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Financial Creditors and Operational Creditors: The Difference

Financial Creditors and Operational Creditors: Differences

Background

Previously, there have been many overlapping laws and adjudicating forums who used to deal with financial failure and insolvency of the companies and individuals in India. Talking about the current legal and institutional framework, it does not help in the effective and timely recovery of defaulted assets and therefore causes undue strain on the Indian credit system. Recognizing the present reforms in the bankruptcy and insolvency regime are actually critical for improving the business environment and also alleviating distressed credit markets.

Formation of the Code

The Government felt the need to introduce the Insolvency and Bankruptcy Code Bill in November 2015, which was specially drafted by a specially constituted  “Bankruptcy Law Reforms Committee (BLRC) under the Ministry of Finance.

After a proper consultation process and further recommendations from the joint committee of Parliament, both houses have now passed the Insolvency and Bankruptcy Code, 2016

Purpose of the Code

The code intends to offer comprehensive insolvency legislation in order to encompass all companies, partnerships, and individuals. The Government also proposes a separate framework for bankruptcy resolution in failing banks and all financial sector entities. After the implementation, the classification has become easier.

Taking note of one of the fundamental features of the code is that gives the capacity to the creditors to assess the feasibility of a debtor in order to take a business decision and hence to agree upon a certain plan in the future for its revival or speedy liquidation. 

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Who are the creditors?

They are defined in Section 3(10) of the Insolvency and Bankruptcy Code, 2016 which is as follows:

         “Creditor” means any person to whom a debt is owed and includes a financial creditor, and operational creditor, a secured creditor, and an unsecured creditor and a decree-holder.

As in the definition, we can observe that IBC has introduced new and distinct concepts of “financial Creditor” and Operational Creditor” unlike the Companies Act, 2013 which only introduced the term ‘creditor’, without any classification.

The differences between Financial creditors and operational creditors are:

ParticularsFinancial CreditorOperational Creditors
MeaningSection 5(7) of the Code defines 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(20) of the Code defines Operational Creditor, meaning a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned to transfer to.
Meaning of the term ‘debt’ A financial debt, as defined in Section 5(8), means a debt along with the interest, if there is any which is anyway disbursed against the consideration for the time value of money.Operational debt as defined in Section 5(21) means a claim in respect of the provision of goods or services including employment or a debt in respect of any dues arising under any law which shall be payable to the Central Government, any State Government or any local authority.
Voting ShareA financial creditor is based on the proportion of financial debt that is owed to such financial creditor. The approval of the committee of the creditor shall have to be obtained by a vote which should not less than seventy-five percent of the voting shares.The operational creditor does not have any right to vote at the meeting of the committee of the creditor.
Initiation of Corporate Insolvency Resolution processIf any default has occurred, a financial creditor may either by himself or along with other financial creditors may file an application for the initiation of corporate insolvency resolution process against a corporate debtor before the Adjudicating AuthorityThe operational creditor may, if he wants to, deliver a demand notice of unpaid operational debtor copy of an invoice in order to demand payment of the amount involved in the default to the corporate debtor.
Appointment of Interim Resolution ProfessionalThe financial creditors, along with the application, are eligible to furnish the name of the resolution professional proposed to act as an interim resolution professional.The operational creditors may propose a resolution professional to act as interim resolution professional.
Constitution of Committee of CreditorsThe committee of creditors shall only consist of financial creditors and all other financial creditors of the corporate debtorOperational Creditors does not form part of the committee.


The recent Judgment explains the Financial creditors and Operational creditors

If we see today, maintaining of applications for the initiation of Corporate Insolvency Process, mainly depends on the applicant being able to satisfy the tribunal that the application falls within the definition of ‘Financial Creditor’ or Operational Creditor under the IBC. 

In Col. Vinod Awasthy v. AMR Infrastructure Limited, Judgment passed in February 2017, the Hon’ble Tribunal has interpreted the definition of ‘Operational Creditor’ under the IBC

The Hon’ble Tribunal dismissed the Petition that was instituted under Section 9 of the Insolvency and Bankruptcy Code, 2016 at the admission stage only, intended to decide the issue of if a Petitioner would fall within the definition of an ‘Operational Creditor’ as defined under Section 5(20) of the IBC.

The Hon’ble Tribunal observed that the framers of the IBC did not want to include a ‘debt’ within the expression of an ‘operation debt’. Hence, an operational debt would be restricted only to four categories of the IBC such as goods, services, employment, and Government dues, as defined under the IBC. The Tribunal, therefore, held that the debt owed to the Petitioner had not arisen from any goods, services employment or dues which were payable to the Central or the State Government or local bodies. Rather, the refund that was sought to be recovered by the Petitioner was associated with the possession of the immovable property.

The Hon’ble Tribunal also considered the observations of the Bankruptcy Law Reforms Committee in paragraph no. 5.2.1. of the Final Report.

        “Operational Creditors are those whose liability from the entity comes from a transaction on operations. Thus, the wholesale vendor of spare parts whose spare plugs are kept in inventory by car mechanics and who gets paid only after the spark plugs are sold is an operational creditor. Similarly, the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease”

It was therefore held that the Petitioner had neither supplied goods nor had he rendered any services to acquire the status of an ‘Operational Creditor’.

Conclusion

Although there is not much difference between Financial creditors and Operational Creditors, But we see that, at the time of filing a suit regarding insolvency, it is important to figure that actually what kind of creditors are involved who may file an application. Nowadays, the Tribunals have also become stringent, that is they do not accept applications for initiating Insolvency Resolution process unless it satisfies them that the applicant falls within the ambit of definitions of ‘Financial Creditors’ and ‘Operational Creditors’ as defined under the Insolvency and Bankruptcy code 2016. In other words, it is very important that only a Financial or an Operational Creditor could file an application, nobody else.

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