India: Dominance of Financial Creditors Amongst Creditors

Last Updated: 17 September 2018
Article by AMLEGALS  

CORPORATE INSOLVENCY RESOLUTION PROCESS i.e. CIRP

The Insolvency and Bankruptcy Code has replaced the 'debtor centric' insolvency regime with the 'creditor centric' insolvency regime.

As per provisions of IB Code if there is a debt and there is a default of such debt by the corporate debtor then any financial or operational creditor can make an application to the adjudicating authority (i.e. the NCLT) for commencing the Corporate Insolvency Resolution Process(IRP).

Once the application is admitted by the NCLT, then under Section 13 of the IB Code an IRP will be appointed.

The IRP so appointed will cause a public announcement for the initiation of CIRP and call for submissions of claims and the moratorium period will be declared during which all pending and future legal proceedings against Corporate Debtor will be stayed subject to exceptions carved out to be outside the moratorium.

During the moratorium period, as per Section 18 of the IB Code, an IRP is required to constitute the committee of creditors and as per Section 21 of the IB Code IRP will constitute the Committee of Creditors.

The main purpose of the committee is to create a resolution plan within the stipulated time frame.

FINANCIAL CREDITOR v. OPERATIONAL CREDITOR

For the purpose of proceedings under the IB Code, a distinction has been created between 'Financial Creditors' and 'Operational Creditors'. However there is no such distinction under the Companies Act, 2013 as it rather uses the term 'creditor'.

Under IB Code, a Financial Creditor is defined under Section 5(7) as "a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred".

Financial debt has been defined under Section 5(8) as "a debt along with interest, if any, which is disbursed against the consideration for time value of money"

Under IB Code Operational Creditor is defined as Section 5(20) as "any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred".

Operational Debt has been defined under Section 5(21) as "a claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority".

DIFFERENCE BETWEEN CREDITORS UNDER THE CODE

1. DEMAND NOTICE

Before filing an application before NCLT an operational creditor, as per Section 8 of the IB Code, shall have to serve a demand notice upon the Corporate Debtor however there is no such requirement for the Financial Creditor.

2. DISPUTED DEBTS

As per Section 9 of the IB Code the application of Operational Creditor shall be rejected if the debt is a disputed debt however there is no such rejection criteria for Financial Creditor

3. COMMITTEE OF CREDITORS

IRP will constitute the Committee of Creditors under Section 21 of the IB Code.

However Section 21 (2) of the Code states that the committee of creditors shall consist solely of financial creditors and operational creditors are not allowed to be the part of the COC.

Each financial creditor shall vote in accordance with voting share assigned and the resolution plan can be implemented only if it has been approved by vote of 66% of voting shares of Financial Creditors.

However Section 24 (3) (c) states that only those operational creditors who are having aggregate dues of at least 10% of the total debt shall be given the notice of the meeting and they may attend the meetings of committee of creditors, but shall not have any right to vote in such meetings.

Therefore it is clear that an operational creditor is not allowed to be a member of the Committee of Creditors. Also, Code limits the right of an operational creditor to only attending the meeting of COC subject to the abovementioned threshold.

The rationale behind the difference between financial and operational creditor under IB Code has been explained in the Banking law Reforms Committee as below: -

"members of the creditors committee have to be creditors both with the capability to assess viability, as well as to be willing to modify terms of existing liabilities in negotiations. Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors committee should be restricted to only the financial creditors."

POWER OF FINANCIAL CREDITORS WHO ARE PART OF COC

  • Committee of Creditors shall have the right to ask the resolution professional to furnish for any financial information in relation to the corporate debtor at any time during the CIRP.
  • COC shall appoint the IRP as a RP or to replace the IRP by another RP.
  • COC can replace Resolution Professional with another Resolution Professional.
  • COC may agree to extend the time period of CIRP beyond 180 days subject to final approval of adjudicating authority.
  • Decision shall be taken by COC by a vote of not less than 66%.
  • COC approve the Resolution Plan subject to final approval of adjudicating authority.

APPROVAL OF COC FOR CERTAIN ACTIONS

Section 28 of the Code provides certain actions that cannot be taken by the RP without the prior approval of COC namely:

  • Raise any interim finance in excess of the amount as may be decided by the COC in their meeting;
  • Create any security interest over the assets of the corporate debtor;
  • Change the capital structure of the corporate debtor, including by way of issuance of additional securities, creating a new class of securities or buying back or redemption of issued securities in case the corporate debtor is a company;
  • Record any change in the ownership interest of the corporate debtor;
  • Give instructions to financial institutions maintaining accounts of the corporate debtor for a debit transaction from any such accounts in excess of the amount as may be decided by the COC in their meeting;
  • Undertake any related party transaction;
  • Amend any constitutional documents of the corporate debtor;
  • Delegate its authority to any other person;
  • Dispose of or permit the disposal of shares of any shareholder of the corporate debtor or their nominees to third parties;
  • Make any change in the management of the corporate debtor or its subsidiary;
  • Transfer rights or financial debts or operational debts under material contracts otherwise than in the ordinary course of business;
  • Make changes in the appointment or terms of contract of such personnel as specified by the COC; or
  • Make changes in the appointment or terms of contract of statutory auditors or internal auditors of the debtor.

Therefore it can be inferred that the power given to COC under the IB Code is very wide and if the COC was constituted then all the power with respect to the corporate debtor will vest with COC.

EFFECT OF RECENT AMENDMENT

After the ordinance of 6th June new Section was inserted in the code which states that insolvency cases can be withdrawn even after the admission of the application and initiation of CIRP if the 90% of the member of COC are in favour of withdrawal of Insolvency.

But this will only lead to a chaos as most of the application was filed in the NCLT by Operational Creditor and they are not part of the COC and if the recommendation was accepted then that will be against the law of reasonableness as there will be no voting right provided to the operational creditor.

Also if the recommendation was accepted then the order of the COC will be prejudicial to public interest and oppressive to all the operational creditors.

The content is purely an academic analysis under "Legal intelligence series.

© Copyright AMLEGALS.

Disclaimer: The information contained in this document is intended for informational purposes only and does not constitute legal opinion, advice or any advertisement. This document is not intended to address the circumstances of any particular individual or corporate body. Reade should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a particular situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.

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