The current insolvency framework in India is focused more on creditors rather than the previous debtor-centric approach. The goal of the resolution process is to maximise asset value while balancing the interests of all stakeholders, attempting to revive struggling businesses. The creditors of the corporate debtor should be treated fairly with equal treatment through the insolvency process. Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws.
Understanding Operational Creditors and Their Role in IBC
Creditors play a crucial role in the corporate insolvency resolution process (CIRP). As per section 3(10) of the Insolvency and Bankruptcy Code, 2016 (IBC), a creditor is any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor, and a decree-holder. For this article, let’s look into Operational Creditor Challenges:
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Who Are Operational Creditors?
Section 3(20) defines an “operational creditor” as a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Therefore, operational creditors (OCs) are entities that supply goods or services to the corporate debtor, including employees, vendors, and trade creditors. On the other hand, a “financial creditor” is any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred, according to section 5(7) of the IBC.
Role of OCs in Insolvency Proceedings
OCs are critical in supporting businesses through trade credit and operational services. They can impact economic ability during an insolvency process, as their ability to receive timely payments can affect a company’s ability to continue operations, potentially disrupting supply chains and impacting overall economic flow. Their actions are especially important for micro, small, and medium enterprises (MSMEs) and supply chain networks.
Challenges Faced by Operational Creditors Under the IBC
Operational creditors challenges under the IBC provisions, rules, or regulations, including:
Exclusion from the Committee of Creditors:
OCs are excluded from the CoC as stated under section 21(2) of the IBC unless they represent more than 10% of total debt. Their exclusion means that they have no voting rights in crucial decisions, potentially leading to unfair treatment of their dues and lack of representation in how their debts are restructured. Therefore, they have a lower recovery rate compared to financial creditors.
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Limited Voting Rights:
As per section 21, Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws. are typically not allowed to vote on key decisions regarding the resolution process, including the approval of the resolution plan as they do not hold voting shares in the Committee of Creditors (CoC).
Low Priority in the Waterfall Mechanism:
In the case of liquidation, Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws. are placed lower in the payment hierarchy under section 53 of the IBC than financial creditors. As a consequence, they may receive a smaller proportion of their outstanding dues.
Information Asymmetry and Transparency Issues:
Due to the limited role of OCs in insolvency or liquidation proceedings, they often have issues accessing critical information about these proceedings. This lack of transparency leaves OCs unaware of the status of their claims or the progress of resolution plans.
Delayed Payments and Operational Disruption:
The insolvency process can be lengthy and uncertain due to internal and external factors. The delayed payments to Operational creditors challenges disrupt business operations, especially for small vendors and MSMEs.
Judicial Interpretation of OC Rights
Through judicial precedents, courts have been able to elaborate upon the rights of OCs under the IBC. For instance, the Hon’ble Supreme Court held in the Essar Steel Case, that while OCs and FCs are treated differently, Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws. must receive at least what they would get in liquidation. In Swiss Ribbons v. Union of India the Supreme Court upheld the distinction between financial and operations creditors under the IBC because of the nature of their debts. The court also ruled that the distinction was justified because of the different competency of the two types of creditors. From these cases, it is clear that courts have attempted to strike a balance between FCs and OCs while adhering to the IBC provisions. However, due to the limitations in India’s insolvency framework, there are legal barriers to improving the role of OCs in CIRP.
Comparative Analysis: Operational Creditors in Global Insolvency Frameworks
Insights from the US Chapter 11 Framework:
In Chapter 11 of the US Bankruptcy Code, operational creditors are treated as unsecured creditors and can participate in the bankruptcy process through unsecured creditor committees. Similar to India, unsecured creditors have a lower priority than secured creditors. However, trade creditors and employees are given a more prominent role in the proceedings under this Chapter.
Lessons from the UK Insolvency Framework:
Under the UK Insolvency framework, operational creditors are treated as unsecured creditors, they can file a petition to initiate insolvency proceedings if they owe a significant amount of money. Depending on the specific insolvency procedure, such as Company Voluntary Arrangement (CVA), Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws. may have an opportunity to be part of a creditor committee and voice their concerns about the proposed restructuring plan.
Recommendations to Address OC Challenges in IBC
The current insolvency framework is unfair to Operational creditors challenges in the insolvency or liquidation proceedings because of their responsibilities in the insolvency laws. , who are essential parties to the continued existence of distressed companies, hence it is recommended to:
Enhance their Representation in CoC:
The threshold for OCs representation in the CoC under section 21 of the IBC should be reduced to ensure OCs debts are recovered. They could be allowed to OCs to directly participate in the CoC, establishing mechanisms for consultation with large OCs. This will ensure that their concerns are considered during the drafting of the resolution plan.
Revisit the Waterfall Mechanism:
The waterfall mechanism under section 53 prioritises the distribution of assets during liquidation, where financial creditors have a higher priority than OCs. This leads to unfair treatment of these creditors where OCs may not recover their debts. Hence, it is recommended to propose a minimum guaranteed recovery percentage for OCs during liquidation.
Strengthen Information Utilities:
Strengthening information utilities (IUs) for OCs within the CoC is crucial because it ensures that they have access to accurate and timely financial information about the corporate debtor. It is recommended to leverage blockchain technology and information utilities to improve transparency, ensuring OCs have real-time access to critical data.
Promote ADR Mechanisms for OCs:
Alternative dispute resolution (ADR) mechanisms can improve the situation for OCs by providing a faster, more cost-effective, and flexible way to resolve disputes with a debtor company in distress. This allows them to recover their outstanding dues more efficiently with greater control over the resolution process compared to IRP.
Strengthening OCs’ Role in the Insolvency Ecosystem
It is essential to reevaluate the legal framework governing the CoC under the IBC to permit OCs participation in decision-making. In addition to this, there is a need for legislative amendments to ensure equitable treatment of OCs while maintaining the IBC’s objective of creditor-driven resolution. This would enhance fairness and inclusivity in insolvency proceedings. Introducing a creditor-driven resolution process would strive to treat all creditors fairly, including OCs, to maintain the integrity of the insolvency system and encourage responsible business practices.
Conclusion
OCs play a critical role in the insolvency framework by representing the suppliers, vendors, and service providers who are owed money by a company undergoing insolvency proceedings. They face challenges under the IBC, due to their limited voting power and potential for being marginalised by financial creditors when it comes to resolution plans. This leads to concerns about fair treatment and potential disruption to the company’s operations during the insolvency process. Therefore, there is an increasing requirement to introduce legislative amendments to improve the position of OCs under the IBC. Granting OCs greater voting power or seats on the CoC ensures their interests are considered during resolution plan discussions, aligning with the principle of fairness and equity.