Dated 31st August, 2020
Introduction
Under the Insolvency and Bankruptcy Code, 2016 (IBC), Insolvency proceedings can be initiated by a Financial Creditor or an Operational Creditor upon a default made by the Corporate Debtor. A Financial Creditor is the one to whom a financial debt is owned while an Operational Creditor is the one to whom an operational debt is owed and is a supplier of goods and services to the Corporate Debtor.
Ever since the enactment of the statute in 2016, several provisions of the Code have come up as a matter of concern in a plethora of cases before various Adjudicating Authorities. Initially, it appeared that the Code has strengthened the positions of suppliers by awarding them the status of Operational Creditors. However, with the onset of various reforms and judicial pronouncement, the protections given to the Operational Creditors has come under microscopic scrutiny and has been the focal point of various petitions.
Operational Creditors Vis-à-vis the Real Estate Sector
In January 2020, National Company Law Tribunal, New Delhi initiated Insolvency Proceedings against a Gurgaon based Company- Bright BuildTech Pvt. Ltd. This case is the first of its kind wherein a Real Estate company has been dragged into Insolvency by its Operational Creditors who are the Real Estate Agents. So far, only Financial creditors such as Banks, Financial Institutions, and Homebuyers used to file cases against the Real Estate Developer under the Provisions of IBC.
While dealing with the question of whether the Brokerage services come under Operational debt under Section 5(21) of the Code, the New Delhi Bench stated – “the bills raised by the Operational Creditor are in respect of the services provided to the Corporate Debtor. Hence, brokerage services would fall within the definition of Operational Debt under the Code.”
Therefore, it becomes clear that even in the case of Insolvency Proceedings initiated by a Financial Creditor, Real Estate Brokers/Agents can file their claims in the capacity of Operational Creditors.
Analysis of the Status of Operational Creditors
Under the Insolvency and Bankruptcy Code, the Financial Creditors are prioritized and given more importance as compared to the Operational Creditors in terms of distribution of assets of the Corporate Debtor over all classes of Financial Creditors and also the right of the former to vote in the meetings of Committee of Creditors under Section 21, right to appoint Insolvency Resolution Professional and absolute discretion enjoyed by the Financial Creditors to take decisions during the CIRP. As a result, the Resolution Plan that is proposed in the meeting of CoC through the voting of the Financial Creditors often fails to take into consideration the interests of the Operational Creditors.
Though various committee reports, reforms, amendments and judicial pronouncements were made in order to bring the Operational Creditor at par with the Financial Creditors, the Supreme Court in Swiss Ribbons Case while upholding the constitutional validity of the Code stated that the Financial Creditors are in a better position to decide the fate of the Corporate Debtor. Operational creditors are rarely interested in the financial health of the Company, hence cannot be allowed to decide the future course of action.
The Hon’ble Court in Essar Steel case upheld a resolution plan wherein NIL amounts were prescribed for certain class of Creditors. Ensuring maximum possible value of the assets of the Corporate Debtor while balancing and safeguarding the interests of the Stakeholders are the fundamentals of the Code. However, with the zero amounts prescribed for certain class of Operational Creditors would in turn undermine the basic objective of the Code.
The Bankruptcy Law Reforms Committee Report,2018 admitted that very often, Operational creditors do not receive anything or a negligible amount under a Resolution Plan as they fall in the residual category under the Waterfall Mechanism under Section 53 of the Code. If it continues, the Operational Creditors will not have any incentive to continue the supply to the Corporate Debtors.
However, the NCLAT’s verdict in Binani Industries v. Bank of Baroda & Anr. is a welcoming step to establish the law of equality. The NCLAT in the case established the principle of similar treatment under the IBC and reinterpreted the legislative intent by declaring that the waterfall mechanism to distribute due debts under Section 53 must not discriminate the operational creditors from the financial creditors and while approving the resolution plan, the interest of the operational creditors, despite not being a member of CoC, must be taken into consideration instead of maximization of interest of the Financial Creditors. The Supreme Court also upheld the NCLAT reasoning in this case.
Further, the 2018 Amendment to the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provided that the resolution plan should mandatorily provide that the amount due to operational creditors under a resolution plan shall be given priority in payment over financial creditors.
A petition was also filed by Sanjay Singhal, promoter of Bhushan Power and Steel before the Hon’ble Supreme Court challenging various provisions of the IBC. The court acknowledged that the Operational Creditors should have a say in the resolution proceedings in proportion to their debt and even have voting rights.
Additionally, Section 30(2)(b) of the Code ensures that the resolution professional before submission of resolution plan to the adjudicating authority must examine that the resolution plan should provide for debt payment to the operational creditor in such a prescribed manner and not less than the liquidation value to be paid to the operational creditors under Section 53 of the Code in the event of a liquidation.
Besides, although the amount to be paid to the operational creditors as per Section 30(2) of the Code shall not be less than the liquidation value to be paid to the Operational Creditors u/S. 53, it also ensures that according to Regulation 38, the payment after it is decided shall be paid to the operational creditors immediate basis over the financial creditors.
The Insolvency Committee Report, 2020 seems to be providing a ray of hope by recommending that the operational creditors be conferred with voting rights subject to fulfillment of certain criteria. Therefore, in the near future, we also foresee operational creditors conducting due diligence on the assets of the company, the number of existing creditors, and the general creditworthiness of the company. After all, protection and prevention are the need of the hour.
Article by Ms. Purvi Devpura under internship of Adv Shankarlal Raheja
The Views herein are personal and while careful attention has been given to ensure that the information is accurate and assume no liability or responsibility for any reliance thereon. This article is merely information and knowledge sharing activity and is not a substitute to legal advice. We shall not be liable for any loss or damage caused due to any reliance thereof
