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Banking Law

Topic: Define insolvency and bankruptcy and discuss the provisions

Submitted by: Gursimran Singh

Registration no: 11616268

Submitted to: Dalliandeep Kaur

I would like to express my special thanks of gratitude to my teacher Dalliandeep Kaur

Secondly I would also like to thank my parents and friends who helped me a lot in
finalizing this project within the limited time frame. And lastly authors and writers of
various essays and books from where i have borrowed content for this assignment.

Gursimran Singh
(11616268)
Define insolvency and bankruptcy. Discuss the provisions relating to
initiation of corporate insolvency process by operational creditor

Insolvency and Bankruptcy

Insolvency is a term for when an individual or organization can no longer meet its financial
obligations to its lenders as debts become due. Before an insolvent company or person gets
involved in insolvency proceedings, it will likely be involved in informal arrangements with
creditors, such as setting up alternative payment arrangements. Insolvency can arise from poor
cash management, a reduction in cash inflow, or an increase in expenses.1

While at the other hand when an organization is unable to honour its financial obligations or
make payment to its creditors, it files for bankruptcy. A petition is filed in the court for the same
where all the outstanding debts of the company are measured and paid out if not in full from the
company’s assets. One must follow a legal procedure to declare themselves bankrupt and get aid
from government to deal with their creditors. To do this debtor must apply for bankruptcy in a
relevant court. Or else one of his creditors files an application in a relevant court to declare that
entity or person as bankrupt. This can also be result of a special resolution passed by Register of
Companies for the entity to be declared bankrupt.2

Often an entity facing state of insolvency can be declared bankrupt however the opposite is not
true. Bankruptcy is a legal procedure which could be one of the ways to solve insolvency. Also,
insolvency could be temporary and can be fixed with time. Often people may just ask for some
legal protection from its creditors for said period to allow him pay off its debts easily. In other
words, all insolvent entities might not be declared bankrupt however all bankrupt’s entities are
said to be insolvent.

Insolvency and Bankruptcy code defines the complete legal procedure which governs the
bankruptcy and insolvency related matters. It also intends to ensure that bankruptcies are
governed in fair manner and are not misused to ditch the fellow creditors.

In case you are insolvent and tend to file for bankruptcy then you must seek legal advice in doing
so, there are many insolvency professional agency in the market who can help you with the
1
https://www.investopedia.com/terms/i/insolvency.asp
2
https://www.taxmann.com/blogpost/2000000380/the-difference-between-insolvency-and-bankruptcy.aspx
same. If you have been through any such condition, then please do share your experience in
comment box below.3

Understanding Operational creditor

A company has different types of creditors each of whom have different rights and motivations.
Accordingly, when insolvency resolution commences, their concerns are different, and may have
to be accounted for differently. Thus, typically insolvency regimes make accommodation for
different creditors. In India, the Code recognises three different types of creditors: financial
creditors, operational creditors and other creditors. Each of these have been given different rights
and powers. Accordingly, it becomes relevant to determine which types of debt would be
classified as financial, operational or other debt.4

Section 3(10) of the Insolvency and Bankruptcy Code 2016 defines creditors in following terms
“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
section clearly states that the operational creditors are also creditors under this definition. In the
very next sub-section operational debt has been covered under the definition of the debt. 5 The
definition of operational creditors in the act has been provided as following “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 transferred.”6

It is necessary to understand what the term operational debt itself means. It will help us
understand the concept of operational creditor in a better manner. Operational debt means “a
claim in respect of the provision of goods or services including employment or a debt in respect
of the repayment of dues arising under any law for the time being in force and payable to the
Central Government, any State Government or any local authority”7

The key criteria to determine if a debt is a financial debt is if it was extended for time value of
money. On the other hand, a debt would be operational debt only if it relates to the four
categories: goods, services, employment and Government dues. Debts other than these would be
3
https://www.taxmann.com/blogpost/2000000380/the-difference-between-insolvency-and-bankruptcy.aspx
4
Vidhi Center for Legal Policy, Understanding the Insolvency and Bankruptcy Code, 2016.
5
Section 3(11), The Insolvency and Bankruptcy Code, 2016.
6
Section 5(20), The Insolvency and Bankruptcy Code, 2016.
7
Section 5(21), The Insolvency and Bankruptcy Code, 2016.
classified as other debts. The rights and powers of relevant creditors of each of these different
categories of debts are different and thus classification of debts is key in the corporate insolvency
resolution process.

