Before the Insolvency and Bankruptcy Code, 2016 was enacted, India’s legal framework classified creditors into two categories: secured and unsecured. Secured creditors had the benefit of collateral or a security interest in the assets of the debtor. Unsecured creditors, on the other hand, had no such protection and were often left vulnerable in recovery proceedings. However, this binary division failed to account for the complexity and variety of commercial arrangements that exist in the modern economic system.
The IBC introduced a more refined classification under Section 3(10), distinguishing creditors into five categories: secured creditors, unsecured creditors, financial creditors, operational creditors, and decree holders. This change aimed to bring structure to insolvency proceedings by recognizing the different roles creditors play in a corporate entity’s financial ecosystem. Two of these categories, financial creditors and operational creditors, were newly introduced terms that significantly altered the treatment of claimants during insolvency resolution and liquidation processes.
The concept of operational creditors, in particular, has drawn attention due to its role in the day-to-day functioning of a company. These creditors are typically involved in the routine supply of goods or services or are owed statutory dues. Their recognition under the IBC has provided them with legal standing in insolvency matters, which previously remained underdefined in Indian corporate law.
Understanding the Scope of Financial Creditors
To understand operational creditors more clearly, it is essential to first define financial creditors. Section 5(7) of the Code defines a financial creditor as any person to whom a financial debt is owed. This includes those to whom such a debt has been legally assigned or transferred. The corresponding definition of financial debt under Section 5(8) refers to a debt, along with any interest, that has been disbursed against the consideration for the time value of money.
The definition includes a broad range of financial instruments and arrangements, such as money borrowed under loan agreements, amounts raised through bonds or debentures, and transactions involving derivatives and guarantees. Financial creditors are typically banks, financial institutions, bondholders, and other investors whose contributions are based on credit facilities extended to the debtor with repayment terms involving interest over time.
These creditors play a central role in the corporate insolvency resolution process, especially since they form the Committee of Creditors, which holds the authority to evaluate and approve resolution plans. Their role is well-defined and central to the success of the resolution mechanism under the IBC.
Who Qualifies as an Operational Creditor
Section 5(20) of the Code introduces the term operational creditor and defines it as any person to whom an operational debt is owed, including those to whom such debt has been legally assigned or transferred. Operational debt, as defined in Section 5(21), refers to a claim in respect of the provision of goods or services, including employment, or a debt in respect of dues arising under any law payable to the Central Government, State Government, or local authority.
This means that suppliers, service providers, employees, and government departments can all be considered operational creditors, provided there exists a legitimate claim against the debtor for goods delivered, services rendered, salaries unpaid, or statutory dues not remitted.
Unlike financial creditors who provide capital in return for interest-bearing obligations, operational creditors contribute to the working capital cycle of a company by offering goods or services essential for its operation. Their claim arises from commercial contracts or statutory liabilities rather than financing arrangements.
Subcategories of Operational Creditors
Operational creditors are not a homogeneous group. They can be broadly categorized into three main classes depending on the nature of the claim and the claimant. Understanding these classifications is crucial for analyzing their treatment under the insolvency process.
Suppliers and Service Providers
The most common type of operational creditors includes those who have supplied goods or rendered services to the corporate debtor. These suppliers could range from vendors providing raw materials to software companies offering technical support. Such transactions typically involve a contractual arrangement, where the consideration is payable upon delivery or within a specified credit period.
When the debtor defaults on payment, the unpaid supplier becomes an operational creditor. Their claims are often backed by invoices, purchase orders, and delivery receipts, although informal arrangements in smaller businesses can complicate documentation. These creditors are essential to the continued operations of any business and, therefore, their inclusion in the insolvency framework is critical.
Employees and Workmen
Another important class of operational creditors includes employees and workmen who have rendered services to the company. This category covers unpaid wages, salaries, bonuses, and other employment-related dues. While employees are often the most vulnerable group during financial distress, their recognition as operational creditors provides them with a mechanism to assert their claims in insolvency proceedings.
It is noteworthy that employee dues also enjoy a specific position in the waterfall mechanism under the liquidation process. Their claims are prioritized above other unsecured creditors but below secured claims and liquidation costs. However, this prioritization does not necessarily translate into full recovery, especially in cases of severe financial collapse.
Government Authorities and Statutory Dues
Perhaps the most legally complex category of operational creditors comprises government authorities. These include departments responsible for collecting taxes, levies, cess, and other statutory dues. Under the IBC, any unpaid obligation under laws such as the Goods and Services Tax Act or the Income Tax Act qualifies as an operational debt.
Consequently, the Central Government, State Governments, and local bodies become operational creditors when statutory dues remain unpaid. Although these authorities do not render services in the traditional sense, the Code explicitly includes such liabilities within the scope of operational debt. This clarification is crucial, as it harmonizes commercial insolvency proceedings with the government’s right to collect revenue.
Legislative Intent and Policy Considerations
The introduction of operational creditors into the legal framework of insolvency reflects the legislature’s intent to recognize all forms of commercial and statutory obligations. The IBC seeks to create a unified mechanism to resolve insolvency while ensuring that no genuine claim is left outside the process.
By classifying operational creditors separately, the Code acknowledges the difference in their risk profiles, the nature of their claims, and their limited role in financial decision-making. This classification also ensures that resolution plans and liquidation proceeds address the rights of all stakeholders, not just those who provide financial capital.
The policy approach emphasizes fairness, transparency, and inclusivity. While operational creditors do not hold voting rights in the Committee of Creditors unless they qualify under specific criteria, the law ensures that they are not ignored altogether. The resolution plan must include provisions for payment of their dues, and they are allowed to raise objections if they believe the plan does not treat them equitably.
Treatment of Assigned and Transferred Claims
The definition of operational creditor also includes those to whom an operational debt has been assigned or transferred. This inclusion is particularly relevant for factoring companies, debt collection agencies, and investors who purchase distressed receivables. When such entities acquire the operational debt of a supplier or service provider, they step into the shoes of the original creditor and are entitled to pursue claims under the IBC.
This provision supports a secondary market for receivables and enhances liquidity for operational creditors. It allows businesses to monetize their unpaid invoices without waiting for protracted recovery timelines. At the same time, it adds a layer of complexity to the insolvency process, as resolution professionals must carefully verify the legitimacy and chain of title of assigned claims.
Procedural Requirements for Operational Creditors
Operational creditors can initiate insolvency proceedings against a corporate debtor by filing an application under Section 9 of the Code. However, this is subject to a threshold of default, and the creditor must issue a demand notice prior to initiating action. If the debtor disputes the claim and provides evidence of a pre-existing dispute, the application may be rejected.
This mechanism ensures that insolvency is not misused as a tool for debt recovery in cases of genuine contractual disagreement. It also introduces a degree of legal scrutiny, as the adjudicating authority must determine whether the dispute raised by the debtor is valid and substantial.
Operational creditors are also required to submit their claims in a prescribed format when a corporate insolvency resolution process is admitted. These claims must be supported by invoices, contracts, correspondence, and other documentary evidence. Upon verification by the resolution professional, the claims are admitted and considered for distribution.
Legal Developments and Interpretations
Several judicial decisions have clarified the position and rights of operational creditors. The courts have emphasized that operational creditors cannot be treated unfairly in a resolution plan and must receive at least the liquidation value of their claims. In cases where they are offered negligible amounts or excluded altogether, tribunals have directed resolution professionals to revise or reject such plans.
The judiciary has also upheld the requirement of serving a demand notice before initiating insolvency and stressed the need for adequate evidence in cases of contested debt. These rulings have strengthened the procedural safeguards available to operational creditors while discouraging frivolous or abusive litigation.
Role in Corporate Insolvency Resolution
Although operational creditors do not generally participate in the decision-making process of the Committee of Creditors, they have the right to be heard by the adjudicating authority. They can submit objections to resolution plans and raise concerns if they believe their interests are not being adequately protected.
Their inclusion in the insolvency ecosystem ensures that critical suppliers and service providers are not forced out of business due to unpaid dues. It also maintains the continuity of operations in distressed companies, allowing for smoother resolution or liquidation. By providing a formal forum for claim resolution, the Code brings predictability and order to what was previously a chaotic and uncertain process.
Introduction to the Classification
The Insolvency and Bankruptcy Code, 2016 introduced a novel approach to classifying creditors, distinguishing operational creditors from other categories like financial creditors and decree holders. This differentiation is not merely semantic but has significant legal and practical implications during the corporate insolvency resolution process.
Statutory Definition and Scope
As per Section 5(20) of the IBC, an operational creditor is any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Section 5(21) further elaborates that operational debt refers to claims arising from the provision of goods or services, including employment, or debts related to statutory dues payable to central or state governments or local authorities.
Classes of Operational Creditors
Operational creditors can be broadly categorized into three major groups based on the origin and nature of their claims. These categories also help define the way such claims are treated during resolution or liquidation proceedings.
Suppliers and Service Providers
This group includes vendors and contractors who supply goods or render services to the corporate debtor in the ordinary course of business. Their dues are considered operational debts under the IBC. For example, if a construction company fails to pay a subcontractor for raw materials supplied, the subcontractor is an operational creditor.
