Operational Creditor: Limit to initiation of CIRP.

Article by Anand Shelke ,5th year of B.A.LL.B (Hons) from Sandip University, Nashik, Maharashtra.

Introduction

The IBC plays a major reform in recovery of debt from 2016. The Insolvency is a financial distress where the corporate debtor is unable to pay debt and there is cycle of defaults. IBC is a time bound time process and it gets enhance with the time. Earlier there where no provision for MSME Sector but in 2021 an amendment, made a process is establish called as Prepackaged Insolvency Resolution Process for the MSME sector.

The IBC in India has some shortcomings in ensuring equality between financial and operational creditor in the corporate insolvency resolution process. Financial Creditors appear to have more power and rights compared to operational creditor, which can lead to unfair treatment of the latter. The prioritization of claims is a crucial aspects of insolvency laws, and it appears that the current prioritization in IBC favors financial creditors. This may lead to operational creditors being left behind in the process and not receiving their due share.

The article argues for the need to amend the existing insolvency law in order to protect the interest of operational creditors and create a more equal playing field. It is important to ensure that all creditors, whether financial or operational, have a fair chance at recovering their dues in the corporate insolvency resolution process. 

Operational Creditor and Operational Debt:

 In simple terms operational creditors are the creditors who provides services and transaction to the corporate debtor instead of direct finance.

 Thus the debt owed towards the corporate debtor by provided services is called as operational debt.

According to Law:

  Section 5(20) “ 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.

     Section 5(21) “ operational debt ” means a claim in respect of the provision of goods or services including employment or a 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.

In the case of Col.Vinod Awasthy V. AMR Infrastructure Ltd [i]. The NCLT interpreted the operational debt related only to four categories as specific in Sec 5(21) of the code like goods, services, employment and Government dues.

Operational Creditor in the corporate insolvency resolution process:

Under IBC, a demand notice is served to the corporate debtor for the payment of debt owed after the default. If the corporate debtor within 10 days of the demand notice fails to pay the unpaid operational debt or fails to provide satisfactory reason. The operational creditor may file an application in front of Adjudicating Authority for commencement of corporate insolvency resolution process. The operational creditor have to furnish some evidence of notices and invoices sent to corporate debtor. The Adjudicating Authority will communicate to the operational creditor about the decision whether there shall be commencement of corporate insolvency resolution process or not. Resolution Professional will constitute a committee of creditors but NO voting right has been given to operational creditors. Any person who is financial creditor as well as operational creditor at the same time such person will be having share to the extent of financial debt. Resolution Professional will give notice of meeting to a operational creditors who holds debt of not less than 10% of the aggregate debt. At time of distribution of assets, the operational creditor are to be considered having lower priority.[ii]

Why Operational Creditor does not have voting right in committee of creditors?

      By taking cognizance of report of Bankruptcy Law Reform Committee, the Calcutta High Court in case of Akshay Jhunjhunwala and Anr. Vs Union Of India [iii], held that “members of the committee of creditors have to be creditors both with the capability to asses viability as well as to be willing to modify terms of existing liabilities in negotiations. Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor wiling to take risk of postponing payments for better future prospectus for the entity… for the process to be rapid and efficient, the code will provide that the committee of creditors should be restricted to only financial creditors.” the court also  further held that “the Bankruptcy Committee gives a rationale to the financial creditors being treated in a particular way an operational creditor in an corporate insolvency resolution process regard to a company. Courts are not require to adjudge a legislation on the basis of possible misuse or the crudities or inequalities that may be perceived to be embedded in a legislation. The rationale of giving a particular treatment to a financial creditor in the process of insolvency of a company under the code cannot be said to offend any provision of the Constitution of India.”

In different cases, the discrimination against the operational creditor was brought up but The Supreme Court of India failed to find the way through it.

What if there are only Operational Creditors and not Financial Creditor?

As given in the regulation 16 in Chapter 5 of 2016 by Insolvency Bankruptcy Board of India for Corporate Persons:

Under 16 (2) the committee formed shall consist of –

• 18^th largest operational creditors by value if the number is less than 18 then other operational creditors;
•  1 representative elected by all workmen other than those workmen;
•  1 representative elected by all employees other than those employees.

The members of committee of creditors under this rule shall have voting rights in proportion of the debt they owed. The committee of creditors will have the same powers, rights, obligations and duties as the committee of creditors of financial creditors have.[iv]

Is Operational Creditor only include in the act to initiate the corporate insolvency resolution process?

According to many cases and Law itself declare that operational creditor is just for to start the corporate insolvency resolution process only. After the process at the time of distribution of assets the debt of the operational creditor are under-eyed in the process. In a recent judgment by NCLAT Delhi in Dharmindra Constructions Pvt. Ltd. Vs Rajendra Kumar Jain [v], it was held that “ We are in the view as per the law as exist today, the operational creditors are only entitled for minimum of the liquidation value and there being no breach of any of the provisions of the code, we are unable to interfere with the impugned order”.

        The Supreme Court in the case of ‘committee of creditors of Essar Steel India Ltd V. Satish Kumar Gupta’ held that uniform treatment need not be given out to the operational creditor compared to financial creditor.[vi]

In a recent event at the book launch, Former judge of the Supreme Court and current Chairperson of the NCLAT, Justice Ashok Bhushan said “ The maximum casualty is of the operational creditor who are at the very bottom of the distribution chain. The financial creditors take the major share, while the operational creditors get nothing.” Further Justice explained that there is need for an amendment in Sec 53. “ The legislature may take a call on this. We hope that this year, we will have some more amendments in the code addressing the pertinent issues”.

Conclusion:

It is true that the Insolvency and Bankruptcy Code 2016 (IBC) has played an important role in the recovery of debts in India. The objective of the IBC is to revive the company and maximize the value of its assets, which benefits all stakeholders, including operational creditors. Operational creditors provide goods and services to the corporate debtor, which indirectly helps the debtor generate revenue and profits. The IBC is perceived to be biased towards financial creditors, secured creditors, and government dues, compared to operational creditors. This is because financial creditors are given more control over the insolvency resolution process and they are given priority in the distribution of assets under Section 53 of the IBC. There is an immediate need to amend the IBC to address the concerns of operational creditors. For example, Section 53 can be amended to give equal priority to operational creditors in the distribution of assets. Moreover, Section 21 can be amended to give voting rights to operational creditors in the meetings of the Committee of Creditors (CoC). However it is worth noting that the IBC has been successful in reducing the number of defaults towards operational creditors, and many operational creditors have been able to recover their debts after issuing a demand notice. This is a positive development but more needs to be done to ensure that the rights of operational creditors are protected and that they are given a fair chance to recover their dues through the insolvency resolution process.

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[i]Col. Vinod Awasthy V. AMR Infrastructure Limited, C.P. No. (IB) 10 (PB)/2017

[ii] The Insolvency and Bankruptcy Code 2016, Bare act, 2022 Edition

[iii]Akshay Jhunjhunwala and Anr. V. Union of India, Writ Petition No. 627 of 2017

[iv]Regulation 16 in Chapter 5 of 2016 by IBBI

[v]Dharmindra Construction Pvt. Ltd. & Anr. V. Rajendra Jain, Company Appeal (AT) (Insolvency) No. 1477 of 2022

[vi]Committee of Creditors of Essar Steel India Limited V. Satish Kumar Gupta and Ors, (2020) 8 SCC [ 116].

Author: Anand Shelke