The legislation

The Insolvency and Bankruptcy Code, 2016 (‘The Code’ for short) inter alia empowers an Operational Creditor to initiate an application for a corporate insolvency resolution process (CIRP) against the Corporate Debtor if the default is in excess of Rs. 1 Cr. Sections 8 & 9 of the Code are the governing provisions through which this process gets initiated.

Operational Creditor – an important stakeholder

An Operational Creditor is one of the important stakeholders in any business. The support of operational creditors is equally important as that of a financial creditor in running a successful business.

Even if the financial creditors pull their strings on the Corporate Debtor, the Corporate Debtor can still stay afloat and survive if supported by operational creditors. If suppliers of raw materials ensure uninterrupted supply and get into an arrangement with the Corporate Debtor for reducing their dues, the Corporate Debtor can survive even without the support of financial creditors.

This being the case, operational creditors deserve a better treatment. Sadly, IBC has failed to appreciate this aspect.

Categories of applicants u/s 9 of The Code

As much as 50% of the applications filed before the National Company Law Tribunal (The Adjudicating Authority) under IBC are by operational creditors, albeit the fact that operational creditors hardly have any say in a CIRP. Invariably, Sec 9 of the Code has been used as a ‘recovery mechanism’ for recovery of dues, though the purpose of IBC is debt resolution.

In many cases, the operational creditors would either be defaulters or would not have complied with the statutory requirements of related legislations like Companies Act or both. They would have not filed their audited financial statements for years together and their Directors would have been disqualified as well.

Applicants u/s 9 broadly fall into 4 categories:

a) Successful applicants who have been lucky and have achieved their objectives by recovering their dues without triggering a CIRP;

b) Unsuccessful applicants are the unlucky lot and they end up spending money without realising that they will not get to recover anything.

c) Ill-advised applicants who do not even know the consequences of Sec 9 and where it will lead to.

d) Stage-managed cases, where Corporate Debtors and operational creditors collude with each other to trigger CIRP and misuse the Code with ulterior motives.

Role of Adjudicating Authority in Sec 9 applications

It is sad that the Code has not envisaged such situations. Unfortunately, apart from going through the procedural aspects like service of notice u/s 8 and concluding whether there has been a pre-existing dispute or not, the Adjudicating Authority does not analyse the motives behind such applications, albeit the fact that Sec 65 of the Code prohibits initiation of CIRP fraudulently or with malicious for any purpose other than for the resolution of insolvency.

The real scenario

For example, a Corporate Debtor, besides owing a debt of say, Rs. 15 Cr to its financial creditor(s), may also owe a sum of Rs. 1.50 Cr to one of its operational creditors. The operational creditor is hardly aware of the financial position of the Corporate Debtor and even without the knowledge of the financial creditors, the application gets admitted and CIRP starts. IBC, as it stands now, does not empower the Adjudicating Authority to analyse the motive behind the application. Once CIRP starts, the operational creditor hardly plays any role in the CIRP except for incurring CIRP costs till the Committee of Creditors (COC) is constituted and lodging his claim before the Interim Resolution Professional.

If the CIRP is successful, the operational creditors (including the applicant who initiated the CIRP) walk out by taking home a minuscule portion of their dues. They do not have any place in the COC; they do not know the progress of the CIRP; and do not have any idea on who has submitted a resolution plan. If the CIRP results in debt resolution, they have to be content with a minuscule portion of their dues and if the CIRP ends up in liquidation, their recovery is ‘Zero’.  

Is IBC living up to achieving its objectives? Why at all should operational creditors be empowered to initiate an application under the Code?

This is a grey area that needs to be addressed.  

Checks and Balances

To ensure that IBC achieves its objectives, the following mechanism should be put in place:-

a) An operational creditor who initiates an application u/s 9 should demonstrate that he is capable of submitting a resolution plan – meaning the operational creditor has both the financial bandwidth and does not suffer from any disqualifications laid down u/s 29A of the Code.

b) Form 5 should include a section where the operational creditor furnishes information to demonstrate his capabilities for submitting a resolution plan to revive the Corporate Debtor.

c) The applicant should also serve a copy of the application to the financial creditors of the Corporate Debtor with liberty to the financial creditors to get themselves impleaded as parties to the application.

Only then can the Adjudicating Authority apply its mind and play a meaningful role in deciding whether the application is to be admitted or dismissed.

Such checks and balances in the application stage will ensure that unscrupulous applications and applicants with the sole objective of recovering their dues do not even qualify to file an application u/s 9.

This will also ensure that Corporate Debtors who are otherwise healthy and regular in meeting their obligations to their financial creditors do not get dragged into the CIRP net.

Author Bio

Qualification: CS
Company: N/A
Location: Chennai, Tamil Nadu, IN
Member Since: 08 Aug 2020 | Total Posts: 1

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  1. CA.Nainesh Sanghavi says:

    Dear Sathish kumar

    Happy to read your article published in tax guru ,
    Impress with your analysis of Ibc code 2016 and your suggestions check and balance , before accepting application filed by OC
    I agree with you as on date majority of applicants are I’ll advised and they used IBC code as recovery tools
    CA.Nainesh Sanghavi

  2. Ramana Kumar says:

    A very well written article which laments the plight of the OC in the IBC process.
    the raw deal suffered by the OC needs to be changed
    The article brings out the problem and also the possible solutions.

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October 2021