These creditors form a significant portion of the claims pool in insolvency cases. Their rights under the IBC allow them to initiate corporate insolvency resolution proceedings if the default amount exceeds the prescribed threshold. However, their role in the decision-making process post-admission is limited compared to financial creditors.
Employees and Workmen
Individuals employed by the corporate debtor who have pending dues relating to salaries, wages, or other employment benefits are also categorized as operational creditors. These dues are recognized as operational debt and must be acknowledged and settled as per the insolvency resolution process.
Although employees can also initiate insolvency proceedings, their influence in the Committee of Creditors is virtually non-existent, given their classification. Nevertheless, provisions exist to prioritize their claims during liquidation, recognizing the vulnerable position they hold.
Government Authorities
Government bodies, whether central, state, or local, are often owed various statutory dues by corporate entities. These include taxes like GST, excise, income tax, and other levies. The IBC treats these statutory dues as operational debt, thus making the government departments operational creditors.
This classification has been the subject of judicial scrutiny, particularly with debates on whether sovereign dues should be considered at par with private operational claims. Nonetheless, the Code provides a unified treatment to all operational creditors, including governmental authorities.
Procedural Aspects
Filing of Claims
Operational creditors are required to file their claims with the Interim Resolution Professional in a prescribed format along with relevant documents such as invoices, purchase orders, or statutory demands. This submission forms the basis for the verification and inclusion of claims in the resolution process.
Initiation of Insolvency
An operational creditor can trigger the insolvency resolution process under Section 9 of the IBC. Before initiating the application, a demand notice must be sent to the corporate debtor. If the debtor fails to respond or dispute the claim within ten days, the creditor can file an application before the adjudicating authority.
This process is slightly different from that of financial creditors, who do not require a prior notice before filing an application. The objective is to allow the debtor a fair chance to settle or dispute the dues before the matter escalates.
Representation in the Resolution Process
Operational creditors do not have voting rights in the Committee of Creditors unless they constitute at least ten percent of the total debt. Even when they are included, their role is minimal and largely consultative. This has raised concerns about the equitable treatment of operational creditors within the resolution framework.
Judicial Interpretations
Over the years, Indian courts and tribunals have played a crucial role in clarifying the position and rights of operational creditors. Several key judgments have reaffirmed that operational creditors are to be treated fairly, although not necessarily on par with financial creditors.
For example, courts have ruled that any resolution plan must ensure that operational creditors receive an amount not less than what they would receive in the event of liquidation. This provides a safety net for operational creditors, ensuring they are not completely sidelined.
Comparison with Financial Creditors
Financial creditors generally include banks, financial institutions, and lenders who have extended credit for the time value of money. Their rights under the IBC are significantly greater, including the power to form and vote in the Committee of Creditors.
In contrast, operational creditors, despite being integral to the business’s daily operations, have a limited role post-admission of the insolvency petition. The rationale behind this difference is that financial creditors are considered better equipped to assess the viability and feasibility of resolution plans.
This distinction has sparked debate on whether the current structure under the IBC creates an imbalance, and whether operational creditors should be given greater say in the resolution process.
Role in the Liquidation Process
During liquidation, operational creditors are ranked below secured and unsecured financial creditors. Their dues are settled after paying off insolvency resolution process costs, secured creditors, and employee dues.
Despite their lower ranking, the liquidation value received by operational creditors must comply with the minimum guarantee established by the Code and judicial precedent. Liquidators are required to treat all operational creditors equally within their class.
Practical Challenges
Several challenges confront operational creditors during insolvency proceedings. The lack of representation in key decision-making, delays in realization of dues, and complexities in claim verification are some of the major issues.
Smaller vendors often find the process daunting, especially when dealing with procedural formalities like claim submissions and court appearances. There have been calls for greater institutional support to assist small and medium enterprises in asserting their rights under the IBC.
Case Studies and Examples
In several high-profile insolvency cases, operational creditors have found themselves with limited recoveries. Despite contributing significantly to the debtor’s operational continuity, their claims were often settled at a fraction of the admitted amount.
These instances underline the importance of balanced treatment and the need for a more inclusive framework that recognizes the legitimate concerns of operational creditors.
Role and Treatment of Operational Creditors in CIRP and Liquidation Process
The Insolvency and Bankruptcy Code, 2016, introduces a structured process for resolving insolvency and bankruptcy cases through the Corporate Insolvency Resolution Process (CIRP) and liquidation. One of the critical aspects of this legal framework is the treatment of operational creditors during these proceedings.
