Introduction
The Insolvency and Bankruptcy Code, 2016 (IBC), is an Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons and partnership firms. The primary objective of the Code is to ensure timely resolution, preserve enterprise value, promote the availability of credit, and balance the interests of all stakeholders.
Under the IBC, creditors can initiate insolvency proceedings before the National Company Law Tribunal (NCLT) if a company defaults on any outstanding dues owed to creditors. Conversely, if any company suffers financial distress and is unable to repay its dues, the company itself can initiate insolvency proceedings before the NCLT. The IBC mainly categorises creditors as Operational Creditors and Financial Creditors.
Creditors to whom debt is owed for supplying goods and services are known as Operational Creditors, and creditors to whom financial debt is owed are known as Financial Creditors. Although both categories are entitled to initiate insolvency proceedings upon default, the procedure, rights and legal principles under the IBC governing both categories of creditors are very different in nature. Hence, the distinction between Financial Creditors and Operational Creditors is crucial under the IBC.
Statutory Framework Governing Financial and Operational Creditors
The Insolvency and Bankruptcy Code, 2016, provides a clear statutory framework defining financial and operational creditors. Before examining these classifications, it is essential to understand certain foundational concepts under the Code.
Foundational Definitions Under The Code
| Section | Term Defined | Definition |
|---|---|---|
| Section 3(10) | Creditor | Any person or entity to whom a debt is owed, which includes Financial Creditors, Operational Creditors, Secured Creditors, Unsecured Creditors and a Decree Holder. |
| Section 3(11) | Debt | Any liability or obligation in respect of a claim which is due from any person or entity to any other person or entity, and includes financial debt and operational debt. |
| Section 3(12) | Default | Non-payment of debt in whole or in part, which has become due and has not been paid by the debtor or corporate debtor. The occurrence of default constitutes the trigger for the initiation of the corporate insolvency resolution process (CIRP) before the NCLT. |
Definition Of Financial Creditor
Section 5(7) of the Code defines a Financial Creditor as a person to whom a financial debt is owed, and includes a person to whom such debt has been legally assigned or transferred.
Meaning Of Financial Debt Under Section 5(8)
Section 5(8) defines ‘financial debt’ as disbursement of funds against consideration for the time value of money, and includes:
- Money borrowed with interest.
- Any amount raised by a credit facility where banks pay on behalf of the company, and later the company repays the bank, along with the bank’s charges.
- Any amount raised by issuing bonds, notes, debentures, loan stock or any similar instrument.
- Any lease or hire-purchase contract that is deemed to be a finance or capital lease under the Indian Accounting Standards.
- Receivables that are sold or discounted to get quick money from banks, provided that the receivables were not sold on a non-recourse basis.
- Any amount raised through any other transaction, including any forward sale or purchase agreement having the commercial effect of borrowing.
Sub-Clause: Any Amount Raised From Allottees Of A Real Estate Project
Any amount raised from allottees of a real estate project shall be deemed to have the commercial effect of borrowing.
Definition Of Operational Creditor
Section 5(20) defines an Operational Creditor as a person to whom an operational debt is owed for the supply of goods and services.
Meaning Of Operational Debt Under Section 5(21)
Section 5(21) defines ‘operational debt’ as any debt arising from:
- Non-payment for goods supplied.
- Services rendered (including employment).
- Statutory dues payable to the government or local authorities.
Initiation Of Corporate Insolvency Resolution Process
Section 7 of the Insolvency and Bankruptcy Code, 2016, enables a Financial Creditor to initiate the corporate insolvency resolution process either by itself or jointly with other Financial Creditors before the Adjudicating Authority, i.e., the NCLT. The allottees in a real estate project or creditors of the same class (such as debenture holders or debt in the form of securities) can initiate the corporate insolvency resolution process, subject to the mandatory requirement of at least 100 creditors or 10 percent of the total number of such creditors, whichever is less.
