Operational Creditors v. Financial Creditors: Evolution of Differences

[Shubham Sancheti is a 4th year B.A., LL.B. (Hons.) student at NALSAR University of Law, Hyderabad]

The Insolvency and Bankruptcy Code, 2016 [“Code”] has had its maiden anniversary but problems regarding its interpretation have continued since its inception. The segregation of the “operational creditor” from the “financial creditor” is one of the areas which still needs jurisprudential and statutory clarity. The fact that the Gujarat High Court recently admitted a petition challenging the constitutional validity of Code, as well as the ordinance amending it, on the grounds of being violative of articles 14 and 19 of the Constitution reinforces the need for a proper interpretation of the Code.

The Code distinguishes between two classes of the creditors, fundamentally over the fact that a financial creditor provides the debt for a relatively longer period of time. Nevertheless, the definition of “debt” under the Code is not limited to just these two classes. The Code defines the two creditors as –

“Financial creditor” 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.[1]

“Operational creditor” means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.[2]

Although both the definitions comprise of different classes of creditors, it has been categorically held by the National Company Law Tribunal [“NCLT” or “Tribunal”] that the two classes are not mutually exclusive. Parliament was posed with a troublesome interpretation of the Code in the Homebuyers’ case which was followed by the 2017 Amendment which carved out a third category of the creditors. The new regulation 9A of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2017 [“CIRP Regulations”] provides a recourse to the new class of creditors. However, it is still to be seen whether homebuyers would actually be categorised in the said class of creditors.

Earlier this month, the difference between the said classes was solidified when the NCLT Kolkata passed an order in the matter of Suresh Narayan Singh v. Tayo Rolls Limited whereby the application by the “operational creditor” was dismissed by the Tribunal on interpreting the aforementioned definitions literally.

Facts and Holding

The facts of the said matter were that Tayo Rolls Limited filed for closure[3] and the workers of the said undertaking were awarded their unpaid dues along with the compensation from the Labour Court. Another set of workers had also claimed their dues as arrears. The workers had satisfied every criterion mentioned in the Code and authorised Suresh Narayan Singh to file an application under section 9 of the Code.

The Tribunal referred to the aforementioned definition of operational creditor and stated that for Suresh Narayan Singh’s application to be maintainable, the workers shall have assigned or transferred their dues to him and further stated that merely authorising one to pursue a case before the tribunal does not make one an operational creditor. The Tribunal jumped upon the opportunity to differentiate between the two classes of creditors on the ground that, as per the statute, the financial creditors can make a joint application whereas the operational creditor cannot.

Interestingly, the Tribunal referred to Form 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 [“Form 5”] which, if given effect to, would not have led to dismissal of the application. However, the Tribunal opined that there is a need for reconsideration for the note in the Form 5, which provides for a person authorised to act on behalf of the operational creditor, since it is not in accordance with section 8 of the Code.

Analysis

The Tribunal (Principal Bench) had briefly discussed the scope of “operational creditor” in Col. Vinod Awasthy v. AMR Infrastructures Ltd. wherein the Tribunal stated that, as per the Code, the operational creditor is one to whom the debtor owes a debt under four categories viz. goods, services, employment and government dues. The liability of the operational debt arises out of transactions on operations of the corporate debtor.

In the Suresh Narayan Singh case, the Tribunal did not consider workers as operational creditors since it is statutorily provided, but the Tribunal ascertained the position of the “authorised representative” of those workers. Although the operational creditor is the one to whom “operational debt” is owed, limiting the filing of the application only to the operational creditor or a legal assignee defeats the purpose of the Code. The Code has been recognised as a “creditor-friendly legislation”[4] and, insofar as maintaining the company as a going concern is concerned, the ultimate decision lies in the hands of creditors who may either accept a or reject the resolution plan. Nonetheless, this decision makes it difficult for the creditors (here “workers”) to file an application for their respective dues, and the NCLT will be flooded with litigation for the same cause of action for numerous creditors.

