NCLAT: Operational Creditor Can't Claim Priority Over Unsecured Financial Creditor In Liquidation

The National Company Law Appellate Tribunal bench, comprising Justice Ashok Bhushan (Chairperson) and Arun Baroka (Technical Member) held that under Section 53(1) of the Insolvency and Bankruptcy Code (IBC), unsecured financial creditors have priority in the waterfall mechanism over operational creditors in the distribution of a corporate debtor's liquidation estate. The tribunal reiterated that there is no distinction between related-party unsecured financial creditors and other unsecured financial creditors.

Brief Facts:

The Corporate Insolvency Resolution Process (CIRP) for the Corporate Debtor, namely, Brand Connect Communications (India) Pvt. Ltd., commenced on 27.03.2018 under Section 9 of IBC. The Adjudicating Authority ordered the liquidation of the Corporate Debtor on 28.01.2019.

The Appellant, an Operational Creditor, and Respondent No. 2, an ex-director of the Corporate Debtor and a Financial Creditor, filed their claims before the Liquidator. The Liquidator had rejected the Appellant's objections regarding the distribution of proceeds under Section 53 of the IBC, which gives preference to financial creditors over operational creditors. The Appellant filed IA No. 2382 of 2021, seeking to set aside the Liquidator's order dated 03.09.2021.

The National Company Law Tribunal (NCLT), by its impugned order dated 24.04.2024, rejected the Appellant's application, holding that Section 53 of the IBC does not differentiate between unsecured financial creditors and related-party unsecured financial creditors. It was held that the Appellant, as an Operational Creditor, cannot be given preference over the debt of an unsecured financial creditor.

The Appellant filed this Appeal challenging the impugned order passed by the NCLT.

Observations of the NCLAT:

The issue for determination before the Tribunal was whether the Appellant, an Operational Creditor, has priority in payment during the distribution of the liquidation estate over Respondent No.2, an Unsecured Financial Creditor. The Tribunal observed that “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 tribunal referred to the Supreme Court's decision in Swiss Ribbons Private Limited v. Union of India, which upheld the constitutional validity of Section 53. In that case, it was held that there is an intelligible differentia between financial debts (secured or unsecured) and operational debts, which justifies the differential treatment in the waterfall mechanism. The reasoning was that repayment of financial debts infuses capital into the economy.

The Tribunal noted that Respondent No. 2 was not seeking distribution as an equity shareholder under Section 53(1)(h) but on the basis of an unsecured financial debt. The Tribunal relied on its decision in Shailesh Sangani vs. Joel Cardoso [2019 SCC OnLine NCLAT 52] where it was held that money advanced by a promoter or director to improve the financial health of the company can be treated as financial debt, even without interest. This Tribunal concluded that the loan given by Respondent No. 2 to the corporate debtor constitutes a 'financial debt'.

The Tribunal held that the Appellant cannot claim any priority in the distribution of assets of the corporate debtor as compared to unsecured financial creditor.

Thus, the Appeal was dismissed.

Case Title: Times Innovative Media Limited vs Pawan Aggarwal (Liquidator) & Anr.

Case Number: Company Appeal (AT) (Insolvency) No.1139 of 2024

Counsel for Appellant: Dr. Atul Singh, Advocate

Counsel for Respondents: Ms. Honey Satpal, Mr. M.S. Bhardwaj and Mr. Yash Dhyani, Ms. Nandini Choudha, Advocates for R-2; Mr. Yahya Batatawala, Advocate for R-1/Liquidator.

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