Legal Realities For Operational Creditors In CIRP - An Analysis Of The Insolvency And Bankruptcy Code, 2016

Author: LawSphereX

Category: Corporate & Insolvency

Published: 2026-08-23T20:31:29.921293+00:00

Updated: 2026-08-26T17:10:40.617+00:00

LEGAL REALITIES FOR OPERATIONAL CREDITORS IN

CIRP: AN ANALYSIS OF THE INSOLVENCY AND

BANKRUPTCY CODE, 2016

Bhoomijaa.C.S, National Law School of India University

INTRODUCTION

The Insolvency and Bankruptcy Code, 20161 (hereinafter ‘the Act’/ ‘IBC’), enacted with the intention of reforming and resolving the failing legislations in India's insolvency landscape, aims primarily at achieving resolution and, when that proves impossible, offers liquidation procedures. The act aims to facilitate the swift repayment of creditors with minimal haircuts while balancing the interests of all stakeholders. Unlike traditional processes where debtors are mostly in control, the IBC ensures that creditors hold power through the creation of the Committee of Creditors (CoC), and the Stakeholders consultation committee (SCC) which play a vital role in decision-making. Despite being in its nascent stages, the law has shown positive changes and developments in the field.

However, this progress has placed one of the primary stakeholders—Operational Creditors (OC), essentially unsecured creditors—in a confusing and disadvantaged position. In Section 3(10), the IBC, in a never before move differentiates creditors solely based on the nature of debt into financial creditors (Hereinafter FC) and operational creditors (Hereinafter OC). Section 5(20) defines OC as those to whom the company owes an operational debt- debt incurred through day-to-day operations, extending to goods and services, rents, utilities, and similar transactions ( The exact categorization of a creditor as financial or operational remains subject to ambiguity). Despite both categories of creditors having equal rights to initiate Corporate Insolvency Resolution Process (CIRP) or liquidation, only financial creditors are granted voting rights in the CoC.

Further up, the liquidation value for resolution is determined by a waterfall mechanism, where OC’s end up getting amounts which are often negligible or equivalent to zero.

1 Insolvency and Bankruptcy Code 2016.

This paper aims to elaborate on the implications for an unsecured operational creditor the lack of active representation in the CoC and subordination in waterfall mechanism under section 53, in navigating through the Insolvency and Bankruptcy Code in general and CIRP in particular, Thus the thesis of the paper is to argue that this legal and procedural disparity to OC’s inequitably overrides the interests of Operational creditors (by referring to data’s of all approved resolution plans in year 2022 till January 2023 )and goes against the preamble of the act which promises to balance the interests of all stakeholders. The essay tries to facilitate this by analysing the above two problems through legal and practical lenses.

In the first section the paper addresses the lack of active representation of OC’s in the CoC by understanding the issue and analysing the legal justifications and safeguards provided by the SC and NCLT’s. In the second section the essay will then delve into the procedural disparity done to OC’s through the waterfall mechanism and further elaborate the arguments by relying upon data of all approved resolution plans from 2022.

SECTION 1: THE LACK OF VOTING RIGHTS AND ACTIVE PARTICAPATION

THE COMMITTEE OF CREDITORS (COC) – A LEGAL DISPARITY

Operational creditors ranging right from the essential utility provider’s upto construction contractors, undoubtedly form an integral part for the smooth functioning of a business ecosystem, and are one of the first in the system to sense insolvency. The IBC thus, gives the OC’s rights in par with other creditors to apply for initiation of CIRP speedily under section 8. 2 Once the process of CIRP is initiated a moratorium is passed as per section 14 prohibiting any suit or proceedings against the corporate debtor leaving CIRP and liquidation through IBC as the only means of recovery. In the following sections we look at the problems this causes to an OC and its implications. 1.

1Passive participation in CoC: Immediately after an interim resolution professional is appointed and the claims of all the creditors including OC’s are accepted, a Committee of Creditors is formed under section 21. And only if the debt of all operational creditors aggregated, is greater than 10% of the total debt, OC’s are granted the right to participate in the CoC through a representative under section 24(3) with no voting rights. The CoC’s through vote will then select a resolution plan which if approved by the Adjudicating Authority stands unequivocally binding over all the creditors.

