Erstwhile Creditors and their Continued Participation in the Committee of Creditors

[Chandni Ghatak is an advocate practicing in New Delhi.]

Recently, the National Company Law Appellate Tribunal, Chennai (“NCLAT”) in Mr. KN Rajakumar v. V. Nagarajanallowed the resolution professional to reconvene a meeting of the committee of creditors (“CoC”) as it stood in the year 2017 at the time of initiating CIRP against the corporate debtor. This was ordered to enable the CoC to consider an application for withdrawal under section 12A of the Insolvency & Bankruptcy Code, 2016 (“IBC”). The appellant who was an erstwhile director of Aruna Hotels Limited, i.e., the corporate debtor, urged that one of the financial creditors whose claim had not yet been filed must be considered insofar as its membership in the pre-existing CoC was concerned.

Although the NCLAT was correct to disallow the admission of such financial creditor in the pre-existing/original CoC in the absence of a formal claim having been filed, an important issue has been overlooked. As per the recorded facts of the matter, certain financial creditors who were part of the original CoC of the corporate debtor withdrew their claims entirely during the course of the CIRP. Despite such change in circumstances, the NCLAT went on to order the original CoC which is constituted by such erstwhile creditors as well to reconvene and determine the fate of the corporate debtor as on present date.

The NCLAT upheld the NCLT’s Order on the basis that the resolution professional does not have any ‘adjudicatory power’ under the IBC and no change can be made in the CoC when it was already formed. It is undisputed that the resolution professional as per the provisions of the IBC does not have adjudicatory powers and cannot reject a claim or even change the status of a creditor once the CoC is constituted (Rajnish Jain v. Manoj Kumar Singh). However, this does not fully answer the question in the present appeal because the issue is not so much about changing status of the creditor from financial to operational as it is about whether they may participate in such proceeding once they do not stand to be creditors of the corporate debtor in any respect.

The Constitution of Committee of Creditors

Section 21(2) of the IBC provides that the CoC shall comprise of all the ‘financial creditors’ of the corporate debtor. A financial creditor as defined under section 5(7) means “…any person to whom a financial debt is owed…”; whereas a financial debt as defined under sub-section 8 means “…a debt along with interest, if any, which is disbursed against the consideration for the time value of money…”.

The above definitions amply clarify the following, i.e., (a) all financial creditors are to be a part of the CoC; and (b) such financial creditors shall be identified amongst those persons/entities who are owed a debt in a financial debt.

In conjunction with the above eligibility criteria, it is important to note that section 3(10) of the IBC defines a creditor to mean “…any person to whom a debt is owed…”; which means that an essential factor to be borne in mind when constituting the CoC is to ascertain if at such time the creditor concerned is owed any debt.

Withdrawal of Claims & Consequences – An Unanswered Question

In chapter III of the IBC which contains provisions regarding ‘liquidation process’, section 38(5) provides that a creditor may withdraw its claims as filed before the liquidator within 15 days of submission.

Curiously however, neither does chapter II of the IBC nor do the Insolvency & Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provide for the event of withdrawal of claim submitted by a financial creditor after its admission in the CoC thus adding to the ambiguity in the given situation.

Should Erstwhile Creditors Determine the Fate of a Corporate Debtor?

The IBC as a statute envisages the commencement of CIRP as a mechanism which allows the creditors of the corporate debtor to carve out a path which prevents such entity from meeting an untimely corporate death. The CoC acts as the ultimate decision maker for the affairs of such entity and as confirmed by the Supreme Court in Kalparaj Dharamshi v. Kotak Investment Advisors Ltd.

However, the pertinent question in the present case is whether an entity which has withdrawn its claim be allowed to participate in the CoC. It is pertinent to note that the presence of a claim/debt which continues to be owed is a sine qua non to be considered as a creditor for it shows that such entity continues to hold an interest in the affairs of such distressed entity.

Interestingly, section 3(28) of the IBC defines ‘voting share’ to mean “…the share of the voting rights of a single financial creditor in the committee of creditors which is based on the proportion of the financial debt owed to such financial creditor in relation to the financial debt owed by the corporate debtor”. This supports the view that a financial creditor would have no voting share if a financial debt is no longer owed. This also supports the view that if a debt can no longer said to be owed, the entity in question not only loses its status as a creditor let alone a financial creditor but also loses any real interest insofar as the affairs of the corporate debtor are concerned.

Conclusion

The CoC wields immense power in shaping the future of a distressed corporate debtor. However, it ought to be appreciated that its decision making and commercial wisdom emanates from motivations of its members insofar as repayment of their debts are concerned.

In situations such as the present it is erroneous to allow creditors who have withdrawn their claims to continue participating in the decision-making process of the CoC. Doing so contravenes various provisions of the IBC and is an inequitable measure generally, since a decision of the CoC cannot ordinarily be challenged in a court of law. Therefore, in view of such realities it is necessary that the NCLAT and the legislature reconsider such question in light of the anomalous situation arising as a consequence of such unsettled position.

– Chandni Ghatak

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