This article is written by Abhinav Mahajan, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.

Introduction

Insolvency and Bankruptcy Code, 2016 was enacted to restructure the debt of a corporate entity or rehabilitate a company buried under debt. A financial institution or even an individual creditor may approach the adjudicating authority for the recovery of their dues. The Companies Act, 2013 merely introduced the term ‘creditors’ and failed to give any clarification in this regard. For the purpose of transparency, Insolvency and Bankruptcy Code, 2016 has classified creditors into ‘financial’ and ‘operational’. Further, this classification under IBC has been used to put the creditors on different pedestals at every stage of the proceedings, therefore, it is important for the creditors to be aware of the scope of rights available to them under the Code. 

When a corporate debtor is unable to pay back the amount to its creditors or lender, it can lead to the process of insolvency under the Code. The application for initiating insolvency proceedings can be initiated by any of the three:

• Financial Creditor: Section 5(7) of the Code defines a financial creditor as- “a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred.” In other words, financial creditor refers to lenders who have provided any sort of credit facility or a loan such as a bank or a financial institution. 
• Operational Creditor: Section 5(20) of the Code defines operational creditors as – “any person to whom an operational debt is owed and included any person to whom such debt has been legally assigned or transferred.” Therefore, it refers to anyone who has provided goods or services and the payment for the same is due from the corporate debtor. 
• Corporate Debtor: A corporate debtor under the Code is the Corporate Person who owes a debt to any person.

Committee of creditors

The Committee of Creditors, though not defined in the Code, mean the group of creditors of a company undergoing the insolvency proceedings. After submission of the claims the insolvency professional shall form a committee of creditors and all the creditors whose claims get admitted shall form the Committee of Creditors. Under section 21(2) of the Code, the committee of Creditors shall comprise only financial creditors. The main agenda of the committee is to create a resolution plan within the stipulated amount of time provided under the Code in order to rehabilitate the company. For the resolution plan to come into force, approval of 75% of the creditors is required and failing which the company would go into liquidation.

Is Insolvency and Bankruptcy Code fair to operational creditors

The Code explicitly excludes operational creditors from Committee of Creditors (CoC), which undertakes all the major decisions when a company is undergoing insolvency proceedings. However, if the dues claimed by operational creditors are not less than 10% of the total debt, they can participate in a committee of creditors without possessing any voting rights. Operational creditors are granted representation in the Committee of Creditors only when Corporate Debtor does not have any financial creditors. While a financial creditor can be either a secured or unsecured creditor, an operational creditor always falls under the category of unsecured creditors. Even in the case of liquidation and asset distribution, financial creditors are prioritised over operational creditors. Thus, IBC limits the rights of an operational creditor to only attending the meeting of CoC. Therefore, they are rendered unable to vote in the decision-making process. It is quintessential to note that homebuyers make a member of a committee of creditors as distinguished in the case of Pioneer Urban Land and Infrastructure Limited and Anr. V. Union of India & Ors..

The code effectively confers only three rights to an operational creditor:

1. To initiate the insolvency resolution process. 
2. To receive notice of a meeting of the committee of creditors.
3. To attend the meeting of CoC, provided they have no less than 10% of the total debt to recover from the corporate debtor. 

Despite the fact that a resolution plan can be proposed by either a financial creditor or operational creditor, the same needs to be approved by the committee which comprises only financial creditors. The rights conferred on operational creditors are subjective as opposed to financial creditors which gives financial creditors a monopoly over the Corporate Insolvency Resolution Process (CIRP). 

Should operational creditors be at par with financial creditors

The Bankruptcy Law Review Committee in its report dated November 4, 2015 expressed their views that OC’s will not risk their dues in exchange for the potential bright future of the corporate debtor and reached a conclusion that CoC should consist only of financial creditors to carry out the insolvency resolution process more effectively. The hypothesis behind this view was that operational creditors would be more interested in the liquidation of the corporate debtor rather than the revival of the company which ultimately would defeat the key objective behind the enactment of IBC. 

The US Insolvency Law has distinguished between secured and unsecured creditors as well. However, both classes of creditors have the right to vote or deny any proposal that diminishes their claims. A committee of unsecured creditors is formed under Chapter 11 of the US Bankruptcy Code to ensure that the rights of such creditors are equally represented.

Thus, exclusion of operational creditors from the Committee of Creditors under IBC and depriving them of decision-making powers is not only opposed to other insolvency laws but rather seems illogical. 

