“Decoding the Code”
Persons who may initiate Corporate Insolvency Resolution Process(CIRP)
Chapter-II of the Insolvency and Bankruptcy Code, 2016 (referred as ‘IBC’ or ‘the Code’) covers Corporate Insolvency Resolution Process(CIRP).
This part of the decoding the code analyse followings definitions:
- Definition of Creditors, Debt & Claim
- Financial Creditor under IBC and inclusion of Home Buyer
- Operational Debt and Operational Creditor definitions
- Corporate Debtor & Corporate Applicant
- Corporate & Personal Guarantor
- Financial Service Providers
- Other issues
As per Section 6 of the Code, following persons may initiate CIRP against corporate debtor on commits a default in debt:
- a financial creditor or
- an operational creditor or
- a corporate applicant
Legal content of the Section 6 reproduced here:
“6. Where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor in the manner as provided under this Chapter.”
I. Who is a Creditor and what is Debt & Claim
Before going for discussion on the financial creditor, operational creditor and corporate debtor, we should know the definition of ‘creditor’ which is defined under Section 3 (10) of the Code as reproduced here:
“(10) “creditor” means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decreeholder;”
The Code of 2016 segregates creditors of a company into two broad categories of financial and operational creditor. The classification of a creditor of a company as secured, unsecured and statutory creditor stands to be replaced by financial or operational creditor of a company in the initiation of an insolvency proceeding of a Company under the Code of 2016. A creditor of a Company when involved in an insolvency proceeding of a company under the Code of 2016 does not lose the character of being either a secured or unsecured or statutory creditor, of such company as the case may be. However, in the insolvency proceedings, under the Code of 2016, a creditor is also classified as a financial or an operational creditor to deal with the insolvency proceeding of a company.
Section 3 (11) defines the debt means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt and Section 3 (6) defines claim as under:
(6) “claim” means—
(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured;
(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;””
Apex Court in the matter of Swiss Ribbons Pvt. Ltd. & Anr. Vs. Union of India & Ors. held that whereas a “claim” gives rise to a “debt” only when it becomes “due”, a “default” occurs only when a “debt” becomes “due and payable” and is not paid by the debtor. It is for this reason that a financial creditor has to prove “default” as opposed to an operational creditor who merely “claims” a right to payment of a liability or obligation in respect of a debt which may be due. When this aspect is borne in mind, the differentiation in the triggering of insolvency resolution process by financial creditors under Section 7 and by operational creditors under Sections 8 and 9 of the Code becomes clear.
Person defines under Section 3 (23) of the Code includes:
(a) an individual;
(b) a Hindu Undivided Family;
(c) a company;
(d) a trust;
(e) a partnership;
(f) a limited liability partnership; and
(g) any other entity established under a statute,
and includes a person resident outside India;
The CIRP process can be initiated against a government company by virtue of it being covered under the definition of Corporate Person as provided in sec. 3(7) of the Code.
Hon’ble Supreme Court in the matter of Hindustan Construction Company Limited & Anr. Vs. Union of India & Ors. held that that the CIRP process can be initiated against a government company by virtue of it being covered under the first part of ‘corporate person’ as provided in section 3(7) of the Code. The Court cleared that NHPC, NTPC and IRCON, being PSUs are government companies as they are incorporated under the Companies Act, and they would be covered within the section 3(7) of the Code. However, the Supreme Court also laid down that so far as the NHAI is concerned, referred to the Statement of Objects and Reasons of the National Highways Authority of India Act, 1988 and some sections of the said Act to show that NHAI is a statutory body which functions as an extended limb of the Central Government, and which is to carry out the sovereign function of laying down national highways. The Insolvency Code cannot be used against such a statutory body, because no resolution professional or private individual can take over the management of such body, as it performs sovereign functions, nor can such body be driven to insolvency under an Insolvency Code.
II. Financial Creditor under IBC
A financial creditor means a creditor whose claim arises out of a transaction in liquidity entered into by such creditor with the company. A financial creditor can be either a secured creditor or an unsecured creditor.
Financial creditor defines under section 5 (7) means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.
