Operational creditors may get relief

Insolvency experts are making a fresh pitch for changes to the Insolvency and Bankruptcy Code (IBC) to address one of the glaring shortfalls of the current regime – absence of a mechanism to ensure a fair share of realised proceeds of resolution for operational creditors.

“Operational creditors have been muted with abysmally low recoveries (under the IBC), and now they understand that the IBC cannot shield their rights as its provisions seem to be predominantly financial creditor-centric,” said Anjali Jain, partner, Areness. “The reason behind such discrimination is the lack of statutory protection of claims of OCs over and above the liquidation value and since in majority of cases resolved, the liquidation value assigned to their claims is negligible,” she said.

Financial creditors (FCs) are those who lend money to a company, whereas OCs are those who provide the goods and services to a company in their common course of business. Under the IBC, enacted in 2016, FCs have a primary claim on the assets during distribution while OCs have a secondary claim. Home buyers, too, have acquired FC status after an amendment to the code, and the general discourse on apportioning of the realised values under the code centred around FCs’ rights.

According to the latest Insolvency and Bankruptcy Board of India (IBBI) newsletter, the amount distributed to OCs under liquidation stands at a mere 0.8% of the total amount recovered. The share is not very different in cases of corporate insolvency resolution process (cases that haven’t slipped into liquidation), but the data are not publicly available.

To quote a few cases, under the resolution of Srei companies, FCs recovered 45% of their claims, while OCs received zero value. OCs, in this case small enterprises, who were suppliers of goods, had raised a claim of Rs 150 crore. Similarly in the Indu Projects case, trade creditors realised only 2.8% of their outstanding claims of over Rs 178 crore, whereas FCs recovered a far higher share; and in the Birla Tyres matter, OCs recovered 2.23% in comparison to FCs who recovered almost 30%.

The kind of impact the haircut leaves on small businesses is “unimaginable”, say experts while pointing out that the IBC is majorly supporting ease of exit to medium and large corporations. The disruption in the supply chain would be the most affected if OCs as trade creditors are not ensured effective representation, they say.

Typically, OCs receive a smaller share under IBC, mainly due to the nature of their debts and limited influence under the Committee of Creditors (CoC). Financial creditors usually have secured debts, meaning their loans are backed by collateral, which gives them a higher priority in terms of repayment, while operational creditors often hold unsecured debts, arising from transactions related to the supply of goods and services to the debtor company.

Also, the IBC gives financial creditors a significant role in the CoC, which decides on the resolution plans, including the distribution of proceeds from the resolution process. “In the case of OCs, unless their aggregate dues are significant, they do not have voting rights in the CoC, which limits their influence over the resolution outcome,” said Vatsal Gaur, partner, King Stubb & Kasiva.

Anoop Rawat, partner, Shardul Amarchand Mangaldas & Co, said, “The IBC mandates payment of a minimum of the liquidation value to the operational creditors which is a globally accepted principle for operational creditors being an impaired class.

Experts say an amendment in the code is required to protect the financial rights of OCs, which could involve setting up a minimum threshold under recoveries.

“A minimum threshold may be carved out to address the peculiarities of this prejudiced situation and the same may be done probably in terms of asset value of the corporate debtor or definite percentage of outstanding claims of OCs or definite proportion of recovery to OCs in relation to recovery by FCs,” said Areness’ Jain.

“Providing operational creditors with a guaranteed minimum recovery could be seen as a matter of equity, recognising their role in the company’s operations,” said Gaur, while adding that this would make suppliers feel more secure in their transactions with corporates under financial distress.

That said, Jayesh H, Co-founder, Juris Corp says that these data sets miss out the amounts recovered by operational creditors who after filing application under IBC agree to a settlement and get paid off “substantial amounts” of their claim outside of the IBC process.

Last month, an expert committee of the IBBI proposed a mediation process to settle cases for OCs, which would run parallel with the admission proceedings, and not substitute CIRP. This mechanism could potentially offer an alternative pathway for operational creditors to negotiate their recoveries, believe experts.

A member of the expert committee, on the condition of anonymity, had told FE: “Historically, we have seen applications by OCs withdrawn, even before the CoC (committee of creditors) is constituted, or even before the admission of petition takes place. That’s where chances of mediation are ‘optimum’ as no one wants to go to CIRP because of the small amount that’s owed to OCs.”