A relatively large number of judicial pronouncements with regard to the status of operational creditors have seen the light of day in the recent past. In the case of Swiss Ribbons Pvt. Ltd. And Another v. Union of India, the Supreme Court held that intelligible differentia came into play when distinguishing between operational creditors and financial creditors. This is, therefore, not discriminatory as rendered by the aegis of Article 14 of the Indian Constitution. The classification has been justified as there is a difference in the kind of loan offered by these two types of creditors. It was also mentioned within this judgment, that a loan from the financial creditor is to include a larger amount of money and a specified schedule for repayment, and this made them engaged in the reconstruction of the said loan.

This distinction was also held in the case of Akshay Jhunjhunwala and another v. Union of India, through the Ministry of Corporate Affairs and others. The Supreme Court pronounced that the distinction made between financial creditors and operational creditors did not attract any provision of the Constitution. In the case of Maharashtra Seamless Ltd. V. Padmanabhan Venkatesh and others, equitable treatment of operational creditors was preferred over equitable treatment.

Some judgments, like the Binani Industries Ltd. v. Bank of Baroda case, showed incongruity from the cases mentioned above and made their contentions for equitable treatment for all creditors. This was a one-of-a-kind judgment that laid out the interests of the operational creditor, but failed to make a mention of the operational creditor in the CoC. Some of the adjudications of this judgment took from the Essar Steel Case. 

The Essar Steel Judgment

The CIRP Company Petition of Essar Steel had been filed in the Ahmadabad NCLT, where ArcelorMittal suggested a resolution plan that was accepted by the RP and CoC. Within this plan, the operational creditors were to be paid 8% of their total claim. The financial creditors, au contraire, were being paid 92.5% of their claims. This resolution was challenged through a series of petitions from the operational creditors.

The NCALT then redistributed the payable claims under the plan, and gave a judgment that serves as a breakthrough in the decision of whether operational creditors need to be at par with their financial counterpart. As the financial creditors were members of the CoC and the operational creditors were not, it was held that the financial creditors already have the discretion to choose what their resolution plan looks like. Therefore, the power of the CoC to choose the distribution was taken away by the tribunal. It was decided so as otherwise the situation would cause a conflict of interests, wherein it would have an upper hand in deciding a distribution that favoured them.

The CoC then challenged this order in the Supreme Court and reversed the judgment. The highlights of the same are:

• The Supreme Court overturned the judgment to uphold the committee of creditors and their understanding of the Resolution Professional.
• The NCALT wished to propose similar treatment for both types of creditors, but this was not accepted as only creditors in the same class were offered this privilege. The classification was made deeper.
• The rights of financial creditors to beget priority when choosing a distribution amount over operational creditors was upheld and owed to the fact that the financial creditors held the capability to assess viability and the willingness to modify the terms of existing liabilities in negotiations.
• Operational creditors who claimed over 10% of the total debt of a corporate debtor were given the right to take part in the CoC meetings but were not given voting rights.

Conclusion

It is pertinent from the Essar Judgment that the framers of the Code created the classification between the creditors with the aim to protect the rights of all stakeholders by providing for a mechanism which primarily focuses on resolution and restructuring of the debt by treating the corporate debtor as a going concern and provides for liquidation only when all the attempts towards such a resolution ultimately fail. 

However, it must also be stressed that due to lack of rights of operational creditors, they are unable to recover their dues in some cases as evident from the abovementioned judgments. Furthermore, home-buyers are now brought into the purview of financial creditors whereas operational creditors, being from business industry, may hold a better business acumen and still lack those rights. 

The reasoning given in the judgment fails to hold logic when the majority of the debt is owed to operational creditors. In such cases, operational creditors would be deprived of voting rights despite having most of the debt owed. The reasoning of the Essar Judgment also fails in cases where a committee of creditors comprises only one or few financial creditors and the nemesis of the corporate debtors is left hanging in a few hands. Similarly, in the case of Bhushan Steel, the operational creditor was denied its dues amounting to Rs. 900 crores by National Company Law Appellate Tribunal.

Insolvency and Bankruptcy Code has been successful so far in the re-establishment of corporate debtors. Nevertheless, absolute power with financial creditors may pan out in some cases, but may seem unjustifiable in many. Operations of the business are as important as finance. It is thus pertinent to make the legislature more balanced. 

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: