Distinction in Treatment of FCs and OCs under IBC
Table of Contents
Distinction in Treatment of Financial Creditors vs. Operational Creditors
The Insolvency and Bankruptcy Code, 2016 consolidated India’s insolvency laws to ensure time-bound resolution of corporate insolvency. Unlike the Companies Act, 2013, which used the broad term “creditors,” the IBC distinguishes between financial creditors and operational creditors.
This distinction is not merely semantic — it affects the rights, remedies, and recoveries of creditors at every stage of the Corporate Insolvency Resolution Process. Understanding these differences is vital for creditors seeking to safeguard their interests.
Who is a Financial Creditor?
Defined U/S 5(7), a financial creditor is someone to whom a financial debt is owed. Section 5(8) elaborates that financial debt is money lent against the time value of money, including:
- Loans, bonds, debentures, and similar instruments.
- Liabilities from finance or capital leases.
- Receivables financing (other than on a non-recourse basis).
- Forward sale or purchase agreements with the effect of a loan.
- Guarantees, indemnities, and bank instruments.
- Example: Banks, NBFCs, bondholders, ARCs.
Who is an Operational Creditor?
Defined U/S 5(20), an operational creditor is someone owed an operational debt, i.e., U/S 5(21):
- Claims for goods or services (including employment).
- Statutory dues (e.g., GST, income tax, local authority levies).
- Example: Vendors, suppliers, employees, contractors, and government authorities.
IBC Section 7 vs IBC Section 9 – At a Glance
| Aspect | Section 7 (Financial Creditor) | Section 9 (Operational Creditor) |
| Role in CoC | Full voting rights | Limited / No voting rights |
| Demand Notice | Not required | Mandatory (Form 3 / Form 4) |
| Evidence Required | Proof of debt + default | Debt + proof + no pre-existing dispute |
| Control of CIRP | Financial creditors dominate | Operational creditors are secondary |
| Eligible Applicant | Banks, NBFCs, ARCs, bondholders | Vendors, suppliers, employees, govt. |
| Threshold | INR 1 crore default | INR 1 crore default |
Legal Conundrum in Section 7 of the Insolvency and Bankruptcy Code (IBC), 2016
The Insolvency and Bankruptcy Code, enacted in 2016, consolidated India’s fragmented insolvency framework into a single, creditor-driven process aimed at ensuring timely resolution, maximizing asset value, and balancing stakeholders’ interests. A key provision, Section 7, allows financial creditors to initiate the corporate insolvency resolution process upon default.
However, conflicting judicial interpretations have created a significant conundrum regarding the scope of the National Company Law Tribunal’s discretion U/S 7(5).
- In Vidarbha Industries Power Ltd. v. Axis Bank Ltd. (2022), the Supreme Court held that National Company Law Tribunal’s has discretion to admit or reject a Section 7 application despite proof of debt and default, considering broader factors like the debtor’s financial health.
- In M. Suresh Kumar Reddy v. Canara Bank (2023), the Supreme Court clarified that once debt and default are established, National Company Law Tribunals has a mandatory duty to admit the application, with no residual discretion.
The NCLAT in subsequent cases (e.g., Sunder Nagar Coop. Housing Societies Union Ltd. v. SBI) aligned with the stricter interpretation, reinforcing that CIRP admission is mandatory when debt and default are proved and acknowledged.
This divergence has led to uncertainty about whether National Company Law Tribunal’s role U/S 7 is purely mandatory or allows for discretionary refusal in special circumstances. The Ministry of Corporate Affairs has proposed an amendment to clarify that NATIONAL COMPANY LAW TRIBUNAL ’s role is limited to verifying default and procedural compliance, leaving no discretion to consider solvency or external factors.
Comparative Treatment Under IBC- with of FCs and OCs
| Aspect | Financial Creditors (FCs) | Operational Creditors (OCs) |
| Right to file CIRP | Section 7: May file directly upon default. | Section 9: Must first issue demand notice U/S 8. Application only if unpaid within 10 days. |
| Resolution Professional | Must propose an Interim Resolution Professional (IRP) in application (Sec. 7(3)). | May nominate an IRP (Sec. 9(4)). |
| Committee of Creditors (CoC) | Exclusively composed of FCs (Sec. 21(2)). | operational creditors are excluded. |
| Voting Rights | Voting share proportional to debt (Sec. 5(28)). Key decisions need 66% approval. | No voting rights; can only attend CoC meetings if dues ≥ 10% of total debt. |
| Information Filing | Must submit detailed financial information & security interests (Sec. 215(2)). | May file information voluntarily (Sec. 215(3)). |
| Liquidation Priority | Higher priority U/S 53: secured FCs first, then unsecured FCs. | Paid after secured/unsecured FCs, under “other debts and dues” (Sec. 53(2)(f)). |
Judicial Perspective
- Swiss Ribbons v. Union of India (2019, SC): Upheld differential treatment, ruling that FCs are better positioned to evaluate viability and negotiate restructuring, while operational creditors are primarily interested in payment for goods/services. No violation of Article 14 (equality before law).
- Mobilox Innovations v. Kirusa (2017, SC): Clarified that operational creditors cannot initiate insolvency if a “pre-existing dispute” exists.
- Innoventive Industries v. ICICI Bank (2017, SC): Once default by a corporate debtor is established by an FC, National Company Law Tribunal’s must admit the case.
Priority and Discrimination Concerns under of FCs and OCs under IBC
The Banking Law Reforms Committee justified excluding operational creditors from the CoC, reasoning that:
“Operational creditors are neither able nor willing to restructure liabilities, while financial creditors are equipped to assess viability and take long-term risks.” However, critics argue this creates inequality:
- operational creditors lack voting rights in CoC despite being significant stakeholders.
- In liquidation (Sec. 53), operational creditors rank much lower than FCs, leading to minimal recoveries.
- The constitutional challenge under Article 14 (equality) was rejected by the SC in Swiss Ribbons, but concerns remain about fairness.
To address this, Regulation 38 (2018 amendment) requires resolution plans to provide OCs at least the liquidation value, thereby offering a minimum safeguard.
Opinion & Conclusion on of FCs and OCs under IBC
The debate highlights a clash between rigid enforcement (ensuring creditor rights) and pragmatic discretion (preventing unnecessary insolvency of solvent companies). Two conflicting Supreme Court rulings have deepened the confusion. To ensure consistency and align with the IBC’s objectives, the issue requires resolution by a larger Supreme Court Bench. Until then, uncertainty continues to affect insolvency proceedings and creditor-debtor dynamics in India. The IBC makes a clear hierarchy:
- Financial creditors dominate corporate insolvency resolution process, CoC, and restructuring decisions.
- Operational creditors remain secondary, with limited procedural rights and lower recovery priority.
While the Supreme Court has upheld this distinction as constitutionally valid, the imbalance between FCs and operational creditors continues to fuel debate. For true fairness, reforms may be needed to:
- Enhance operational creditors participation in CoC decision-making.
- Provide pro-rata or more equitable distribution in resolution plans.
- Prevent misuse of majority power by FCs at the expense of operational creditors.
Until such reforms, operational creditors must proceed cautiously, ensuring strong documentation and timely compliance with Insolvency and Bankruptcy Code’s procedural requirements to protect their rights.
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