The Insolvency and Bankruptcy Code, 2016 ("IBC" or "Code") was enacted after the previous legislations failed in delivering effective and efficient resolution of distressed companies and protect the interests of all stakeholders involved.As such, it deviates from those legislations in many ways, one of them being the waterfall mechanism incorporated in the IBC, which provides for order of priority in distribution of proceeds from liquidation estate.

One of the essential features of this waterfall mechanism is the precedence of unsecured Financial Creditors ("FC") over the Central and State Governments. However, the discussion paper released by the Ministry of Corporate Affairs recommends to do away with this by introducing equal treatment of all unsecured creditors including FCs, Operational Creditors ("OC") and Government.This article examines the proposed changes to the IBC while discussing its potential benefitsvis-à-vis OCs, and also explores the concerns raised by secured creditors, shedding light on the intricate balance between equal treatment and protecting the interests of secured creditors in the insolvency resolution process.

Proposed Recommendation

On January 18, 2023, the Hon'ble Ministry of Corporate Affairs came up with a discussion paper in order to recommend a few changes to the IBC covering myriad of its aspects.1 Among other, the said paper recommended that all unsecured creditors, which is inclusive of FCs, OCs and Government Authorities, shall be treated at par to each other under Section 53 of the Code.2 The said recommendation was backed by the fact that OCs compared to FCs receive peanuts when it comes to resolution process/liquidation of the Corporate Debtor. It is significant that at least the Hon'ble Ministry noted this prejudice present in the Code regarding OCs though after seven years.

The said discussion paper further recommended, secured creditors would retain their priority status in recovering funds but would face a limitation on the amount they can claim. In simple words, secured creditors would have the first claim on proceeds up to the liquidation value of the corporate debtor. However, any recovery beyond the liquidation value would be distributed proportionally among all creditors, including unsecured financial creditors, unpaid vendors, and statutory dues owed to the government.

These two recommendations are certainly a major breakthrough whose practical implications are required to be discussed.

Benefits of Proposed Changes

The plight of Operational Creditors is pertinent to discuss in order to get a clear picture of the pros of this major breakthrough. After the difference between OCs and FCs was held rational and well within Article 14 by the Hon'ble Apex Court considering the Bankruptcy Law Committee, Report, UNCITRA Insolvency Law Guide and the Code's Object and Purpose, the OCs are being considered as second-class citizen within their own country. The plight was such that even the opinion of Mr. MS Sahoo, the Chairman of Insolvency and Bankruptcy Board of India, changed within fourteen months3 and he stated that the realisation of claims of OCs is far less than that of FCs as the claims of OCs are most of the times disputed, either rejected or considered for a meagre amount.4 He even stated that the OCs are realising as little from the resolution plan as from liquidation itself.

In 2020, when the Insolvency Law Committee recommended that the OCs shall be given voting powers but also restricted the same by stating that IBC is at a nascent stage and certainly some more development is required to enact this recommendation.5 The recommendation was never seen light of the day and with this new proposed change, now the FCs, OCs and Government Authorities shall be treated at par, which means fourth in their ranking as per Section 53 of the Code. It shall be appreciated as the OCs that were kept in a limbo during realisation of their claims are treated in fourth priority however the admittance of their claim is still a crucial concern.

Shortcomings of Proposed Changes

The proposed change to the Code is not free from scrutiny as the same has sparked a contentious debate, with secured creditors, such as banks and bondholders opposing the change6 citing that it could result in them recovering less in insolvency resolutions.7 One of the primary concerns raised by them is the perceived unfair treatment of secured creditors. While the proposal acknowledges the priority of secured creditors in recovering funds, it imposes a limitation by capping their claims at the liquidation value of the corporate debtor. Any amount recovered beyond this value would be distributed among all creditors, including unsecured financial creditors, unpaid vendors, and statutory dues owed to the government. This provision significantly diminishes the rights and protections of secured creditors, potentially reducing their recovery amounts.Moreover, by limiting the recovery potential of secured creditors, the proposal may discourage lenders, including Indian banks and international private credit funds, from extending credit to businesses. The reduced protection for secured creditors may result in higher borrowing costs, as lenders would demand higher interest rates to compensate for the increased risk.

When giving loans, creditors have a clear structure that gives security thanks to the current Insolvency and Bankruptcy Code. Secured creditors in particular are comforted by the certainty that, in the case of insolvency, their claims will be given priority. The proposed modification, however, weakens this long-standing security structure by limiting secured creditors' rights. Because lenders could be hesitant to offer loans without enough certainty of a prompt and appropriate recovery, this might result in a loss of faith in the broader lending ecosystem. There is a chance of unforeseen repercussions even if the proposed reform aims to encourage an equitable allocation of bankruptcy resolution funds among different stakeholders. The plan may unintentionally discourage financing, slow corporate growth, and obstruct the resurrection of financially troubled enterprises by restricting the recovery possibilities of secured creditors. The decrease in secured creditors' recovery sums may also have an effect on their ability to make future loans, which would influence their desire to take part in the credit market.

Suggestions & Conclusion

Considering the change with respect to the OCs, the authors would recommend that more such amendments shall be introduced for the benefit of OCs. The lex loci must be liberal enough to treat OCs judiciously rather treating them as Jews in Nazi-Germany. The Hon'ble Ministry and Board must consider the plight of OCs and endeavour to facilitate them. Apart from the said recommendation, the authors, in light of the shortcomings, would suggest that to resolve the issue of capping the claims of secured creditors at the liquidation value of the CD, the recovery potential of the secured creditors could be increased through revising the proposal to allow secured creditors to recover a higher percentage of their claims, or by removing the cap altogether. This would provide greater protection for secured creditors and could encourage lenders to extend credit to businesses.Ultimately, a balanced approach that takes into account the interests of both secured creditors and other stakeholders would be necessary to ensure a fair and sustainable resolution of insolvency cases.









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