2 The Insolvency and Bankruptcy code, 2016.

Thus, the above sections in combination modify and affect the right of the OC in a binding manner, through a process where in most of the cases, OC’s have not even been given a chance to voice their opinion or look into the process which would permanently be sealing their fate. The following table illustrates the percentage of Creditors whose aggregate claims were below 10% and had no participation in CoC for all approved resolution plans in year 2022 validating the point made above. Table 1: percentage of Operational creditors whose aggregate claims were less than 10% (For all Resolution plans approved in 2022)3 Total number of Number of resolution plans where Claims by OC less than resolution Plans claims of OC’s below 10% 10% (in percentage) 49.36% ~ 50%

1.2 Contradicting Legal principles:

This passive treatment of OC’s is in contrary to various legal principles and international regulations which generally govern insolvency laws.

1. The world Banks – ‘principles for effective insolvency and creditor/debtor regimes’

urges that creditor interests should be safeguarded in a manner wherein they are able to effectively monitor and participate in proceedings.4 This is the reason why, the process of CIRP is made transparent, accountable and time bound. In the case of Bhushan Shringapure v. Mr B K Mishra,5 the honourable NCLT Delhi also held that invitation to eligible OC’s for participation though passive in CoC was not optional but mandatory to satisfy the same purpose.

2. The UNCITRAL Guide also mentions that “insolvency law should specify that a

creditor or equity holder whose rights are modified or affected by the plan should not be bound to the terms of the plan unless that creditor or equity holder has been the 3 Insolvency and Bankruptcy board of India, ‘corporate insolvency resolution process yielding plans as on 30th June 2023’ Ibbi.gov.in, .

4 Law commission report

5 (2023) ibclaw.in 254 NCLAT

given the opportunity to vote on approval of the plan”.6 However, in the matter of voting rights and active participation for OC’S all these recommendations are blindsided by a series of justifications and safeguards by the SC and NCLT which is discussed below.

1.3 Justificatory Arguments:

One landmark judgement justifying the nature of this treatment to the OC’s came from the Supreme Court on November 15, 2019 in the case of Essar Steel India Ltd v. Satish Kumar Gupta & Ors. 7 Stating the role of the CoC as ‘the driver’s seat for directing the insolvency resolution process’ the court was of the opinion that financial creditors, unlike operational creditors, engage in the dynamics of money lending regularly and are thus better equipped to evaluate and make informed and rational decisions for the revival of the company. 8 A similar line of justifications is also taken up by the BLRC in its report regarding the subject. Both promise resort to certain set of safeguard mechanisms in case of unfair treatments.

• The Supreme Court in the same case also noted that operational and financial creditors, who are unequal in various aspects including the sum credited, nature of credit and risk criteria’s need not be treated equally quoting that “equal does not necessarily mean equal recovery in a resolution Plan of dissimilar categories”. 9 Though, broadly in law they both fall in the same category of creditors

1.4 Provisions safeguarding interests of the OC’s:

The Bankruptcy Law Reforms Committee (BLRS) noted the necessities to safeguard the interests of the OC’s and thus some protections and privileges are given including the following: • That preferential treatment be given to OC’s in clearing debt and they be treated in a fair and equitable manner as prescribed under regulation 38.10

6 Law commission (n3).

7 Committee of Creditors of Essar Steel India Limited (through authorized signatory) v. Satish Kumar Gupta and Others, (2020) 8 SCC 531. 8 Prerna Jain Kala, Status Quo of Operational Creditors under IBC - A Judicial Analysis, 5 INT'l J.L. MGMT. & HUMAN. 2039 (2022).

9 Ibid.

10 Corporate Insolvency resolution Process- Regulations

That the resolution professional must take into account in any negotiation the obligations owed and interests of all creditors irrespective of whether they are represented or not.11 • The Adjudicating Authority must check into whether all creditors have received equitable treatment and otherwise discard the RP in cases where abuse of power is seen before approving the Resolution plan under section 31 of the Act.12 In the case of Tata Cellular v. Union of India13 the honourable court finally gave a strong holding that it was the duty of the NCLT to regulate and ensure that the power in the hands of CoC was not being misused for personal benefits irrationally. Before proceeding to our inference, it would be useful to get a glimpse into how OC’s are treated in other jurisdictions and in laws of India prior to implementation of IBC.