In Swiss Ribbons Ltd. v. Union of India,8 the Court laid down the distinction between ‘Financial
Debt’ and ‘Operational Debt’ in the following terms, “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.”

In Col. Vinod Awasthy v. AMR Infrastructure Limited,9 the NCLT interpreted the definition of
‘operational creditor’under the Code. The NCLT observed that the framers of the Code had not
proposed to include within the expression of an ‘operational debt’, a debt other than a financial
debt.34Therefore, an operational debt would be related only to four categories as specified in
section 5(21) of the Code like goods, services, employment and Government dues. A similarly
strict approach to interpreting this section was exhibited in the cases of Mukesh Kumar v. AMR
Infrastructure Limited10 and Pawan Dubey and Another v. J.B.K. Developers Private Limited.11

However, the term has been interpreted more broadly on a case-to-case basis. For instance, in
Renish Petrochem FZE v. Ardor Global Private Limited,12 where the issue for consideration was
whether a guarantor can be considered as Corporate Debtor in case of claim by an operational
creditor, the NCLT, held that “the amount due from the buyer of the goods, and which is due to
the seller of the goods and is guaranteed by the Guarantee Agreement, is also an ‘operational
debt’”

How the process starts?

8
Swiss Ribbons Pvt. Ltd & Anr v. Union of india, Writ Petition (Civil) No. 99 of 2018.
9
Col. Vinod Awasthy v. AMR Infrastructure Limited, C.P. No. (IB)10(PB)/2017. Decision date-20.02.2017.
10
Mukesh Kumar v. AMR Infrastructure Limited, C.P. No. (IB)-30(PB)/2017. Decision date-31.03.2017.
11
Pawan Petrochem FZE v. Ardor Global Private Limited, C.P. (I.B) No. 33/9/NCLT/AHM/2017.
12
Renish Petrochem FZE v. Ardor Global Private Limited, C.P. (I.B) No. 33/9/NCLT/AHM/2017. Decision date-31.07.2017.
Section 6 of Chapter II of the code, states that in case a corporate debtor commits a default, then
“operational creditor may initiate corporate insolvency resolution process in respect of such
debtor in the manner provided in prescribed resolution.” 13 Now let us understand this process
through which this insolvency process is to be initiated. Firstly when a default is done on the part
of corporate debtor, the operational creditor has to send a demand notice of a copy of invoice to
demand payment of the amount involved in the default to such corporate debtor. 14 After such
notice is sent the corporate debtor has to within ten days of receiving such notice, bring into the
notice of the operational creditor of (1) any dispute which exists along with existence of any
“record of the pendency of the suit or arbitration proceedings filed before the receipt of the
notice in relation to dispute”15 (2) the details of the repayment of such debt done by the corporate
debtor to the operational creditor.16

Secondly, after the expiry of the period of ten days of the delivery of the notice demanding
payment, if the operational debtor does not receive payment or notice of dispute from the
corporate debtor, the Operational debtor can then file an application before the adjudicating
authority for initiating a corporate insolvency resolution process. 17 The adjudicating authority as
per Section 5(1) is the National Company Law Tribunal which is constituted under Section 408
of the Companies Act, 2013.