That is a financial creditor is a person who has right to a financial debt including assignee. In order to understand the expression financial creditor the requirements of expression financial debt have to be satisfied which is defined under Section 5 (8) of the IBC. Legal content of the Section 5 (8) reproduced here:
“(8) “financial debt” means a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money and includes—
(a) money borrowed against the payment of interest;
(b) any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;
(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;
(d) 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;
(e) receivables sold or discounted other than any receivables sold on nonrecourse basis;
(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;
Explanation. -For the purposes of this sub-clause,-
(i) any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing; and
(ii) the expressions, “allottee” and “real estate project” shall have the meanings respectively assigned to them in clauses (d) and (zn) of section 2 of the Real Estate (Regulation and Development) Act, 2016 (16 of 2016);
(g) 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;
(h) 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;
(i) 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 opening words of the definition clause would indicate that a financial debt is a debt along with interest which is disbursed against the consideration for the time value of money and it may include any of the events enumerated in sub-clauses (a) to (i). Therefore the first essential requirement of financial debt has to be met, that the debt is disbursed against the consideration for the time value of money and which may include the events enumerated in various sub-clauses. The key feature of financial transaction as defined by section 5(8) is its consideration for time value of money. It may also be a sum of money invested today to be repaid over a period of time in a single or series of installments to be paid in future. It is significant to notice that in order to satisfy the requirement of this provision, the financial transaction should be in the nature of debt and no equity has been implied by the opening words of Section 5(8) of the IBC.
Home Buyer [Explanation after section 5 (8)(f)]
Whether Home Buyer or buyers of under-construction apartments includes under financial debts as defined under clause 8 of Section 5.
The above definition of ‘financial debt’ under section 5 (8) of the Code uses the word “includes”, thus the kinds of financial debts illustrated are not exhaustive as interpreted by NCLAT in case of B.V.S. Lakshmi v. Geometrix Laser Solutions Private Limited.
The phrase “disbursed against the consideration for the time value of money” has been the subject of interpretation only in a handful of cases under the Code. The words “time value” have been interpreted to mean compensation or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money as elaborated by NCLAT in case of Nikhil Mehta and Sons(HUF) & Ors. Vs. AMR Infrastructure Ltd, or factoring of a discount in the payment.
Apart from the above judgment, there are various judgments have categorised home buyers as neither fitting within the definition of ‘financial’ nor ‘operational’ creditors, some case laws as under:
- Nikhil Mehta v. AMR Infrastructure, NCLAT, New Delhi- If Developer has shown the amount taken from home buyer under borrowing head and charged the interest thereon under Finance Cost in his Financial statements then that amount is constituted as debt under IBC.
- Anil Mahindroo & Anr v. Earth Organics Infrastructure– Money disbursed by home buyer is against the consideration for the time value of money and for all purpose, they come within the meaning of ‘Financial Creditor’ as defined in Section 5(7) of the ‘IBC’
- Col. Vinod Awasthy v. AMR Infrastructure Ltd., NCLT, Principal Bench, Delhi, CP No. (IB)-10(PB)/2017, Date of decision – 20 February, 2017- Home Buyer as neither fitting within the definition of ‘financial’ nor ‘operational’ creditors.
The Insolvency Laws Committee, chaired by Shri Injeti Srinivas, made following recommendations on issue of home buyers under IBC:
“On a review of various financial terms of agreements between home buyers and builders and the manner of utilisation of the disbursements made by home buyers to the builders, it is evident that the agreement is for disbursement of money by the home buyer for the delivery of a building to be constructed in the future. The disbursement of money is made in relation to a future asset, and the contracts usually span a period of 4-5 years or more.The Committee deliberated that the amounts so raised are used as a means of financing the real estate project, and are thus in effect a tool for raising finance, and on failure of the project, money is repaid based on time value of money. On a plain reading of section 5(8)(f), it is clear that it is a residuary entry to cover debt transactions not covered under any other entry, and the essence of the entry is that “amount should have been raised under a transaction having the commercial effect of a borrowing.” An example has been mentioned in the entry itself i.e. forward sale or purchase agreement.
Thus, not all forward sale or purchase are financial transactions, but if they are structured as a tool or means for raising finance, there is no doubt that the amount raised may be classified as financial debt under section 5(8)(f). Drawing an analogy, in the case of home buyers, the amounts raised under the contracts of home buyers are in effect for the purposes of raising finance, and are a means of raising finance. Thus, the Committee deemed it prudent to clarify that such amounts raised under a real estate project from a home buyer fall within entry (f) of section 5(8).
