Introduction
The classification of financial and operational debts within the context of insolvency proceedings presents a complex legal landscape that demands scrutiny and nuanced interpretation. Recently, the NCLAT Delhi was confronted with a peculiar case involving intricacies of debt classification under the Insolvency and Bankruptcy Code (IBC) in
Background of the Case
The Appellant argued that the funds provided were not a direct financial debt to the Corporate Debtor but were used for payments to suppliers on behalf of the Corporate Debtor. They referred to various clauses in agreements such as the Business Support Agreement (BSA), Share Purchase Agreement (SPA), and deed of guarantee to support their argument.
On the other hand, Respondent No. 1 contended that the funds provided were indeed for working capital requirements, including raw material procurement, at the instruction of the Corporate Debtor, thus constituting financial debt. The Tribunal rejected the argument that the agreements were solely between the
The Tribunal analyzed the agreements and deeds presented by both parties, noting clauses indicating financial assistance provided by Respondent No. 1 for the benefit of the Corporate Debtor. These agreements were jointly entered into by the Promoters, the Corporate Debtor, and Respondent No. 1, with the Corporate Debtor's consent. The Tribunal pointed out that the intent behind the agreements was clear: to provide working capital to the Corporate Debtor, including making payments for raw materials on its behalf. They reasoned that raw materials are inherently part of working capital, and any financial assistance for this purpose should be considered financial debt.
Differentiating Financial Debt and Operational Debt under IBC
Operational debt and financial debt differ primarily in their nature under insolvency laws. Section 5(21) of the IBC defines an operational debt as a claim for the provision of goods or services, including employment, or a debt for the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government, or a local authority.
On the other hand, Section 5(8) of the Insolvency and Bankruptcy Code (IBC) provides an inclusive definition of "financial debt." It states that financial debt includes a debt along with interest, if any, which is disbursed against the consideration for the time value of money.
Further, the IBC distinguishes between financial creditors and operational creditors based on the nature of their claims in the insolvency process. Financial creditors are entities that lend money to a company. They have a primary claim on the assets of the company in case of insolvency. Operational creditors are entities that provide goods and services to a company in their ordinary course of business. For instance, the wholesale vendor whose spark plugs are stocked by the car mechanic and who receives payment only after the spark plugs are sold qualifies as an operational creditor. They have a secondary claim on the assets of the company in the event of insolvency after the claims of financial creditors have been addressed.
Section 21 of the IBC provides for the
"Ordinarily, operational creditors are neither able nor willing to make decisions on the entity's insolvency or to incur the risk of delaying payments in exchange for the entity's prospects. The Committee concluded that the Code would stipulate that the creditor's committee should be limited to only the financial creditors in order for the process to be quick and effective."
The Committee justified the preference for financial creditors by suggesting that the creditors committee is tasked with evaluating the viability of an entity and negotiating changes to liabilities which is understood by financial creditors. Operational creditors may lack the expertise or willingness to participate effectively in these decisions. Therefore, restricting the committee to financial creditors is deemed crucial for expediting the insolvency process and achieving favorable outcomes.
Implications of the Judgment
From the above discussion, it is evident that there is a disparity in the authority given to financial creditors compared to operational creditors under the Insolvency and Bankruptcy Code (IBC). This discrepancy underscores the importance of accurately classifying debts as operational or financial during the Corporate Insolvency Resolution Process (CIRP). The case,
This approach ensures that the substance of the agreements, rather than their form, determines the classification of debt. The judgment is peculiar as adopts a pragmatic stance by prioritizing the economic reality of the transactions over formalistic arguments. It recognizes that the ultimate aim is to facilitate the resolution process by accurately classifying debts. The judgment has broader implications for insolvency resolution processes, as it sets a precedent for accurately classifying debts and ensuring equitable treatment of creditors.
Concluding Remarks
The Insolvency regime in
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Pratishtha Shrivastava
Khurana and Khurana
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