Difference B/W Financial Creditor and Operational Creditor under IBC, 2016
Currently, applications to begin a corporate bankruptcy resolution procedure must first persuade the Tribunal that the petitioner is a “Financial Creditor” or an “Operational Creditor” under the Insolvency and Bankruptcy Code, 2016. A financial creditor and an operational creditor are two essential components of the insolvency procedure under the IBC, 2016.
The Code 2016 distinguishes between financial and operational creditors. Financial creditors are those who have a strictly financial contract with the company, such as a loan or debt security. Operational creditors are those that owe the firm money as a result of a business transaction.
The IBC, which had been much anticipated, received the President’s approval on May 28, 2016. Section 3 (10) of the Code defines the term “creditor” as “any person to whom a debt is due, including a financial creditor, an operational creditor, a secured creditor, an unprotected creditor, and a statutory instrument;”
What Is Financial Creditor
“A person who owes a financial obligation, including anybody to whom such debt has been legitimately assigned or transferred,” according to Section 5(7) of the Insolvency and Bankruptcy Code.
The debt owing to a person must meet the definition of a “Financial Debt” as defined by Section 5(8) of the IBC to establish if that person is a financial creditor.
A “Financial Debt” is defined as follows in section 5(8) of the IBC: – “A debt that is disbursed in consideration for the time value of money, including any interest, and includes:-
- Money that has been borrowed and will be returned with interest;
- Any amount raised by the acceptance of a credit card or its dematerialized equivalent;
- Any money raised through a note purchase facility or by the issuing of bonds, notes, debentures, loan stock, or other similar instruments;
- The total amount of any liability deriving from a lease or hire purchase arrangement categorised as a finance or capital lease under The Indian Accounting Standards or other accounting standards as stated;
- Other than non-recourse receivables sold, a receivable sold or reduced
- Any amount raised by any other transaction, including any forward sale/purchase agreement, with the commercial impact of borrowing;
- Any counter-indemnity obligation created by a bank or financial institution’s guarantee, indemnity, bond, recorded letter of credit, or other instruments;
- The amount of any obligations arising from any of the guarantees or indemnities for any of the items listed in subclauses (a) through (h).”
What is Operational Creditor
“Anybody who owes an operational obligation, including anyone to whom such liability has been legally assigned or transferred,” according to section 5(20) of the IBC.
The debt owing to a person must fulfil the definition of an operational debt as defined in Section 5(21) of the Insolvency and Bankruptcy Code to determine if that person is an operational creditor.
“Operational Debt” is defined as “a claim for the delivery of goods or services, as well as employment, or a debt for the repayment of dues originating under any legislation presently in existence and payable to the Central Government, any State, or any regional government” under Section 5(21) of the IBC.
Significant differences between financial Creditor and Operational Creditor
- Someone who owes a financial debt is referred to as a financial creditor, but someone who owes an operational debt is referred to as an operational creditor.
- Debt to financial creditors refers to a debt that is distributed against the consideration for the time value of money, whereas debt to operational creditors refers to a demand for the supply of products and services in exchange for the repayment of government dues.
- In the event of a default, a financial creditor may collectively or separately with other lenders file an application for the onset of arbitration proceedings against a corporate debtor before an adjudicating officer, while an operational creditor may deliver a demand notice of unpaid operational debtor copy for invoice requesting payment of the amount involved in the default. The operational creditor may submit an application at a later date.
- A financial creditor may include the name of a suggested resolution professional in the application for an interim resolution professional appointment, but an operational creditor must recommend a resolution professional for an interim resolution professional appointment.
- Only financial creditors and corporate debt creditors will be represented on the creditor’s committee. Members of the creditor’s committee will not be operational creditors. The operational creditors do not have a vote at the meetings of the committee of creditors.
Let us briefly describe the key differences between Financial creditors and Operational Creditors.
|A financial creditor, according to Section 5 (7) of the Code, is anyone to which a financial obligation is made, especially anyone to whom such indebtedness has been legitimately delegated or transmitted.
|According to Section 5 (7) of the Code, a financial creditor is anybody to whom a financial obligation is made, specifically anyone to whom such debt has been lawfully transferred or conveyed.
|According to Section 5 (8), financial debt is defined as a debt, including any interest associated with it, payable against the compensation for the time value of money, and includes the items listed in sub-clauses (a) – (c) (i).
|According to Section 5 (21), operational debt is defined as a demand for the delivery of goods or services, including employment, or a debt for the recovery of dues originating under any existing legislation and attributable to the Central Government, State Government, or any local authority.
|Section 5 (28) – The voting rights of a financial creditor are determined by the share of the financial debt owed to such financial creditor. A majority of at least 75% of the voting shares is required to approve the creditor committee.
|The functional creditors will not be able to vote at the creditor’s committee meeting.
|Launch of the Corporate Insolvency Resolution Program
|Section 7 (1) states that in the case of a default, a financial creditor may file an application with the Adjudicating Authority to begin the corporate insolvency resolution procedure against a corporate debtor, either alone or together with other financial creditors.
|In the case of a default, the operational creditor may submit to the corporate debtor a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount connected with the default, according to Section 8 (1) of the Code. If the operational creditor does not receive compensation from the corporate debtor or notice of the dispute as required by Section 8 sub-section (2), the operational creditor may file an application for payment within 10 days of receiving the notice or invoice as required by Section 8 sub-section (2). (1).
|The appointment of an IRP
|According to Section 7(3), the financial creditor must include the name of the resolution professional who will serve as an interim solution practitioner with the application.
|Section 9(4) provides that an operating creditor may appoint a resolution expert to act as an interim resolution professional.
|The composition of the Committee of Creditors
|Section 21(2) states that the committee of creditors must be fully composed of financial creditors, along with all financial creditors of the corporate debtor.
|The Lenders Commission shall not include any functional creditors.
|Financial Information Submission
|A financial creditor must provide financial information as well as information regarding the assets over which a financial asset has been created, according to Section 215(2).
|An operational creditor may transmit financial records to the data utility under Section 215(3).
