Despite the corporate laws in India showing a trend towards being more market-centric, the roots lie in the principle of Constitutionalism itself, which in turn, endeavours to protect rights of the individuals and alleviate any kind of discrimination. Under the Insolvency and Bankruptcy Code, 2016, during the corporate insolvency resolution proceedings the Financial Creditors are generally given more emphasis and importance over the all classes of creditors including Operational Creditors in terms of distribution of amounts due to the Corporate Debtor and by way of providing the former the right to vote in the meeting of the Committee of the Creditors under Section 21, the right to appointment Insolvency Resolution Professional and absolute discretion to assist the Insolvency Resolution Proceedings under the Insolvency and Bankruptcy Code, 2016 against the Corporate Debtor.

As a result, the resolution plan as proposed in the meeting of the Committee of Creditors through the voting of the Financial Creditors fails to protect the interest of the Operational Creditors as witnessed in many IBC cases. Therefore, a detailed and analytical study is much-required in order to recognize the locus standi of the Operational Creditors and the limitations to such locus standi.

Besides, the National Company Law Appellate Tribunal in the landmark Binani Industries Case criticized the priority in terms of treatment as prescribed under Section 53 of the Code, towards the Financial Creditors over other classes of creditors with respect to the repayment plan of dues.

The NCLAT expressly held that the Code or the Regulations made thereunder does not promote any disparity or difference between Financial and Operational Creditors on the grounds of right to vote or repayment of dues and other grounds. The conflict merely ceases to rise when, despite the decision of Binani Industries, Section 53 of the Code still persists without being held partly or wholly unconstitutional.

Although the 2018 amendment of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 act in consistent with the NCLT's decision to promote 'similar treatment' in CIRP, it does not per se override the enforceability of Section 53 ('Waterfall Mechanism') and therefore portrays an incessant dispute over the discrimination existing in the locus standi of the Operational Creditors under the IBC – for which the present research appraisal has been undertaken.

Why there is a need for revisit?
The present revisit relates to the famous waterfall mechanism laid down in Section 53 of the Insolvency and Bankruptcy Code, 2016. The Insolvency and Bankruptcy Code, 2016 is enforced in order to improve the revival of reorganization framework in India by means of valuing the creditors with more benefits and power and adhering to various statutory compliances.

However, some provisions directly connected with the resolution process indicate a primacy in treatment to the Financial Creditors over other creditors such as Operational Creditors etc. From the right to participate and vote in the meeting of the Committee of Creditors (CoC) to under Section 21 of the Code, to the distribution of due debts of the corporate debtor to the creditors under Section 53 of the Code, the discrimination continues to treat the financial creditors, whether secured or unsecured, over the Operational Creditors.

Hence, in the many cases under the IBC, the resolution plan voted by the Financial Creditors would reflect the sheer ignorance to protect the interest of the Operational Creditors and accordingly, the fate of such Operational Creditors was sealed with the final approval of the pending resolution plan by the NCLT. Besides, under the circumstances where the liquidation value is less than the debt due to the Financial Creditors, the Financial Creditors are benefitted with repayment of the entire liquidation plan and the Operational Creditors do not have any choice to reject such treatment and demand for advance repayment under the waterfall mechanism and erstwhile scenario.

Subsequently, the National Company Law Appellate Tribunal in 'Binani Industries v. Bank of Baroda & Anr.[1] 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 maintained instead of maximization of interest of the Financial Creditors. The Supreme Court also upheld the NCLAT reasoning in this case.

The decision in Binani Industries although shows an welcoming move towards achieving the equality of law, but the flaws still persist as the constitutional validity of Section 53 has been upheld by the Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India[2] case shortly after the Binani verdict and the claim of discrimination between the Financial and Operational Creditors under Section 53 was duly rejected on the ground of the doctrine of intelligible differentia under Article 14 of the Indian Constitution.

The scenario continues to become more haphazard when the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 has again amended and the amended Regulation 38 ensures the dues to the Operational Creditors be prioritized in payment over the financial creditors:
which is nothing the direct violation of Section 53 of the Code. The irony carries forward as the Apex Court in the Swiss Ribbons case, besides upholding the constitutional validity of Section 53, supports the amended Regulation 38 which in turn violates Section 53 itself.

Therefore, at this juncture of several dilemmas and loopholes, a detailed and analytical study is conducted in this article in order to find out a balanced approach to the incessant battle of priority between the Financial and Operational Creditors under the IBC.

Whether the interest of the Operational Creditors under the IBC was well-protected enough from being exploited by the priority treatment provided to the Financial Creditors in the pre-Binani verdict phase?

