Operational creditors under IBC are oppressed.
With the enhancement of the threshold limit under Section 4 of the IBC, a large number of Creditors who are having due of Rs 1 Crore or less became remediless under the provisions of the Companies Act as well as under the provisions of IBC. Though the enhanced threshold limit is applicable for all the applicants viz. Operational Creditors, Financial Creditors and Corporate Debtor, the Operational creditors are the most affected category among them. This article explores the plight of operational creditors who are sandwiched between the legislation and jurisprudence and also identifies the related areas in which operational creditors are getting oppressed.
Insolvency and Bankruptcy Code, 2016 has been notified on 28th May, 2016 as a panacea for all kinds of debts, with an intention to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.
Part I of the Code that deals with insolvency and liquidation of corporate debtors. Section 3 (7) of the Code defines “corporate person” as a company as defined in clause (20) of section 2 of the Companies Act, 2013 (18 of 2013), a limited liability partnership, as in clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009), or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider. “Any other person incorporated with limited liability under any law” mentioned in Section 3(7) has been interpreted by the Hon’ble NCLAT Asset Reconstructions Company (India) Ltd v. Mohammadiya Educational Society that societies ‘registered’ under the Societies Registration Act would not fall under the definition of the Corporate Persons under the IBC. The reason is , a society is not ‘incorporated’ but only ‘registered’.
Applicability of the Code
Section 4 of the Code had made the minimum amount of the default amount to invoke the section 7,9 and 10 applications as one lakh rupees . However, the proviso to the Section 4 clearly enabled the Central Government to enhance the minimum amount of default upto Rupees one crore rupees by way of a notification. The Code had created two new breeds of Creditors viz, ‘Financial Creditors’ and ‘Operational Creditors’ and had also defined the terms ‘Financial Debt’ and ‘Operational Debt’. Subject to the above threshold limits, the Corporate Insolvency Resolution Process (CIRP) can be triggered either by the Financial Creditor (Section 7) Operational Creditor (Section 9) or by the Corporate Debtor itself(Section 10).
Definitions under the Code
Creditor means 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. The said definition is having very broad coverage of the term creditors. As per Section 3(11) , “debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt. The definition of the ‘debt’ is also very wider in its scope due to its inclusive nature. However, the CIRP can be initiated only if the Creditor is either Financial or Operational and the debt should be either operational or financial in nature and the said debt is in default.
As per Section 5 (20) of the Code, “operational creditor” means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Section 5(21) defines “operational debt” means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.
Section 5 (7) “financial creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to. Section 5(8) “financial debt” means a debt along with interest, if any, which is disbursed against the consideration for the time value of money.
The Code can be triggered only when the operational debt or financial debt , which is above the specified threshold limit, is in default. Section 5 (12) “default” means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be;
Creditors right to apply for winding up- Provisions of the Companies Act, 1956
Prior to the introduction of the Companies Act, 2013 and notification of the IBC, Section 433 (e) and 434 of the Companies Act, 1956 (1956 Act) were governing the creditor driven winding up of the companies. As per 433(e) of the Companies Act, 1956, if the company is unable to pay its debts the said company may be wound up by the Tribunal. Section 434 of the 1956 Act dealt with the circumstances in which a Company shall be deemed as unable to pay its debts. The text of Section 434 of 1956 Act is reproduced below
434. Company when deemed unable to pay its debts
(1) A company shall be deemed to be unable to pay its debts -
a) if a creditor, by assignment or otherwise, to whom the company is indebted in a sum exceeding Rs. 1 lakh then due, has served on the company, by causing it to be delivered at its registered office, by registered post or otherwise, a demand under his hand requiring the company to pay the sum so due and the company has for three weeks thereafter neglected to pay the sum, or to secure or compound for it to the reasonable satisfaction of the creditor ;
b) if execution or other process issued on a decree or order of any Court or Tribunal in favour of a creditor of the company is returned unsatisfied in whole or in part ; or
c) if it is proved to the satisfaction of the Tribunal that the company is unable to pay its debts, and, in determining whether a company is unable to pay its debts, the Tribunal shall take into account the contingent and prospective liabilities of the company.
