Difference B/W Financial Creditor and Operational Creditor under IBC, 2016

Currently, applications to begin a corporate bankruptcy resolution procedure must first

persuade the Tribunal that the petitioner is a “Financial Creditor” or an “Operational
Creditor” under the Insolvency and Bankruptcy Code, 2016. A financial creditor and an
operational creditor are two essential components of the insolvency procedure under the IBC,
2016.

The Code 2016 distinguishes between financial and operational creditors. Financial creditors
are those who have a strictly financial contract with the company, such as a loan or debt
security. Operational creditors are those that owe the firm money as a result of a business
transaction.

The IBC, which had been much anticipated, received the President’s approval on May 28,
2016. Section 3 (10) of the Code defines the term “creditor” as “any person to whom a debt is
due, including a financial creditor, an operational creditor, a secured creditor, an unprotected
creditor, and a statutory instrument;”

What Is Financial Creditor

“A person who owes a financial obligation, including anybody to whom such debt has been
legitimately assigned or transferred,” according to Section 5(7) of the Insolvency and
Bankruptcy Code.

The debt owing to a person must meet the definition of a “Financial Debt” as defined by
Section 5(8) of the IBC to establish if that person is a financial creditor.

A “Financial Debt” is defined as follows in section 5(8) of the IBC: – “A debt that is
disbursed in consideration for the time value of money, including any interest, and includes:-

1. Money that has been borrowed and will be returned with interest;
2. Any amount raised by the acceptance of a credit card or its dematerialized equivalent;
3. Any money raised through a note purchase facility or by the issuing of bonds, notes,
debentures, loan stock, or other similar instruments;
4. The total amount of any liability deriving from a lease or hire purchase arrangement
categorised as a finance or capital lease under The Indian Accounting Standards or
other accounting standards as stated;
5. Other than non-recourse receivables sold, a receivable sold or reduced
6. Any amount raised by any other transaction, including any forward sale/purchase
agreement, with the commercial impact of borrowing;
7. Any counter-indemnity obligation created by a bank or financial institution’s
guarantee, indemnity, bond, recorded letter of credit, or other instruments;
8. The amount of any obligations arising from any of the guarantees or indemnities for
any of the items listed in subclauses (a) through (h).”

What is Operational Creditor

“Anybody who owes an operational obligation, including anyone to whom such liability has
been legally assigned or transferred,” according to section 5(20) of the IBC.

The debt owing to a person must fulfil the definition of an operational debt as defined in
Section 5(21) of the Insolvency and Bankruptcy Code to determine if that person is an
operational creditor.

“Operational Debt” is defined as “a claim for the delivery of goods or services, as well as
employment, or a debt for the repayment of dues originating under any legislation presently
in existence and payable to the Central Government, any State, or any regional government”
under Section 5(21) of the IBC.

Significant differences between financial Creditor and Operational Creditor

 Someone who owes a financial debt is referred to as a financial creditor, but someone
who owes an operational debt is referred to as an operational creditor.
 Debt to financial creditors refers to a debt that is distributed against the consideration
for the time value of money, whereas debt to operational creditors refers to a demand
for the supply of products and services in exchange for the repayment of government
dues.
 In the event of a default, a financial creditor may collectively or separately with other
lenders file an application for the onset of arbitration proceedings against a corporate
debtor before an adjudicating officer, while an operational creditor may deliver a
demand notice of unpaid operational debtor copy for invoice requesting payment of
the amount involved in the default. The operational creditor may submit an
application at a later date.
 A financial creditor may include the name of a suggested resolution professional in
the application for an interim resolution professional appointment, but an operational
creditor must recommend a resolution professional for an interim resolution
professional appointment.
 Only financial creditors and corporate debt creditors will be represented on the
creditor’s committee. Members of the creditor’s committee will not be operational
creditors. The operational creditors do not have a vote at the meetings of the
committee of creditors.

Let us briefly describe the key differences between Financial creditors and Operational
Creditors.

  Particulars   Financial Creditor   Operational Creditor

A financial creditor, according to
Section 5 (7) of the Code, is According to Section 5 (7) of the
anyone to which a financial Code, a financial creditor is anybody
obligation is made, especially to whom a financial obligation is
Definition
anyone to whom such made, specifically anyone to whom
indebtedness has been such debt has been lawfully
legitimately delegated or transferred or conveyed.
transmitted.
Debt meaning According to Section 5 (8), According to Section 5 (21),
 operational debt is defined as a
financial debt is defined as a
demand for the delivery of goods or
debt, including any interest
services, including employment, or a
associated with it, payable
debt for the recovery of dues
against the compensation for the
originating under any existing
time value of money, and
legislation and attributable to the
includes the items listed in sub-
Central Government, State
clauses (a) – (c) (i).
Government, or any local authority.
Section 5 (28) – The voting
rights of a financial creditor are
determined by the share of the
The functional creditors will not be
financial debt owed to such
Voting share able to vote at the creditor’s
financial creditor. A majority of
committee meeting.
at least 75% of the voting shares
is required to approve the
creditor committee.
In the case of a default, the operational
creditor may submit to the corporate
debtor a demand notice of unpaid
operational debtor copy of an invoice
Section 7 (1) states that in the
demanding payment of the amount
case of a default, a financial
connected with the default, according
Launch of the creditor may file an application
to Section 8 (1) of the Code. If the
Corporate with the Adjudicating Authority
operational creditor does not receive
Insolvency to begin the corporate insolvency
compensation from the corporate
Resolution resolution procedure against a
debtor or notice of the dispute as
Program corporate debtor, either alone or
required by Section 8 sub-section (2),
together with other financial
the operational creditor may file an
creditors.
application for payment within 10
days of receiving the notice or invoice
as required by Section 8 sub-section
(2). (1).
According to Section 7(3), the
financial creditor must include Section 9(4) provides that an operating
The
the name of the resolution creditor may appoint a resolution
appointment of
professional who will serve as an expert to act as an interim resolution
an IRP
interim solution practitioner with professional.
the application.
Section 21(2) states that the
The
committee of creditors must be
composition of The Lenders Commission shall not
fully composed of financial
the Committee include any functional creditors.
creditors, along with all financial
of Creditors
creditors of the corporate debtor.
Financial A financial creditor must provide An operational creditor may transmit
Information financial information as well as financial records to the data utility
Submission information regarding the assets under Section 215(3).
 over which a financial asset has
been created, according to
Section 215(2).
Financial Creditor Are Prioritised