Importance of dispute filing

Vis-à-vis operational creditors, therefore, the Code provides a mechanism for the corporate
debtor to specifically raise a dispute. This can be used to prevent the admission of a petition to
initiate an insolvency resolution process. However, there has been a lack of clarity on the scope
of the term dispute, and on the point at which a dispute should have been raised. Different
benches of the NCLT provided conflicting interpretations to the terms ‘dispute’ and ‘existence of
dispute’. The Mumbai Bench gave a strict interpretation to the terms,50and observed that the
word ‘includes’ should be read as ‘means’, and consequently, a dispute would meandisputes
raised in a court of law or Arbitral Tribunal before receipt of notice under section 8 of the Code.
On the other hand, the Principal Bench provided a very liberal interpretation to the terms in
13
Section 6,
14
Section 8(1)
15
Section 8(2)(a)
16
Section 8(2)(b)
17
Section 9(1)
question in a catena of cases,51and held that the definition of dispute is illustrative in nature and
any dispute raised post issuance of a demand notice, whether before a court of law/ competent
authorityor otherwise, could also be considered as a valid dispute.

The NCLAT took a similar view as the Principal Bench of the NCLT in Kirusa Software Pvt.
Ltd. v. Mobilox Innovations Pvt. Ltd.18 and provided a liberal interpretation to the phrases
‘dispute’ and ‘existence of dispute’. The NCLAT held that the definition of “dispute” is
“inclusive” and not “exhaustive” and includes mediation, conciliation, labour court, consumer
court or any other proceedings pending or raised before any court of law or authority. The
NCLAT also held that the dispute need not be pending between the parties prior to the notice of
demand, but could be raised thereafter. Significantly, it also clarified that Adjudicating Authority
need not verify the adequacy of dispute. It only needs to be satisfied that a genuine dispute
exists. This matter was finally settled by the Supreme Court in Mobilox Innovations Pvt. Ltd. v.
Kirusa Software Pvt. Ltd.19 The Court held that the definition of dispute is an inclusive one and
also held that it would not be necessary for the dispute to be pending before the filing of the
application since “a dispute may arise a few days before triggering of the insolvency process, in
which case, though a dispute may exist, there is no time to approach either an arbitral tribunal or
a court.”To determine if the dispute exists, the court held that “all that the adjudicating authority
is to see at this stage is whether there is a plausible contention which requires further
investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact
unsupported by evidence.

The Court does not at this stage examine the merits of the dispute except to the extent indicated
above. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the
Adjudicating Authority has to reject the application.”20 By virtue of the Second Amendment to
the Code, the decision in Mobilox was given statutory recognition.

18
Kirusa Software Pvt. Ltd. v. Mobilox Innovations Pvt. Ltd., Company Appeal (AT) (Insolvency) 6 of 2017. Decision
date-24.05.2017.
19
Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd.,Civil Appeal No. 9405 of 2017. Decision date-
21.09.2017.
20
Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd.,Civil Appeal No. 9405 of 2017. Decision date-
21.09.2017.
This decision has thereafter been applied in context of arbitration proceedings by the Supreme
Court itself. In K. Kishan v. Vijay Nirman Company Pvt. Ltd., 21 the Court held that “operational
creditors cannot use the Insolvency Code either prematurely or for extraneous considerations or
as a substitute for debt enforcement procedures. The alarming result of an operational debt
contained in an arbitral award for a small amount of say, two lakhs of rupees, cannot possibly
jeopardize an otherwise solvent company worth several crores of rupees. Such a company would
be well within its rights to state that it is challenging the Arbitral Award passed against it, and
the mere factum of challenge would be sufficient to state that it disputes the Award. Such a case
would clearly come within para 38 of Mobilox Innovations (supra), being a case of a pre-existing
ongoing dispute between the parties.”22 Further, the Court stated that “the object of the Code, at
least insofar as operational creditors are concerned, is to put the insolvency process against a
corporate debtor only in clear cases where a real dispute between the parties as to the debt owed
does not exist.”

