Median recovery for operational creditors only 6% under IBC: Report

Even though recovery of total claims under the Insolvency and Bankruptcy Code averaged around 32%, with a median of 24%, median recovery for operational creditors has remained as low as 6%, according to a report prepared by Insolvency Law Academy in collaboration with EY and law firm Chandhiok & Mahajan.

The report further says when considering the cases with some of the largest approved plan value (greater than Rs 2,500 Cr), the average recovery of 34% (with median of 29%) to financial creditors does witness an uptick to average recovery of 46% (with median of 42%). But the median recovery for operational creditors follows a similar trend at 5%.

Operational creditors under IBC include trade creditors or employees who have provided goods or services to the corporate debtor or government and its instrumentalities that are owed debt for payment of dues arising under law. The report points out the biases in IBC against the operational creditor, and suggest a hybrid insolvency resolution process to address the issue.

According to the report, a resolution applicant is legally bound to pay to operational creditors, only a minimum value which is linked to value payable to them in liquidation as per the priority of payment in distribution prescribed in Section 53 of IBC. It further pointed out that in the waterfall under section 53, unsecured operational creditors stand way behind in the queue as compared to financial creditors. Invariably, the payment of their debt as per section 53 is Nil.

“This has created resentment amongst the operational creditors. Operational creditors often may not possess the resources or a sufficient economic stake to hire their own advisors or fight for their dues,” says the report.

International experience

The report points to the US bankruptcy law, where trade creditors are treated as unsecured creditors. Unlike under IBC, says the report, operational creditors have right to participate in a bankruptcy case through official committees of unsecured creditors, which represent the interests of all unsecured creditors. After the enactment of US Bankruptcy Code, the concept of paying critical vendors has become increasingly common in Chapter 11 cases, as, for a debtor trying to reorganize, the concept is quite logical. Parties increasingly began to recognize that a Chapter 11 debtor’s ability to obtain trade terms from key vendors often is critical to the survival and success of a struggling business in Chapter 11.

Alternative method

The hybrid procedure proposed in the report creates an obligation on corporate debtor to pay the dues of operational creditors in full in case the corporate debtor wishes to avoid the risk of resolution plan of another resolution applicant being approved. The base plan of corporate debtor must compete with resolution plans invited from market if any discount on their payment is provided in the resolution plan, proposes the report.

As hybrid process provides little visibility over the initial process to operational creditors until the commencement of process and little engagement after that and till an application, if any for approval of resolution plan is filed, there is justification in providing for their full dues (as provided under PPIRP) or an assured percentage of recovery which should not be less than what is payable to financial creditors (based on a competitive and transparent process). This will also counter the apprehension of lack of transparency in hybrid procedure. It will ensure smooth approval of resolution plan by Adjudicating Authority. It will also provide a big respite to MSMEs

Also See: ARCs to recover 500-700 bps more from stressed residential realty projects