SHOULD AN OPERATIONAL CREDITOR INITIATE INSOLVENCY PETITION ?

An operational creditor must exercise extreme caution before initiating an insolvency petition against a company. Although such a creditor may trigger the insolvency process, there is a real possibility of receiving nothing in return. On the contrary, the operational creditor may even be required to bear a portion of the insolvency costs.

Under the Insolvency and Bankruptcy Code, 2016, operational creditors have been accorded a secondary and subordinate status. The insolvency resolution process is, in substance, a process driven by financial creditors and designed primarily for their benefit. This differential treatment between financial creditors and operational creditors has been upheld by the Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India, wherein the Court held that the classification is valid and constitutionally permissible.

Generally, operational creditors are not members of the Committee of Creditors, which is the principal decision-making body under the Code. As such operational creditors have no control over key decisions relating to the resolution of a financially stressed company. This lack of participation often results in poor treatment of operational creditors under resolution plans. In several cases, operational creditors have been allotted either a nil or a negligible amount under approved resolution plans.

An attempt has been made to provide some protection to operational creditors by amending Section 30 of the Code. The amendment mandates that operational creditors must receive at least the amount they would be entitled to in the event of liquidation. However, this safeguard does not adequately protect their interests. Most companies undergoing the Corporate Insolvency Resolution Process are already severely financially distressed, and the likelihood of recovering a meaningful amount in liquidation under Section 53 is itself minimal.

Even where the CIRP fails and the corporate debtor proceeds into liquidation, operational creditors rank lower in the statutory waterfall mechanism. As a result, the possibility of receiving a substantial recovery remains remote.

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