Before the Binani Industries' case was pronounced, the Insolvency and Bankruptcy Code, 2016 laid down the waterfall mechanism under Section 53 to distribute the dues of the corporate debtor to all classes of creditors based on the list of priorities u/S. 53. Secured and unsecured Financial Creditors are always given due primacy under the provisions of this section with respect to satisfaction of amounts due to them.

Financial Creditor as defined in Section 5(7) of the Code, 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.[3] Apart from the financial creditors, amongst the rest of the classes of creditors, the Operational Creditors are one such creditor with whom the battle of priority has been carrying out. The Operational Creditor as defined in Section 5(20) of the Code, means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.[4]

Moving towards Section 21 of the Code, the powers vested to the financial creditors are wide enough to dominate the operational creditors. This is because, Section 21 provides for the Committee of Creditors which will be constituted by the Insolvency Resolution Professional after collating all the claims against the corporate debtor and in order to vote for a scheme of insolvency resolution and repayment plan against the corporate debtor.

It is pertinent to note that Section 21(2) expressly excludes the operational creditors and comprises all the financial creditors of the concerned corporate debtor as members of the CoC, except those categories of financial creditors or the representatives of the financial creditors who are related parties to the corporate debtor.

Such Committee of Creditors comprising of the financial creditors is vested with the following powers:

• According to Section 21(9), the CoC shall have the right to furnish any financial information through the RP (Resolution Professional) and such information must be directly related to the corporate debtor during the course of CIRP.
   
• Further, under Section 22(2), the CoC shall have the right to appoint the resolution professional afresh or by replacing the existing interim resolution professional at their first meeting by a majority vote of not less than 66% of the total voting share of the financial creditors who all are part of the CoC.
   
• The financial creditors as members of the CoC shall have the right to vote in the meetings of the CoC as per their assigned voting share and the amount of financial debt payable by the corporate debtor.
   
• The CoC comprising of the Financial Creditors shall vote and approve the Resolution and repayments Plan subject the final grant of approval by the concerned NCLT.
   
• For the purpose of following actions laid down in Section 28(1), the prior approval of the CoC by way of vote of not less than 66% of the total voting shares is mandatory to be obtained by the resolution professional during the course of CIRP [5]:
  
  1. To raise excess interim finance apart from the decided amount in the meeting of the CoC
  2. To create interests as a form of security over the Corporate Debtor's assets
  3. To restructure the capital of the corporate debtor through buyback, the issue of new class of securities or additional securities, or redeeming the securities already issued, where the corporate debtor is a company
  4. To preserve the records of the changes introduced by the corporate debtor in terms of ownership
  5. To undertake related party transactions, and give instructions to the financial institutions of the corporate debtor in relation to a debit transition in excess of the decided amount
  6. To make changes in the Board of management and administration of the corporate debtors including its subsidiaries and amendments to the corporate debtor or its subsidiaries' constitutional nature of instruments
  7. To transfer the financial or operational debts or the rights under the material contracts to any other person otherwise than in ordinary course of business
  8. To change the appointment or its terms and conditions of the statutory or interim auditors of the corporate debtor or any other specified personnel
  9. Therefore, it is very much well-interpreted that neither an operational creditor is permitted to be a member of the CoC nor it is vested with any such powers as mentioned above.
  Also, with regard to the right of an Operational Creditor to attend such CoC meeting, Section 24(3)(c) stipulates a limitation that the operational creditors whose aggregate dues are at least 10% of the total debt payable by the corporate debtor, such operational creditors may have right to attend the CoC meeting but not the right to participate and vote as per Section 24(4) and absence of such operational creditors shall not have any impact on the proceedings of the such CoC meeting.

Further, under Section 53 of the Code, for the purpose of distribution of liquidation assets so due from the corporate debtor, a detailed order or priority has been enlisted to distribute such liquidation assets in accordance with such order. Amongst the Secured and Unsecured Financial as well as Operational Creditors, the priority order shows the secured financial creditor followed by the unsecured creditors are given due importance and prevalence as per Section 53(2)(b)(ii) and Section 53(2)(d), whereas due owed to the operational creditors are impliedly interpreted under the expression 'any remaining debts and dues' and given comparatively less importance as per Section 53(2)(f).

The reasoning behind this wide gap of powers and priority treatment under the Code between the Financial Creditors and Operational Creditors is clarified by the Banking Law Reforms Committee in their report under Para 5.3.1, sub-para. 4:
The Committee reasoned that members of 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 creditors[6]

Although the Banking Law Reforms Committee explains the reason behind such discrimination of powers and priority between Financial and Operational Creditors under the Code, it remains silent when we witness the circumstances where such wide powers conferred to the financial creditors are duly misused and fails to protect the interest of the operational creditors by introducing an arbitrary resolution and repayment plan. Also, the Code remains silent when a situation that the amount due is higher than the liquidation value, occurs and such liquidation value gets absolutely exhausted while paying the financial creditors and other classes ranking prior in the order than the Operational Creditor who gets paid nothing at the end.

