Quick Take | Operational creditors getting a say in IBC proceedings could complicate bankruptcy code

The Insolvency and Bankruptcy Code, 2016 has seen its share of twists and turns. One more twist may be lying in wait; operational creditors seeking a voice alongside financial creditors in the insolvency process.

A financial creditor is one who has lent money to the company, and an operational creditor is a vendor who has supplied goods or services and is owed money by the company.

In the insolvency food chain, secured financial creditors rule the roost at the all-powerful committee of creditors (CoC). This is logical, no doubt. Banks should have a first claim to the proceeds of resolution when a borrower has defaulted on their loans. That is key for them to recover bad loans.

But other creditors are also victims. The hierarchy of creditors as prescribed under the code is unlikely to change. But operational creditors are asking for a voice, to be heard or even represented on the CoC. While hearing a case, the Supreme Court has asked the government to think about whether such creditors can be given a voice and also be given voting rights, according to the Economic Times.

The CoC comprises solely of financial creditors. Operational creditors call this unfair. They claim that they would like a resolution plan to help the company restart operations, and turn viable again. They have claimed that banks are keen on selling the assets and reduce their bad loans with the sale proceeds. This has adverse consequences for other creditors.

Operational creditors may be suppliers to the company or even contractors who have set up a factory for the company. Not recovering their dues puts them in a difficult financial position, in turn affecting their ability to repay debt or pay employees. That’s a valid concern.

The sums involved can be considerable. In the Essar Steel Ltd resolution, for instance, financial creditors’ claims amount to Rs 49,473 crore while those of operational creditors amount to Rs 5,059 crore. These are admitted claims. Disputed claims of operational creditors amount to Rs 11,593 crore.

This is not the first time that there is a demand for non-financial creditors to be given a greater say in the resolution process. Homebuyers were given the status of financial creditors by the government. This status allows home buyers to initiate insolvency proceedings and also be heard at the CoC.
When financial creditors initiate an insolvency process, they do so after having exhausted other means of resolution. They are also deemed more competent to decide on the best course of action for the company.

In the Bankruptcy Law Reforms Committee report, November 2015, this issue was discussed. It said that the CoC has the powers to decide whether to keep the company as a going concern or to liquidate it. The members of the CoC should have the capability to assess viability and modify terms of existing liabilities in negotiations, the report said.

It added, ‘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 creditors committee should be restricted to financial creditors.

How this case proceeds could play a crucial role in determining if operational creditors will have a greater say in the insolvency process. This will also affect the timelines for resolution and the benefits to financial creditors.