Class of Creditors: Insolvency and Bankruptcy Code 2016

This article discusses the two main classes of creditors, namely, operational, and financial creditors. This article also discusses the views of National Company Law Tribunal with decided case laws.
Estimated Reading Time: 7 minutes

Introduction

The Insolvency and Bankruptcy Code (2016) envisages a “creditor in control” regime where creditors, any financial or operational shall exercise a control through Insolvency professionals in the event of default in payments of loans or interest.

The aforesaid code hereby ensures that stressed or distressed Corporate need to honour an accurate cash flow forecasting mechanism to identify mismatch of inflows with due commitment timely in line with contractual relationships.

Classification of Debts under Insolvency Code

The new law has observed a bifurcated approach towards the eligibility of complainant to initiate a corporate insolvency resolution process. It majorly depends on the nature of the debt. The ‘Financial Debt’ under the code is defined as “a debt along with interest, if any, which is disbursed against the consideration for time value of money and includes:

  • Money borrowed against payment of interest
  • Any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent
  • Any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures loan stock or any similar instrument.
  • The amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or other such accounting standards as may be prescribed.
  • Receivable sold on non-recourse basis or discounted other than any receivable
  • Any amount raised under any other transaction, including, any forward sale or purchase agreement having the commercial effect of borrowing
  • Any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account
  • Any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution
  • The amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub clauses (a) to (h) of this clause”, and the person to whom such debt is owed and or has been legally assigned is called a ‘Financial Creditor.”[1]

Further, the ‘Operational Debt’ means “a claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment 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” and “any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred” is identified as an operational creditor[2].

Committee of Creditors

Committee of Creditors (Committee) is a committee consisting of the financial creditors of the Corporate Debtor. This Committee eventually forms the decision-making body of the various routine tasks involved in Corporate Insolvency Resolution Process (CIRP), responsible for giving approval to the IRP/ RP to carry out actions that might affect the CIRP.

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A major chunk of the dues of the Corporate Debtor is that of Financial Creditors and thus, to recognize their substantial interest, the Committee is formed. The power to ratify the managerial decisions taken by the RP vests upon the Committee; It is this Committee that approves/ rejects the Resolution Plan, extension of CIRP, decides upon liquidation of the Corporate Debtor, ratifies expenses borne by the RP etc. In short, all decisions having an impact on the Corporate Debtor shall first be approved by the Committee.

As per section 18[3] of the Code, it is the duty of the Interim Resolution Profession to constitute the Committee upon collation of all claims received against the corporate debtor and determination of the financial position of the corporate debtor. It shall consist of all those financial creditors whose claims have been received within the time period stipulated in the public announcement.

Classification of Creditors

The IBC has introduced new and distinct concepts of ‘Financial Creditor’ and ‘Operational Creditor‘ as opposed to the Companies Act, 2013 which merely introduced the term ‘creditor’, without any classification thereof.

Statutory definitions:

  • A financial creditor is defined under Section 5(7) of the IBC to mean:

a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred“.

  • An operational creditor is defined under Section 5(20) of the IBC to mean:

any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred“.

In order to ascertain whether a person would fall within the definition of an operational creditor, the debt owed to such a person must fall within the definition of an operational debt as defined under Section 5(21) of the IBC.

An operational debt is defined under section 5(21) of the IBC to mean:

a claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment 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“.

Distinction between a financial creditor and operational creditor

Distinction between a financial creditor and operational creditor has been drawn by the Bankruptcy Law Reforms Committee .It states:

Here, the Code differentiates between financial creditors and operational creditors. Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or debt security. Operational creditors are those whose liabilities from the entity comes from a transaction on operations…The Code also provides for cases where a creditor has both a solely financial transaction as well as an operational transaction with the entity. In such a case, the creditor can be considered a financial creditor to the extent of the financial debt and an operational creditor to the extent of the operational debt.”

It is clearly evident that the law makers have chalked out distinct definitions of ‘financial creditor’ and ‘operational creditor’ and that they are not to be interpreted as inclusive or exclusive of each other.

Hon’ble National Company Law Tribunal on ‘Operational Creditors’

In Col. Vinod Awasthy v. AMR Infrastructure Limited[4], the Hon’ble Tribunal while dismissing the Petition instituted under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC) at the admission stage itself, decided the issue of whether a flat purchaser would fall within the definition of an ‘Operational Creditor‘ as defined under Section 5(20) of the IBC to whom an ‘Operational Debt’ as defined under Section 5(21) of the IBC is owed.

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The Hon’ble Tribunal observed that the framers of the IBC had not intended to include within the expression of an ‘operation debt’ a debt other than a financial debt. Therefore, an operational debt would be confined in four categories as specified in Section 5(21), IBC like goods, services, employment, and Government dues. The Tribunal held that the debt owed to the Petitioner (a flat purchaser in this case) had not arisen from any goods, services, employment, or dues which were payable under any statute to the Centre / State Government or local bodies. Rather, the refund sought to be recovered by the Petitioner was associated with the possession of immovable property.

The Hon’ble Tribunal while deciding the question of whether a flat purchaser could be considered an operation creditor considered the observations of the Bankruptcy Law Reforms Committee. It states that-

“Operational Creditors are those whose liability from the entity comes from a transaction on operations. Thus, the wholesale vendor of spare parts whose spark plugs are kept in inventory by car mechanics and who gets paid only after the spark plugs are sold is an operational creditor. Similarly, the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease.”

The Hon’ble Tribunal held that the Petitioner had neither supplied goods nor had rendered any services to acquire the status of an ‘Operational Creditor’.

It was further held that it was not possible to construe Section 9 read with Section 5(20) and Section 5(21) of the IBC so widely to include within its scope, cases where dues were on account of advance made to purchase a flat or a commercial site from a construction company like the Respondent especially when the Petitioner had other remedies available under the Consumer Protection Act and the General Law of the land.

Conclusion

While the Code has classified creditors into financial and operational creditors, it has given only one class the powers to decide the fate of the other class.

The reason for such classification is because creditors may have rights which are so dissimilar in nature so as to make it impossible for them to consult together with a common interest. This reasoning has been followed in both the Companies Act, 1956 and 2013. However, the Code by classifying such creditors and then making only one of them responsible for taking a decision that is binding on the other, renders such classification moot, thereby defeating the very purpose of classifying them.


[1] Sec 5(8) Insolvency and Bankruptcy Code 2016

[2]  Equitable classification of Creditors under the Insolvency Law https://ibclaw.in/equitable-classification-of-creditors-under-the-insolvency-law-by-shubham-garg/ By Shubham Garg on April 26,2020.

[3] The Insolvency and Bankruptcy Code 2016.

[4]  C.P. No. (IB)10(PB)/2017.

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