Operational Creditors and their Exclusion from the Committee of Creditors under the IBC

[Deevanshu Jaswani is a 4th year B.A., LL.B. (Hons.) student at National Law University, Odisha]

The Supreme Court recently in K.N Rajakumar v. Nagarajan has reiterated the ‘settled principle’ of going concern of corporate debtor and held that “[e]very attempt has to be first made to revive the concern and make it a going concern, liquidation being the last resort.”

This came in the backdrop of the order of the National Company Law Tribunal (NCLT), Chennai, which approved the committee of creditors’ (CoC) decision regarding the withdrawal of the corporate insolvency resolution process (CIRP) involving the corporate debtor and held that the powers and management of the resolution professional (RP) and CoC were to be handed over the to the directors of corporate debtor.

While agreeing with the findings of the aforesaid order, the Supreme Court in the instant case held that since it has been unanimously resolved to withdraw CIRP proceedings under section 12A of the Insolvency & Bankruptcy Code, 2016 (“IBC”), the matter is settled between the corporate debtor and erstwhile financial creditors. The CoC and the RP concerning the corporate debtor had become functus officio.

However, because of applying the aforesaid ‘settled principle’ of going concern, the Court showed reluctance in examining various contentions raised and has overlooked major concerns of operational creditors regarding the constitution of the CoC. The bench was of the view: “It is a settled principle of law that the Court should not go into the academic issues and seek to interpret the provisions of law when it is not necessary for deciding the issues in the appeal(s)”. Therefore, this post is an attempt to analyze the contentions raised during the proceedings by the operational creditors concerning the formation of the CoC and related issues involved therein. 

Composition of CoC

It is well-known that the CoC is the primary decision-maker regarding the fate of the corporate debtor; therefore, the composition of the committee must be such that the members hold interest in the affairs of the distressed entity. Section 21(2) of the IBC, which provides for the composition of the CoC, states that the CoC shall comprise all the financial creditors of the corporate debtor. Section 3(10) of the IBC defines creditor to mean “any person to whom a debt is owed and includes a financial creditor, an operational creditor…”. Hence, the presence of a debt that continues to be owed is a sine qua non to be considered as a creditor.  

In addition, section 5(7) of the IBC states that a “financial creditor” shall be any person to whom corporate debtor owes financial debt. Furthermore, section 5(8) of the IBC sets out the meaning of financial debt as “a debt along with interest, if any, which is disbursed against the consideration for the time value of money”. Subsequently, according to sections 5(28) and 24(6) of the IBC, the voting share in the CoC bears a relation to a financial debt owed to the corporate debtor.

In the instant case, an anomaly that can be observed is that the fate of the distressed entity rested in the hands of the erstwhile financial creditors who had already settled their claims with the corporate debtor, except for HDFC bank, to whom the corporate debtor still owed a debt. Therefore, relying on regulation 16 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 (“CIRP Regulations”), one of the operational creditors, D. Ramjee, contended that since the matter was settled between the financial creditors and the corporate debtor, the CoC was required to be constituted only of the operational creditors.

The order of the National Company Law Appellate Tribunal (NCLAT) allowing the RP to reconvene the meeting of the CoC as it stood in 2017, while initiating CIRP against the corporate debtor, has been elaborately discussed in this post with detailed analysis of the issue of erstwhile creditors having voting rights in the CoC. Hence, the current post examines a related issue, i.e., when a preference is given to a sole remaining financial creditor over other operational creditors.

That being said, before delving into the analysis of the aforesaid issue, it is important to determine first the nature of the debt owed to HDFC bank. According to D. Ramjee, the debt owed was in the nature of “interim finance” and cannot be termed as a “valid claim: to be a member of CoC as provided under Section 25(2)(e) of the IBC. In order to determine the nature of debt owed to HDFC Bank, it becomes imperative to highlight the legislative framework of “interim finance” under the IBC.

“Interim finance” as defined under section 5(15) of the IBC means “any financial debt raised by the resolution professional during the insolvency resolution process period; and such other debt as may be notified”. The scope of the definition was widened through an amendment to give the “highest priority” in the corporate insolvency resolution process (CIRP) under section 30(2)(a) read with section 5(13)(a) of the IBC or liquidation to last-mile financing under section 53(1)(a) read with section 5(13)(a) of the IBC to prevent insolvency and make it a going concern.

It is worth noting here that the loan from HDFC bank was taken by the new management of the corporate debtor when the CIRP was not in place. Furthermore, the above-mentioned NCLT order, while allowing the application for withdrawal of CIRP, acknowledged that HDFC bank was one of the financial creditors. Therefore, the contention that assailed the nature of debt owed by the corporate debtor does not hold water.  

Preference to Sole Financial Creditor over Operational Creditors

It is to be noted that the IBC does not envisage a minimum number of financial creditors required to constitute CoC for deciding the fate of a corporate debtor. Instead, it provides that the CoC shall comprise of all financial creditors of the corporate debtor. Additionally, the voting share is the share to be in proportion of financial debt owed to financial creditors. As a result, the presence of a sole financial creditor would also perform the task. The same is evident from Café D Lake Private Limited wherein the CoC, comprising a sole financial creditor, passed a resolution for withdrawal of CIRP and the same was allowed by adjudicating authority.

In the instant case, the disputed fact regarding the erstwhile creditors deciding the fate of the corporate debtor gets overlooked when the CoC, which had “unanimously” passed the resolution in the 8th meeting, comprised HDFC Bank as the sole “financial creditor having a valid claim”. Therefore, even if the erstwhile creditors are removed from the picture, the presence of a sole financial creditor would have been sufficient to decide the fate of the distressed entity. Interestingly, this is a situation wherein the principle of “fair and equitable treatment” among similarly placed creditors could not come into play. In such a context, the interests of operational creditors get undermined.

The only scenario in which operational creditors would get voting right in the CoC is in absence of any financial creditor as provided under regulation 16 of the CIRP Regulations. This conditional representation of operational creditors has always been a point of debate, as it goes against the very objective of the IBC, which is to “balance the interests of all stakeholders”.

Moreover, under the UK Companies Act, 2006, a scheme of arrangement proposed requires the approval of 50% in number representing 75% in value of each class of creditors. This framework adds an element of procedural fairness by giving each class of creditors a right to vote while deciding the fate of the distressed entity thereby serving the interests of the creditors. Such a requirement also exists in section 230(6) of the Companies Act, 2013 in India in the context of a scheme of arrangement.

Lastly, the present legislative framework which gives even a sole financial creditor power to decide on behalf of other creditors is not only contrary to the position in other jurisdictions, but it also lacks a sufficient basis. Thus, this exclusion of operational creditors from participating in the CoC should be reconsidered and they should be allowed to have a say in decision-making process to ensure that their interests are duly served. 

Conclusion: A Way Forward

In the present case, the contribution of the financial creditors in keeping the corporate debtor a going concern is appreciated; however, at the same time, the issues with respect to “composition of CoC” with erstwhile creditors as its members as well as undermining of interests of operational creditors cannot be overlooked under the garb of “going concern” of the distressed entity. Given the potentially wide scope of “commercial wisdom” of the CoC with restricted judicial scrutiny, the composition of the CoC with erstwhile creditors should have been reconsidered rather than upholding such order and stating that the court should not go into academic issues and interpret the law. 

Deevanshu Jaswani

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