The Insolvency & Bankruptcy Code (BC the Code) was introduced as a tool
for consolidation and amendment of the extant laws relating to reorganization
and insolvency resolution of corporate persons, partnership firms and
individuals in a time effective manner while ensuring balance of interests
amongst all stakeholders and maximization of value of assets involved. With the
introduction of IBC, multiple laws dealing with corporate restructuring, debt
recovery and bankruptcy came under one overarching umbrella seeking to simplify
the process & achieving faster resolution of corporate insolvency.
IBC came into effect as a means for ensuring that if a troubled corporate can be
kept afloat by providing for alternatives such as change of management/
protection from immediately insolvency/ tranche-wise repayment mechanism etc.,
it should be given a fighting change. The primary focus of IBC, as compared to
the earlier debt recovery laws, is tilted towards corporate restructuring &
allowing for a more wholesome rescue effort through involvement of all the
Financial Creditor vis-ŕ-vis Operational Creditor under IBC
IBC segregates debt as defined under the Code into two broad classes – (a)
financial debt; & (b) operational debt. In a nutshell – financial debt is the
debt that has been incurred by way of loan raised by the Corporate Debtor,
whereas operational debt is the debt that has been incurred on account of
procurement of goods and services by the Corporate Debtor. As mentioned earlier,
the primary focus of the Code is not in recovery (as was the case with DRT
earlier) but on resolution process.
This brings into light a very important
aspect of the Code that is the high important of Operational Creditors in the
scheme of things as they are the ones who help upkeep the corporate debtors by
providing all the day to day necessities. The position of Operational Creditors
is more akin to the financial debtors who provide mezzanine or interim finances
to the Corporate Debtor to ensure that the Corporate Debtor survives the
Irrespective of the intent of IBC, the focus of the resolution process has
always remained on the financial creditors. The resolution process is driven by
the Committee of Creditors (CoC) constituted of the financial creditors of the
corporate debtor. Operational Creditors are only allowed representation when
their claims (collectively) exceed 10% of the total debts of the corporate
debtor, which is seldom the case. Given that there is no provision for adequate
representation for the Operational Creditors in the CoC, the level of protection
available to the Operational Creditors automatically reduces.
One may argue that the stakes of financial creditors in case of corporate
insolvency is invariably a lot higher than the operational creditors. This also
translates into minimal liquidation value of such operational debts in the whole
scheme of liquidation & therefore, the moneys recoverable by such operational
creditors are reduced to close to nothing. This position has its roots in terms
of Section 53 of the IBC placed Operational Creditors much below the Secured
Creditors; and effectively relegated Operational Creditors to the slab just
above share-holders of the Corporate Debtor.
In the Supreme Court order in Committee of Creditors of Essar Steel India
Limited v. Satish Kumar Gupta & Ors.
(2019), the Apex Court held that most
financial creditors are secured creditors and most operational creditors are
unsecured creditors thereby affirming the lower priority granted to operational
creditors in practice. The intent of the court was to assert that the intent of
IBC was not to treat all the creditors equally but to treat similarly placed
Even though the rationale behind treating Operational
Creditors on a different pedestal is a sound one, the very fact that in the same
case, the recovery of Operational Creditors was almost to the tune of 20%
whereas the recovery of financial creditors was almost 80% goes on to show the
differential outcome of such treatment. The Court seems to have blurred the line
between equal treatment and equitable treatment for the Operational Creditors.
Suspension of IBC – the COVID story
Despite not being able to record a huge success rate, IBC has indeed helped a
lot of corporate entities in reaching a resolution plan that ‘maximizes the
value of assets’ rather than resorting to winding up which, more often than not,
results in losses to not only the Corporate Debtor but also to the Creditors.
In furtherance of the measures taken by the finance ministry to provide relief
to the Covid hit economy, IBC (Second Amendment Act), 2020 deemed to have come
into force from June 5, 2020 (the Amendment Act).
The key provision of the Amendment Act provided that:
notwithstanding anything contained in section 7,
9 and 10, no application for initiation of corporate insolvency resolution
process of a corporate debtor shall be filed, for any default arising on or
after 25th March, 2020 for a period of six months or such further period, not
exceeding one year form such date, as may be notified in this behalf.
Amendment Act also clarifies further that the aforementioned moratorium is not
applicable to any default arising before 25th March 2020 & also that no action
lies, in the future, for any default committed by the Corporate Debtor in the
said period (from 25th March 2020 to such period for which the actions are
The aforementioned sections of the Code that have been suspended for the
stipulated period deal with the rights of financial creditor, operational
creditor as well as corporate applicant (including the corporate debtor itself)
to initiate corporate insolvency resolution process. However, there is no
restriction on the operational creditor being able to raise a demand for payment
from the Corporate Debtor requiring the Corporate Debtor to either pay within 10
days of such demand or raise a valid dispute in relation to the same.
What does the suspension entail for Operational Creditors?
Providing the Operational Creditors with a right to demand their payments under
the IBC even within the moratorium period does show some consideration towards
the Operational Creditors vis-ŕ-vis the Financial Creditors. This move will also
ensure that the funds of the Corporate Debtors are not tied up in a resolution
process & is available for making payments for the goods and services procured.
It is also very important to note that preventing all the creditors as well as
the corporate applicant from initiating an action with respect to corporate
insolvency resolution process, furthers the need to allow companies a breathing
space from lengthy proceedings in these Covid hit times.
This is also in line with the other remedies brought in by RBI in terms of
moratoriums in payments of EMIs to the financial creditors and other myriad of
relief measures brought in for medium and small enterprises and small scale
However, this is not to say that this step from the finance ministry is a
full-proof mechanism for ensuring that the Operational Creditors get their due
in terms of the payment for the goods and services provided by them. There is
always a risk of the Corporate Debtor raising a dispute with respect to the
payments. Once a dispute is raised & there is no resolution to the satisfaction
of both the parties, the Operational Creditor can’t initiate the IBC proceedings
under Section 9 of the Code.
Looking at the history of resolution under IBC and the effective remedies for
the Operational Creditors, it might not be wrong to state that the move by
finance ministry through this Amendment Act does have its own advantage for
Operational Creditors. It not only puts a restriction on creditors from
initiating insolvency process but also prevents the operational creditors from
falling behind all the other secured creditors in the hierarchy of repayments
under the Code.
The need of the hour is for the Operational Creditors to be able to monetize
their payments under the Code. This may also mean a lot of extra efforts taken
for amicable negotiations and possibly some haircuts & discounts on already
agreed prices but it could also mean making recoveries of the dues from
companies that are at the verge of insolvency in light of the Covid situation &
may end up in an insolvency proceeding in the future. However, all the
Operational Creditors will have to do their own cost-benefit analysis,
especially taking into account the repayment capability of the Corporate Debtor,
& ascertain the best way forward.
Written By: Rashmi Priya
- IBC or the Code means the Insolvency and Bankruptcy Code, 2016 means as
amended from time to time.
- The capitalized terms used in the article including Committee of
Creditors, Corporate Debtor, Financial Creditor and Operational Creditor
etc. are as defined under the Code.
- IBC Second Amendment Act, 2020 means the Insolvency & Bankruptcy
Code (Second Amendment ) Act, 2020 available at: http://www.mca.gov.in/Ministry/pdf/IBCAmedBill_24092020.pdf