How does the recent Binani Landmark verdict create a serious impact on this battle of priority between Financial and Operational Creditors?

In the rise of battle between the Financial Creditors and the Operational Creditors on the ground of sheer discrimination in terms of treatment, powers and priority; the decision pronounced in Binani Industries case gives a balanced, fair and welcoming move to remove the aforesaid dilemma.

In this case, the resolution plan against the Binani Cements as submitted by the financial creditor, Dalmia Cements were found to be discriminatory as it suppressed the operational creditor, Ultra Tech Cements without taking their interest into consideration.

Therefore the decision pronounced by the NCLAT and upheld by the Supreme Court declared that the Financial and Operational Debts must be placed on an equal footing in a resolution process and any resolution plan if found to be discriminatory and fails to protect the interest of the Operational Creditors, shall be rejected by the adjudicating authority in contrary to the Code:
48. If the Operational Creditorsare ignored and provided with liquidation value on the basis of misplaced notion and misreading of Section 30(2)(b) of the I&B Code, then in such case no creditor will supply the goods or render services on credit to any Corporate Debtor.

All those who will supply goods and provide services, will ask for advance payment for such supply of goods or to render services which will be against the basic principle of the 'I&B Code' and will also affect the Indian economy.

Therefore, it is necessary to balance the Financial Creditors and the 'Operational Creditors' while emphasizing on maximization of the assets of the 'Corporate Debtor'. Any Resolution Plan if shown to be discriminatory against one or other 'Financial Creditor' or the 'Operational Creditor', such plan can be held to be against the provisions of the 'I&B Code'.[7]

Further, as per Para 17.3.c of the Binani Industries verdict, the NCLAT held that the Operational Creditors although are not members of the Committee of Creditors (CoC), but while making and approving a resolution plan, their interest and liability shall also be satisfied.

With regard to Section 53 of the Code, the NCLAT as per Para 17.3.c(iii) read with Para 29 held that while approving a resolution plan, the order of distribution of assets under Section 53 cannot be given any reliance and the priority should be given to the Operational Creditors over the Financial Creditor to be paid on immediate basis as it is not possible for the former to undertake the risk to delay the payment for better opportunities in future, whereas the latter can easily take risks by way of modification of the term loan facility.

Although the decision in Binani Industries Case as pronounced by the NCLAT, Delhi and upheld by the Supreme Court is well-clarified and endeavoured to settle the unintelligible differentia between these two classes of creditors, a question still remains unanswered – If the Operational Creditors are prioritized over the Financial Creditors to be paid on immediate basis and if Section 53 of the Code (waterfall mechanism) cannot be relied upon to approve a resolution plan, then whether the Section 53 of the Code is not constitutionally valid and violative of Article 14 of the Constitution?

Whether the 2018 amendment of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 is in consistent with the principles laid down in Binani Rulings and proposes a sound approach to cease the said conflict between the Financial and Operational Creditors?

The IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 has recently on 05.10.2018 has been amended where Regulation 38 providing the mandatory contents of the resolution plan has also been amended. The erstwhile Regulation 38 stated that:

1. A resolution plan shall identify specific sources of funds that will be used to pay the:
   
   1. insolvency resolution process costs and provide that the [insolvency resolution process costs, to the extent unpaid, will be paid] in priority to any other creditor;
   2. liquidation value due to operational creditors and provide for such payment in priority to any financial creditor which shall in any event be made before the expiry of thirty days after the approval of a resolution plan by the Adjudicating Authority; and
   3. liquidation value due to dissenting financial creditors and provide that such payment is made before any recoveries are made by the financial creditors who voted in favour of the resolution plan.[8]

But after the amendment, Regulation 38(1)(b) and 38(1)(c) have been deleted whereas Regulation 38(1) has been substituted. Therefore, as per the current scenario, the amended Regulation 38(1) states that the amount so due to an operational creditor under an insolvency resolution scheme shall be prioritized over the financial creditors in terms of payment.[9] Further, a new sub-regulation (1-A) under Regulation 38 has been inserted where a resolution plan is stated to mandatorily include a statement indicating the treatment and dealings with the interest of all the stakeholders not excluding financial and operational creditors of the corporate debtor.[10]

Henceforth, while comparing between Binani Rulings and Amendment to Regulation 38, it is clear that the Amended Regulation 38 is somewhat consistent with the observations laid down in Binani Rulings to the extent that the Regulation 38 (as amended) protects the interest of the operational creditors by way of including the detailed statement of treatment and dealings under the resolution plan based on which the adjudicating authority shall approve or reject the plan. Also, while disbursing the payment of the due amount, the operational creditor is given priority over the final creditor and thus is consistent with Para 17.3.c of the Binani judgment.

