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FINANCIAL CREDITORS v.

OPERATIONAL CREDITORS

6.3: Corporate Law II

Submitted by-

Shreya Pandey

UID No- UG16-48

3rd Year, VI Semester

Submitted to-
Prof. Ramesh Kumar Chamarti

Maharashtra National Law University, Nagpur


TABLE OF CONTENTS

1. INTRODUCTION ................................................................................................................. 3
2. RESEARCH AIMS AND OBJECTIVES ............................................................................... 4
3. RESEARCH METHODOLOGY ............................................................................................ 4
4. RESEARCH SCOPE AND LIMITATIONS .......................................................................... 5
5. DICHOTOMY BETWEEN FINANCIAL AND OPERATIONAL CREDITORS ................ 5
6. IRREGULARITIES IN IBC .................................................................................................... 7
6.1. IN THE MATTER OF BINANI CEMENTS ....................................................................... 8
7. CONCLUSION ..................................................................................................................... 10
8. BIBLIOGRAPHY ................................................................................................................. 11
8.1. BOOKS .............................................................................................................................. 11
8.2. E-RESOURCES ................................................................................................................ 11
1. INTRODUCTION
The economy of a country can thrive to foster industrialization, ease of doing business,
entrepreneurship with an appropriate legislation and policies of the government. In the wake of
growing concerns, many legislations were enacted for different insolvency resolutions depending
on the nature of their business. However, the period was characterized by intricacy in the non-
specialised forums and a failure of business expediency. In order to effectuate the insolvency
procedures and economically viable arrangements, the Insolvency and Bankruptcy Code
(hereinafter referred to as IBC) was enacted in 2016. The Code has created a new category of
complaininats i.e., Operational Creditors and Financial Creditors.

As per the provisions of IBC, a financial creditor is the one to whom a financial debt is owed or
it is legally assigned or transferred.1 A financial debt can be termed 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-
materialized 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 such other
accounting standards as may be prescribed;
 Receivable sold or discounted other than any receivable sold on non-recourse basis;
 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;

1
Section 5(8), Insolvency and Bankruptcy Code,2016.
 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"

The code provides an exhaustive list of the debts which can be covered under a financial
creditor’s debt. On the other hand, an operational creditor is a person to whom an operation debt
is owed or legally assigned or transferred.2 Further, an operational debt is "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."3

2. RESEARCH AIMS AND OBJECTIVES


The primary aim of this research is to study difference between financial and operational
creditors, In particular, this proposed study seeks to achieve the following objectives:

 To understand the different types of creditors


 To understand the new legislation governing insolvency and bankruptcy laws in India.
 Study of various case laws which leads to a definite conclusion
 The differential treatment of both the creditors.
 The roles and accountability of both the creditors.
 The importance of instituting insolvency resolution proceedings.

3. RESEARCH METHODOLOGY
In order to achieve the prescribed objectives of study, doctrinal method of research methodology
is adopted, literature review on the subject is applied and the issues under study are examined in
a comprehensive manner. The various aspects of the study are reflected in the substantive
sections of this research work. The study of the concepts will involve:
i. An analysis of the features of legal system in the Indian law system.
ii. An attempt to supplement and update the existing legal literature to promote more
intensive research in this area of law under study.

2
Section 5 (20), Insolvency and Bankruptcy Code, 2016.
3
Section 5(21), Insolvency and Bankruptcy Code, 2016.
The doctrinal work adopted for the research work and the study on the concerned concept is both
analytical as well as descriptive. The research has put efforts to critically examine the primary
sources like books, articles, journals, case laws and e-resources. Also, the latest information the
web in the field of constitutional law has helped the researcher to explore the subject through
various dimensions and taken into consideration the dynamism of this area of law.

4. RESEARCH SCOPE AND LIMITATIONS


The research topic of financial creditors v. operational creditors encompasses various views and
perspectives the eminent jurists from which the concept has been understood and analyzed
judicially through various theory understanding. The research has been pursued after referring to
various sites, books, journals, reports and statutes.

Also, various legal provisions has been adhered and examined in relation to this topic.
Applicability of the provisions of the civil procedure code has been studied. After a thorough and
extensive research, a detailed analysis of the research topic has been provided by putting various
substantial inputs and merits of the case. Limitations include lack of scholarly articles and
applicability of various case laws in the subsequent cases law due to the unavailability of
information on the web.

5. DICHOTOMY BETWEEN FINANCIAL AND OPERATIONAL


CREDITORS
Financial creditors are those whose relationship with the entity is a pure financial contract, such
as a loan or a debt security. Operational creditors are those whose liability 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.4

4
The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design. (2015). Retrieved from
https://ibbi.gov.in/BLRCReportVol1_04112015.pdf
in the case of Col. Vinod Awasthy v. AMR Infrastructure Limited5, held 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 get 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.

