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This article is written by Aditi Kumari who is pursuing a Certificate Course in Insolvency and Bankruptcy Code from Lawsikho.

Introduction

In the corporate insolvency resolution process of EPC Constructions India Limited, the liquidation amount offered to the operational creditors was ‘NIL’. In the instant case, only 10% of the claim was approved by the resolution professional. The decision of the resolution professional was claimed to be unfair and non-equitable later on however the National Company Law Tribunal, Mumbai chose not to interfere in the commercial business and understanding of the Resolution Professional and the Committee of Creditor in which the operational creditor have ‘Zero’ representation (see here). The same fate was met by Alok Industries in the matter of State Bank of India v Alok Industries.

The situation of subordination of operation creditors in the matter of decision making has been a point of great debate right from the time of commencement of the Insolvency and Bankruptcy Code, 2016.

What is the committee of creditors?

Committee of creditors though not defined in the Code, mean the group of creditors of a company undergoing insolvency and bankruptcy proceedings which takes, almost all important decisions, like change in capital structure or change in management or suitable resolution plan for the corporate debtor. 

Constitution of Committee of Creditor

According to Section 21 of the code, the CoC is constituted by the resolution profession after the collation of all the claims against the corporate debtor. It consists of financial creditors, but not those who are related parties to the corporate debtor.

Operational creditors claiming aggregate debts of not less than 10% can take part in the meeting of CoC, but are not the members of the same, hence they can’t vote in any of the decisions being made by the CoC. It is pertinent to note that homebuyers also make a member of CoC as decided in the landmark judgment of Pioneer Urban Land and Infrastructure Limited and Anr. V. Union of India & Ors. [(2019) 8 SCC 418] .

Quorum of CoC meeting

Representation by 33% of the members of the CoC needs to present physically or by video conferencing.

Voting required to take a decision

All the decisions are made by vote of not less than 51% of the total voting share of the financial creditors.

The decision of the CoC is final and binding in the Corporate Insolvency resolution Process and even the apex court refrains from interfering in its commercial expertise. The scope of judicial review is also limited in regard of decision of the CoC.

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Can operational creditors be a part of CoC?

Section 21 specifically excludes operational creditors from the CoC, however, given the dues claimed by them is not less than the threshold 10% of the total debt, they can participate in the meetings of the CoC without possessing any voting rights. 

The legislative intent is quite adamant in presuming that the operational creditors, regardless of the size of their debts, would be interested in the liquidation rather than the resolution of the corporate debtors due to the risk involved (see here). However the main objective of the Code is resolution and not liquidation, hence the operational creditors are deemed to be ineligible to be members of the CoC.  One the other hand, in the case of financial creditors it is assumed that – they have the margin to take haircuts in debt repayment and hence are more probable to support the resolution process. 

There has been a plethora of judicial pronouncements regarding the subordinate status of the operational creditors. In SWISS RIBBONS PVT. LTD. & ANR. Vs. U.O.I  the Hon’ble Apex Court concluded that the classification between operational creditors and financial creditors is based on intelligible differentia, hence not discriminatory under Art. 14 of the Constitution. The Hon’ble Court justified the classification due to the difference in the kind of loan extended by these two kinds of creditors. It was further mentioned that the loan provided by the financial creditors includes a larger sum of money with specified repayment schedule and therefore they are more engaged in the reconstruction of the loan.

Prior to this, there have been many judgments which upheld the distinction like in Akshay Jhunjhunwala & Anr. v. Union of India through the Ministry of Corporate Affairs & Ors the Hon’ble Supreme Court was of the view that a certain distinction between financial and operational creditors does not attract any provisions of the Constitution. Similarly in Maharasthra Seamless limited v Padmanabhan Venkatesh & ors the equitable treatment of th operational creditors was preferred rather than equal treatment.

While most of the judgments followed the same equation, some showed incongruity like Binani Industries Limited v Bank of Baroda which rooted for similar treatment of both kinds of creditors. Thought it was one of kind judgment discussing the interests of the operational creditor, it still did not talk about the position of the operational creditor in the CoC. The climatic adjudication in this matter was Essar steel case: 

The Essar Steel case

The Company Petition for the Corporate Insolvency Resolution proceeding of the Essaer Steel Ltd. was filed in front of Ahemdabad NCLT. The resolution plan suggested by ArcelorMittal was approved by the RP and CoC, in which the operational creditors were being paid as to 85 as compared to their total claim of INR 3339 Crores. The financial creditors however, were to recover 92% of their total claims. 

A challenge to the said resolution plan was filed through a series of petitions by the operational creditors as well as Standard Chartered Bank.

The NCALT redistributed the amount payable under the resolution plan. It gave a breakthrough judgment in deciding that the operational creditors should be paid in par with the financial creditors. It went on to even decide the power of CoC, by saying that the CoC does not have the power to determine the distribution in the resolution plan. The financial creditors being majority members of CoC already have a lot of discretion in choosing the resolution plan. The power of distribution of to the CoC further would create a conflict of interests, wherein it would have upper hand in making the distribution favourable to them. 

This judgment was challenged in the apex court by the CoC, which reversed the judgment of the NCALT in a very long process stretching to much more than 330 days:

  • The Apex Court overturned the judgment of NCALT upholding the wisdom of CoC and the understanding of CoC and the Resolution Professional.
  • The grounds of judgment of the NCALT to prove similar treatment were overturned to rather give equitable treatment only to the creditors belonging to the same class, further classifying apart the operational and financial creditors.  
  • The rights of financial creditors to get priority in the matter of distribution of the resolution amount over operational creditors was upheld they have the “capability to assess viability, and willingness to modify terms of existing liabilities in negotiations”
  • The Operational creditors claiming not less than 10% of the total debt of the corporate debtor can take part in the CoC meetings without any voting rights.

Conclusion

The abovementioned judgment hence clarifies that the rationale followed by the judiciary is that the financial creditors are the primary investors in the market, hence eligible to take the upper hand in the decision making of the insolvency resolution process, which is logical in most of the circumstances.  However, there are cases where the most of debt is owed to the operational creditors, in such circumstances this logic does not hold good. Also, In cases where the CoC comprises of only one financial creditor or even very few financial creditors, the fate of the corporate debtor as well the financial creditor is unilaterally in hands of one person or say two or three people.

In the Essar Judgment equal treatment was denied to both kind of creditors being from a different class of creditors and classified on the basis of intelligible differentia. It was decided that all the creditors are to get equitable and not equal treatment. Though it is to be examined the equitability of the resolution plans by the CoCs. It is pertinent to refer the cases where the operational creditors were made to accept even zero percent of their claims as discussed above in the matter of Alok Industries. Similarly, in the case of Ruchi Soya resolution, the operational creditors received 3% of their total claims. 

Hence a complete discretion in hands of financial creditors over the interest of operational creditors may sometime be intelligible but may come out to be irrational for the economic viability of the operational creditors as small vendors and service providers. Thus it is pertinent to make the resolution procedure equitable, which they are theoretically claimed to be.


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