Finally, the Committee concluded that the current definition of ‘financial debt’ is sufficient to include the amounts raised from home buyers / allottees under a real estate project, and hence, they are to be treated as financial creditors under the Code. However, given the confusion and multiple interpretations being taken, at this stage, it may be prudent to explicitly clarify that such creditors fall within the definition of financial creditor, by inserting an explanation to section 5(8)(f) of the Code. Accordingly, in CIRP, they will be a part of the CoC and will be represented in the manner specified in paragraph 10 of this report, and in the event of liquidation, they will fall within the relevant entry in the liquidation waterfall under section 53. The Committee also agreed that resolution plans under the Code must be compliant with applicable laws, like RERA, which may be interpreted through section 30(2)(e) of the Code. It may be noted that there was majority support in the Committee for the abovementioned treatment of home buyers. However, certain members of the Committee, namely Sh. Shardul Shroff, Sh. Sudarshan Sen and Sh. B. Sriram, differed on this matter.” (From Report of the Insolvency Law Committee, March 2018)
Amendment by the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (6 of 2018) to include Home Buyer under the financial debt:
On recommendation by Insolvency Law Committee, an explanation after section 5 (8)(f) inserted by the Ordinance to state that any amount raised under a real estate project from an allottee shall be deemed to be an amount having the commercial effect of borrowing where the terms “real estate project” and “allottee” shall have the meaning assigned to them under the Real Estate (Regulation and Development) Act, 2016.
From the provisions of law and discussion as made above, we can say that following essential criteria’s to be fulfilled for a Creditor to come within the meaning of ‘Financial Creditor’ :-
(i) A person to whom a ‘Financial debt’ is owed and includes a person whom such debt has been legally assigned or transferred
(ii) The debt along with interest, if any, is disbursed against the consideration for time value of money and include any one or more mode of disbursed as mentioned in clause (a) to (i) of sub-section (8) of Section 5.
III. Operational Creditor under the IBC
The next question is arises that who is operation creditor under the Code. An operational creditor is a creditor whose claim arises out of a normal business transaction that such creditor may have had with the legal entity. It would include money receivable by an employee or a worker of the company as wages or salary. It would also include a claim of a statutory authority on account of money receivable pursuant to an imposition by a statute.
Operation creditors means as per Section 5 (20) a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.
Again, next point arises that what is constitute the operation debt under the Code. The definition of the operation debt under Section 5 (21) coveres following claim:
- claim in respect of the provision of goods or services
- claim in respect of the provision employment
- 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.
So, a trade payable, employee’s dues and dues payable to CG or SG under law are covered under the operation debt.
1. Whether a trade union could be said to be an operational creditor :
Supreme Court in the matter of JK Jute Mill Mazdoor Morcha Vs. Juggilal Kamlapat Jute Mills Company Ltd. Through Its Director & Ors. held that the trade union represents its members who are workers, to whom dues may be owed by the employer, which are certainly debts owed for services rendered by each individual workman, who are collectively represented by the trade union. Equally, to state that for each workman there will be a separate cause of action, a separate claim, and a separate date of default would ignore the fact that a joint petition could be filed under Rule 6 read with Form 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, with authority from several workmen to one of them to file such petition on behalf of all.
2. Whether the recovery of arrears of rent can be claimed as operational debt within the meaning of section 3(11) of the Code?:
An important question as to whether the transaction of lease of immovable property can be brought within the definition of “Operational Debt” and landlord/lessor can be categorized as an “Operational Creditor” for the purpose of the Code.
NCLT, Kolkata Bench in the matter of Sarla Tantia V/s Nadia Health Care (P) Ltd. [CP(IB) No. 108/KB/2018 and CA(IB) No. 119/KB/2018, dated 05.10.2018] held that receiving any consideration by way of rent, lease from time to time, license fees for letting out the premises would fall under the purview of providing services and the consideration that is receivable becomes operational debt. Related portion of the order reproduced here:
“8. In view of this, it has to be held that, “letting out premises on rent is nothing but providing the services. Section 5(21) of the IB Code defines the operational debt as a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment of dues arising under the law for the time being in force and payable to the Central Government, any State Government or any local authority.” Hence, receiving any consideration by way of rent, lease from time to time, license fees for letting out the premises would fall under the purview of providing services and the consideration that is receivable becomes operational debt. In view of these facts on record, I hold that recovery of arrears of rent is operational debt within the meaning of section 5(21) of the Code.”
