Insolvency and Bankruptcy Law
12 mons ago
Advocate Jhanak Singh
Category : Insolvency and Bankruptcy Law
purpose of proceedings under the Insolvency and Bankruptcy Code, 2016 (“the Code”) a distinction between the financial
creditors and operational creditors has been created.
argument is that there is no intelligible
differentia having relation
to the object intended to be achieved by the Code between financial and
operational creditors and therefore, it is alleged to be discriminatory, arbitrary and violative of Article
14 of the Constitution of India.
Creditor v. Operational Creditor
Under Section 5(7) of the Code, a Financial Creditor is defined
as "a person to whom a financial debt is owed and includes a person to
whom such debt has been legally assigned or transferred".
Financial debt has
been defined under Section 5(8) as "a
debt along with interest, if any, which is disbursed against the consideration
for time value of money".
Creditor is defined under Section 5(20) of the Code as "any person to whom an operational debt is owed and includes any person to
whom such debt has been legally assigned or transferred".
Operational Debt has
been defined under Section 5(21) as "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".
the creditors under the Code:
1. Requirement of Demand Notice
creditor, as per Section 8 of the Code, is required to serve a demand notice
upon the corporate debtor before filing an application before the National
Company Law Tribunal. However, there is no such requirement for the financial creditor.
2. Disputed Debts
As per Section 9 of the Code the application of operational creditor
shall be rejected if the debt is a disputed debt, however, there is no such
rejection criteria for financial creditors.
3. Committee of Creditors
Section 21(2) of the Code
states that the committee of creditors (“CoC”)
shall consist only of financial creditors whereas operational creditors are not
allowed to be a part of the CoC.
creditor shall vote in accordance with voting share assigned and the resolution
plan can be implemented only if it has been approved by vote of 66% of voting
shares of financial creditors.
24(3)(c) of the Code states that unless the operational creditors amount to 10%
of the aggregate of the amount of debt owed, they will have no voice in the
Therefore, it is clear
that an operational creditor is not allowed to be a member of the CoC. Also, the
Code limits the right of an operational creditor to only attending the meeting
of CoC subject to the abovementioned threshold.
The issue now appears to have
been bedded down in finality:
year 2018 saw many writ petitions assailing the constitutional validity of the Code.
Various matters were brought into question and on January 25, 2019, a judgment
was pronounced by the Supreme Court (the "SC")
on this batch of petitions in Swiss Ribbons Private
Limited & Anr. v. Union of India.
SC concluded that the distinction is "neither discriminatory, nor
arbitrary, nor violative of Article 14 of the Constitution of India".
Insofar as the disparity between the creditors is concerned, this is
because operational creditors are typically interested only in getting payment
for supply of goods or services made by them, whereas financial creditors are
typically involved in seeing that the entirety of their loan gets repaid, for
which they are better equipped to go into the viability of corporate
enterprises, both at the stage of grant of the loan and at the stage of
Section 53 was
analysed separately. This section lays down the waterfall mechanism of claims and the priority
in distribution of assets in liquidation. The Code accords preference to financial
creditors secured claims and the operational creditors find themselves at the
bottom of the hierarchy.
The SC went on record to state
that they do not find that operational creditors are discriminated against or
that Article 14 has been infracted on the ground of arbitrariness.
The rationale behind
the difference between financial and operational creditor under the Code has also
been explained in the Banking Law Reforms Committee as under:
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
In summary, 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 sought to be protected, having relation to
the object sought to be achieved by the statute in question, Article 14 does
not get infracted. For these reasons, the challenge to Section 53 of the Code
must also fail".
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