As per Section 5(28) of the IBC Code, the financial creditors have the voting rights subject to the
financial debt owed to the financial creditor. However, an approval of the committee of creditors
is required by voting of not less than 75 percent of the voting shares. On the other hand, Section
24(4) provides that operational creditors does not have the voting rights but they may attend the
meetings of committee of creditors. Moreover, a financial creditor is authorized to file an
application for initiating corporate insolvency resolution process in the event of a default against
a debtor before the adjudicating authority.6 Section 8 of IBC lays down that for an operational
creditor to succeed in initiating the resolution process, it must satisfy the adjudicating authority
by demonstrating that:

1. It has served a demand notice to the corporate debtor stating that the debtor has
committed a default in debt; and

2. No dispute exists between the parties in relation to the payment of debt

Subsequently, the operation creditor may file an application after the expiry of 10 days from the
date of delivery of the notice. Therefore, under the scheme of the Code, if a debt is not admitted
by the organization (a corporate debtor) and is disputed within the meaning of Section 5 (6) or
Section 8 (2), it is a sufficient ground to reject the insolvency application made by an operational
creditor (i.e even if there are no pending proceedings between the parties, the corporate debtor
can scuttle the insolvency proceedings). On the other hand, a financial creditor is allowed to
initiate the resolution process even in case the debt is disputed by the corporate debtor.

5
[(C.P. No. (IB)10(PB)/2017
6
Section 7(1), Insolvency and Bankruptcy Code, 2016.
In addition to this, financial creditors have been given absolute discretion to furnish the name of
the resolution professional to act as an interim resolution professional as opposed to the
operational creditors. Further, section 21(2) of the IBC Code, 2016 provides the right to financial
creditors to form a part in the committee of creditors. On the contrary, the provisions of the code
do not vest such rights to operational creditors. Though, financial creditors have been given
larger perks in the functioning of a company but they are also subject to larger responsibilities.
As per Section 215(2) of the code, a financial creditor shall submit financial information. The
use of the word “shall” has been used in this context. However, section 215(3) requires that an
operational creditor “may” submit financial information. The presence of such enabling
provision depicts the weightage of the authorities to be performed. Moreover, the priority of
receiving the proceeds from insolvency has been given to the secured creditors which
mandatorily comprises of financial creditors. However, operational creditors falls under the
ambit of ‘unsecured creditors’, those, losing their prioritized rights to financial creditors.

The provisions of Insolvency and Bankruptcy Code have limited the category of rights to the
operational creditors in three contexts:

1. Attend the meeting of committee of creditors.


2. Initiate insolvency resolution process.
3. Receive notice of meeting of committee of creditors.

6. IRREGULARITIES IN IBC
The insolvency regime in India, governed by the Insolvency and Bankruptcy Code, 2016, is
constantly evolving and developing in terms of jurisprudence. However, some provisions require
further judicial interpretation or legislative modification. The code does not regulate the
provisions that may be made in a resolution plan for treatment of financial and operational
creditors of a corporate debtor. It ha also been established thatthe Committee of Creditors’ (CoC)
decision to approve any resolution plan cannot be interfered with unless it is violative of section
30(2) of the code, which prescribes certain mandatory requirements of a resolution plan.
in Central Bank of India v Resolution Professional of The Sirpur Paper Mills Limited7, struck
down regulation 38(1)(b) and (c) of the CIRP regulations inter alia providing for a minimum
7
Company Appeal (AT) (Insolvency) No. 526 of 2018.
payment of liquidation value to the dissenting financial creditors on the grounds that such
provision was not in consonance with the code, being discriminatory between the same set of
financial creditors. It was further observed that any resolution plan that provided for payment of
liquidation value to the dissenting financial creditors of the corporate debtor on the basis of the
CIRP regulations, without any other reason to discriminate between two sets of similarly situated
creditors, could not be approved as it was illegal.

The IBBI subsequently amended regulation 38 of the CIRP regulations to simply provide for
operational creditors being paid in priority to the financial creditors of a corporate debtor.
However, since section 30(2) of the code was not amended, the only effective impact of the
amendment of the CIRP regulations by the IBBI was that the requirement of paying dissenting
financial creditors a minimum of liquidation value was removed.8

Furthermore, owing to larger prioritization given to financial creditors, it has been reiterated in
the court that In some cases, even the operational creditors’ debt is huge but at present they
don’t have a say in the resolution process, Currently, operational creditors such as suppliers of
products and services to bankrupt companies are not included on the committees of creditors
(CoCs), which comprise financial creditors like banks. They have no voting rights when a CoC
decides on what to do with an asset.