1.5 OC’s in foreign jurisdictions:

In most other developed jurisdictions, reorganisation of distressed assets usually have the involvement of all affected creditors. The creditors may be organised and sought for approval on the basis of a class system as in the USA or in a format requiring the approval of the majority of all creditors without any categorisation as in the UK’s insolvency act. Before the passing of IBC, insolvency matters were covered under a multitude of laws such as the Recovery of Debt Due to Banks and Financial Institution Act, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, Sick Industrial Companies Act, The Companies Act, 2013 .

Here, OC’s primarily fell into the category of unsecured creditors who mostly had the same passive roles in resolution alongside other unsecured creditors including financial creditors, as the reigns usually existed in the hands of the debtor.

1.6 Inference:

We infer the following from the above analysis

1. That the lack of active participation given to OC’s is overriding of several

internationally accepted principles of law and justice and is to an extent unfair to the OC’s.

11 Bankruptcy Law reforms Committee, the Interim Report of the Bankruptcy Law Reforms Committee

ss(2015).

12 Ibid.

13 Tata Cellular vs. Union of India (1994) 6 SCC 651.

2. The NCLT along with the SC has embraced this issue and yet continues to consistently

justify this legal mechanism of exclusion as fair by claiming that the OC’s may not be capable of understanding and voting and thus it provides certain alternative safeguards and privileges to the OC’s. The law commission in its report on IBC in February 2020 identified this problem and clearly pointed as to how the treatment to OC’s was unfair. However by stating that the OC’s were not yet prepared to take the wheel of CoC, it suggested that the processes in place be continued for the time being while trying to empower and better equip the OC’s so that they can be actively included in future. 14 But can the NCLT’S and SC’s eliminate the OC’s right to fair procedure just on the fact that they are not well equipped to understand and participate is something worth pondering.

This brings us to the following questions which sadly remain unanswered at present a) Is there any actual actions being taken up to technically empower and better equip the OC’s as recommended by the law commission and b) the question about the extent to which safeguards provided by NCLT which is subject to the fairness and ethics of the CoC’s and NCLT is being implemented SECTION 2: WHO’S IN THE BOTTOM OF THE WATERFALL?

Having read the previous section, we infer that it was the “capability to assess viability, and willingness to modify terms of existing liabilities in negotiations”,15 which inspired BLRC to favour FC’s and prevent OC’s from being an active part of the CoC which though not flawless may be questionably accepted, but should this categorisation of unsecured creditors further discriminate OC’s even in prioritising distribution, is the question we ask in this section. In this section, the essay will look into a procedural discrimination done to the OC’s in the liquidation waterfall mechanism of section 53, where the FC’s who are also unsecured creditors are conveniently prioritised over the OC’s .

The data’s referred to is taken from the corporate insolvency resolution process – yielding resolution plan as on 30th January 2023 published by the insolvency and bankruptcy board for the year 2022 up to January 2023.

14 Law commission report (n4).

15 Vinod Kothari & Sikha Bansal, 'Subordination of Operational Creditors under IBC.

2.1 Liquidation Waterfall mechanism:

The hierarchy by which claims of the creditors are catered to in an insolvency resolution is in simple words the liquidation waterfall. The waterfall works in the following format. The assets flow down the waterfall and only once the member on the top has been completely paid back the fountain of assets reach the stakeholder below. And since, a company enters CIRP only when there is a shortage of assets, who stands first in the queue during distribution is the most significant aspect of the entire process. The priority order for creditors in IBC is listed in section 53 as follows:16 IRP and Liquidations Costs Workers dues and secured dues Employees’ dues (for 12 months) Unsecured financial creditors Government dues, and unpaid dues to secured creditor, if the security has been realized Remaining debts and dues [which include, unsecured operational debts] Preference shareholders

2.2 Procedural discrimination to OC’s

As stated earlier, the IBC in a never before move distinguishes creditors into two sections OC’s and FC’s , and has positioned OC’s two rungs below FC’s whose claims are more often than not greater than the liquidation value of the entire depressed asset, leaving the OC with nothing but an empty plate . The table below elucidates precisely this. Table 2: Total number of Plans where accepted claims of FC was greater than the estimated liquidation value of asset (For the year 2022). 18 Total Number of plans where the admitted claims of Claims of FC> liquidation resolution FC’s > Estimated liquidation value of asset value (In percentage) plans 89.

