Operational creditors will now get more of their dues and a voice in insolvency resolutions, but the process will slow
Given their vastly larger loans, or skin in the game, it is not surprising that the Insolvency and Bankruptcy Code gave financial creditors a preference when it came to getting their dues from defaulting firms. At the same time, however, it is these same banks that are supposed to assess the riskiness, or otherwise, of a firm, aided of course by rating agencies. To that extent, it can be argued that suppliers to firms—operational creditors, in technical jargon—extend credit based on the fact that bankers have, by virtue of their loans, certified that the firms are creditworthy. Despite this, however, the Insolvency and Bankruptcy Code gave operational creditors the short shrift and, while financial creditors got paid whatever they were able to sell the firm for—through auctions that were finally ratified by the National Company Law Tribunal (NCLT)—all that the operational creditors were guaranteed was a payment based on the liquidation value of the company that is, more often than not, zero since debts are greater than assets.
As with any other law that evolves over time, the Insolvency and Bankruptcy Code also underwent many changes over a period of time, partly through government action in response to public opinion and partly through the country’s courts. So, for instance, defaulters were prevented from being able to bid for firms since this would have allowed them to buy back their firm at a significant discount. Similarly, given the number of home-buyers who had given builders thousands of crores of rupees of deposits, they also, over time, got the status of financial creditors. This allowed them one seat in the Committee of Creditors that finally decides on any bid for a defaulting firm. And, now, the government has finally changed the rules as far as operational creditors are concerned and said that they will be paid more than just the liquidation value—so, if a firm is sold through an auction, some part of the proceeds would accrue to operational creditors, and the exact amount would be specified by the bidder.
Given the Committee of Creditors is dominated by financial creditors, they could continue to call the shots. So, if firm A bids `10,000 crore for financial creditors and `1,000 crore for operational ones while firm B bids `10,500 for financial creditors and `100 crore for operational ones, the Committee of Creditors would normally opt for Firm B. Apart from the fact that the NCLT will have the final say—and would probably choose firm A—under the law, if operational creditors are owed more than a tenth of the total debt, they get an observer status at the Committee of Creditors. And courts have, over time, also ruled that if the Committee of Creditors disregards what the operational creditors suggest, they have to justify their decision. While giving more rights to home-buyers and operational creditors is a good thing, the flipside of this is that it will slow down the insolvency process as, the more the number of people get involved in the decision-making process, the more complicated it gets. That, however, is the price to be paid for getting a more equitable process.