6.1. IN THE MATTER OF BINANI CEMENTS


In the case of winding up of Binani Cements with a debt of over Rs 6,469 crore, UltraTech
did not participate in the bidding process as it was disqualified. However later, UltraTech
made an offer of Rs 7,267 crore, The committee of creditors (CoC) did not initially consider
UltraTech’s revised plan and agreed to Dalmia Bharat’s bid of Rs 6,700 crore. However,
UltraTech challenged the CoC decision in NCLT, saying the principle of “maximisation of
value”, the main objective of IBC, was not followed in this case.The NCLT then asked
resolution professionals to consider UltraTech’s revised offer, which paved the way for its
successful bid.9

8
Editor, V. Developing resolution plan for financial, operational creditors | Asia Business Law Journal. Retrieved
from https://www.vantageasia.com/developing-resolution-plan-financial-operational-creditors/
9
C.P.(IB) No. 359/KB/2017.
The foremost point of contention was that Dalmia offered to pay 100% to secured financial
creditors only. Binani Cements’ operational creditors were offered only Rs 150 crore against
their combined exposure of Rs 700 crore.On the other hand, UltraTech offered to make both
the operational and unsecured financial creditors whole.

The court ruled that balance between financial and trade creditors is necessary for maximisation
of a stressed asset and any plan that discriminated against any of the creditor is against the
provisions of the insolvency code.It has set a precedence that committee of creditors can accept
bids made after the deadline prescribed under process document if it results maximisation of
value of corporate debtor and balance interest of all stake holders,” Within the class of
operational creditors or financial creditors, they must get similar treatment and there can be no
differentiation. The NCLAT reiterated that the code does not permit differential treatment to
similarly situated operational creditors, or the same class of financial creditors, on one or the
other ground, and observed that if operational creditors are ignored and provided with only
liquidation value “on the basis of a misplaced notion and misreading” of section 30(2) of the
code, no creditor would supply any goods or services to a corporate debtor.

The NCLAT therefore clearly ruled that discrimination inter se among similarly placed financial
creditors or operational creditors is not permissible under the code.10

10
NCLAT Approves UltraTech’s Revised Bid of ₹7,950 crore for Binani Cement. Retrieved from
https://economictimes.indiatimes.com/industry/indl-goods/svs/cement/nclat-holds-ultratechs-bid-for-binani-cement-
valid/articleshow/66615756.cms
7. CONCLUSION
The rationale behind this imbalance in the rights assigned to financial and operational creditors
under IBC has been explained by the Banking Law Reforms Committee in its report, which
states that:

“members of the creditors committee have to be creditors both with the capability to
assess 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 willing to take the risk of postponing payments
for better future prospects for the entity. The Committee concluded that, for the process
to be rapid and efficient, the Code will provide that the creditors committee should be
restricted to only the financial creditors.”

Therefore it is clear from the above position that framers of the Code created this classification
with the aim to protect the rights of all stakeholders by providing a mechanism which primarily
focuses on resolution and re-structuring 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.

This approach is certainly much more rational than giving the reigns of the resolution process in
the hands of Operational Creditors who are more than often not interested in the revival scheme
and look for the obvious solution of liquidation to recover their dues which would defeat one of
the main objects of the Code that is, to allow an honest but unfortunate corporate debtor to obtain
a discharge from his debts subject to reasonable conditions.
8. BIBLIOGRAPHY

8.1. BOOKS
1. Ashish Makhija, Insolvency and Bankruptcy Code of India: A Commentary on Insolvency
Resolution, Liquidation, Bankruptcy of Corporate Persons, Individuals, Sole
Proprietorship & Partnership Firms,Lexis Nexis,2018
2. India Insolvency (Bankruptcy) Laws and Regulations Handbook - Strategic Information,
Basic Regulations

3. Taxmann’s Guide to Insolvency and Bankruptcy Code, 2018 edition.

8.2. E-RESOURCES
1. Purvi Nanda, M. India Law Journal.
http://www.indialawjournal.org/insolvency_and_bankcrupty.php
2. India's Operational Creditors May No Longer Be Discriminated Against in Bankruptcy
Cases. Retrieved from https://thewire.in/business/binani-cement-nclat-operational-
creditors
3. NCLAT Approves UltraTech’s Revised Bid of ₹7,950 crore for Binani Cement.
Retrieved from https://economictimes.indiatimes.com/industry/indl-
goods/svs/cement/nclat-holds-ultratechs-bid-for-binani-cement-
valid/articleshow/66615756.cms