLT recognized the commercial logic and autonomy underlying the novation of obligations, it refused to permit such recharacterization within the framework of IBC. The Tribunal reasoned that the foundational character of the debt must be examined at the time of initial disbursement. Where the origin of the debt is operational (advance for goods), a subsequent unilateral or bilateral restructuring cannot, without a fresh disbursal or clear evidence of a genuine financial transaction, transform it into a financial debt for the purposes of IBC.

It is a well-settled principle under contract law that parties are free to negotiate, modify, or novate their obligations, including converting unpaid operational dues into loans. Such party autonomy is fundamental to commercial law and has long been upheld by courts. However, this autonomy is not absolute in its operation within a regulatory framework like the IBC, which categorically assigns legal consequences and entitlements based on the nature and character of the debt, not merely on the labels used by parties.

IBC, as a statute intended to balance competing interests and to prevent misuse of insolvency proceedings, requires tribunals to look beyond form and examine the substance of the transaction. In this regard, the judgment in Jaypee Infratech Ltd. IRP v. Axis Bank Ltd. (2020) 8 SCC 401 was invoked to reiterate that disbursal against consideration for time value of money is the sine qua non for classification as financial debt.

The temptation to recharacterize operational debts as financial debts often stems from the significant procedural and substantive advantages that financial creditors enjoy under the IBC:

• Exclusive right to form and vote in the CoC.

• Higher priority in distribution under Section 53 waterfall.

• Greater influence over the resolution plan and process.

As such, permitting parties to alter the character of a transaction simply by mutual agreement (even after years of default) can erode the statutory scheme and reduce IBC to a mechanism of debt recovery or strategic litigation rather than a time-bound insolvency resolution framework. The courts have, therefore, cautioned against such “colourable transactions” and emphasized the importance of maintaining the sanctity of the insolvency process.

Both Minions Ventures and IPK Exports reflect a growing judicial trend to uphold the original character of the transaction at the time of disbursal as determinative of the creditor’s classification under IBC. While not denying the autonomy of parties to structure or restructure their contractual rights, the tribunals have consistently held that such restructuring does not ipso facto change the legal character of the debt for the purposes of insolvency law unless it satisfies the statutory definition of financial debt.

This approach ensure that the privileges accorded to financial creditors, particularly participation in CoC, are not usurped by masquerading as financiers to gain undue advantage or influence in the CIRP. It also acts as a safeguard against the transformation of the IBC into a mere tool for debt recovery or coercive settlement.

While the strict adherence to the original nature of the transaction helps preserve the integrity of the IBC framework, it also raises legitimate concerns about undermining genuine commercial restructurings. The law must strike a balance between (a) preventing abuse and protecting the coherence of the insolvency process and (b) respecting bona fide renegotiations and commercial autonomy of parties in resolving disputes. Until such nuanced standards evolve, the current position, anchored in the economic substance and timing of the transaction, remains a pragmatic safeguard to uphold the objectives of the IBC.

We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.comor write to our authors:

Mukesh Chand, Senior Counsel – Email – mukeshchand@elp-in.com