However, NCLT in the matter of Mrs Parmod Yadav Vs. M/s. Divine Infracon pvt. ltd.-No. IB-209/ND/2017 dated 28.09.2017 held that in relation to immovable property the same cannot be considered as a transaction falling under the term ‘operation’ and ‘operational debt’ unless such a transaction having a correlation of direct input to the output produced or supplied by the corporate debtor. NCLAT in the matter of Jindal Steel & Power Ltd. Vs. DCM International Ltd. also held that the Appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and the debt in respect of the repayment of dues does not arise under any law for the time being in force payable to the Central Government or State Government, we hold that the Appellant tenant do not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-Section (21) of Section 5 of the Code for triggering Insolvency and Bankruptcy Process under Section 9 of the Code.
IV. Corporate Debtor under the IBC
As per Section 3(8), Corporate Debtor means a corporate person who owes a debt to any person.
Section 3 (7) defines the Corporate Person as under:
“(7) “corporate person” means a company as defined in clause (20) of section 2 of the Companies Act, 2013, a limited liability partnership, as defined in clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008, or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider;”(Emphasis provided)
So, as per sub-section 7 of the Section 3, the corporate persons means:
- a Company
- any other persons incorporated with limited liability under any law.
BUT not included Financial Service provider.
That is a financial creditor and an operational creditor cannot file application for initiation of CIRP against the financial service provider and financial service provider also cannot file application against himself.
Financial Service Providers?
The Code is applicable to all entities other than those which are specifically engaged in business of providing financial services listed in Section 3(16). Reliance has been placed on the definition of the financial service provider covered under Section 3(17) to suggest that it must be engaged in the business of providing financial service.
As per Sec. 3(17), financial service provider means a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator(See Note-1 below).
The Code has defined following financial services:
- Accepting of deposits
- Safeguarding and administering assets consisting of financial products(see Note-2 below), belonging to another person, or agreeing to do so
- Effecting contracts of insurance
- Offering, managing or agreeing to manage assets consisting of financial products belonging to another person
- Rendering or agreeing, for consideration, to render advice on or soliciting for the purposes of—
- buying, selling, or subscribing to, a financial product
- availing a financial service or
- exercising any right associated with a financial product or financial service
- Establishing or operating an investment scheme
- Maintaining or transferring records of ownership of a financial product
- Underwriting the issuance or subscription of a financial product or
- Selling, providing, or issuing stored value or payment instruments or providing payment services.
Note-1: Financial sector regulator means an authority or body constituted under any law for the time being in force to regulate services or transactions of financial sector and includes the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India, the Pension Fund Regulatory Authority and such other regulatory authorities as may be notified by the Central Government;
Note-2: Financial products means securities, contracts of insurance, deposits, credit arrangements including loans and advances by banks and financial institutions, retirement benefit plans, small savings instruments, foreign currency contracts other than contracts to exchange one currency (whether Indian or not) for another which are to be settled immediately, or any other instrument as may be prescribed;
V. Who is Corporate Applicant
As per Section 10, a corporate applicant may file an application before adjudicating Authority for initiating CIRP against corporate debtor. The corporate applicant has been defined by the Code under Section 5 (5) which is reproduced here:
“(5) “corporate applicant” means—
(a) corporate debtor; or
(b) a member or partner of the corporate debtor who is authorised to make an application for the corporate insolvency resolution process under the constitutional document of the corporate debtor; or
(c) an individual who is in charge of managing the operations and resources of the corporate debtor; or
(d) a person who has the control and supervision over the financial affairs of the corporate debtor;”
The definition itself content clear construction and no requirement to discuss on the same.
