Does the IBC discriminate between Financial and Operations Creditors?


The Insolvency and Bankruptcy Code, 2016 is a special act which helps to reorganize the business of corporate debtor. The IBC is a complete code created with an objective to balance the interest of all the stakeholders.


To start with, we have to understand as to who a Financial Creditor and an Operational Creditor is. According to Section 5(7) (1) of IBC, Financial Creditor has been defined as:

"Financial creditor" means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned to. (Ex: Bank Loan)

Financial Debt is defined under Section 5(8)(2) of IBC, Financial Debt means:

Debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes-

(a) Money borrowed against the payment of interest;

(b) Any amount raised by acceptance under any acceptance credit facility;

(c) Any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument; etc


According to Section 5(20)(3) under IBC, Operational Creditor is:

"Operational creditor" means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. (Ex: Supplier outstanding credit, Workmen dues)

Operational Debt is defined under Section 5(21)(4) of IBC, Operational Debt means:

"Operational debt" means a claim in respect of -

· The provision of goods or services

· Including employment dues

· 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.


Further, if the corporate debtor commits a default in repayment of debt, then the Financial creditor or Operational creditor can initiate CIRP (Corporate Insolvency Resolution Proceedings) against the debtor. The financial creditors are entitled to file an application under Section 7 and operational creditor under Section 9 of the code. Thus, it can be inferred from the above that there has been no discrimination made between both the creditors at the time of filing the application. Once the application is accepted by the Adjudicating authority, CIRP will commence and the Adjudication authority shall appoint a resolution professional to conduct the CIRP process.


The resolution professional is imposed with a basic duty to constitute a committee in order to reorganize the business or to restructure the debts. The professional shall collect the claims from creditors (both financial and operational creditors) and constitute committee of creditors comprising only of financial creditors as stated under Section 21.

All the decisions relating to reorganization of business as well as key business decisions in carrying out the affairs of corporate debtor shall be taken by the committee of creditors with a majority of more than 51% vote.

After understanding the composition of the committee and decision making power of the committee, there are arguments raised as to discrimination being made in not admitting the operational creditor to the committee of creditors and constitutional validity of the treatment being given to the operational creditor.

On a plain reading of the code we can make out that only financial creditor is given the authority to take decisions with respect to reorganization including the approval of resolution plan. This rationale is explained in the case:


Swiss Ribbons Private Limited & Anr. v. Union of India(5)

In this particular case, the petitioners argued that there is no intelligible differentia having relation to the objects sought to be achieved by the Code between the financial and operational creditors, indeed, has this distinction been made and therefore, it was alleged to be discriminatory in effect.

The Supreme Court in this case concluded that the distinction is “neither discriminatory, nor arbitrary, nor violative of Article 14 of the Constitution of India”. The essence of the decision lays in the fact that Financial Creditors have a better understanding of the business and viability of the corporate debtor owing to techno-evaluative studies conducted by them prior to lending and a long- term interest based on the large amount of loans that are involved. This issue now appears to have been bedded down with finality, with nearly every provision and procedure of the Code posited upon this distinction being stress-tested robustly in the judgement.

Therefore, the SC found sufficient intelligible differentia justifying the differential treatment accorded to financial and operational creditors and concluded:

“It can be seen that unsecured debts are of various kinds, and so long as there is some legitimate interest that sought to be protected, having relation to the object sought to be achieved by the statute in question, Article 14 does not get infracted.”

Also, in the case of Akshay Jhunjhunwala & Anr. v. Union of India(6), the validity of differentiation made between financial creditor and operational creditor was challenged to stick down to the provisions under the code.

In this case, the Court held that the classification made by the IBC between financial creditors and operational creditors is based on reasonable differentia and does not offend any provision of the Constitution of India. The rationale provided for the difference in treatment between the financial and operational creditors in a plausible view taken for an expeditious resolution of an insolvency issue of a company and cannot be said to offend any provisions of the Constitution of India.

From the above two mentioned cases, we can understand that members of committee of creditors should be a creditor who should be capable of validating and willing to modify the terms of existing liability and capable of deciding on matters of insolvency resolution of entity or is willing to take risk of postponing of payment of debt for better future of the company.

Hence, it is pretty evident that there was no discrimination made between the financial and operational creditors and any distinction made is reasonably done, keeping in mind the needs of the entire process.


It has been previously mentioned that the committee of creditors consist of only Financial Creditors. But, what would happen if the corporate debtor does not have any financial creditor?

In such an instance, Regulation 16 prescribed by the code comes into picture. The committee of creditors will comprise of operational creditors and it shall consist of 18 largest members. Therefore, by insertion of this particular regulation, it is much more clear and precise that there has been no discrimination made between the financial and the operational creditors. Equitable treatment is provided to both of them.

Once the committee is formed and resolution plan is received from resolution applicant, there are disputes relating to distribution of amount of funds to operational creditors. Under Section 30(2), it states that the resolution professional shall examine each resolution plan received by him to confirm that each resolution plan-

“Provides for the payment of the debts of operational creditors which should not be less than amount which shall be paid as per Section 53.”


In the above provision the context of Section 53 is used to state the minimum amount paid to the operational creditor but not the priority or proportionate payment.

Also explanation to section 30(2) clarifies that the distribution of funds to the creditors is done in ‘fair and equitable manner’.

Further, under Regulation 38 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, it states that the amount due to the operational creditor shall be given priority in payment over financial creditor. This is because when the committee of creditors are filled with financial creditors and while approving the resolution plan, deciding about the distribution and including amount of payment, financial creditor shall influence the decision taken by the resolution applicant. Even after insertion of Section 30(2) which states specifically about the minimum amount of payment to operational creditor, there are cases where operational creditor has suffered a major hair cut in case of debt recovery (Ex: Synergies Dooray Automatives Ltd) and assuming discrimination being made in such a circumstance, the case of ‘Committee of Creditors of Essar Steel India Limited. v. Satish Kumar Gupta &others’(7) explains the validity of the discrimination being made:

In this case, the Supreme Court clarified that Regulation 38 does not put all the creditors at an equal footing. Fair and equitable treatment of operational creditors means that a resolution plan should protect their interests but it did not mean proportionate payment of debts. Treatment of un-equals equally would violate the object and purpose of IBC. Secured and unsecured financial creditors were differentiated in resolution plans and operational creditors are viewed separately.

The committee of creditors has the power to approve a resolution plan under Section 30(4) of the code and the constitutional validity of Section 30(2)(b) of IBC was upheld as the SC held that NCLT or the NCLAT has no jurisdiction to interfere in the merits of the business decision taken by the majority of the committee of creditors.

Hence, the Supreme Court concluded that there must be equitable footing provided to both the creditors to protect the objective of the code.


Footnotes:

1. Section 5(7), Insolvency and Bankruptcy Code

2. Section 5(8), Insolvency and Bankruptcy Code

3. Section 5(20), Insolvency and Bankruptcy Code

4. Section 5(21), Insolvency and Bankruptcy Code

5. Swiss Ribbons Private Limited & Anr. v. Union of India, 25th January 2019

6. Akshay Jhunjhunwala & Anr. v. Union of India, 2 Febrauary 2018

7. Committee of Creditors of Essar Steel India Limited. v. Satish Kumar Gupta &others, 15 November 2019

Submitted by,

Anusri. S and Sagar. N,

BMS College of Law.

© 2019 by AmicusX