2024 (9) TMI 1304 - AT - IBC

Operational creditor cannot claim priority over financial creditor in asset distribution under Section 53 IBC

Times Innovative Media Ltd. Versus Pawan Kumar Aggarwal (Liquidator) & Anr.

NCLAT Principal Bench dismissed appellant's challenge to asset distribution priority. The operational creditor appellant sought preference over respondent ... Rejection of application filed by the Appellant - Appellant who is an Operational Creditor can be given any preference over the debt of the unsecured financial creditor or not - difference between unsecured financial creditor and related party unsecured financial creditor u/s Section 53 of IBC - whether Appellant who is an operational creditor has priority in payment in distribution of the liquidation estate of the corporate debtor over the Respondent No.2 who was financial unsecured creditor? HED THAT:- Section 53(1) provides that liquidation assets shall be distributed in the order of priority as enumerated therein. In the order of priority, financial debts owed to unsecured creditors are at Clause (d). Clause (f) deals with any remaining debts and dues. The operational debt of the Appellant falls under clause (f). Thus, on plain reading of Section 53(1), it is clear that financial debts owed to unsecured creditors ranked higher than debt of operational creditor. The submission which has been advanced by the Counsel for the Appellant to support the appeal is that the Respondent No.2 being related party, he need not be treated under sub-clause (d) rather he has to fall under sub-clause (h) as equity shareholder. The submission of the Appellant is that admittedly Respondent No.2 was ex-director and being related party of the corporate debtor, he cannot claim any preference over the operational creditor who have given services to the corporate debtor and who are entitled for priority in payment. The Hon’ble Supreme Court in Swiss Ribbon [2019 (1) TMI 1508 - SUPREME COURT] held that there is intelligible differentia between the financial debts and operational debts. The reason for differentiating between financial debt and operational debt was noticed and differentiation was upheld. The BLRC Report has also been quoted by the Hon’ble Supreme Court in paragraph 118 of the judgment. The BLRC Report also highlighted the importance of financial debt and dues of unsecured financial creditor were kept higher than the remaining debts within which operational debt now formed. Definition of ‘financial debt’ as contained in Section 5(8) does not indicate any exclusion of financial debt which is reflected by any transaction with the corporate debtor by related party. When a financial debt is extended by related party the consequence for such creditor is captured in Section 21. As per Section 21(2), a financial creditor if it is related party of the corporate debtor shall not have any right of representation, participation or voting in a meeting of the CoC. Further by virtue of Section 29A, related party may incur any of the disqualifications under Section 29A. The judgment in M.K. Rajagopalan vs. Dr. Periasamy Palani Gounder and Anr [2023 (5) TMI 344 - SUPREME COURT] was rendered in context of Section 21 of the IBC which mandates that the related party of corporate debtor is prohibited to be part of CoC. The Hon’ble Supreme Court further held that so long as the provisions of the Code and the CIRP Regulations are met, any proposition of differential payment to different class of creditors in a resolution plan is, ultimately, subject to the commercial wisdom of CoC and no fault can be attached to the resolution plan merely for not making the provisions for related party. Those observations made by the Hon’ble Supreme Court were in context of approval of the Resolution Plan by the CoC in its commercial wisdom and in the said case also, the Hon’ble Supreme Court has not laid down any ratio with respect to distribution under Section 53 in reference to operational creditor and unsecured financial creditor. The Adjudicating Authority has not committed any error rejecting the application filed by the Appellant. Appellant cannot claim any priority in distribution of assets of the corporate debtor as compared to unsecured financial creditor - Appeal is dismissed. Issues Involved:1. Priority of payment distribution between Operational Creditor and Financial Creditor under Section 53 of the IBC.2. Treatment of related party Financial Creditor in the distribution of liquidation assets.3. Applicability of previous judgments and legal precedents in the context of liquidation distribution.Issue-Wise Detailed Analysis:1. Priority of Payment Distribution Between Operational Creditor and Financial Creditor Under Section 53 of the IBC:The core issue in this appeal is whether the Operational Creditor (Appellant) has priority in payment distribution over the Financial Creditor (Respondent No.2) during the liquidation process of the Corporate Debtor, as per Section 53 of the Insolvency and Bankruptcy Code (IBC). The Adjudicating Authority had previously rejected the Appellant's claim, stating that Section 53 does not differentiate between unsecured financial creditors and related party unsecured financial creditors. The Appellant argued that the Financial Creditor, being a related party, should not be given priority over the Operational Creditor. However, the judgment clarified that financial debts owed to unsecured creditors rank higher than operational debts under Section 53(1)(d) of the IBC. The Hon'ble Supreme Court in 'Swiss Ribbons Pvt. Ltd. vs. Union of India' upheld the constitutional validity of Section 53, reinforcing the differentiation between financial debts and operational debts, emphasizing the economic rationale behind such differentiation.2. Treatment of Related Party Financial Creditor in the Distribution of Liquidation Assets:The Appellant contended that the related party Financial Creditor should be treated as an equity shareholder under Section 53(1)(h) and not be given priority over the Operational Creditor. The Respondent No.2, who had resigned as a director in 2013, argued that even if considered a related party, they should still be treated as an unsecured financial creditor. The judgment highlighted that the definition of 'financial debt' under Section 5(8) of the IBC does not exclude debts from related parties. The related party's involvement is restricted under Sections 21 and 29A of the IBC, primarily concerning representation and participation in the Committee of Creditors (CoC) and eligibility to propose a Resolution Plan. The judgment concluded that the related party Financial Creditor is still classified under unsecured financial creditors for the purpose of distribution under Section 53.3. Applicability of Previous Judgments and Legal Precedents in the Context of Liquidation Distribution:The Appellant relied on several judgments, including 'J.R. Agro Industries P. Limited v. Swadisht Oils P. Ltd.' and 'Arun Kumar Jagatramka v. Jindal Steel and Power Limited & Anr.', to support their claim for priority. However, the judgment clarified that these cases were contextually different, primarily dealing with Resolution Plans and not liquidation distribution. The judgment also referenced 'Shailesh Sangani vs. Joel Cardoso and Anr', which supported the classification of loans from promoters or directors as financial debts. The Hon'ble Supreme Court's decision in 'M.K. Rajagopalan v. Dr. Periasamy Palani Gounder & Anr.' was also discussed, emphasizing that related parties are treated differently in the CoC but not necessarily in liquidation distribution.Conclusion:The judgment affirmed that the Appellant, as an Operational Creditor, cannot claim priority over the Financial Creditor (Respondent No.2) in the distribution of liquidation assets. The Adjudicating Authority's decision was upheld, emphasizing that Section 53 of the IBC does not provide for differentiation between related and unrelated unsecured financial creditors in the context of liquidation distribution. The appeal was dismissed, reinforcing the established hierarchy of claims under Section 53.