Section 7 – Application By Financial Creditor
- Proof of default
- Details of the debt
- Particulars of the proposed Interim Resolution Professional (IRP)
- The requisite form and fee
The Financial Creditor, along with the application, must provide proof of default, details of the debt, particulars of the proposed Interim Resolution Professional (IRP), the requisite form and fee.
Examination By Adjudicating Authority Under Section 7
The Adjudicating Authority, within 14 days, examines whether a default exists, whether the application is complete, and whether any disciplinary proceedings are pending against the proposed IRP.
| Ground | Outcome |
|---|---|
| Default exists, application complete, no disciplinary proceedings pending | Application Admitted |
| Conditions not satisfied | Application Rejected (7 days granted to rectify defects) |
The Adjudicating Authority can admit the application if it is satisfied that a default exists, the application is complete, and there is no disciplinary action pending against the proposed IRP. It can reject the application if it is not so satisfied; however, the Adjudicating Authority must grant 7 days to the Financial Creditor to rectify any defects in the application.
The corporate insolvency resolution process starts from the date of admission of the application, and not from the date of filing. Upon admission or rejection of the application, the Adjudicating Authority shall inform the Financial Creditor and the Corporate Debtor within seven days.
Supreme Court Clarification – Innoventive Case
The Supreme Court in Innoventive Industries Ltd. v. ICICI Bank clarified that, at the admission stage, the Adjudicating Authority is required only to determine the existence of a default. Once such satisfaction is recorded, the application must be admitted. The commencement of CIRP takes effect from the date of admission of the application and not from the date of its filing.
Section 8 And 9 – Application By Operational Creditor
Section 9 of the Code enables an Operational Creditor to initiate the corporate insolvency resolution process against the Corporate Debtor, but Section 8 of the Code outlines a mandatory procedure to be followed by an Operational Creditor before initiating CIRP, which is as follows:
Mandatory Pre-CIRP Procedure Under Section 8
- Upon the occurrence of default, the Operational Creditor must deliver a demand notice demanding unpaid dues from the Corporate Debtor or a copy of the invoice demanding unpaid dues.
- The Corporate Debtor, upon receipt of such demand notice or copy of invoice, shall, within 10 days, bring to the notice of the Operational Creditor the existence of a dispute, if any. The dispute must relate to the debt in question and must have existed prior to the receipt of the demand notice.
After the expiry of 10 days, if the Operational Creditor does not receive any payment from the Corporate Debtor or any notice of dispute from the Corporate Debtor, the Operational Creditor may file an application to initiate CIRP before the Adjudicating Authority.
Documents Required With Section 9 Application
- A copy of the demand notice or invoice demanding unpaid dues
- An affidavit confirming that no notice of dispute was received from the Corporate Debtor
- A copy of the certificate from a financial institution confirming that payment of unpaid dues has not been received
- Any other proof in corroboration of non-payment of unpaid dues
The Operational Creditor shall, along with the application, furnish a copy of the demand notice or invoice demanding unpaid dues, an affidavit confirming that no notice of dispute was received from the Corporate Debtor, a copy of the certificate from a financial institution confirming that payment of unpaid dues has not been received, and any other proof in corroboration of non-payment of unpaid dues. The Operational Creditor may propose a Resolution Professional to act as an Interim Resolution Professional.
Examination By Adjudicating Authority Under Section 9
The Adjudicating Authority, upon receipt of such an application and within 14 days, may admit or reject the application if it is satisfied that the application is complete, there is no payment of unpaid dues, an invoice or a demand notice has been delivered by the Operational Creditor, no notice of dispute has been received, and no disciplinary action is pending against the proposed Resolution Professional.
Supreme Court Clarification – Mobilox Case
The Supreme Court in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. held that if a dispute truly exists and is not a sham, the Adjudicating Authority must reject the application at the stage of admission itself.
