Decree holders not financial creditors under IBC

The Insolvency and Bankruptcy Code, 2016 (IBC) was conceived as a solution to the growing problem of non-performing assets. Together with the Reserve Bank of India’s framework for the resolution of stressed assets, the IBC is to be used to resolve viable businesses in a timely fashion. Banks and financial institutions were given precedence in initiating corporate insolvency resolution processes (CIRP) and approving plans for the resolution of the corporate debtor. Operational creditors often bemoan their unequal status under the IBC, as they are forced to take an almost complete haircut on what is owed to them. The right of an operational creditor to initiate insolvency proceedings is also restricted, since a disputed debt cannot be used as the basis for initiating insolvency proceedings.

As financial creditors only need to show a default in the payment of debt by the debtor, creditors often attempt to classify every amount due as a financial debt under the IBC. Using settlement agreements that prescribe interest on delayed payments or decrees, parties have sought to persuade tribunals that operational debts have become financial debts by the imposition of a rate of interest or internal rate of return. Decree holders have gone before tribunals claiming to be financial creditors on the strength of adjudicated debts.

In the recent case of Sushil Ansal v Ashok Tripathy & Ors, the National Company Law Appellate Tribunal (NCLAT) had to decide whether a decree obtained by allottees of a real estate project (REP) under the Real Estate (Regulation and Development) Act, 2016, could make them financial creditors, allowing them to trigger a CIRP. The NCLAT, noting that a decree is only an adjudication of liability and not a debt, held that the amount was not a financial debt for the purposes of the IBC. The mode of execution is found in the statute under which the decree is passed and a decree holder cannot therefore circumvent such recovery proceedings by initiating insolvency proceedings against the debtor. An application to initiate a CIRP against a corporate debtor by allottees under an REP has to be filed jointly by not less than 100 of such allottees or not less than 10% of the total number of such allottees under the same REP. The allottees in this case did not fulfill these conditions and were not therefore financial creditors. To overcome this obstacle, the allottees claimed to be financial creditors because they were decree holders.

In other judgments, the NCLAT has refused to allow decree holders to initiate insolvency proceedings under section 7 of the IBC because section 65 states that insolvency proceedings attract penal sanctions if filed maliciously other than for the resolution of insolvency. The NCLAT has thus made it clear that creditors other than those who are owed debts as strictly defined cannot recover their debts under the IBC. Not even undisputed debts, debts awarded by adjudication, interest for delayed payment or penal interest are classified as financial debts.

The NCLT has refused to accept jurisdiction under the IBC in such cases because the IBC is not a recovery mechanism. Amounts awarded under a decree may be classified as debts under the IBC as decree holders fall within the definition of creditors under section 3(10) of the IBC. However, whether they are financial or operational creditors depends on the nature of the underlying transaction. The NCLAT has clarified in Sushil Ansal that a creditor is not automatically deemed to be a financial creditor merely because it holds a decree in its favour. When an underlying transaction can be independently proved to be a financial transaction, and the decree only decides the quantum of the debt, the decree can be treated as a financial debt.

The NCLT appears to be following a consistent approach of disallowing decree holders to initiate proceedings under the IBC on the strength of the decrees alone. These decisions are consistent with the purpose of the IBC, that is the resolution of stressed assets and not the provision of a recovery mechanism. Had the tribunal allowed decree holders to apply as financial creditors, it would render the execution provisions of individual statutes otiose.

The National Company Law Tribunal and the NCLAT have also relied on the conduct of the party who claims to be a creditor. After pursuing litigation or arbitration, a successful litigant cannot use the IBC mechanism merely because it offers an easier and quicker process. Insolvency proceedings are not a substitute for recovery proceedings, especially when the corporate debtor is a viable company with sufficient assets.

Anush Raajan is a joint partner and Swastika Chakravarti is a senior associate at Lakshmikumaran & Sridharan.

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