While financial creditors play a central role in the resolution process, operational creditors are also provided with specific rights and responsibilities. We explored how operational creditors are treated under the Code during CIRP and liquidation, analyzing their position in the waterfall mechanism, their right to participate in meetings, and their recourse in case of dissatisfaction with the process.
Rights of Operational Creditors in CIRP
Filing of Claims
Operational creditors may initiate CIRP by filing an application before the Adjudicating Authority under Section 9 of the Code, provided there is a default in the payment of operational debt. Before initiating proceedings, the operational creditor is required to serve a demand notice or invoice demanding payment. If the corporate debtor fails to respond within ten days or fails to provide evidence of dispute or payment, the operational creditor can move forward with the application.
Additionally, operational creditors can submit their claims to the interim resolution professional (IRP) once CIRP is initiated, even if they were not the applicant. These claims must be supported by relevant documents like invoices, contracts, or statutory notices.
Committee of Creditors (CoC)
While operational creditors are not part of the CoC, which primarily consists of financial creditors, the Code permits them limited participation. If the aggregate amount of their claims is not less than ten percent of the total debt, an operational creditor may be invited to attend CoC meetings. However, their presence is limited to attendance and they do not possess voting rights.
Role During Resolution Plan Approval
Operational creditors are entitled to receive payments under any approved resolution plan. Section 30(2)(b) of the Code requires that the resolution plan must provide for payment of debts to operational creditors in a manner that is not less than the amount they would receive in the event of liquidation. This ensures a minimum level of protection for operational creditors and creates an obligation on the resolution applicant to consider their claims.
Priority of Claims in Liquidation
Waterfall Mechanism
The IBC prescribes a waterfall mechanism under Section 53 that prioritizes the distribution of assets during liquidation. Operational creditors fall below certain other categories in this hierarchy, which affects their ultimate recoveries. The priority is as follows:
- Insolvency resolution process costs and liquidation costs
- Workmen’s dues for the preceding twenty-four months and debts owed to secured creditors who have relinquished their security
- Wages and unpaid dues owed to employees (other than workmen) for the preceding twelve months
- Financial debts owed to unsecured creditors
- Government dues and debts owed to operational creditors
- Any remaining debts and dues
- Preference shareholders
- Equity shareholders or partners
This sequence indicates that operational creditors are lower in the hierarchy than unsecured financial creditors and are treated on par with government dues. This often results in reduced recovery for operational creditors during liquidation.
Implication of Priority Position
The priority position of operational creditors means that, in most liquidation cases, their chances of full recovery are slim, particularly where the corporate debtor has limited assets. Therefore, operational creditors often prefer resolution plans to liquidation, as they are likely to receive higher amounts in the former scenario.
Challenges Faced by Operational Creditors
Delayed Recoveries
Operational creditors often face delays in receiving their dues due to the structured timelines and complexities involved in CIRP and liquidation. Despite the statutory deadlines, procedural hurdles and litigation can extend the duration of recovery.
Limited Participation in Resolution Decisions
Due to their exclusion from voting rights in the CoC, operational creditors have minimal influence over the decision-making process, including approval of resolution plans. This sometimes leads to dissatisfaction among operational creditors who feel their interests are inadequately represented.
Disputes over Claims
Operational creditors are also frequently subject to disputes regarding the quantum or validity of their claims. Corporate debtors may raise objections, citing pre-existing disputes, deficiencies in service or supply, or prior settlements. These disputes must be resolved before the claim can be admitted, which can result in further delays.
Legal Safeguards and Judicial Interpretations
Minimum Payout Provision
As noted earlier, the Code mandates that the resolution plan must provide for operational creditors to receive at least the amount they would obtain in liquidation. Courts and tribunals have emphasized this safeguard to prevent arbitrary exclusion of operational creditors from meaningful payouts.
Equal Treatment Principle
Judicial forums have reiterated that operational creditors should not be treated in a discriminatory manner compared to similarly placed creditors. The National Company Law Appellate Tribunal (NCLAT) has on several occasions directed resolution applicants to revise plans to ensure fairness in payouts to operational creditors.
Rejection of Resolution Plan
If a resolution plan does not adequately address the claims of operational creditors, the Adjudicating Authority has the power to reject the plan. This encourages resolution applicants to ensure that operational creditors are treated fairly.
Role in Triggering Insolvency Proceedings
Operational creditors often play a key role in initiating insolvency proceedings. Since their payments are typically short-term and non-interest bearing, any default may seriously affect their liquidity. Hence, the IBC allows them to serve demand notices and initiate insolvency if their dues remain unpaid and undisputed.
