The Insolvency & Bankruptcy Code (BC the Code) was introduced as a tool for consolidation and amendment of the extant laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time effective manner while ensuring balance of interests amongst all stakeholders and maximization of value of assets involved. With the introduction of IBC, multiple laws dealing with corporate restructuring, debt recovery and bankruptcy came under one overarching umbrella seeking to simplify the process & achieving faster resolution of corporate insolvency.

IBC came into effect as a means for ensuring that if a troubled corporate can be kept afloat by providing for alternatives such as change of management/ protection from immediately insolvency/ tranche-wise repayment mechanism etc., it should be given a fighting change. The primary focus of IBC, as compared to the earlier debt recovery laws, is tilted towards corporate restructuring & allowing for a more wholesome rescue effort through involvement of all the stakeholders.

Financial Creditor vis-à-vis Operational Creditor under IBC

IBC segregates debt as defined under the Code into two broad classes – (a) financial debt; & (b) operational debt. In a nutshell – financial debt is the debt that has been incurred by way of loan raised by the Corporate Debtor, whereas operational debt is the debt that has been incurred on account of procurement of goods and services by the Corporate Debtor. As mentioned earlier, the primary focus of the Code is not in recovery (as was the case with DRT earlier) but on resolution process.

This brings into light a very important aspect of the Code that is the high important of Operational Creditors in the scheme of things as they are the ones who help upkeep the corporate debtors by providing all the day to day necessities. The position of Operational Creditors is more akin to the financial debtors who provide mezzanine or interim finances to the Corporate Debtor to ensure that the Corporate Debtor survives the resolution process.

Irrespective of the intent of IBC, the focus of the resolution process has always remained on the financial creditors. The resolution process is driven by the Committee of Creditors (CoC) constituted of the financial creditors of the corporate debtor. Operational Creditors are only allowed representation when their claims (collectively) exceed 10% of the total debts of the corporate debtor, which is seldom the case. Given that there is no provision for adequate representation for the Operational Creditors in the CoC, the level of protection available to the Operational Creditors automatically reduces.

One may argue that the stakes of financial creditors in case of corporate insolvency is invariably a lot higher than the operational creditors. This also translates into minimal liquidation value of such operational debts in the whole scheme of liquidation & therefore, the moneys recoverable by such operational creditors are reduced to close to nothing. This position has its roots in terms of Section 53 of the IBC placed Operational Creditors much below the Secured Creditors; and effectively relegated Operational Creditors to the slab just above share-holders of the Corporate Debtor.

In the Supreme Court order in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors. (2019), the Apex Court held that most financial creditors are secured creditors and most operational creditors are unsecured creditors thereby affirming the lower priority granted to operational creditors in practice. The intent of the court was to assert that the intent of IBC was not to treat all the creditors equally but to treat similarly placed creditors equally.

Even though the rationale behind treating Operational Creditors on a different pedestal is a sound one, the very fact that in the same case, the recovery of Operational Creditors was almost to the tune of 20% whereas the recovery of financial creditors was almost 80% goes on to show the differential outcome of such treatment. The Court seems to have blurred the line between equal treatment and equitable treatment for the Operational Creditors.

Suspension of IBC – the COVID story

Despite not being able to record a huge success rate, IBC has indeed helped a lot of corporate entities in reaching a resolution plan that ‘maximizes the value of assets’ rather than resorting to winding up which, more often than not, results in losses to not only the Corporate Debtor but also to the Creditors.

In furtherance of the measures taken by the finance ministry to provide relief to the Covid hit economy, IBC (Second Amendment Act), 2020 deemed to have come into force from June 5, 2020 (the Amendment Act).

The key provision of the Amendment Act provided that:

notwithstanding anything contained in section 7, 9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March, 2020 for a period of six months or such further period, not exceeding one year form such date, as may be notified in this behalf.

The Amendment Act also clarifies further that the aforementioned moratorium is not applicable to any default arising before 25th March 2020 & also that no action lies, in the future, for any default committed by the Corporate Debtor in the said period (from 25th March 2020 to such period for which the actions are suspended).

The aforementioned sections of the Code that have been suspended for the stipulated period deal with the rights of financial creditor, operational creditor as well as corporate applicant (including the corporate debtor itself) to initiate corporate insolvency resolution process. However, there is no restriction on the operational creditor being able to raise a demand for payment from the Corporate Debtor requiring the Corporate Debtor to either pay within 10 days of such demand or raise a valid dispute in relation to the same.

What does the suspension entail for Operational Creditors?

Providing the Operational Creditors with a right to demand their payments under the IBC even within the moratorium period does show some consideration towards the Operational Creditors vis-à-vis the Financial Creditors. This move will also ensure that the funds of the Corporate Debtors are not tied up in a resolution process & is available for making payments for the goods and services procured. It is also very important to note that preventing all the creditors as well as the corporate applicant from initiating an action with respect to corporate insolvency resolution process, furthers the need to allow companies a breathing space from lengthy proceedings in these Covid hit times.

This is also in line with the other remedies brought in by RBI in terms of moratoriums in payments of EMIs to the financial creditors and other myriad of relief measures brought in for medium and small enterprises and small scale industries.

However, this is not to say that this step from the finance ministry is a full-proof mechanism for ensuring that the Operational Creditors get their due in terms of the payment for the goods and services provided by them. There is always a risk of the Corporate Debtor raising a dispute with respect to the payments. Once a dispute is raised & there is no resolution to the satisfaction of both the parties, the Operational Creditor can’t initiate the IBC proceedings under Section 9 of the Code.

Conclusion
Looking at the history of resolution under IBC and the effective remedies for the Operational Creditors, it might not be wrong to state that the move by finance ministry through this Amendment Act does have its own advantage for Operational Creditors. It not only puts a restriction on creditors from initiating insolvency process but also prevents the operational creditors from falling behind all the other secured creditors in the hierarchy of repayments under the Code.

The need of the hour is for the Operational Creditors to be able to monetize their payments under the Code. This may also mean a lot of extra efforts taken for amicable negotiations and possibly some haircuts & discounts on already agreed prices but it could also mean making recoveries of the dues from companies that are at the verge of insolvency in light of the Covid situation & may end up in an insolvency proceeding in the future. However, all the Operational Creditors will have to do their own cost-benefit analysis, especially taking into account the repayment capability of the Corporate Debtor, & ascertain the best way forward.

End-Notes:

1. IBC or the Code means the Insolvency and Bankruptcy Code, 2016 means as amended from time to time.
2. The capitalized terms used in the article including Committee of Creditors, Corporate Debtor, Financial Creditor and Operational Creditor etc. are as defined under the Code.
3. IBC Second Amendment Act, 2020 means the Insolvency & Bankruptcy Code (Second Amendment ) Act, 2020 available at: http://www.mca.gov.in/Ministry/pdf/IBCAmedBill_24092020.pdf

Written By: Rashmi Priya