2% The NCLT has also found in several instances the CoC using section 53, along with the lack of active representation of OC’S, as a practical lacunae for distributing far less money to the OC’s , giving them 0% of the claimed amount while the FC’s received more than 90% in the chosen resolution Plan. 19 For instance, in the data of the approved resolution plans for January 2023 OC’s got less than 5% of their claimed value in 48% of the cases in the same category of which 20% of the FC’s received more than 70%. Table 3: Data of recovered claims– A comparison between FC’s and OC’s – 2022. 20

75-100% 13.29 8.8 (a) 100% 0-1%

6.32 2.53

7.59 (b) This brings us to the question of why then are a contractually equal category of unsecured creditors, OC’s and FC’s not treated at par in the distribution of assets.

2.3 Justificatory Arguments by the BLRC

The BLRC though in its report does not explicitly state the reasons for the unequal treatment of OC’s and FC’s, subtly hints at its intention of promoting and developing the market of unsecured financing by protecting financers interests through the act and its provisions, As one of the purposes of the legislation is also to promote entrepreneurship, investment and accelerate economic growth. 21 However, rapid growth of one focused group of stakeholders at the cost of another’s right is not indicative of development or justice. And in the long run, discriminating a particular stakeholder is going to drastically harm developments, This is precisely the point made by NCLT in one of its holdings and which is elaborated upon in the next part. Why the BLRC may be wrong?

• In the case of Binani Industries Ltd v Bank of Baroda and others,22 the NCLT pointed out to how the unfair valuation of OC’s was based upon a wrong reading of 30(2)(b) which by being explicitly unfair made the section completely against the very spirit of the Act to be balanced and equal to all stakeholders. Observing that "Any 'Resolution Plan' if shown to be discriminatory against one or other 'Financial Creditor' or the 'Operational Creditor', such plan can be held to be against the provisions of the I&B Code”.

21 BLRS (n9).

22 Binani Industries Limited Vs Bank of Baroda & Anr. Company Appeal(AT) (Insolvency) No. 82 of 2018

Additionally, in the long run such unfair treatment would also violate the intention of the legislation to promote growth and entrepreneurship as goods and supplies given for credit is as important for an economy as is flowing finances.23 And though, the OC’s unlike FC’s are scattered, small with little expertise in the matter, it would not take long for MSME’s to realise that on insolvency, they, would receive only the scraps left out if any, after the assets got distributed first amongst bankers and the big financers. Thus, neither through the perspective of justice and equity nor through the realistic perspective of growth and economic development is this discrimination of FC’s and OC’s justified.

SECTION 9 – A RECOVERY MECHANISM

Before concluding, it would be interesting to look at a small pattern formed in data indicating an under the table pigeon hole the OC’s seem to have carved for themselves using their feature of being small and insignificant Table 4: data regarding the categories under which CIRP was initiated (For the year 2022)24 Triggered by

Out of 158 83% 10% 7%

Section 7 Section 9 Total cases

21 ~ 16.6%

105 ~ 83.3%

withdrawn =126 This, is indicative of nothing else but how the OC’s take advantage of the small sizes of their claims and the easy and quick process of section 7 as a recovery mechanism.

SECTION 3: CONCLUSION

This paper as the title suggest was a guide to operational creditors in practically navigating through the CIRP in the relatively nascent Insolvency and Bankruptcy code. The paper has by, relying upon recent data consistently proved as to how the code side-lines and more or less overrides the interests of a majority operational creditors at the cost of securing the interests of financial creditors. Though, under the rule of law and principles of equity it is certainly not right to keep the OC’s as passive entities in the CoC proceedings. With safeguards and preferences in place, for the reasons of practicality, greater good and to ensure the rapidity of the processes be fulfilled, section 24(3) could be questionably accepted for the time being.

However, no amount of reasoning and arguments allow for the code to discriminate between OC’s and FC’s, in the priority to receive what is rightfully theirs as both of them conventionally are just unsecured creditors. The paper, argued that this bias is not fair and worthy of going against the preamble of the act even if it is done for the greater good as MSME’s are as important to industrial progress economically as are financial creditors. Since, the flourishing of economic development is intricately linked to the presence of a robust unbiased legal framework that preserves property rights and ensures the rule of law, creating an environment conducive to holistic growth and prosperity must be the fundamental goal for all aspiring economies.

Because, going back to the fundamentals, Growth and development of the country can never be ensured without proper protection of equity and fairness.