The NCLT Chennai in the matter of RNB Arc Design Systems v. Trivitron Healthcare Pvt. Ltd. granted relief to an operational creditor who filed an application in the NCLT through an “authorised representative” and there was no event corroborating the fact that the debt of operational creditor was “assigned” or “transferred” to the representative. This ruling was evident of the fact that the Tribunal shall be concerned with the object of the legislation rather than the applicant’s status.

A more recent and landmark ruling of the Supreme Court in the matter of Macquarie Bank Ltd. v. Shilpi Cable Technologies Ltd. further clarified the position of an “authorised representative”. The Court reinstated the position of a person “authorised to act” in the Form 5 being of a wide import which includes a position that is outside or indirectly related to the operational creditor. The Court, therefore, specifically included “authorised agent” of the operational creditor within the ambit of delivering a demand notice and filing an application under sections 8 and 9 of the Code respectively. The financial creditor, on the other hand, has always been presumed to act through an “authorized representative” since, in the majority of the cases, the financial creditor is an artificial person. If the Tribunal solely relied on this reasoning to dismiss the application in the instant matter then, with due respect, the Tribunal prima facie erred in its reasoning, as in numerable cases, the operational creditor may be a juristic person too.

The ruling of the Tribunal in the instant matter does not reconcile with the CIRP Regulations as regulation 9(2) entitles an “authorised representative” to submit a proof of claim to the interim resolution professional if there are numerous workmen or employees whose dues are yet to be paid. Parliament would not have intended to leave such a lacuna by allowing a representative to present the claims of the workers before the resolution professional whilst refusing the same to be done before the NCLT. Regulation 9(3)(b)(iii) further states that the existence of dues can be proved either individually or collectively if there is an order of the Tribunal on non-payment of dues. Will the direct consequence of the NCLT’s decision in the instant matter be that the dues do not exist? The usage of the term “collectively” for proving the existence of dues on the basis of Tribunal’s order may be interpreted in the manner that a Tribunal may have passed an order granting a collective relief.

Lastly, the National Company Law Appellate Tribunal [“NCLAT”] in Palogix Infrastructure Private Limited v. ICICI Bank Ltd. declined the application of the NCLT Rules, 2016 [“Rules”] on the matters pertaining to the Code since the Rules apply only to the Companies Act, 2013 [“Act”] and not to the Code. However, Rule 45 categorically allows the “authorised representative” to appear before a Tribunal as provided under section 432 of the Act for any proceeding. This inconsistency of not having an explicit mention of the application of the Rules on the Code may have existed because the Code was enacted on a later date and, since then, there had not been any matter requiring interpretation of both the statutes simultaneously.

The NCLT, with due respect, ought to have looked into the aforementioned considerations. It will be interesting to note if the matter goes on an appeal and the NCLAT adjudicates upon the intersection of the Rules and the Code.

Conclusion

It has been more than a year since the enactment of the Code but the Tribunal has taken dichotomous views on the similar issues.[5] Notwithstanding the fact that there lies an appeal to the NCLAT, the different interpretations of different NCLT benches show a lack of uniformity, particularly with respect to the Code. The application of the Rules on the Code may instil. some uniformity among the NCLT rulings. Another interpretation problem which still hovers is that, since the Code is a creditor-friendly legislation with the object of revival of the distressed entities, entrusting the creditors to keep the entity as a going concern may lead to the failure of the latter object as the creditors may prioritise their own stakes over the resuscitation of the entity.

– Shubham Sancheti

[1] Section 5(7) of the Code.

[2] Section 5(20) of the Code.

[3] Section 25O of the Industrial Disputes Act, 1947.

[4] See M/s. Innoventive Industries Ltd. v. ICICI Bank & Anr., AIR 2017 SC 4084.

[5] See Schweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd. & Ors. and Sanjeev Shriya v. State Bank of India; Neelkanth Township and Construction Pvt. Ltd. v. Urban Infrastructure Trustees Ltd. and Black Pearl Hotels Pvt. Ltd. v. Planet M Retail Ltd.

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