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 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.

Therefore, it is evident that the new regulations as amended in 2018 ensures that the treatment towards operational creditors, financial creditors and other stakeholders must be mentioned in a resolution, considering which the adjudicating authority shall approve or reject the plan. 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.

With regard to the question of constitutional validity of Section 53 of the Code, the Supreme Court in Swiss Ribbons case upheld such constitutional validity and also, accepted the Binani Rulings ratio in consistent with the amendments introduced to Regulation 38:
46.The NCLAT has, while looking into viability and feasibility of resolution plans that are approved by the committee of creditors, always gone into whether operational creditors are given roughly the same treatment as financial creditors, and if they are not, such plans are either rejected or modified so that the operational creditors' rights are safeguarded. It may be seen that a resolution plan cannot pass muster under Section 30(2)(b) read with Section 31 unless a minimum payment is made to operational creditors, being not less than liquidation value. Further, on 05.10.2018, Regulation 38 has been amended....

47. The aforesaid Regulation further strengthens the rights of operational creditors by statutorily incorporating the principle of fair and equitable dealing of operational creditors' rights, together with priority in payment over financial creditors.

48. For all the aforesaid reasons, we do not find that operational creditors are discriminated against or that Article 14 has been infracted either on the ground of equals being treated unequally or on the ground of manifest arbitrariness.[11]

Considering all the aforecited legal provisions and judgments, it is therefore safe to state that the applicability of the order of priority for distribution of assets under Section 53 of the Code is followed in the event of a liquidation process and cannot therefore be relied upon during approval of a resolution plan.

However, the amount to be paid to the Operational Creditor during resolution process shall not be less than the liquidation value allotted to the operational creditors under Section 53 during liquidation and thus, Section 53 does not overlap Section 30 of the Code as well as Regulation 38 of the said amended regulations and the Binani Rulings.

For the purpose of preventing the oppression of the operational creditor due to the misuse of power by the financial creditors cum members of the CoC, the said amended regulations are contained with the principles laid down in Binani Rulings and hence found to propound a sound approach to the battle and a non-discriminatory solution.

Conclusion
Although in terms of immediate payment of resolution amount and discriminatory nature of the resolution, the current legal scenario has been able to settle the disputes, the battle is not over yet. Delving deeper into the scenario, we still find no clarity or regulation available to guide the IBC framework to answer the questions relating to the mechanism of distribution of the resolution amount[12] (unlike distribution of liquidation value, since Section 53 cannot be relied upon in case of resolution process) whether equally or through pro-rata between the Financial and Operational Creditors or whether the Operational Creditors may also be conferred with the power to take part with the CoC (Financial Creditors) in granting certain Section 28 approvals which would otherwise have a direct impact on the interest of the Operational Creditors had they been oppressed by the arbitrary action undertaken and approved by the Committee of Creditors. Until and unless these contradictions view are encountered with a proper and clarified law, the end of the battle of priority between the Financial and Operational Creditors is a far-fetched dream.

End-Notes:

1. Binani Industries Ltd. v. Bank of Baroda & Anr., Company Appeal (AT) (Insolvency) No. 82 of 2018, dated 14th November, 2018
2. Swiss Ribbons Pvt. Ltd. v. Union of India, Writ Petition (Civil) No. 99 of 2018, vide Judgment dated 25.01.2019
3. Section 5(7), The Insolvency and Bankruptcy Code, 2016
4. Section 5(20), The Insolvency and Bankruptcy Code, 2016
5. Section 28(1), The Insolvency and Bankruptcy Code, 2016
6. Supra Note.1, Para. 3.a.i.
7. Supra Note. 1
8. Before substitution, Regulation 38 of The Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016
9. Substituted by Notification No. IBBI/2018-19/GN/REG032, dated 5th October, 2018 (w.e.f. 05.10.2018)
10. Inserted by Notification No. IBBI/2017-18/ GN/ REG018, dated 5th October, 2017 (w.e.f. 5-10-2017)
11. Supra Note. 2
12. Prithu Garg, SC upholds IBC but the battle between Financial and Operational Creditors rages on, February 15, 2019, available at: https://blog.ipleaders.in/sc-upholds-ibc-battle-financial-operational-creditors-rages/#_ftnref2 (Last Accessed on 18.02.2018)