Bankruptcy Code - Difference between Financial and Operational Creditor is reasonable

In Akshay Jhunjhunwala & Anr. Vs.Union of India through the Ministry of Corporate Affairs & Ors., the petitioner stated before the Calcutta High Court that according to him The Bankruptcy Code of 2016 makes a distinction between a financial creditor and an operational creditor in respect of a corporate debtor which does not have a rational and intelligible basis. The differentiation between the two categories of creditors being unintelligible and irrational, the provisions of Sections 7, 8 and 9 of the Code of 2016 should be struck down.

The Court stated that a company has various stakeholders. Creditors of a company are one of the stakeholders. Prior to the concepts of financial and operational creditors being introduced through the Code of 2016, a creditor of a company was classified broadly under three categories, namely, secured creditor, unsecured creditor and statutory creditor.

The Code of 2016 segregates creditors of a company into two broad categories of financial and operational creditor. In addition to the three classifications of creditors existing prior to the Code of 2016, it now seeks to introduce financial and operational creditors. The definition of financial creditor appears in Section 5(7) which is to be read along with Section 5(8) and Section 3(10) of the Code of 2016.

Classification amongst similarly situated persons is permissible if the classification is based on reasonable differentia. If the classification is on reasonable differentia it does not offend the principle of equality. Consequently, creditors of a company can be classified, provided the classification is on reasonable differentia.

The differentia introduced by the Code of 2016 in respect of a creditor of a company does not offend any provisions of the Constitution of India. At least the same is not the argument of the parties before Court. What has been argued is that, the differentiation between the two creditors is such that, one of the classified creditors, that is to say, the financial creditor takes precedence over the operational creditor. Whether the treatment of a financial creditor on pedestal higher than an operational creditor and bestowing a higher or better right, so to speak, to a financial creditor is just and proper or whether the same offends any provisions of the Constitution of India requires consideration.

The Bankruptcy Law Reforms Committee deliberated on who should be on the creditors committee, given the power of the credits committee to ultimately keep the entity as a going concern or liquidate it. The Committee reasoned that members of the creditors committee have to be creditors both with the capability to access viability, as well as to be willing to modify terms of existing liabilities in negotiations. Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors committee should be restricted to only the financial creditors."

An operational creditor is not ousted in its entirety from coming into the committee of creditors. An operational creditor does not have a voting right in the event it is in the committee of creditors.

The Court while dismissing the appeal held that Code of 2016 is in the economic sphere and the Supreme Court in Bhavesh D. Parish & Ors. v. Union of India and Government of Andhra Pradesh & Ors. v. P. Laxmi Devi has decided that the Court should be slow in staying the applicability of a piece of legislation particularly in the economic spheres even if arguable points are raised unless such provisions are manifestly unjust or glaringly unconstitutional. The Bankruptcy Committee gives a rationale to the financial creditors being treated in a particular way vis-à-vis an operational creditor in an insolvency proceeding with regard to a company. The rationale is a plausible view taken for an expeditious resolution of an insolvency issue of a company.