Difference Between Operational And Financial Creditors
“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 Insolvency and Bankruptcy Code, 2016 differentiates between financial creditors and operational creditors. Financial Creditors are those whose relationship with the entity is a pure financial contract, such as a loan or a debt security. Operational creditors are those whose liability from the entity comes from a transaction on operations.
The Insolvency and Bankruptcy Code, 2016 (IBC) has consolidated and amended the laws relating to reorganization and insolvency of corporate persons, partnership firms and individual firms. The sole intention of this legislation is to facilitate resolution of corporate bankruptcy in a time bound manner. The IBC has introduced new and distinct concepts of ‘Financial Creditor’ and ‘Operational Creditor‘ as opposed to the Companies Act, 2013 which merely introduced the term ‘creditor’, without any classification thereof.
Today, the maintainability of applications for initiating corporate insolvency resolution process chiefly depends on the applicant first satisfying the Tribunal that it falls either within the definition of ‘Financial Creditor’ or ‘Operational Creditor’ under the IBC. In this article, we are particularly discussing the Order dated 20th February 2017 passed by the Hon’ble National Company Law Tribunal, Principal Bench, New Delhi in Col. Vinod Awasthy v. AMR Infrastructure Limited1 whereby the Hon’ble Tribunal interpreted the definition of ‘Operational Creditor’ under the IBC to ascertain the applicability of the same to a flat purchaser.
Prior to discussing the aforesaid Order, it is imperative to first understand the definitions of ‘Financial Creditor’ and ‘Operational Creditor’ under the IBC.
A financial creditor is defined under Section 5(7) of the IBC to mean
“a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred“.
An operational creditor is defined under Section 5(20) of the IBC to mean
“any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred“.
In order to ascertain whether a person would fall within the definition of an operational creditor, the debt owed to such a person must fall within the definition of an operational debt as defined under Section 5(21) of the IBC.
Difference by the bankruptcy law
Distinction between a financial creditor and operational creditor has been drawn by the Bankruptcy Law Reforms Committee in para 5.2.1 of its final report. It states:
“Here, the Code differentiates between financial creditors and operational creditors. Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or debt security. Operational creditors are those whose liabilities from the entity comes from a transaction on operations…The Code also provides for cases where a creditor has both a solely financial transaction as well as an operational transaction with the entity. In such a case, the creditor can be considered a financial creditor to the extent of the financial debt and an operational creditor to the extent of the operational debt.”
It is clearly evident that the lawmakers have chalked out distinct definitions of ‘financial creditor’ and ‘operational creditor’ and that they are not to be interpreted as inclusive or exclusive of each other.
Detailed differences between Financial Creditor and Operational Creditor
|particulars.||Financial Creditor.||Operational Creditor.|
|Meaning||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 (20) – 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
|Voting share||Section 5 (28) – Voting right of a|
financial creditor is based on
the proportion of the financial
debt owed to such a financial creditor. The approval of
committee of creditor shall be
obtained by a vote of not less than
seventy five percent of the voting shares.
|Operational creditor shall not have|
any right to vote at the meeting
of committee of creditors.
|Initiation of corporate|
|Section 7 (1) – On occurrence of a|
default, a financial creditor shall
either by itself or jointly with other
financial creditors may file an
application for initiating corporate
insolvency resolution process
against a corporate debtor before
the Adjudicating Authority
|Section 8 (1) – On occurrence of a|
default the operational creditor
may, deliver a demand notice of
unpaid operational debtor copy of
an invoice demanding payment of
the amount involved in the default
to the corporate debtor. The
operation creditor may file an
application after the expiry of 10
days from the date of delivery of
the notice or invoice demanding
payment under sub-section (1) of
section 8, if the operational
creditor does not receive payment
from the corporate debtor or
notice of the dispute under subsection (2) of section 8.
|Appointment of IRP||Section 7 (3) – The financial|
creditor shall along with the
application furnish the name of the
resolution professional proposed
to act as an interim resolution
|Section 9 (4) – An operational|
creditor may propose a resolution
professional to act as an
Committee of Creditors
|Section 21 (2) – The committee of|
creditors shall consist solely of
financial creditors, and all financial
creditors of the corporate debtor.
|Operational creditors shall not|
form part of the committee.
Hon’ble National Company Law Tribunal on ‘Operational Creditors’
In Col. Vinod Awasthy v. AMR Infrastructure Limited, the Hon’ble Tribunal while dismissing the Petition instituted under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC) at the admission stage itself, decided the issue of whether a flat purchaser would fall within the definition of an ‘Operational Creditor‘ as defined under Section 5(20) of the IBC to whom an ‘Operational Debt’ as defined under Section 5(21) of the IBC is owed.
The Hon’ble Tribunal observed that the framers of the IBC had not intended to include within the expression of an ‘operation debt’ a debt other than a financial debt. Therefore, an operational debt would be confined only to four categories as specified in Section 5(21) of the IBC like goods, services, employment and Government dues. The Tribunal held that the debt owed to the Petitioner (a flat purchaser in this case) had not arisen from any goods, services, employment or dues which were payable under any statute to the Centre / State Government or local bodies. Rather, the refund sought to be recovered by the Petitioner was associated with the possession of immovable property.
The Hon’ble Tribunal while deciding the question of whether a flat purchaser could be considered an operation creditor 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 spark 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.”
The Hon’ble Tribunal held that the Petitioner had neither supplied goods nor had rendered any services to acquire the status of an ‘Operational Creditor’.
It was further held that it was not possible to construe Section 9 read with Section 5(20) and Section 5(21) of the IBC so widely to include within its scope, cases where dues were on account of advance made to purchase a flat or a commercial site from a construction company like the Respondent especially when the Petitioner had other remedies available under the Consumer Protection Act and the General Law of the land.
Supreme Court’s View
The difference between financial and operational creditors under the Code is not merely surficial – it is fundamental. If the crux of the insolvency regime is priorities, the priorities of the two in the distribution waterfall differ, even if both are unsecured. Is this a differentiation, or discrimination? The differentiation, along with certain other provisions of the Code, was challenged before the Supreme Court in a bunch of petitions.
In Swiss Ribbons Ltd. v. Union of India, the Supreme Court observed that :
“A perusal of the definition of ‘financial creditor’’ and ‘financial debt’ makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition. On the other hand, an ‘operational debt’ would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local
authority.” And, “financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business. Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less.” The difference between operational and financial debt/creditors was thus upheld by the Supreme Court. The most important consideration in determining whether a debt is a financial debt or an operational debt is to “intent of the parties”. Merely because a creditor claims interest for a delayed payment, does not imply that the debt is financial – in such transactions, interest is contemplated as a ‘penalty’ and not ‘returns’. Also, lending for time value of money does not necessarily involve ‘interest’. In order to qualify to be a financial debt, what matters is that the amount was disbursed against time value of money, whether or not expressed in terms of ‘interest’. Besides financial and operational debts, there can be other types of debts too – however, such other creditors are not entitled to initiate an application under the Code, but can file claims in the specified form.