Classification Of Creditors Under IBC
Creditor has been defined in Section 2 (10) as any person to whom a debt is owed and includes a Financial Creditor, an Operational Creditor, a Secured Creditor, an Unsecured Creditor and a Decree Holder.
Under the Code every category of creditors does not have equal rights particularly in case of Corporate Insolvency Resolution Process.
Every creditor cannot initiate Corporate Insolvency Resolution Process against the Corporate Debtor. Only an Operational Creditor or a Financial Creditor can initiate insolvency proceedings. Only Financial Creditors can become part of Committee of Creditors in most of the cases. In a Resolution Plan, there is no compulsion to give equal treatment to all the creditors. In case of liquidation of Corporate Debtor, the assets of the Corporate Debtor are distributed in order of priority as given under Section 53 of the Code, wherein Operational Creditors (other than workmen and employees of Corporate Debtor) come much below and in majority of cases disbursement to such creditors are negligible or NIL.
In case of insolvency proceedings of Individuals, Partnership Firms or Personal Guarantors to a Corporate Debtor, different category of creditors has been given more equal treatment. Such insolvency proceedings can be initiated by any creditor. Further in meeting of creditors, each creditor is eligible to participate.
FINANCIAL CREDITOR
Financial Creditor has been defined under Section 5 (7) as any person to whom a Financial Debt is owed and includes a person to whom such debt has been legally assigned or transferred to.
Time value of money is an important concept in commercial world. Time value has been defined in Black Law Dictionary as ‘the price associated with the length of time that an investor must wait until an investment matures or the related income is earned’. The value of money will not increase if the same is kept idle and hence banks and other financial institutions lend money or invest so that there can be increase in value of money over time.
Specific stances of Financial Debt are given in clauses (a) to (i) of the definition.
Nikhil Mehta1 was one the earliest cases, where NCLT has an opportunity to analyse definition of “Financial Debt”. The NCLT had observed that key feature of Financial Debt is consideration of time value of money. In other words, such transactions are covered under Financial Debt, which are usually a sum of money received today to be paid over a period of time in sing or series of payment in future.
Time Value of Money can be Something Equivalent to Money
In Pioneer Urban Land2, the Supreme Court has expanded the scope of time value of money and included things which are equivalent to money under time value of money. A flat, which has been booked against which installments have been paid, was included under time value of money.
Disbursement Essential to Financial Debt
In Anuj Jain3, the Supreme Court held that disbursement against consideration of time value of money is essential for a debt to be covered under Financial Debt.
Interest not compulsory component of Financial Debt
In Orator Marketing Pvt Ltd4 the Supreme Court has held that interest is not an essential component of Financial Debt. If there is no interest, only the principal will qualify as Financial Debt.
Transfer of all Risks and Rewards Essential in Lease Agreements
The Supreme Court in New Okhla Industrial Development Authority5 has an occasion to consider whether the NOIDA will be a Financial Creditor on basis of lease deed it has entered into for development of residential colonies. The Supreme Court analysed Section 5 (8) (d) regarding the amount of any liability in respect of any lease or hire purchase agreement which is deemed as finance or capital lease under the Indian Accounting Standards. The Supreme Court held that for a lease agreement to be covered under Financial Debt under Section 5 (8) (d), transfer of all risks and rewards are essential.
OPERATIONAL CREDITOR
Operational Creditor has been defined under Section 5 (20) of the Code as a person to whom an Operational Debt is owed and includes any person to whom such debt has been legally assigned or transferred.
First category of claims is in respect of provisions of goods and services including employment. Second category of claims are in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, State Government or Local Authority.
Earlier, in certain judgments the definition of Operational Debt was being interpreted to include only supply of goods and services. In Consolidated Constructions6 the Supreme Court has held that “in respect of” has to be interpreted in broad and purposive manner. All those who provide goods or services or receive goods and services from the Corporate Debtor have to be included in the category of the Operational Creditors.
CONSTITUTIONAL CHALLALENGE TO CLASSIFICATION OF OPERATIONAL CREDITOR AND FINANCIAL CREDITOR
The Indian insolvency law is unique to the extent that creditors have been classified into Financial Creditors and Operational Creditors. In the insolvency laws of the United Kingdom, or in the insolvency laws of the United States or UNICITRAL Model Law there has not been any classification of creditors in Financial Creditor and Operational Creditor. Financial Creditors enjoy many privileges which are not available to Operational Creditors. Financial Creditors can only become members of Committee of Creditors and vote on decisions taken regarding Corporate Insolvency Resolution Process in most of the cases. Operational Creditors have no effective role in conduct of Corporate Insolvency Resolution Process.
The constitutionality of classification of creditors in Financial Creditor and Operational Creditor was challenged before the Supreme Court in Swiss Ribbons7. It was contended in the said case that classification of creditors in Operational Creditors and Financial Creditors is arbitrary and violative of Article 14 of the constitution. Supreme court negated the same and held that there is intelligible differentia to classify creditors in Financial Creditors and Operational Creditors and hence the classification is not arbitrary.