(2) The demand referred to in clause (a) of sub-section (1) shall be deemed to have been duly given under the hand of the creditor if it is signed by any agent or legal adviser duly authorised on his behalf, or in the case of a firm, if it is signed by any such agent or legal adviser or by any member of the firm.
1956 Act contains amble provisions enabling a creditor to approach the Tribunal with an application for winding up of a Company, if that said Company is unable to pay its debts. Section 434 clearly states the ground upon which the circumstances under which a company shall be deemed as ‘unable to pay its debts’. If the due amount is Rs 1 lakh and the same is proved before the Tribunal, the Tribunal shall pass winding up order. Section 434(2) deals with the requirement of serving a demand notice to invoke the provisions for winding up.
To sum up the enabling provisions of the 1956 Act with respect to the Creditors winding up, the Section 433(e) and Section 434 provided adequate head room for all type of Creditors to whom more than Rs One lakh was owed by a Company.
Creditors right to apply for winding up- Provisions of Companies Act, 2013
With the replacement of the 1956 Act, with Companies Act, 2013, the Chapter XX has been introduced and the said chapter contained detailed provisions with respect to winding up of the Company. Section 270 (2) , which is the replica of Section 433(e) of the 1956 Act. As per Section 270 of 2013 Act, a company shall be deemed to be unable to pay its debts,– (a)if a creditor, by assignment or otherwise, to whom the company is indebted for an amount exceeding one lakh rupees then due, has served on the company, by causing it to be delivered at its registered office, by registered post or otherwise, a demand requiring the company to pay the amount so due and the company has failed to pay the sum within twenty-one days after the receipt of such demand or to provide adequate security or re-structure or compound the debt to the reasonable satisfaction of the creditor;
As per Sec 272(1)(b) of 2013 Act, a petition to the Tribunal for the winding up of a company shall be presented by any creditor or creditors, including any contingent or prospective creditor or creditors. Section 272 (6) provides that before a petition for winding up of a company presented by a contingent or prospective creditor is admitted, the leave of the Tribunal shall be obtained for the admission of the petition and such leave shall not be granted, unless in the opinion of the Tribunal there is a prima facie case for the winding up of the company and until such security for costs has been given as the Tribunal thinks reasonable.
A contingent liability is defined as a liability which may arise depending on the outcome of a specific event. It is a possible obligation which may or may not arise depending on how a future event unfolds. A contingent liability is recorded when it can be estimated, else it should be disclosed. Section 270 and Section 272 enabled the creditors who were having more than Rupees One Lakh credit from a company to move winding up application before the Tribunal.
It is pertinent to note that corresponding provisions under 1956 and 2013 Acts had not classified or discriminated the Creditors who are secured or unsecured to move the relevant applications to the Tribunal for winding up the defaulting company. This had ensured the level playing field for all types of creditors and enabled them to approach the Tribunal whenever there is a debt of Rs 1 lakh is in default.
Notification of IBC and reciprocal actions through amendment in winding up provisions of the Companies Act, 2013.
Upto the notification of the Insolvency and Bankruptcy Code, 2016, Chapter XX of the Companies Act, 2013 were governing the winding up of the Companies. However, the said chapter was not notified and had not come into effect. The legislative intent of the IBC, among others, was to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons . Inorder to make the related laws in line with those legislative intent, the conflicting provisions of Chapter XX of the Companies Act, 2013 had got de-notified/not to be notified. However, the limit for invoking the application for CIRP under Code was kept at Rupees One lakh Only, same as in 1956 and 2013 Acts, and the same had given a level playing field for the Creditors.
Enhancement of threshold limit and its adverse impact on operational creditors
Hon’ble Supreme Court of India had, in Swiss Ribbons case, clearly demarcated the financial creditors from operational creditors and established that there is an intelligible differentia between the said two categories of creditors. It is established through the said landmark judgment that there is an intelligible differentia which separates two kinds of creditors so long as there is some rational relation between the creditors so differentiated, with the object sought to be achieved by the legislation. Hon’ble Court had observed that the financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code. It was also underlined that most financial creditors, particularly banks and financial institutions, are secured creditors whereas the operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like. To concrete the arguments regarding the intelligible differentia it was pointed out by the Hon’ble Court that financial contracts generally involve large sums of money in contrast to the small debts owed to the operational creditors. Through the said landmark judgement, the legal position of the both types of Creditors under the Code got crystallised.