Comparative Analysis of Financial and Operational Creditors
Although both Financial and Operational Creditors are entitled to initiate the corporate insolvency resolution process upon default, the statutory framework creates distinct procedural thresholds and institutional roles for each category.
Initiation of CIRP Under Sections 7, 8 and 9
A Financial Creditor can file an application under Section 7 as soon as a default occurs to initiate CIRP, whereas an Operational Creditor may file an application under Section 9 only after complying with the mandatory requirements under Section 8, which include issuing a demand notice, observing a 10-day waiting period, and ensuring that there is no pre-existing dispute between the Operational Creditor and the Corporate Debtor.
| Particulars | Financial Creditor | Operational Creditor |
|---|---|---|
| Relevant Section | Section 7 | Section 9 (after compliance with Section 8) |
| When Application Can Be Filed | Immediately upon occurrence of default | After issuing demand notice and waiting 10 days |
| Pre-existing Dispute Requirement | No bar due to dispute | Application barred if genuine pre-existing dispute exists |
Concept of Pre-Existing Dispute
In the case of a Financial Creditor, there is no concept of a pre-existing dispute barring initiation. Even if a dispute is pending between the Financial Creditor and the Corporate Debtor, the Financial Creditor can still file an application under Section 7 of the Code and initiate CIRP against the defaulter. In contrast, if there is any genuine pre-existing dispute pending between the Operational Creditor and the Corporate Debtor, the Operational Creditor is barred from filing the application under Section 9. At the stage of admission, the Financial Creditor must establish that there is a financial debt and that a default has occurred to have the CIRP admitted, whereas the Operational Creditor must establish that there is no pre-existing dispute and that it has complied with the mandatory requirements of Section 8.
- Financial Creditor: Must establish existence of financial debt and occurrence of default.
- Operational Creditor: Must establish absence of pre-existing dispute and compliance with Section 8 requirements.
Constitution of Committee of Creditors (CoC)
Once the CIRP is admitted, the Interim Resolution Professional forms the Committee of Creditors (CoC), which consists of all Financial Creditors, who have discretionary power and voting rights for the approval of the Resolution Plan. Operational Creditors do not form part of the CoC; they may attend the meeting only if their aggregate claim exceeds 10 percent of the total claims.
| Aspect | Financial Creditors | Operational Creditors |
|---|---|---|
| Membership in CoC | Form part of CoC | Do not form part of CoC |
| Voting Rights | Have voting rights on Resolution Plan | No voting rights |
| Right to Attend Meetings | Yes | Only if aggregate claim exceeds 10% of total claims |
Approval of Resolution Plan and Doctrine of Commercial Wisdom
Once the Resolution Plan is approved by the CoC (Financial Creditors) with a plausible commercial view, the approved plan is generally final and is not subject to appeal on merits before the Adjudicating Authority. This is known as the doctrine of commercial wisdom of the CoC. The approved plan may or may not benefit the Operational Creditors; their recovery depends upon the terms of the Resolution Plan as approved by the CoC.
Conclusion
The Insolvency and Bankruptcy Code, 2016, recognises both Financial and Operational Creditors as distinct categories within its insolvency framework. While both are entitled to initiate the corporate insolvency resolution process upon default, the statutory scheme assigns differentiated procedural thresholds and institutional roles to each category.
The primacy accorded to Financial Creditors, particularly in the constitution and functioning of the Committee of Creditors, is grounded in the commercial nature of financial debt and the systemic significance of institutional lending. Conversely, the safeguards embedded in Sections 8 and 9 seek to prevent misuse of the insolvency process in matters involving genuine operational disputes.
The distinction between Financial and Operational Creditors is therefore structural rather than merely classificatory. It reflects a deliberate legislative balance between ensuring efficient insolvency resolution and protecting against unwarranted initiation of proceedings. As insolvency jurisprudence continues to evolve, this differentiation will remain central to the functioning and integrity of the Code.
