Constitutionality of IBC viz-a-viz Operational Creditors: Swiss Ribbons Judgment

[Ashish Rana is an Advocate on Record in the Supreme Court of India]

This post is in continuation from my previous post “Binani Judgment: Ray of Hope for Operational Creditors”. Recently, in Swiss Ribbons vs. Union of India, the Supreme Court has upheld the constitutional validity of the Insolvency and Bankruptcy Code, 2016 against various challenges. In this post, I shall be dealing only with the issues pertaining to operational creditors.  

Classification between Financial Creditor and Operational Creditor not violative of Article 14 of the Constitution of India.

The constitutionality of the Code was, among other things, challenged on the differential treatment of financial and operational creditors under the Code. The Supreme Court, relying upon reports of the Bankruptcy Law Reform Committee, the Notes on the Insolvency and Bankruptcy Bill and the Insolvency Law Committee Report of 2018, concluded that there is intelligible differentia between the two types of creditors, which has a direct relation to the objects sought to be achieved by the Code. The Court specifically took note of the fact that most financial creditors, particularly banks and financial institutions, are secured creditors whereas most operational creditors are unsecured. Apart from this, the nature of the loan agreements with financial creditors is different from the contracts with operational creditors for supplying goods. Financial creditors generally lend finance on a term loan or for working capital requirements that enable a corporate debtor to set up and operate its business. One the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business. Financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations. Further operational debt tends to be recurring and sometimes not free of disputes. There may be a dispute with respect to the quality or quantity of the goods or services, whereas financial debts are well documented and defaults made are easily verifiable. The Supreme Court held, most importantly, that financial creditors are from the beginning involved with assessing the viability of the corporate debtor. Financial creditors can and do engage in restructuring of the loan as well as reorganisation of the corporate debtor’s business when there is financial stress, which are matters operational creditors do not and cannot undertake. Therefore, as the preservation of the corporate debtor as a going concern while ensuring maximum recovery for all creditors are the main objectives of the Code, financial creditors are clearly different from operational creditors and therefore there is intelligible differentia.

Resolution professional has no adjudicatory powers.

Though the aforesaid reasoning fits perfectly well with the object of Code, the more problematic issues for the operational creditors were that of the admission and rejection of the claims of the operational creditors by the resolution professional. It has come to light that, in many cases, the resolution professional was reducing, rejecting or refusing to admit the claims of the operational creditors. Further, by the time operational creditors were informed about this decision or could have approached adjudicating authority, the resolution plan was to be passed under section 31 of the Code, making it binding on all concerned. Once approved, successful resolution applicants claim that under the plan the debt of the operational creditor has been rejected or reduced and, therefore, the operational creditor is only entitled to the admitted claim amount or no amount.

Laying to rest this controversy as to whether the resolution professional has power to adjudicate or not, the Supreme Court has held that the resolution professional does not have any power to adjudicate, reduce or reject the claims of the operational creditors. The Court held that, as opposed to a liquidator who has been conferred specific powers under sections 38 to 40 of the Code to determine and decide the claims, a function that is quasi-judicial in nature and with appeal provided against its decisions, no such specific powers to decide are provided to the resolution professional. The resolution professional does not have the power to act independently as is evident from section 28 of the Code and can be replaced by the committee of creditors under section 27 of the Code. Thus, the resolution professional is merely a facilitator with administrative powers. This decision and finding is much in favour of the operational creditors; however, this leaves a vacuum and a question, i.e. in such circumstances where the claims of the operational creditor has not been admitted, what is the recourse available to the operational creditors especially when section 31 of the Code provides that the resolution plan which is approved is binding on the all those involved in the process?

Despite approval of resolution plan under section 31, a civil suit can preferred against corporate debtor for previous claims

The National Company Law Appellate Tribunal (NCLAT) answered this question in a subsequent and recent judgement in Prasad Gempes vs. Star Agro Marine Exports Pvt. Ltd. & Ors., wherein the NCLAT relied upon section 60(6) of the Code which provides:

“60. (1) The Adjudicating Authority, in relation to insolvency resolution and liquidation for corporate persons including corporate debtors and personal guarantors thereof shall be the National Company Law Tribunal having territorial jurisdiction over the place where the registered office of the corporate person is located.

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(6) Notwithstanding anything contained in the Limitation Act, 1963 or in any other law for the time being in force, in computing the period of limitation specified for any suit or application by or against a corporate debtor for which an order of moratorium has been made under this Part, the period during which such moratorium is in place shall be excluded.”

The NCLAT held that notwithstanding the order passed under section 31 of the Code, it is open to a creditor to file a suit or an application against the corporate debtor after completion of the period of moratorium. Based on this reasoning, the NCLAT allowed the creditors to prefer their claims before the appropriate court of law irrespective of the approval of the resolution plan under section 31 of the Code.

Even if a claim is decreed to be recovered from the corporate debtor, it may only be payable to the extent the claims of the operational creditors are paid under the resolution plan. Therefore, the adjudication is only for the purposes of admission of the claim; however, the treatment or payment against the claim shall continue to be governed under the approved resolution plan, failing which the entire sanctity of the resolution plan will be lost. Another fallout of this judgement may result in the admission of all claims and the consequent handing out of an uneven deal to the operational creditors.

Resolution plan to be fair and equitable to operational creditors

This aspect has also been dealt with by the Supreme Court while considering the issue of the non-voting powers given to the operational creditors. The Court, though not referring to the Binani judgment, has observed that NCLAT has, while looking into the 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. If they are not, such plans are either rejected or modified so that the operational creditors’ rights are safeguarded.  In all, though the law is evolving at a fast pace in respect of the operational creditors, there is still much clarity which is yet to come.

Ashish Rana

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