Classification Of Digital Assets Under The Insolvency And Bankruptcy Code, 2016
Author: LawSphereX
Category: Corporate & Insolvency
Published:
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CLASSIFICATION OF DIGITAL ASSETS UNDER THE
INSOLVENCY AND BANKRUPTCY CODE, 2016 Velicheti Sri Harshith, LLM, The National Academy of Legal Studies and Research (NALSAR) Manaswini Duggineni, LLM, The National Academy of Legal Studies and Research (NALSAR)
R S B Siva Harshit, BA LLB, Krishna University
ABSTRACT
Digital assets are the future of finance is what, is being told for the past few years. In true fashion, a new technology is adopted way ahead of the laws that follows. Digital assets are very volatile in terms of their values and in past few years that has led to a lot of companies going insolvent all over the world. That raises a question has Indian insolvency laws caught up to this new era of finance, so far it looks like these Indian laws are not only behind but also adversely affecting the creditors. The most basic thing that’s dealt with, before entering the corporate insolvency resolution process is what kind of debt is owed which helps determining what kind of a creditor is a creditor. Finding the best answer to this basic question in the context of digital assets is the quest of this article.
INTRODUCTION
Digital assets include Cryptocurrencies, NFTs, Crypto Tokens, etc. These digital assets are seen as the new era of finance and are paving the way for a faceless economy. India was an early adopter in the era of information technology, and we are seeing the result of that. We must adopt this Blockchain technology to be the global leader in the upcoming Web 3 revolution. For a country to adopt any new technology, the laws of that country pave the way for adoption by institutions and individuals. The truth is that our laws need to catch up to the rate at which this technology is being adopted. While MNCs are adopting this technology and adding these Digital Assets to their balance sheets, our corporate laws have yet to adapt to this new technology. Indian law currently defines digital assets as "virtual digital assets " and classifies them as goods.
However, due to their complex nature, this approach might not work with all the legislations, especially with legislations like the Insolvency and Bankruptcy Code,2016. To exercise a remedy under the IBC and participate in CIRP, firstly it has to be determined which kind of debt does the Corporate Debtor owes to the creditors ito exercise a remedy under IBC. Here itself the issues with IBC being silent about digital assets arise. CLASSIFICATION OF DEBT UNDER IBC: There are two kinds of debts under IBC: (i)
1. Financial debt
(ii)
2. Operational debt
Financial debt: Under Section 5(8), financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes1 clauses (a) to (i) The Hon'ble Supreme Court in the case Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr2 said that, for a debt to be classified as financial debt, there must be
1 The Insolvency and Bankruptcy Code, 2016, § 5(8), No.31, Acts of Parliament, (India).
2 Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr, 2024 LiveLaw (SC) 331.
the existence of debt along with interest, if any, which is disbursed against the consideration for the time value of money. Operational Debt: Under Section 5(21), "operational debt" means 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 for the time being in force and payable to the Central Government, any State Government or any local authority;3 For a debt to be classified as an operational debt, the debt should be claim against a goods or service. The Hon’ble Supreme Court in the case Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr4 said that the nature of the agreement is a key indicator to determines if that’s an operational debt or not. DIGITAL ASSETS UNDER VARIOUS LAWS: Under Indian law, these digital assets are widely treated as property but not as money.
In the case Internet and Mobile Association of India vs. Reserve Bank of India5, the Apex Court held that these virtual currencies could be classified under different categories ranging all the way from property to commodity to non-traditional currency to money, and even these descriptions can't capture the true sense of Crypto. Later, in the Income Tax Act of 1961, all these different types of digital assets were brought under the definition of Virtual Digital Assets (VDA) in Section 2(47A). In Australian Law, Crypto is treated as a personal use asset. Essentially, it is treated as property. In the UK, as the English High Court held in AA v. Persons Unknown & Others Re Bitcoin6, Crypto is treated as property.
On the one hand, many countries, including India, treat these digital assets as properties, goods, and commodities, but there are some other countries that consider Crypto to be money.
3 the Insolvency and Bankruptcy Code, 2016, § 5(21), No.31, Acts of Parliament, (India).
4 Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr, 2024 LiveLaw (SC) 331.
5 Internet and Mobile Association of India vs. Reserve Bank of India, AIR 2021 SUPREME COURT 2720.
6 AA v. Persons Unknown & Others Re Bitcoin, [2019] EWHC 3556 (Comm)
In Central African Republic and El Salvador, Crypto has been adopted as a legal tender for those countries. In Major countries like the United Arab Emirates, which is a commercial hub, accepts crypto for payment of goods and services. Russia, one of India's biggest trade partners, has begun to use Crypto for international trade. All these countries have accepted Crypto as money in some form, and some of those countries are the countries with whom we trade the most. TYPES OF DIGITAL ASSETS: The digital assets include various evolving blockchain-based products that serve different purposes. Some of the more significant digital assets are:
1. Cryptocurrency
2. Smart Contracts
3. Crypto Token
4. Non-Fungible Tokens (NFTs)
5. Decentralized Finance (DeFi)
Cryptocurrency: This is a digital form of currency that uses cryptography to carry out secured transactions. These transactions occur on a blockchain and are stored on the blockchain in the form of a digital ledger. They are mainly used for peer-to-peer transactions. Many companies are using blockchain and cryptocurrency to make fast, secure, and efficient transactions because, unlike banks, it is hassle-free and without any unnecessary restrictions. These cryptocurrencies are mainly used for cross-border transactions. Smart Contracts: These contracts are agreements that reside on a blockchain in digital form and are enforced based on the terms and conditions of contracts. Smart Contract is a new form of blockchain technology that is used as the underlying technology for NFTs and DeFi.