On notification of the IBC, a floodgate of litigations had opened which resulted in high number of applications under section 7 and 9 of the Code. The Insolvency Law Committee (ILC) in its report dated 20th February, 2020 had suggested to enhance the threshold limit for invoking the provisions of Code to Rs 1 Crore as the lower threshold had resulted in huge number of applications. With the onset of Covid 19 and consequent invocation of Nationwide lockdown, on 24th March, 2020, Ministry of Corporate Affairs (MCA) had issued a notification under Section 4 of the Code by which the Union Government had increased the minimum amount of default from Rs 1 lakh to Rs 1 Crore, resultant to which the CIRP can be invoked only if the default amount is Rs 1 Crore or more.
With the notification under Section 4, a large number of Creditors who are having due of Rs 1 Crore became remediless either under the provisions of the Companies Act or under the provisions of IBC. Though the enhanced threshold limit is applicable for all the applicants viz Operational Creditors, Financial Creditors and Corporate Debtor, the Operational creditors are the most affected category among them.
Section 7(1) of the Code enables a financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor to file an application for initiating corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default has occurred. The said provisions of the Code enables Financial Creditors to file the joint applications as per section 7 of the Code. This facilitates a Financial Creditor who is having default amount of less than Rs 1 Crore to move the application jointly with other Financial Creditor and thereby get the application for CIRP admitted. However, the Code or the Regulation does not permit an Operational Creditor to file a joint application. That means , if an Operational Creditors due amount is less than Rs 1 Crore, he cannot find remedy under the provisions of the Code.
Though there is intelligible differentia between the Financial Creditors and Operational Creditors , due to the enhancement of the threshold limit from Rs 1 lakh to Rs 1 Crore under the Code and due to denotification of the Chapter XX of the Companies Act, 2013, the interest of the Operational Creditors had got prejudicially affected. Presently the said set of Operational Creditors have no remedy available under both the legislations ,which is a clear violation of Article 14 of the Constitution of India.
As a sole remedy to recover the dues which is less than Rs 1 Crore, the Operational Creditors have to seek remedy under Section 26 of the Civil Procedure Cod by filing a suit for recovery of the money , which is proved to be a tiresome and slow process, unlike the time-bound process under the IBC. Moreover, as per Section 430 of the Companies Act, 2013, no civil court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which the Tribunal or the Appellate Tribunal is empowered to determine by or under this Act or any other law for the time being in force and no injunction shall be granted by any court or other authority in respect of any action taken or to be taken in pursuance of any power conferred by or under this Act or any other law for the time being in force, by the Tribunal or the Appellate Tribunal.
A conclusive solution
1956 and 2013 Companies Acts contained provisions enabling creditors to recover the debts from a company, if the debt is more than Rs One lakh and the said debt is in default. The said provisions enabled the creditors to file the applications to Tribunal even against ‘Contingent liabilities’ which are not crystallized in the financial statements. With the introduction of the IBC, the operational creditors were able to file CIRP applications if the default is more than Rs 1 Lakh, which is similar to that of Companies Acts. Due to the introduction of IBC the provisions of the Companies Act 2013 became redundant and the IBC started governing the said creditors. However, with the enhancement of the threshold limit to move application under Section 4 to Rs 1 Crores, there is no remedy available to the Operational Creditors who are having debts less than Rs One Crores. To mitigate the adverse impact the same had created and to create a level playing field among two sets of Creditors, it is suggested to adopt any of the following measures
Like Financial Creditors, permit the Operational Creditors to file joint applications under Section 9 of the Code. The provisions of Section 8 also to be modified to enable the Operational Creditors , either to send joint notice or to combine the grounds while moving the Application.
Notify Section 270 and 272 of the Companies Act, 2013 to the extend it will enable the Operational Creditors who are having less than Rupees One Crore Only to file application to Tribunal to wind up the defaulting Company.
In the absence of any such suitable remedy, the Operational creditors are in lurch and the said anomaly to be cured , either through judicial intervention or through legislative action
Bijoy P Pulipra LL.B, FCS, IP, RV
Senior Partner | Artis Law House