To Discriminate or Not to Discriminate: NCLAT’s ruling on differential treatment of the creditors

Chetan Saxena, 4th-year student, Institute of Law, Nirma University.

Introduction

The National Company Law Tribunal [NCLAT] on February 28th, 2020 in Pacific World Shipping PTE Ltd. v. Dadi Impex Pvt. Ltd. and Ors. ruled that the tribunal cannot examine the commercial wisdom of the Committee of Creditors [CoC] and refuted the appellants’ argument of discriminatory treatment of the Operational Creditors as supposed to that of the Financial Creditors.

Ever since the enforcement of the Code, there have been conflicts over preferential treatment given to the financial creditors over the operational creditors. The two categories of the creditors have been intentionally segregated and both follow different procedural norms to initiate the CIRP process against corporate debtor. While the financial creditors file their application for initiation of CIRP under section 7 of the I & B Code, operational creditors proceed with under section 9 the I & B Code, This case comment analyzes the NCLAT’s judgment on differential treatment of creditors.

Factual Scenario

In the aforementioned case, the appellant who was the original operational creditor filed an application under section 9 of the I&B Code, 2016 which was subsequently accepted. On acceptance of the application, the Resolution Plan was put forth, which was laid down by the Promoters of the Corporate Debtor. While the RP provided for settling the claims of the financial creditors to 100%, the claims of the operational creditors where to be settled only up to 2% of the claimed amount. It is also important to note that the debt owed to the operational creditors was much higher compared to the contrasting category of creditors.

Contentions of the appellant

The appellant challenged the validity of the resolution plan on the grounds that,

  • the RP submitted and accepted by the CoC was discriminatory in nature and treated the two categories an arbitrary and unjust manner;
  • that the copies of the resolution plan were not provided to the appellant.

The appellant relied on the landmark judgment of the Committee of Creditors of Essar Steels India Ltd. Through Authorized Signatory v. Satish K. Gupta &Ors.,[Essar Steels] and stated that the tribunal has the power to reconsider the resolution plan if it feels that the interest of all the stakeholders has not been properly taken into account. Further, the appellant stated that in the case of the Vijay Kumar Jain v. Standard Chartered Banks & Ors., the Supreme Court of India has clearly stated that the copy of the Resolution Plan has to be mandatorily provided to the Operational Creditors even if it was part of the meeting of CoC.

Reply of Respondents

Respondent argued that Regulation 37 of IBBI (Insolvency Resolution Process for Corporate Persons) regulations 2016 provide that in order to maximize the value of the assets – which is the main purpose of initiating the CIRP, the reduction of claims can be made under the code and the operational creditors can be paid a lesser amount than what is claimed for.

Further, relying on Essar Steels (supra) and K. Shashidhar v. Indian Overseas Bank and Ors advocated  that the Apex Court has settled the position in regard to challenging the decision of the CoC and the Tribunal cannot enter into commercial wisdom of the CoC, thus had no power to amend the resolution plan. Further, it presented before the tribunal that the necessary documents stating that the minutes of the meetings and copy of the RP was provided to the representative of the Operational Creditors.

Tribunal Ruling

Repudiating the contentions of the appellant, the NCLAT looked into the circumstances and modifications made by the adjudicating authority and held that it is important to keep the Corporate Debtor a going concern, for the liquidation value of the company does not seems to be enough to recover the debts. Further, affirming the apex court rulings opined that it cannot play with the commercial wisdom of CoC and thus acceding the decision taken by CoC. Therefore, they reject the appeal for infructuous grounds

Comment

While the tribunal may have correctly relied on the rulings of the apex court, it fails to provide as to why such demarcation or discrimination is valid between the two categories of creditors. Where on one hand it relies on Essar steel for not encroaching upon the commercial wisdom of the CoC, it fails to consider that the same judgment talks of balancing the interest of all stakeholders. The primary objective of the code is to protect the interest of all the stakeholders which is very well enshrined in the preamble of the code itself.

Further, Respondent has wrongfully placed reliance on Regulation 37 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations of 2016 which lays down the reduction can be made in the claims of the operational creditors in order to maximize the value of the assets of the company. However, Regulation 37 nowhere uses the term operational creditor, rather only mentions a reduction in claims of creditors under R. 37(f). Thus, the tribunal without going into the enquiry of the same falsely relied on the Respondent’s argument.

While it is important not to play with the commercial wisdom of the CoC, it is also significant to note that such commercial wisdom should not encroach upon the rights of the stakeholders in an arbitrary or discriminatory manner. Where the basic objectives of the code get a hit, the adjudicating authority should have the authority to take measures to protect such objectives of the code. 

4 Replies to “To Discriminate or Not to Discriminate: NCLAT’s ruling on differential treatment of the creditors”

  1. The CoC has an obligation to consider the feasibility and viability of the RP and of they deem fit, they can accordingly approve the plan. The scope of interference of the AA is very limited as has been held by SC in essar steel’s case. Thus, in my limited knowledge, the judgment is a good piece of understanding of law.

    1. Judgment is good law. Reg. 37 allows reduction in payment to Creditors and Creditors u/s 3(10) includes OCs and FCs. As a matter of fact, Reg. 37 is the only statutory provision which enables reduction in amount payable to Creditors.

      Swiss Ribbons and Essar both recognise the differential treatment. In Essar, the limited benefits to OCs is that if they are given nil consideration, then it may amount to not balancing interest of stakeholders.

      Differential treatment among Creditors of same class has further been recognised by re-introduction of Dissenting Financial Creditors into the Code by legislating that DFC can be given amount due under liquidation.

  2. What’s your opinion on changing the status quo and seeing into issues like these where the recovery of debt for OC’s is zero or of negligible amount?

    Should Commercial Wisdom of CoC never be challenged?

    Looking forward to your comments.

    1. If it is zero, it’s unfair. It should be a considerate amount. From a very practical standpoint, it should be 5-8% of the debt. If it’s a listed company, may be more.

      Commercial wisdom should not be interfered with, save and except:
      – nil amount to OCs
      – discriminatory amounts within OCs. Many Plans give 100% to Statutory Dues and 1% to other OCs;

      In Maharashtra Seamless, SC upheld that Resolution Plan Value can even be lesser than Liquidation Value.

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