The Alienation of Operational Creditors from Committee of Creditors- A lacunae in IBC – Adv. Ankit Chandra

The Alienation of Operational Creditors from Committee of Creditors- A lacunae in IBC

Authored by: Ankit Chandra, Advocate

Since the inception of the Insolvency and bankruptcy code (IBC) in 2016, India has seen a steady rise in insolvency cases lining up before the NCLT. On one hand, where IBC, being a very rigid code has helped numerous creditors in realization of their finances and has also rescued many corporate debtors from distress by providing an effective and timely resolution, but on the other hand, it lacks with certain material difficulties.

The moment a creditor approaches the adjudicating authority, the corporate debtor is relieved from the board of directors and the Insolvency Professional (IP) takes up the burden of the corporate debtor. The IP invites resolution applicants for an effective resolution of the corporate debtor in distress. Now it is on the Committee of Creditors (CoC) to choose the most effective resolution plan, which in numerous cases is not as effective as expected. It is pertinent to note that for passing a resolution plan, the CoC, needs at least sixty-six percent majority and then only a resolution plan can be approved. An ideal resolution plan shall provide for the measure for insolvency resolution of the corporate debtor for maximization of value of its assets, but the approval of the resolution plan is entrusted with the CoC who with their financial wisdom lookout for a plan which would maximise their recoveries.

 Generally, the monetary value of resolution plan is much lower than the amount due to the creditors, and to properly distribute the money the creditors tend to take a haircut. The CoC which consists of only financial creditors (FCs) have often overlooked the interests of operational creditors (OCs). FCs which generally are banking institutions, often in an effort to clear bad loans and to reduce NPA’s tend to accept the best resolution plan available. Since the Insolvency and Bankruptcy Board of India (IBBI) has barred from disclosing the liquidation value, and has also allowed that the resolution plan can provide for an amount which is lower than the liquidation value, the CoC have, at numerous instances, approved a resolution plan which is way below the liquidation value. Thus, the OCs who are not part of the CoC, but have equally contributed to the corporate debtor by providing operational needs, tend to take the highest of haircuts in the short history of the new insolvency regime

The Hon’ble Supreme court of India vide its judgment in Essar Steel (India) Ltd. Committee of Creditors v. Satish Kumar Gupta[1], said that the OCs need not be treated at par with FCs, muddling the situation of OCs as they don’t have a strict financial relationship with the corporate debtor. Earlier in Rajputana Properties Pvt. Ltd. v Ultratech Cement Ltd. & Ors[2],  the supreme court held that the dues owed to the OC should be treated in par with FCs, however the Essar steel judgment has completely changed the scenario. The distribution of payment among the class of creditors is done by the waterfall mechanism enshrined in Sec 53 of the IBC, 2016. The waterfall mechanism gives much more preference to FCs rather than the OCs. This gives an unfair advantage to the FCs leaving the OC completely helpless.

The Bankruptcy Legislative Reforms Commission (BLRC), was of the view that the FCs have better financial wisdom and making them the only part of the CoC will apace the resolution process. The BLRC in BLRC report vol.1[3], have stated that ‘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’. BLRC in their report has vaguely opined about the OCs decision making in matters of insolvency, and has also undermined the willingness of OCs in risk taking factors.

In most of the developed nation where insolvency laws are exemplary, OCs are not discriminated and are treated at par with FCs. The UK Insolvency Act, 1986; doesn’t differentiate between OCs and FCs, however, they do differentiate between secured and unsecured creditors; even though every creditor has the right to vote in a proportionate matter in the creditor’s meeting.

The US insolvency code too doesn’t differentiate between the OCs and FCs; however, secured creditors have special rights and an absolute priority rule is followed to secure the rights of secured creditors. The absolute rule specifies that higher priority creditors must be paid in full before creditors of lower priority receive any distribution from a bankruptcy estate. As a result of which secured creditor’s claims must be paid in full from collateral before the unsecured creditors receive any recoveries. Even though all sorts of creditors have voting rights towards approval of reorganisation plan.

The Singapore’s new ‘Insolvency, Restructuring and Dissolution Act 2018 (IRDA)’, does not differentiate between the class of creditors giving all the creditors voting rights in the meeting of creditors. All though, the secured creditor are given special rights and they can realise all their claim, though they cannot realise their interest applicable in relevant cases.

As per the data published by IBBI quarterly newsletter Oct-Dec. 2021[4], an all total of Rs. 32,861.90 crore was admitted as claims and up till December, 2021 only Rs. 4406.76 crore was recovered, i.e., just a mere sum of 13.41% of all admitted claims. It is ironical that the FCs total admitted claims and realised claims were mentioned in the quarterly report, but the same of the OCs couldn’t find a place in the said report. Analysing the data issued by the IBBI, it can be inferred that the operational creditors have been vehemently side-lined by lawmakers and realization of their claims has not been proportionate.

The preferential treatment of FCs is necessary to an extent so that the economy runs smoothly, but the invidious approach towards OCs is a matter of concern and is defeating the very objective of IBC. The very objective of IBC, 2016; is maximizing the value of assets, to promote entrepreneurship, availability of credit and balance the interests of stakeholders, but the differential treatment of OCs is not in line with it. The preference given to secured financial creditors in terms of composition of CoC defeats the motive of the law of being fair and equitable, and is inconsistent with the principles of natural justice. The OCs should be given a proportionate representation in the CoC to provide them with an equal and fair opportunity to decide their claim. The MSMEs forming the majority part of OCs are the worst hit by unfair representation of OCs. It is hence important, that the OCs are given representation in the CoC to strengthen the MSME sector of India, which further compromise of the largest sector in the Indian Economy.

Reference:

[1] [2019] ibclaw.in 07 SC

[2] (2018) ibclaw.in 100 SC

[3] https://ibclaw.in/report-of-the-bankruptcy-law-reforms-committee/

[4] https://www.ibbi.gov.in/uploads/publication/f93d15cd01db076d3ff7931450acb4bd.pdf

 

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