1. The Core Conflict

Borrower View: EBITDA should show "future earning capacity which may be expected from business by buyer" - therefore eliminate non-recurring, extraordinary, irregular or non-core expenses or income. This is called Normalized or Adjusted EBITDA.

Lender / GAAP View: Ind AS 1 para 87 prohibits presentation of any item as "extraordinary". Everything must be in profit and loss. For covenant calculation, you cannot add back what management calls extraordinary unless loan agreement allows it.

The Conflict Timeline:

• Pre-2016 - AS 5: Extraordinary items defined as "unusual and non-recurring items for example, any loss to company due to flood, natural disaster, loss due to labour strike etc, those items are not part of operation." Allowed separate disclosure.
• Post-2016 - Ind AS 1: Extraordinary items banned. Only "Exceptional items" allowed as per Schedule III - e.g. Sale of machine not in use, sale of long term investment, litigation settlement etc are part of operation but non-recurring.
• Loan Agreements: Still use 1990s definition - "EBITDA shall exclude extraordinary items" - but accounting no longer has that line item.

Result: Borrower adds back flood loss, COVID loss, one-time bonus, derivative loss as "extraordinary" to inflate EBITDA. Lender says under Ind AS, these are operating and must stay in EBITDA.

2. Three EBITDA Definitions Fighting

Non-recurring items can have significant impact on company's financial performance and can distort evaluation of profitability.

3. Where It Litigates

Scenario A: Flood / Fire / Strike
Company suffers Rs.20 cr loss due to flood in Noida plant. Under old AS 5, it was extraordinary below line. Under Ind AS, it is part of P&L as exceptional. Borrower says for DSCR, add back Rs.20 cr as extraordinary not part of operation. Lender says no, it is operating risk.

Scenario B: Sale of Investment
Company sells long-term investment for profit Rs.50 cr. Is it EBITDA? Borrower excludes as non-core. Lender includes as it is exceptional item part of operation but non-recurring.

Scenario C: COVID, One-time Restructuring, Derivative MTM
All claimed as extraordinary.

4. Case Laws and Regulatory Precedents

A. Indian Accounting / Tax Case - What is Extraordinary vs Exceptional

1. Guffic Chem P. Ltd vs CIT, Belgaum - Supreme Court CA No.2522 of 2011
Question: Whether payment under agreement not to compete (negative covenant) is capital receipt or revenue receipt?

SC held: Non-compete payment is capital receipt, not operating income, and cannot be included in profit for EBITDA under normal business. This is foundation for arguing exceptional items (sale of machine not in use, sale of long term investment, litigation settlement) are not part of core operation.

Borrowers use this case to argue: Exceptional items are Sale of machine which is not in use, Sale of long term investment, litigation settlement etc are part of operation but non reoccurring - should be excluded from covenant EBITDA.

2. AS 5 Framework - TaxTMI 2025 (8) TMI 627 - AT
Court applies accounting framework of AS 5, noting AS 5 defines prior period items as income or expenses which arise in current period due to errors or omissions. Requires items recognised in a period be included.

This case used by lenders: Under Ind AS, you cannot carve out extraordinary items - must be included in period.

3. Breach of Covenants - Reclassification Case - CACLubIndia Ind AS Interpretation
After reading clauses, it is clear that in case any material covenant will be breached by borrower relating to its long-term loan, then loan will be treated as immediate payable and accordingly re-classed from non-current to current.

Applied to EBITDA: If borrower inflates EBITDA by adding back extraordinary items without lender consent, covenant DSCR appears compliant, but on true EBITDA, breach exists - auditor must reclassify loan as current liability. This triggers cross-default.

B. IBC / Loan Covenant Cases

4. DSRA Obligation Case - TMI 2025 (7) TMI 487 - NCLAT
Items: Rs.4.69 cr Total Rs.166.78 cr - DSRA obligation arose under financial covenants requiring borrower to maintain dedicated reserve for timely servicing of debt. Its breach gave rise to specific contractual event of default, separate from failure to repay principal or interest.

Tribunal held EBITDA must be calculated as per facility agreement definition, not as per management adjusted EBITDA. Borrower had calculated EBITDA adding back DSRA funding as extraordinary, NCLAT rejected.

5. State Can't Unilaterally Deduct Dues - Supreme Court (2024) - Deccan Herald Report
No contractual clause or provision of law permitted adjustment of amounts claimed under earlier works against sums payable under separate, subsisting contracts without contractor's consent.

Used in EBITDA disputes: Lender cannot unilaterally adjust extraordinary items from unrelated contracts (e.g., deduct flood loss claim receivable) against EBITDA without agreement.

C. US SEC - The Ultimate Case Law on Adjusted EBITDA Abuse

6. SEC vs Companies on Non-GAAP - Latham & Watkins Client Alert & SEC Regulation G
SEC has brought enforcement actions where companies defined Adjusted EBITDA as net income as further adjusted to eliminate impact of certain items that we do not consider indicative of ongoing operating performance, but adjustments were inconsistent.

Key precedents:

• SEC vs Valeant (2016): Added back "restructuring" every quarter for 3 years - SEC said if it occurs regularly, it is not extraordinary.
• SEC vs MDC Partners: Company added back "non-recurring litigation" that occurred 4 years in a row.
• SEC Guidance 2022: Adjusted EBITDA cannot be presented more prominently than GAAP net income, and must not eliminate items that are normal recurring cash expenses.

Indian SEBI has adopted same for LODR: Listed companies must reconcile Adjusted EBITDA to audited PAT.

5. How to Draft to Avoid Conflict - Best Practice

Bad Clause (creates conflict):
"EBITDA means profit before interest, tax, depreciation, amortization and extraordinary items."

Good Clause (SEBI LODR / LMA Standard):
"EBITDA means, for any period, audited consolidated operating profit before interest, tax, depreciation and amortization, excluding (to extent included):
(a) Exceptional Items as defined in Schedule III to Companies Act, 2013, but only to extent (i) loss from flood/fire/earthquake exceeding Rs.5 cr per event, (ii) gain/loss on sale of fixed assets, (iii) litigation settlement >Rs.10 cr;
(b) Shall NOT exclude: ESOP charge, FX loss, derivative MTM, restructuring costs, COVID related costs, unless approved by Majority Lenders.

All add-backs to be certified by statutory auditor.

And:
(c) For covenant testing, EBITDA shall be as per prevailing Ind AS without frozen GAAP, but Extraordinary Items as defined under old AS 5 shall not be excluded unless listed above."

Market Rule Now:

If item is expected to occur once in 3 years, it's exceptional and can be added back if agreement allows. If it occurs 2 years in a row, it's recurring and cannot be called extraordinary.