The Insolvency and Bankruptcy Code, 2016 (IBC) is a key law in India designed to make it easier to resolve financial troubles for businesses, individuals, and partnership firms when they cannot pay their debts. It was passed on May 28, 2016, and started being used on December 1, 2016. The IBC brings together older laws and sets a clear timeline for solving insolvency cases, allowing up to 180 days for businesses, with an extra 90 days possible if creditors agree. Section 5(8) is an important part of this law, found in Part II, which deals with resolving insolvency and liquidating businesses. This section explains what counts as a "financial debt," a term that decides who can be considered a financial creditor and have certain rights in the insolvency process. This article explains Section 5(8) in simple terms, covering its parts, changes made over time, and why it matters.
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What is Financial Debt under Section 5(8) of IBC
Section 5(8) of IBC defines "financial debt" as money borrowed, including any interest, that is given in exchange for the value of money over time. This means it covers debts where someone lends money expecting to be paid back with interest or some other benefit over time. The definition is broad and includes several types of financial arrangements, which are explained below in simple language.
Types of Financial Debt
The law lists specific types of financial debts under Section 5(8). Here’s what they are:
Money Borrowed with Interest: This includes regular loans, like those from banks or individuals, where the borrower has to pay back the loan amount plus interest. For example, if a company takes a loan from a bank to buy equipment, that’s a financial debt.
Acceptance Credit Facilities: These are amounts raised through financial tools like commercial paper or bills of exchange, often used in business trading. Think of it as a promise to pay later for goods or services, commonly used in trade finance.
Securities Issued: This covers money raised by issuing things like bonds, debentures, or notes. These are financial instruments companies use to borrow money from investors, promising to pay them back with interest.
Lease and Hire Purchase Liabilities: This includes debts from lease or hire purchase agreements that are considered "finance" or "capital" leases under Indian Accounting Standards (Ind AS). For example, if a business leases machinery and the lease acts like a loan, it counts as a financial debt.
Receivables Sold or Discounted: This happens when a company sells its receivables (money it’s owed) to someone else at a discount, but not on a "non-recourse" basis, meaning the seller still has some responsibility if the receivables aren’t paid. It’s like borrowing money against future payments.
Transactions That Act Like Borrowing: This includes any deal that feels like borrowing, even if it’s not called a loan. For example, forward sale or purchase agreements (where you agree to buy or sell something later) can count if they work like a loan. A key part of this is:
Real Estate Projects: Since a change in the law in 2018, money paid by homebuyers or allottees for a real estate project is treated as a financial debt. This means if someone pays a developer for a future home, it’s considered like a loan to the developer. This rule came from the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, effective from June 6, 2018. The terms "allottee" and "real estate project" come from the Real Estate (Regulation and Development) Act, 2016, to keep things consistent.
Derivative Transactions: These are financial deals used to protect against or benefit from changes in prices or rates, like interest rate swaps or currency forwards. Their value is based on the current market price, and they count as financial debt.
Counter-Indemnity Obligations: These are obligations where someone agrees to cover losses for guarantees, bonds, or letters of credit issued by banks or financial institutions. It’s like a backup promise to pay if something goes wrong.
Guarantees and Indemnities: This includes any promises to cover debts related to the above types, like guaranteeing someone else’s loan or bond. It ensures even these backup promises are treated as financial debts.
Find out What Insolvency is
Importance of Section 5(8) of IBC
The definition of financial debt in Section 5(8) is crucial because it decides who qualifies as a "financial creditor" under the IBC. Financial creditors have special rights, like starting the Corporate Insolvency Resolution Process (CIRP) under Section 7 of the IBC. This process helps figure out how to save or wind up a company that can’t pay its debts. Unlike operational creditors (who are owed money for goods or services), financial creditors get to vote in the Committee of Creditors (CoC), which makes big decisions about the company’s future during insolvency.
The addition of real estate allottees as financial creditors in 2018 was a big deal. It means homebuyers who paid for apartments or houses can now have a say in what happens if the developer goes bankrupt. This was highlighted in a famous court case, Chitra Sharma v. Union of India (2018), where the Supreme Court supported this change.
The definition is broad to cover many types of financial deals, keeping up with modern business practices. But because it’s so broad, it can sometimes be tricky to decide if a deal counts as a "financial debt," which can lead to disagreements and court cases.
How It Compares to Other Sections
To understand Section 5(8) better, it’s helpful to compare it to Section 5(21), which defines "operational debt." Financial debt is about money lent for the time value of money (like loans or investments), while operational debt is about money owed for goods or services (like unpaid bills from suppliers). This difference matters because financial creditors have more power in insolvency proceedings, like starting the CIRP under Section 7, while operational creditors use Section 9 and have fewer rights.
Summary
Section 5(8) of the IBC explains what counts as a financial debt, which is key to deciding who gets to be a financial creditor in insolvency cases. It covers things like loans, bonds, leases, and even money paid by homebuyers for real estate projects since the 2018 change. This section is important because it gives financial creditors, including homebuyers, a strong role in deciding what happens to a company in financial trouble. Its broad definition keeps up with modern financial practices but can sometimes cause confusion, leading to court cases. Understanding this section helps businesses, creditors, and homebuyers protect their rights in India’s insolvency process.
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Section 5 (8) of IBC: FAQs
Q1. What is financial debt under Section 5(8) of the IBC?
Financial debt is money borrowed, including interest, for the time value of money. It includes loans, bonds, finance leases, receivables sold (with recourse), real estate allottee payments (since 2018), derivatives, counter-indemnities, and guarantees.
Q2. What is Section 8 of the Insolvency and Bankruptcy Code, 2016?
Section 8 outlines the process for an operational creditor to initiate insolvency proceedings by issuing a demand notice to the debtor for unpaid operational debt, giving them 10 days to respond or pay before filing an application.
Q3. What is the minimum amount for insolvency and bankruptcy code, 2016?
The minimum amount for initiating insolvency proceedings is ₹1 crore for both financial and operational creditors, as per the amendment effective from March 24, 2020.
Q4. What is Form 5 under IBC?
Form 5 is the application form used by an operational creditor to file for insolvency resolution under Section 9 of the IBC, submitted to the Adjudicating Authority with details of the debt and default.
Q5. What is proof of debt in insolvency rules, 2016?
Proof of debt is a document submitted by a creditor to the insolvency professional, detailing the amount owed, evidence of the debt (like invoices or agreements), and claims, as per the Insolvency and Bankruptcy Board of India Regulations, 2016.