Financial Creditor Are Prioritised
Financial creditors are given higher priority since they are members of the creditor’s committee and have voting power, whereas operational creditors are not members of the creditor’s committee. The underlying issue is that some categories of operational creditors are subjected to discrimination since the statute’s provisions protect the rights and interests of Financial Creditors. This is reinforced by the fact that when the application is submitted by operational creditors, the respective class has no authority to make any proposals during the creditor’s meeting held.
Should operational creditors be treated the same as financial creditors?
In its report dated November 4, 2015, the Bankruptcy Law Review Committee stated that OCs will not risk their dues in exchange for the potentially bright future of the corporate debtor and concluded that the CoC should consist only of financial creditors to carry out the insolvency resolution process more effectively. The theory underlying this viewpoint was that operational creditors would be more interested in the liquidation of the corporate debtor rather than the resurrection of the firm, which would eventually contradict the primary goal of the IBC.
Insolvency law in the United States distinguishes between secured and unsecured creditors. Both groups of creditors, however, have the opportunity to vote on or reject any plan that reduces their claims. Under Chapter 11 of the United States Bankruptcy Code, an unsecured creditors committee is created to guarantee that the rights of such creditors are fairly represented.
Excluding operational creditors from the IBC Committee of Creditors and stripping them of decision-making rights is thus not only contrary to existing bankruptcy rules, but also irrational.
In the recent past, a relatively high number of judicial decisions on the status of operational creditors have been made public. The Supreme Court decided in the case of Swiss Ribbons Pvt. Ltd. and Others v. Union of India that intelligible differentia came into play while differentiating between operational creditors and financial creditors. As a result, this is not discriminatory as defined by Article 14 of the Indian Constitution. The categorization is warranted since the sorts of loans given by these two categories of creditors differ. It was also indicated in this decision that a loan from a financial creditor is to contain a bigger amount of money and a defined payback plan, which caused them to become involved in the reconstruction of the aforementioned loan.
In the case of Akshay Jhunjhunwala and others v. Union of India, through the Ministry of Corporate Affairs and others, this difference was also upheld. The Supreme Court ruled that the separation created between financial creditors and operational creditors did not violate any constitutional requirement. Equitable treatment of operating creditors was favoured above equitable treatment in the case of Maharashtra Seamless Ltd. v. Padmanabhan Venkatesh and others.
Some rulings, such as the Binani Industries Ltd. v. Bank of Baroda case, demonstrated inconsistency with the preceding cases and stated their claims for fair treatment for all creditors. This was a one-of-a-kind ruling that outlined the operational creditor’s interests but omitted to name the operational creditor in the CoC. Some of the decisions in this ruling were based on the Essar Steel Case.
Hon’ble NCLT on the Status of Operational Creditor
According to the Bankruptcy Law Reforms Committee in Paragraph 5.2.1 of its final report, a financial creditor is a person whose connection with the entity is entirely connected to financial transactions, such as a loan or debt security. An operational creditor, on the other hand, is an individual whose liabilities to the company take the form of future payments in exchange for already delivered items or services.
The IBC also provides for circumstances in which a creditor has participated in both a financial and an operational transaction with the firm, according to the research. In such cases, the creditor may be divided into two categories: financial creditors for the amount of the financial debt and operational creditors for the amount of the operational debt.
The National Company Law Tribunal decided in the matter of Col. Vinod Awasthy vs. AMR Infrastructure Limited (C.P. No. (IB) 10 (PB)/2017) that operational creditors are those whose obligation from the firm comes from a transaction on operations. As a result, an operational creditor is a wholesale supplier of replacement parts whose spark plugs are kept in stock by auto mechanics and who is paid only when the spark plugs are sold.
Similarly, the lessor from whom the firm leases space is an operational creditor to whom the company pays monthly rent throughout the duration of a three-year lease arrangement. The Hon’ble Tribunal further decided that the Petitioner had not supplied any goods or rendered any services in order to be classified as an ‘Operational Creditor.’
As a result of the above, it is obvious that Tribunals are unwilling to entertain petitions from anybody who does not fulfil the IBC’s standards for financial and operational creditors. This need must be satisfied in order to initiate business insolvency proceedings under the IBC. The NCLT has made it feasible to severely enforce the new insolvency and bankruptcy legislation.
Efficaciously introduce a corporate insolvency resolution process against a debtor, it is necessary to prove that the creditor falls within the scope and extent of the definitions of ‘Financial Creditor’ as defined in Section 5(7) of the IBC or ‘Operational Creditor’ as defined in Section 5(20) of the IBC. As per the case study, the Tribunals are strict in their interpretation of the phrase “Operational Creditor” under the IBC, refusing to accept petitions when the petitioners do not technically fall within the scope of the IBC and have alternative valid remedies available.