Financial creditors are given higher priority since they are members of the creditor’s
committee and have voting power, whereas operational creditors are not members of the
creditor’s committee. The underlying issue is that some categories of operational creditors are
subjected to discrimination since the statute’s provisions protect the rights and interests of
Financial Creditors. This is reinforced by the fact that when the application is submitted by
operational creditors, the respective class has no authority to make any proposals during the
creditor’s meeting held.

Should operational creditors be treated the same as financial creditors?

In its report dated November 4, 2015, the Bankruptcy Law Review Committee stated that
OCs will not risk their dues in exchange for the potentially bright future of the corporate
debtor and concluded that the CoC should consist only of financial creditors to carry out
the insolvency resolution process more effectively. The theory underlying this viewpoint was
that operational creditors would be more interested in the liquidation of the corporate
debtor rather than the resurrection of the firm, which would eventually contradict the primary
goal of the IBC.

Insolvency law in the United States distinguishes between secured and unsecured creditors.
Both groups of creditors, however, have the opportunity to vote on or reject any plan that
reduces their claims. Under Chapter 11 of the United States Bankruptcy Code, an unsecured
creditors committee is created to guarantee that the rights of such creditors are fairly
represented.

Excluding operational creditors from the IBC Committee of Creditors and stripping them of
decision-making rights is thus not only contrary to existing bankruptcy rules, but also
irrational.

In the recent past, a relatively high number of judicial decisions on the status of operational
creditors have been made public. The Supreme Court decided in the case of Swiss Ribbons
Pvt. Ltd. and Others v. Union of India that intelligible differentia came into play while
differentiating between operational creditors and financial creditors. As a result, this is not
discriminatory as defined by Article 14 of the Indian Constitution. The categorization is
warranted since the sorts of loans given by these two categories of creditors differ. It was also
indicated in this decision that a loan from a financial creditor is to contain a bigger amount of
money and a defined payback plan, which caused them to become involved in the
reconstruction of the aforementioned loan.

In the case of Akshay Jhunjhunwala and others v. Union of India, through the Ministry of
Corporate Affairs and others, this difference was also upheld. The Supreme Court ruled that
the separation created between financial creditors and operational creditors did not violate
any constitutional requirement. Equitable treatment of operating creditors was favoured
above equitable treatment in the case of Maharashtra Seamless Ltd. v. Padmanabhan
Venkatesh and others.
Some rulings, such as the Binani Industries Ltd. v. Bank of Baroda case, demonstrated
inconsistency with the preceding cases and stated their claims for fair treatment for all
creditors. This was a one-of-a-kind ruling that outlined the operational creditor’s interests but
omitted to name the operational creditor in the CoC. Some of the decisions in this ruling were
based on the Essar Steel Case.

Hon’ble NCLT on the Status of Operational Creditor

According to the Bankruptcy Law Reforms Committee in Paragraph 5.2.1 of its final report, a
financial creditor is a person whose connection with the entity is entirely connected to
financial transactions, such as a loan or debt security. An operational creditor, on the other
hand, is an individual whose liabilities to the company take the form of future payments in
exchange for already delivered items or services.

The IBC also provides for circumstances in which a creditor has participated in both a
financial and an operational transaction with the firm, according to the research. In such
cases, the creditor may be divided into two categories: financial creditors for the amount of
the financial debt and operational creditors for the amount of the operational debt.

The National Company Law Tribunal decided in the matter of Col. Vinod Awasthy vs. AMR
Infrastructure Limited (C.P. No. (IB) 10 (PB)/2017) that operational creditors are those
whose obligation from the firm comes from a transaction on operations. As a result, an
operational creditor is a wholesale supplier of replacement parts whose spark plugs are kept
in stock by auto mechanics and who is paid only when the spark plugs are sold.

Similarly, the lessor from whom the firm leases space is an operational creditor to whom the
company pays monthly rent throughout the duration of a three-year lease arrangement. The
Hon’ble Tribunal further decided that the Petitioner had not supplied any goods or rendered
any services in order to be classified as an ‘Operational Creditor.’

As a result of the above, it is obvious that Tribunals are unwilling to entertain petitions from
anybody who does not fulfil the IBC’s standards for financial and operational creditors. This
need must be satisfied in order to initiate business insolvency proceedings under the IBC. The
NCLT has made it feasible to severely enforce the new insolvency and bankruptcy
legislation.

Conclusion

Efficaciously introduce a corporate insolvency resolution process against a debtor, it is

necessary to prove that the creditor falls within the scope and extent of the definitions of
‘Financial Creditor’ as defined in Section 5(7) of the IBC or ‘Operational Creditor’ as defined
in Section 5(20) of the IBC. As per the case study, the Tribunals are strict in their
interpretation of the phrase “Operational Creditor” under the IBC, refusing to accept petitions
when the petitioners do not technically fall within the scope of the IBC and have alternative
valid remedies available.