Corporate Insolvency Resolution Process: Are Operational Creditors being given the cold shoulder?

By Swaroop George

The recent order dated May 4, 2018, of the National Company Law Tribunal at Kolkata, dealing with various applications in C.P.(IB) No.359/KB/2017 with regard to the Corporate Insolvency Resolution Process of Binani Cements has brought to light the plight of operational creditors and their lack of influence in the insolvency process.

Once the Corporate Insolvency Resolution Process is initiated, the Interim Resolution Professional collects and verifies the claims of various debtors and constitutes a Committee of Creditors. The Committee of Creditors is the linchpin of the Corporate Insolvency Resolution Process and all major decisions are routed via the Committee. However, as per section 21 of the Insolvency and Bankruptcy Code, 2016 (‘Code’), the Committee of Creditors is solely comprised of the financial creditors unless no financial creditors exist.

As per Section 24 (3) (c) of the Code, operational creditors are only allowed to send one representative if their aggregate dues are not less than 10% of the total debt. Such a representative of the operational creditor does not even have the right to vote in such meetings even though he/she is representing a class of creditors whose proportion of the total debt is not less than 10% of the total debt. Furthermore, if the debts owed to the operational creditors do not make up 10% of the total debt, then they are completely left out of the meetings of the Committee of Creditors.

As per Regulation 24 (7) of the Insolvency Resolution Process for Corporate Persons Regulations, 2016, even the minutes of meetings of the Committee of Creditors need only be sent to the participants of the meeting of the Committee of Creditors. On the other hand, all financial creditors have the right to vote at the Committee of Creditors and their voting share has been defined in Section 5 (28) of the Code as the share of the voting rights of a single financial creditor in the committee of creditors which is based on the proportion of the financial debt owed to such financial creditor in relation to the financial debt owed by the corporate debtor. Therefore, a financial creditor would have the right to participate in the meetings of the Committee of Creditors and also vote even if the percentage of debt owed to the financial creditor is less than 1% of the total debt.

It is important to remember that financial creditors are not neutral parties who have no personal interest. The aim of every financial creditor being a commercial entity is to ensure that the maximum dues are recovered qua their debts and the dues of operational creditors are a secondary concern at best. This problem is compounded by the lack of safeguards under the Insolvency and Bankruptcy Court, 2016 to protect the rights of the operational creditors. The only safeguard that is available to operational creditors is under Section 30 (2) (b) of the Code, which provides that a resolution plan has to ensure that the operational creditor receives at least the amount which would have been paid to the operational creditors if the corporate debtor had been liquidated i.e. the operational creditors must at least receive the liquidation value.

Regulation 35 of the Insolvency Resolution Process for Corporate Persons Regulations, 2016 defines liquidation value as the estimated realisable value of the assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date. However, there may be a huge difference between the actual value of the assets of a corporate debtor and its liquidation value. This is why the Insolvency and Bankruptcy Board of India had passed the Insolvency Resolution Process for Corporate Person) (Amendment) Regulation, 2018 whereby it had become mandatory for the fair value of the assets of the corporate debtor also to be determined in addition to the liquidation value.

The fair value of the assets of the corporate debtor as per the amendment, is defined as the estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion.

In order that the price may not be pushed towards the liquidation value, the amendment also provides that the fair value and liquidation value shall be provided to the Committee of Creditors only after the receipt of the resolution plans and the same shall be kept confidential. No mention is made of providing the fair value and liquidation value to the operational creditors unless they have a representative on the Committee of Creditors as aforesaid which further handicaps the operational creditors. Even if the representative of the operational creditors is present, he/she cannot vote to accept a resolution plan which provides operational creditors with more than the liquidation value. The most that they can do is to attempt to convince the financial creditors to vote for such a resolution plan.

This can lead to absurd situations. For example, if an operational creditor approaches the adjudicating authority and initiates Corporate Insolvency Resolution Process against the corporate debtor by spending its own funds, even then the operational creditor will have no voting right to determine which resolution plan should be accepted. If the operational creditor had been owed a debt of Rs. 10 crores and financial creditors as a whole were only owed Rs. 5 crores, the decision-making power would still lie in the hands of the financial creditors and the operational creditor would be a spectator at best despite being owed the majority of the debt. The financial creditors will be free to accept a haircut of the debt owed to the operational creditor and force the operational creditor to accept the minimum repayment of the debt due i.e. liquidation value while the Financial Creditors enjoy full repayment of their loans. The Resolution Applicants would also be tempted to reduce the operational creditors compensation to the liquidation value as long as they can obtain votes from the financial creditors to whom they promise full payment.

The lack of safeguards for operational creditors in Code has been made apparent in the Corporate Insolvency Resolution Process of Binani Cements. From the decision of the National Company Law Tribunal, Kolkata, it is apparent that several operational creditors were not even being offered the liquidation value. Furthermore, while several financial creditors had not received any reduction in the debt owed to them, many operational creditors had been given severe reductions in the amounts due to them. Even the verification of the claims of the operational creditors had not been completed even though the resolution plans had already been submitted.

The National Company Law Tribunal had noted that it had been receiving several applications from operational creditors and that each carried a genuine grievance. The adjudicating authority also noted that due to supremacy of financial creditors, the claims of operational creditors were being neglected or ignored. The adjudicating authority was of the view that it was high time that operational creditors also got a say in the process.

The only practical difficulty in allowing the operational creditors access and voting rights in the insolvency process would be that achieving consensus of thousands of operational creditors would not be feasible. That can be resolved by having the operational creditors appoint representatives wherein every representative would represent operational creditors holding a certain percentage of the total operational debt and these representatives would have voting rights equivalent to the proportion of the total operational and financial debt that they represent.

For example, operational creditors being owed 10% of the operational debt may band together to appoint a representative and in which case, ten representatives would represent the operational creditor but their voting rights would be equivalent to the percentage of the entire operational and financial debt that they represent which might be less or more than 10%. In case, the operational creditors are not able to agree on some common representatives within a fixed period, then the Insolvency and Bankruptcy Board of India (IBBI) might appoint representatives to safeguard interests of the operational creditors in such number as may be required keeping in mind the total number of operational creditors and such representatives should have proportionate vote share equivalent to the percentage of the total operational and financial debt owed to operational creditors. Such representatives would also be able to keep the operational creditors aware of the proceedings being conducted. However, in such a case, the voting share of financial creditors should also be calibrated vide the total operational and financial debt and not just the financial debt.

Unless urgent steps are taken by the IBBI to allow operational creditors to participate and represent their interests in the Corporate Insolvency Resolution Process, there is every likelihood of the operational creditors receiving the liquidation value as opposed to the fair value causing grievous loss to them.

Swaroop George is an independent advocate practicing at New Delhi.