Application process

The operational creditor has to furnish along with the application prescribed fee, copy of the
invoice demanding payment, an affidavit to the effect that no dispute notice was given by the
corporate debtor to them, a copy of the certificate by the financial institute managing the
accounts confirming that the payment has not been made and other such information as may be
specified.23 Operational creditor also has a choice to propose an interim resolution professional.24

Within fourteen days of receiving the application the adjudicating authority shall admit or reject
such application. If the authority orders to admit the application then it has to communicate such
decision to both the operational creditor and corporate debtor. Such decision of admittance has to
be based on the following factors, firstly that the application is complete and as per prescribed
format, secondly that there is no repayment done of the said debt, thirdly that the notice for
payment was indeed sent and no notice of dispute was sent by the corporate debtor and lastly that
there is no disciplinary proceedings pending against any resolution professional proposed by the

21
K. Kishan v. Vijay Nirman Company Pvt. Ltd., Civil Appeal Nos. 21824 and 21825 of 2017. Decision date
-14.08.2018.
22
K. Kishan v. Vijay Nirman Company Pvt. Ltd., Civil Appeal Nos. 21824 and 21825 of 2017. Decision date
-14.08.2018
23
Section 9(3)
24
Section 9(4)
operational creditor.25 The corporate insolvency resolution process will commence from the date
of the admission of this application.

The rejection of the application has to be done on the following basis, firstly that the application
made is incomplete, secondly that there has been repayment of the unpaid operational debt,
thirdly that the creditor has not delivered the invoice for payment to the corporate debtor,
fourthly that the notice of dispute has been received by the operational creditor or there is a
record of dispute in the information utility and lastly if it is found that there is a disciplinary
proceeding pending against the proposed resolution professional.26 However if there is a case of
defect in the application then the adjudicating authority can ask the applicant to correct such
mistake within 7 days of the receipt of giving notice of such defect.27

The corporate insolvency process “must be completed within a period of one hundred and eighty
days from the date of the admission of the application to initiate such process.” 28 However if the
committee of creditors by a vote of seventy five percent can instruct the resolution professional
to file an application to the adjudicating authority to extend this period beyond 180 days. If the
adjudicating authority agrees that the process of corporate insolvency resolution cannot be
completed within the prescribed period then it can order to extend the duration only once as it
deem fit not exceeding ninety days.29

Prohibitions on debtors after admitting application

The adjudicating authority after admission shall by an order declare a moratorium i.e. a
temporary prohibition of activity referred in section 14. The authority shall also cause a public
announcement of the initiation of corporate insolvency resolution process and call for the
submission of claims under section 15 and also appoint an interim resolution professional as per
procedure.30

The Adjudicating authority shall by order declare moratorium for prohibiting certain activities
like institution of suits or continuation of pending suits or proceedings against the corporate

25
Section 9 (5)(i)
26
Section 9(5)(ii)
27
Proviso Section 9(5)
28
Section 12(1)
29
Section 12(3)
30
Section 13
debtor which also includes execution of any judgment, decree or order in any court of law,
tribunal, arbitration panel or other authority. Secondly there must also be ordered prohibition on
corporate debtor from transferring, encumbering, alienating or disposing of any of its asset or
any legal right or beneficial interest. Thirdly prohibition can also be imposed on any action to to
foreclose, recover or enforce any security interest created by the debtor in respect of its property
including any action under the SARFESI Act, 2002. Lastly prohibition can also be put on
recovery of property by an owner or lessor where such property is occupied by or in the
possession of the corporate debtor.31

Conclusion

After we understand the meaning of Insolvency and Bankruptcy as per the Insolvency and
Bankruptcy Code, 2016, we also get to know that there are different types of creditors and
debtors which this code covers. The topic for my study was operational creditor and how the
process of corporate insolvency begins in case of these operational creditors. Firstly I made
detailed analysis about the meaning of operational debt and what all it covers. Then I gave a
detailed explanation as to the process which has to be followed from giving notice to corporate
debtor and then filing application before the adjudicating authority. Between this it was also
explained how important it is to file an objection or dispute to the first notice that you receive
from the operational creditor. After this the adjudicating authority takes over the process and
then the routine handing of this dispute takes place through resolution professional.

31
Section 14(1)