The threshold for default is one of the lowest among jurisdictions, set at one lakh rupees, although it may be revised by notification. This empowers even small suppliers or service providers to trigger insolvency proceedings and press for recovery.
Government Dues as Operational Debt
Statutory dues such as Goods and Services Tax (GST), customs duties, income tax arrears, and municipal taxes are all included under the definition of operational debt. Consequently, government departments are recognized as operational creditors and can file claims during CIRP and liquidation.
However, in practical terms, recovery by government bodies is also subject to the waterfall mechanism, where they rank equally with other operational creditors. This parity in ranking is consistent with the principle that all operational creditors should be treated uniformly, irrespective of whether they are private entities or public authorities.
Assignment and Transfer of Operational Debt
Operational debts, like financial debts, can be assigned or transferred to another person or entity. This allows operational creditors to monetize their claims or reduce exposure by transferring the debt to a third party, often a recovery agency or investor.
The transferee assumes the rights of the original creditor and can submit claims or initiate proceedings under the Code. This mechanism provides flexibility and liquidity to operational creditors who may otherwise face prolonged recovery cycles.
Practical Considerations for Operational Creditors
Documentation and Recordkeeping
Maintaining proper documentation, such as purchase orders, delivery receipts, invoices, contracts, and payment reminders, is crucial for operational creditors. In the absence of robust documentation, claims may be disputed or rejected.
Vigilant Monitoring of Debtors
Operational creditors must closely monitor the financial health of their clients and respond promptly to any signs of default. Serving demand notices without delay and filing applications within the stipulated timeline can make a difference in recovery prospects.
Use of Alternative Remedies
While the IBC provides an effective tool for recovery, operational creditors may also explore other remedies such as civil suits, arbitration, or commercial courts, especially in cases involving small debts or where the debtor is not a corporate person.
Emerging Trends and Policy Shifts
Increasing Use of Pre-packaged Insolvency
The introduction of pre-packaged insolvency resolution processes (Pre-Pack) for MSMEs is likely to have implications for operational creditors. These processes are designed to be faster and involve lesser litigation, which may benefit operational creditors through quicker recoveries.
However, since Pre-Pack also relies heavily on negotiations between financial creditors and corporate debtors, the challenge of limited participation by operational creditors continues.
Greater Judicial Scrutiny
Courts and tribunals are increasingly taking a proactive stance in protecting the rights of operational creditors. The insistence on fair treatment in resolution plans and scrutiny of CoC decisions reflect a shift toward more inclusive insolvency practices.
Emphasis on Resolution Over Liquidation
Regulatory authorities are placing greater emphasis on resolution rather than liquidation. Since operational creditors generally receive higher recoveries in resolution, this trend is expected to be favorable to them.
The treatment of operational creditors under the Insolvency and Bankruptcy Code reflects an evolving legal and regulatory environment. Although challenges remain, various safeguards and judicial pronouncements have contributed to improving their position.
Conclusion
The introduction of the Insolvency and Bankruptcy Code, 2016 marked a fundamental shift in the legal treatment of creditors by clearly distinguishing between financial and operational creditors. This nuanced categorization has significantly influenced the resolution and liquidation processes of corporate debtors in India. Operational creditors, who were once overshadowed by their financial counterparts, have now been provided a distinct legal identity with specific rights and entitlements under the Code.
Understanding the scope and definition of operational creditors is essential to grasp their role in insolvency proceedings. These creditors are not just limited to vendors and service providers but also include employees and government authorities to whom statutory dues are payable. The Code ensures that operational creditors are part of the insolvency ecosystem by granting them the right to initiate insolvency proceedings and to participate in the distribution of proceeds, though within the constraints set by the priority waterfall under the resolution and liquidation frameworks.
However, the practical application of the Code has revealed certain disparities between financial and operational creditors, especially in terms of voting rights within the committee of creditors and the proportion of claims recovered during resolution. These differences continue to raise concerns about equitable treatment and the need for further judicial and legislative clarification.
Judicial interpretations by the National Company Law Tribunal, National Company Law Appellate Tribunal, and the Supreme Court have played a critical role in shaping the contours of operational creditors’ rights and obligations. Despite some ambiguity, the evolving jurisprudence reflects a growing recognition of their importance in the insolvency process.
As India continues to refine its insolvency regime, operational creditors are likely to gain a stronger footing through procedural reforms and increased judicial attention. For stakeholders involved in the insolvency process, whether corporate debtors, financial institutions, service providers, or policymakers, understanding the rights, limitations, and strategic importance of operational creditors is vital to ensuring a fair, efficient, and inclusive insolvency resolution system.