The Insolvency and Bankruptcy Code, 2016 (IBC) was passed to establish a framework that is focused on creditors rather than the typical debtor-centric approach. The goal of the resolution process is to maximise asset value while weighing the interests of each party, with a view to helping struggling businesses get back on their feet. The Code's primary goal is to guarantee that all parties involved are treated fairly.
But in reality, there is a clear disparity, especially when contrasting the objectives of financial creditors and operational creditors, underscoring a crucial weakness in the present structure.
After the 2018 amendments to the IBC, homebuyers who have paid for real estate units are now considered "financial creditors" under Section 5(8)(f). It is now imperative that additional amendments be made in order to facilitate the participation of operational creditors in the Committee of Creditors (CoC) and grant them some voting powers.
Why operational creditors deserve a seat at the table
The objective of increasing the total amount of credit available may be compromised if one type of credit is given preferential treatment over another, as the National Company Law Appellate Tribunal (NCLAT) emphasised in the case of Binani Industries Limited v. Bank of Baroda & Anr. Operational creditors are necessary for a corporation to survive. Their workforce and suppliers have a direct impact on the company's long-term financial success and operational integrity. Because of this inter-connectedness, maintaining corporate operations requires a fair credit distribution method.
In Swiss Ribbons Pvt Ltd & Anr v. Union of India & Ors, the Supreme Court considered whether Article 14, which forbids discrimination, was violated by keeping operating creditors out of the CoC. To support this exclusion, the Court cited the Bankruptcy Law Reforms Committee (BLRC) report, which was the basis for the IBC. The BLRC justified the inclusion of solely financial creditors in the CoC, taking into consideration the crucial function played by the CoC in deciding whether an organisation will be liquidated or continue as a going concern. It was reasoned that members of this committee needed to be able to assess the business's viability as well as be open to negotiating changes to current liabilities. It stated that operational creditors are hesitant to postpone payments in the hopes of bettering the company's prospects and are typically unable to influence choices regarding the entity's insolvency.
However, as stated in Principle IV of the principles driving the design of the Code, the IBC will encourage a collaborative approach. The legislation needs to ensure that the collective viability assessment involves all relevant parties. It also needs to make sure that all creditors who are willing and able to restructure their obligations are involved in the negotiation process. The report goes on to state that the legislation shall treat all creditors equally when determining their voting weight in the final resolution of insolvency. Principle V of the report stipulates that the Code would protect the interests of all creditors on an equal basis.
The BLRC posited that financial creditors can assess the viability and feasibility of restructuring plans, leading to the presumption that their approval or rejection of such plans will be based on these considerations. However, the primary objective for all creditors regardless of classification is the maximisation of recoveries. The current framework of the IBC lacks an incentive structure that compels financial creditors to act beyond mere self-interest, thereby perpetuating a system that does not adequately safeguard the interests of all stakeholders.
Global perspectives: How other markets embrace operational creditors
The legislative intent to accord due importance to all classes of creditors has been evident since the inception of the Code. Notably, Clause 10.3 of the Report of the Insolvency Law Committee set up by the Ministry of Corporate Affairs explicitly references the UNCITRAL Guide, which advises that an insolvency law must stipulate that a creditor or equity holder whose rights are modified or affected by a resolution plan should not be bound by the terms of that plan unless they have been allowed to vote on its approval.
According to the Committee's assessment, operational creditors' confidence in the CIRP process may be damaged if they are not included in important decisions, or if they are not able to disagree with a resolution plan that significantly modifies their current contractual rights. The report seeks to ensure that the CIRP is viewed as a fair and just process by enabling operational creditors to meaningfully participate in the decision-making framework.
The World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes Principle C 7.1 further suggest that "creditor interests should be safeguarded by appropriate means that enable creditors to effectively monitor and participate in insolvency proceedings to ensure fairness and integrity." In this regard, it is important to note that the Code's existing structure prevents all stakeholders from voting on the resolution plan, except financial creditors.
Furthermore, it asserts that such approved plans are binding on all stakeholders, irrespective of their participation or deliberation in the process. This raises significant concerns regarding the equitable treatment of all creditors in insolvency proceedings.
Clause 10.4 of The Insolvency Law Committee Report observed that insolvency regimes across various jurisdictions facilitate the participation of all affected creditors in reorganisation proceedings. As per the United Nations Commission on International Trade Law, Legislative Guide on Insolvency Law, (2005), in certain jurisdictions, creditors are organised into distinct classes based on shared or analogous interests allowing for targeted voting. For instance, under US bankruptcy law, a reorganisation plan cannot receive confirmation from a bankruptcy court unless it is approved by each class of creditors and shareholders whose rights are adversely affected, apart from meeting additional criteria.
In Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta & Ors, the Supreme Court held that the CoC must ensure, among other considerations, that the interests of all stakeholders, including operational creditors, have been adequately addressed when approving a resolution plan. In jurisdictions like the US, operational creditors are given distinct classes for voting, ensuring their voices are heard in restructuring processes. In contrast, India's framework does not provide operational creditors with this level of participation.
Conclusion
The exclusion of operational creditors from the CoC and their evident marginalisation in the decision-making process under the IBC is not only inconsistent with practices observed in other jurisdictions, but also appears to rest on questionable justifications. The entitlement of a specific class of creditors to vote on proposals aimed at restructuring their debt is fundamental to ensuring procedural fairness in any final determination of extinguishment of all or part of their claims. The current Indian framework, which effectively denies this class of creditors such a right, is inherently unjust and lacks adequate justification.
In light of these considerations, it is essential to reevaluate the legal framework governing the CoC under the IBC to allow operational creditors to participate in decision-making. Legislative amendments would enhance fairness and inclusivity in insolvency proceedings, aligning India with global best practices. This would ensure that all creditors have a voice, upholding equity and justice in the process. To maintain the values of equity and inclusivity, India must review its legal system. The country can strengthen confidence in its insolvency proceedings and conform to international best practices by guaranteeing operational creditors a place at the table. Operational creditors are essential to the continued existence of businesses. In addition to marginalising their contributions, excluding them from decision-making processes runs the risk of compromising the fundamental objectives of the IBC.
Ritu Raj is an Associate at UKCA and Partners LLP.