Why NCLAT ruling on Essar Steel matters

The resolution plan proposed by ArcelorMittal was questioned by both operational creditors, who alleged that they were not treated on par with financial creditors, as well as some financial creditors such as Standard Chartered Bank that alleged that its claims were not honoured adequately. As it happened, the NCLAT ruled that the Committee of Creditors (CoC) had discriminated between creditors. The NCLAT order stated: “… we hold that the ‘Committee of Creditors’ has no role to play in the matter of distribution of amount amongst the Creditors including the ‘Financial Creditors’ or the ‘Operational Creditors’…” As such, the NCLAT amended the resolution plan in a way that both financial and operational creditors would receive roughly 61 per cent of their claims. The NCLAT logic was: financial creditors, being claimants at par with each other and claimants like the operational creditors, face a conflict of interest when deciding whose claims should be honoured and to what extent. This is more so the case when the maximum amount of money is allocated in favour of one financial creditor and minimum (or nil) for other financial creditors and operational creditors.

Should financial and operational creditors be treated on par?

On the face of it, the NCLAT’s argument that there is no difference between two financial creditors stands to reason. But the NCLAT also observed that there is no difference between financial creditors and operational creditors when it relates to the “resolution” plan under IBC. Referring to Section 53 of the IBC that deals with the distribution of assets, the NCLAT argued that “the distribution of debts to the ‘Financial Creditors’ and the ‘Operational Creditors’ during the ‘Corporate Insolvency Resolution Process’ cannot be equated with [the] distribution of debts to all stakeholders after the liquidation.”

In other words, NCLAT sought to distinguish between distribution of assets under a “resolution” process as against under a “liquidation” process. It argued that Section 53 of the IBC lays out the order of priority for the proceeds from the sale of the “liquidation” assets. This order of priority favours financial creditors over operational creditors. However, the NCLAT pointed out, this is not a liquidation and as such the differentiation between financial creditors and operation creditors is not merited.

Why is this ruling problematic?

c“We have already seen that repayment of financial debts infuses capital into the economy inasmuch as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses.” The SC had favoured prioritising financial creditors because they generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of a business. The SC had concluded that “while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.”