VI. Corporate & Personal Guarantor
The definition of the Corporate Guarantor under section 5 inserted by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 on recommendation by Insolvency Law Committee in Report submitted in March, 2018. Which is reproduced here:
“(5A) “corporate guarantor” means a corporate person who is the surety in a contract of guarantee to a corporate debtor;”
Personal guarantor defines under Section 5 (22) means an individual who is the surety in a contract of guarantee to a corporate debtor
A contract of guarantee is between the creditor, the principal debtor and the surety, where under the creditor has a remedy in relation to his debt against both the principal debtor and the surety. The surety here may be a corporate or a natural person and the liability of such person goes as far the liability of the principal debtor. As per section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor and the creditor may go against either the principal debtor, or the surety, or both, in no particular sequence.Though this may be limited by the terms of the contract of guarantee, the general principle of such contracts is that the liability of the principal debtor and the surety is co-extensive and is joint and several.
Judicial Pronouncement on corporate guarantor under IBC:
Following two question have been answered by NCLAT in the mattter Dr. Vishnu Kumar Agarwal Vs. M/s. Piramal Enterprises Ltd.
i. Whether the Corporate Insolvency Resolution Process can be initiated against a Corporate Guarantor, if the Principal Borrower is not a Corporate Debtor or Corporate Person?;
ii. Whether the Corporate Insolvency Resolution Process can be initiated against two Corporate Guarantors simultaneously for the same set of debt and default? The question can be looked from another angle. Whether the Financial Creditor can claim same amount from the Resolution Professional appointed pursuant to the CIRP against the Corporate Guarantor No.1, as also from the Resolution Professional appointed pursuant to CIRP initiated Corporate Guarantor No.2?
There is no bar in the ‘I&B Code’ for filing simultaneously two applications under Section 7 against the ‘Principal Borrower’ as well as the ‘Corporate Guarantor(s)’ or against both the ‘Guarantors’. However, once for same set of claim application under Section 7 filed by the ‘Financial Creditor’ is admitted against one of the ‘Corporate Debtor’ (‘Principal Borrower’ or ‘Corporate Guarantor(s)’), second application by the same ‘Financial Creditor’ for same set of claim and default cannot be admitted against the other ‘Corporate Debtor’ (the ‘Corporate Guarantor(s)’ or the ‘Principal Borrower’). Further, though there is a provision to file joint application under Section 7 by the ‘Financial Creditors’, no application can be filed by the ‘Financial Creditor’ against two or more ‘Corporate Debtors’ on the ground of joint liability (‘Principal Borrower’ and one Corporate Guarantor’, or ‘Principal Borrower’ or two ‘Corporate Guarantors’ or one ‘Corporate Guarantor’ and other ‘Corporate Guarantor’), till it is shown that the ‘Corporate Debtors’ combinedly are joint venture company.
VI. Special Issues
1. Who is authorised to file application under IBC
Section 179 of Companies Act, 2013 empowers the Board of Directors to do all such acts that a company is authorised to do. A company being a juristic person is capable of initiating and defending legal proceedings and, therefore, the Board of Directors is empowered to exercise such rights on behalf of the Company or may duly empower ‘Authorised Representative‘ to do so on its behalf. Thereby the person authorised by the Board of Directors is duly empowered to initiate or defend any legal proceedings by or against the ‘Financial Creditor’|Corporate Debtor’ in any Court of law including the matters relating to Insolvency and Bankruptcy proceedings. Thereby, the Board of Directors of a Bank are empowered to delegate powers to any of its officer.
Rule 10 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 states that till the time rules of procedure for conduct of proceedings under the Code are notified, an application made under sub-section (1) of section 7, sub-section (1) of section 9 or sub-section (1) of section 10 of the Code shall be filed before the Adjudicating Authority in accordance with Rules 20, 21, 22, 23, 24 and 26 of Part III of NCLT Rules, 2016. Rule 23(1) of NCLT Rules permits an authorised representative to present an application or petition before the Tribunal. Hence, ‘Authorised Representative’ can file an application under Section 7, 9 or 10 of the Code on behalf of the Financial Creditor, Operational Creditor or Corporate Debtor respectively.