Crypto Tokens: These are digital assets that are tokenized to represent a specific use case, a service, or another asset or assets. NFTs: NFTs are a tokenized form of smart contracts. They have an extensive use case, but for now, they are being used to symbolize assets relating to the Metaverse. DeFi: These are platforms where lending and borrowing are done on a blockchain, with an underlying smart contract executing the agreement. IBC AND DIGITAL ASSETS: The Insolvency and Bankruptcy Code of 2016 does not clearly define digital assets. That leads to question Is a debt against a digital asset an operational debt or a financial debt? According to the definition under Section 5(21), one key element to classify a debt as an operational debt is the claim should be related to goods or service.
Only when the digital assets are classified as goods any debt related to digital assets will be classified under operational debt. As mentioned above some of the digital assets have the characteristics of a good, a service or both. Since the digital assets themselves are very diverse the silence on the part of the IBC legislation as to what a digital asset is and how are they classified creates a gap which hinders the rights of the creditors. Key elements for a debt to be classified as a financial debt was made clear by the Hon’ble Supreme Court on many occasions and even by the definition, it’s clear that financial debt deals with debt related to money. There are digital assets which are used and considered as money in many countries with whom trade. This will hinder the rights of creditors who leant their money to the corporate debtor in terms of money.
Even here it’s the same issue the silence on the part of the IBC legislation as to what a digital asset is and how are they classified creates a gap which hinders the rights of the creditors. OPERATIONAL DEBT AND DIGITAL ASSETS: Operational debt: Under Section 5(21) defines operational debt, it’s 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 for the time being in force and payable to the Central Government, any State Government or any local authority;7 Although the Insolvency and Bankruptcy Code of 2016 does not clearly define digital assets, they are defined and classified as goods under the Income Tax Act of 1961.
One key element to classify as an operational debt is that the claim could be related to goods, so any claim made in respect of these digital assets gets classified under operational debt. This might work with NFTs, Crypto Tokens, and some smart contracts. However, it is more complicated than this when it comes to classification debt because this categorization can only cover a few aspects of this class of assets, which has a wide range of utility. The Hon'ble Supreme Court in the case Internet and Mobile Association of India vs. Reserve Bank of India8, while describing this class of assets, said it has characteristics of property, commodity, non-traditional currency, and money. Operational debt only covers two characteristics of this asset class.
FINANCIAL DEBT AND DIGITAL ASSETS: Financial debt: Under Section 5(8), financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes clauses (a) to (i)9 The Hon'ble Supreme Court in the case Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr10 said that, for a debt to be classified as financial debt, there must be the existence of debt along with interest, if any, which is disbursed against the consideration for the time value of money. By definition, it’s clear that financial debt deals with debt related to money. As per The Hon'ble Supreme Court in the case Internet and Mobile Association of India vs. Reserve Bank of India11, these digital assets do have the characteristics of money and non-traditional currency.
7 The Insolvency and Bankruptcy Code, 2016, § 5(21), No.31, Acts of Parliament, (India).
8 Internet and Mobile Association of India vs. Reserve Bank of India, AIR 2021 SUPREME COURT 2720.
9 The Insolvency and Bankruptcy Code, 2016, § 5(8), No.31, Acts of Parliament, (India).
10 Global Credit Capital Limited & Anr. versus Sach Marketing Pvt. Ltd. & Anr, 2024 LiveLaw (SC) 331.
11 Internet and Mobile Association of India vs. Reserve Bank of India, AIR 2021 SUPREME COURT 2720.
However, the legislation doesn't have the same view. Money is defined under Section 2(75) of the CGST Act, which is another corporate legislation. That provision says that any instrument recognized by the Reserve Bank of India, Indian currency, foreign currencies, etc. is money. Here we can clearly see that digital assets aren't treated as money. This difference between what The Hon'ble Supreme Court held in the case Internet and Mobile Association of India vs. Reserve Bank of India12 and how Indian legislation is dealing with this class of assets has led to lack of clarity under IBC which is affecting the transactions made via cryptocurrencies, which are considered money in many countries. A lot of MNCs take out loans, raise capital, etc.
, for commercial purposes from foreign creditors in the form of cryptocurrency and not classifying their debt as financial debt will not only directly affect their rights under the Code and the value that they receive during liquidation but also frustrate the intent behind Insolvency and Bankruptcy Code,
2016 CONCLUSION
Many companies worldwide are transacting via Crypto, raising capital via Crypto for various purposes, even for building a blockchain. Many people are also taking loans from centralized crypto exchanges, etc. , and Insolvency laws sit right in the middle of it all. Our lack of clarity is affecting many Indian corporations and individuals. Therefore, a specialized legislation should be brought in dealing with these digital assets and while dealing with digital assets in the corporate law findings the Hon’ble Supreme Court must be taken into consideration. Similar to the steps taken in terms of the Income Tax Act,1962, there must be introduction of new provision defining the digital assets under IBC and special explanation provisions must be introduced for Section 5(21) and Section 5(8) as done in home buyers’ case to bring more clarity and removing ambiguity.
If we look into the history of IBC since the 1990s, all these revolutionary changes to corporate law were brought in place, keeping globalization in mind. Since many countries are adopting
12 Internet and Mobile Association of India vs. Reserve Bank of India, AIR 2021 SUPREME COURT 2720.
this technology more so in the financial sector, it's high time we overhaul all these corporate laws to deal with this new technology.