SECURED CREDITOR
Secured Creditor has been defined under Section 3 (30) as a creditor in favour of whom security interest is created.
The Secured Creditor cannot enforce his security interest during Corporate Insolvency Resolution Process as long as Moratorium is in force. Secured Creditor is also bound by Resolution Plan if approved by the Committee of Creditors. The Supreme Court in India Resurgence Arc Pvt. Ltd.8 has held that Secured Creditor is bound by decision taken by Committee of Creditors.
In Liquidation Process, the Secured Creditor under Section 52 of the Code, has option to either relinquish the secured interest to Liquidation Estate or realise security interest separately. Under Section 53 of the Code, in distribution of assets of the Corporate Debtor to the creditors, the Secured Creditor has been given highest priority after payment of CIRP costs.
During insolvency proceedings as well bankruptcy proceedings of Individuals and Partnerships Firms, a Secured Creditor has option to realise his security interest separately or to give up his security interest.
Whether Secured Creditor will be Financial Creditor
Generally, a Secured Creditor is also a Financial Creditor, but a Secured Creditor will not be included in category of a Financial Creditor if debt due to such Secured Creditor does not fulfil the constituents of definition of Financial Debt under Section 5(8). The Supreme Court deliberated this aspect in the matter of Anuj Jain (Supra). In that case the Jaypraksah Infratech Ltd. has mortgaged various properties to banks but loan has been availed by holding company Jaypraksh Associates Ltd. Some of the creditors of the Jaypraskash Infratech Ltd. claimed that they are Financial Creditors on the basis of property mortgaged by Jayprakash Infratech Ltd. to them. The Supreme Court went on to hold that Secured Creditor is not a Financial Creditor in this case as no disbursement has been made by the Secured Creditor to the Corporate Debtor.
DECREE HOLDER
Decree Holder is also covered under definition of term “creditor” under Section 3(10) of the Code. Various benches of NCLT and NCLAT had held that the Decree Holder cannot initiate Corporate Insolvency Resolution Process as the Code is not forum for executing a decree. NCLAT in G Ishwara Rao9 held that Section 7 IBC can not used to execute a decree.
Thus, if a Decree Holder on the basis of hard-earned decree after extensive trial before a civil court went on to file application for initiation of Corporate Insolvency Resolution Process, not only there was risk of negation of initiation of CIRP but also there was risk of malicious prosecution under Section 65 hanging over the head of Decree Holder as a sword of Damocles.
Further, a Decree Holder was being forced to file claim in category of other creditors after initiation of Corporate Insolvency Resolution Process as a Decree Holder did not fall under Financial Creditor or Operational Creditor. Prospects of Decree Holder under new insolvency regime seemed bleak.
Decree Holders had a sigh of relief from the judgment of Supreme Court in Dena Bank10 wherein it was held that decree will give fresh cause of action to initiate Corporate Insolvency Resolution Process and limitation period will be calculated from such cause of action.
Finding of in Dena Bank was again affirmed by the Supreme Court in Kotak Mahindra11 case.
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1. Nikhil Mehta & Sons (HUF) & Ors Vs. M/s AMR Infrastructures Ltd.; CP No. (ISB)-03(PB)/2017
2. Pioneer Urban Land and Infrastructure Ltd. & Anr. Vs. Union of India & Ors; WP (C) 47/2019
3. Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd vs. Axis Bank Ltd. Etc Etc.; Civil Appeal No. 8512-8527/ 2019
4.Orator Marketing Pvt. Ltd. Vs. Samtex Desinz Pvt. Ltd.; Civil Appeal No 2231/2021
5.New Okhla Industrial Development Authority Vs. Anand Sonbhadra; Civil Appeal 2222/2021
6.Consolidated Construction Consortium Ltd vs Hitro Energy Solutions Pvt. Ltd.; Civil Appeal No. 2839/2020
7.Swiss Ribbons Pvt. Ltd. & Anr Vs. Union of India & Ors; Writ Petition (Civil) 99/2018
8.India Resurgence Arc Pvt. Ltd. Vs. Amit Metaliks Ltd. & Anr.; Civil Appeal No. 1700/2021
9. Sh. G. Ishwara Rao Vs. Stressed Assets Stabilization Fund and Anr; Company Appeal (AT) (Insolvency) No. 1097/2019
10.Dena Bank (Bank of Baroda) Vs C. Shivakumar Reddy and Anr; Civil Appeal No. 1650/2020
11.Kotak Mahindra Bank Ltd. vs. A. Balakrishnan & Anr; Civil Appeal No. 689/2021
Mukesh Kumar Suman is an advocate and legal author based at Delhi. He regularly appears before various Judicial Forums including NCLT, NCLAT, High Courts and the Supreme Court. He can be approached at mukesh_suman@outlook.com or +91 9717864570.