Financial creditor

When a company goes into insolvency, not every creditor is treated the same way. The Code splits them in two.

A financial creditor lent money and is paid for the time the money is out — interest. A bank is the obvious example.

An operational creditor is owed for goods or services supplied. A raw material supplier, a contractor, an employee.

Both can drag the company into insolvency proceedings. But only financial creditors get to sit on the committee that decides what happens next.

That single asymmetry is the most examined point in this part of the paper.

The Code. Section 14.2.6: the Insolvency and Bankruptcy Code (2016) "consolidates all the laws related to reorganisation and insolvency proceeding against companies, partnership firms and individuals", and "stipulates time bound resolution".

Who can initiate, and the threshold. "Under the law any creditor to the firm (be it financial creditors or operational creditors) can bring in insolvency proceedings against a company, if the undisputed amount outstanding is more than Rs 1,00,000." The corporate itself can initiate proceedings if it defaults on any payment.

The definition. "A financial creditor is one who receives consideration against the time value of money (in other words, earns interest on the amount outstanding)."

What happens next. On application, if the adjudicating authority is satisfied a default has occurred, it appoints an interim resolution professional. On that appointment "the board shall be considered as dissolved and all management personnel are required to report to IRP". The IRP collates the list of amounts outstanding and forms the committee of creditors.

The asymmetry. "Although operational creditors can initiate insolvency proceedings, they cannot be part of the committee of creditors."

So an operational creditor owed Rs 5 crore can start the process and then has no vote in it, while a financial creditor owed the same amount decides the outcome.

The committee's first job and the clock. The committee of creditors must either confirm the IRP as the Insolvency Professional or appoint somebody else. "IBC envisages that every insolvency proceeding should be completed within 180 days since the initiation of the process and IP is responsible to carry it out. However, on many occasions, extension has been granted." Resolution can be restructuring, a takeover or liquidation — "however, liquidation route is preferred only if no other option is available."

A stale figure, and this one matters. The workbook's default threshold is Rs 1,00,000. The statutory minimum default for initiating corporate insolvency was raised to Rs 1 crore by a Ministry of Corporate Affairs notification in March 2020, and that is the figure in force in practice. The exam is set from the workbook, so answer Rs 1,00,000 in the paper — but know that a candidate who meets Rs 1 crore in a real proceeding is not looking at an error. Two numbers, and the workbook's is the one that scores.

A manufacturer defaults. Its creditors, with the workbook's classification applied:

Who can start it. Any of them, on the workbook's test, since every one of these amounts is well above Rs 1,00,000. In fact the steel supplier files first, at Rs 62 crore.

Who then controls it. The committee of creditors is formed from the financial creditors alone — the banks and the debenture holders, Rs 2,250 crore between them. The supplier who initiated the case, the contractor and the employees, Rs 89 crore in total, have no seat.

The clock. If the application is admitted on 1 August, the 180-day envelope runs to about 28 January. The workbook notes extensions are often granted, so treat 180 days as the Code's design rather than a guarantee.

What an equity analyst takes from this. On admission, the board is dissolved and management reports to the IRP. For a shareholder that is close to the end of the story: equity ranks last, and liquidation is used only when nothing else works — which means the going concern being sold is usually worth more to lenders than to owners.

Section 14.2.6 (Insolvency and Bankruptcy Code) sits inside chapter 14 on the legal and regulatory environment, and it is short enough that almost every sentence in it is examinable.

The 3 questions that recur: the definition of a financial creditor — consideration against the time value of money; the default threshold of Rs 1,00,000; and the 180-day timeline. The discriminating question is the committee of creditors one, where the answer is that operational creditors may initiate proceedings but cannot be members. Chapter 14 also expects you to know that the board stands dissolved on the IRP's appointment.

• Operational creditors can initiate but cannot sit on the committee of creditors. This is the single most examined point in the section, and it looks like a contradiction until you read it twice.
• The workbook's threshold is Rs 1,00,000; the figure in force since March 2020 is Rs 1 crore. Answer Rs 1,00,000 for this exam. Do not silently modernise it, and do not assume the workbook is simply wrong.
• "Time value of money" is the test, not "large amount" or "secured". A small interest-bearing loan is a financial creditor's claim; a huge trade payable is not.
• 180 days is the Code's envelope, not a guarantee. The workbook itself says extensions have often been granted.
• The board is dissolved on the IRP's appointment, and management reports to the IRP. It is not merely suspended from some decisions.
• Liquidation is the last resort. The workbook puts restructuring and takeover ahead of it and says liquidation is preferred only if no other option is available.
• The committee of creditors can replace the IRP. Its first task is to confirm the IRP as Insolvency Professional or appoint somebody else, so the 2 roles are not automatically the same person.