2. Whether power of attorney holder can file application under IBC
NCLAT in the matter of Palogix Infrastructure Private Limited Vs. ICICI Bank Limited held that a ‘Power of Attorney Holder’ is not competent to file an application on behalf of a ‘Financial Creditor’ or ‘Operational Creditor’ or ‘Corporate Applicant’. Further held that the Code is a complete Code by itself. The provision of the Power of Attorney Act, 1882 cannot override the specific provision of a statute which requires that a particular act should be done by a person in the manner as prescribed thereunder. Also, held that the Code of Civil Procedure is not applicable for filing application under Code. Decision of the NCLAT reproduced here:
“32. The ‘I&B Code’ is a complete Code by itself. The provision of the Power of Attorney Act, 1882 cannot override the specific provision of a statute which requires that a particular act should be done by a person in the manner as prescribed thereunder.
33. Therefore, we hold that a ‘Power of Attorney Holder’ is not competent to file an application on behalf of a ‘Financial Creditor’ or ‘Operational Creditor’ or ‘Corporate Applicant’.”
Similar plea was taken by the NCLAT in the matter of Shriram EPC Limited Vs. Rio Glass Solar SA –Company Appeal (AT) (Insolvency) No. 133 of 2017 dated 02.11.2017 as “In the present case, as the application under Section 9 has been signed and filed by ‘Power of Attorney holders’ for the said reason also, we hold that the application under Section 9 preferred by the Respondent- ‘Operational Creditor’ was not maintainable.”
VII. Classification into Financial Creditors & Operational Creditors
Apex Court in the matter of Swiss Ribbons Pvt. Ltd. & Anr. Vs. Union of India & Ors. clarified that classification between FCs and OCs is neither discriminatory, nor arbitrary, nor violative of Article 14. The question before the court is that there is no real difference between financial creditors and operational creditors. According to him, both types of creditors would give either money in terms of loans or money‘s worth in terms of goods and services. Thus, there is no intelligible differentia between the two types of creditors, regard being had to the object sought to be achieved by the Code, namely, insolvency resolution, and if that is not possible, then ultimately, liquidation. Shri Rohatgi(petitioner’s side) argued that such classification will not only be discriminatory, but also manifestly arbitrary, as under Sections 8 and 9 of the Code, an operational debtor is not only given notice of default, but is entitled to dispute the genuineness of the claim.
The Court held that the tests for violation of Article 14 of the Constitution of India, when legislation is challenged as being violative of the principle of equality, have been settled by this Court time and again. Since equality is only among equals, no discrimination results if the Court can be shown that there is an intelligible differentia which separates two kinds of creditors so long as there is some rational relation between the creditors so differentiated, with the object sought to be achieved by the legislation. This aspect of Article 14 has been laid down in judgments too numerous to cite, from the very inception.
it is clear that most financial creditors, particularly banks and financial institutions, are secured creditors whereas most operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like. The distinction between secured and unsecured creditors is a distinction which has obtained since the earliest of the Companies Acts both in the United Kingdom and in this country. Apart from the above, the nature of loan agreements with financial creditors is different from contracts with operational creditors for supplying goods and services. Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business. Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less. In the running of a business, operational creditors can be many as opposed to financial creditors, who lend finance for the set up or working of business. Also, financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations. Also, the forum in which dispute resolution takes place is completely different. Contracts with operational creditors can and do have arbitration clauses where dispute resolution is done privately. Operational debts also tend to be recurring in nature and the possibility of genuine disputes in case of operational debts is much higher when compared to financial debts. A simple example will suffice. Goods that are supplied may be substandard. Services that are provided may be substandard. Goods may not have been supplied at all. All these qua operational debts are matters to be proved in arbitration or in the courts of law. On the other hand, financial debts made to banks and financial institutions are well-documented and defaults made are easily verifiable.
Most importantly, financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor‘s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.
In one line, we can say that a ‘corporate debtor’ must be a ‘corporate person’, [Section 3(7)] who owes a ‘debt’ [Section 3(11)], to any person [Section 3(23)]. The ‘debt’ as used in Section 3(8) has to be a ‘debt’ defined under Section 3(11). It must be the ‘liability’ or ‘obligation’ in respect of a ‘claim’ [Section 3(6)] which is due from any person [Section 3(23)] – which means even a corporate entity and shall include ‘financial debt’ and ‘operational debt’ as defined under section 5(8) and 5(21).
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