THE FAULT LINES IN OPERATIONAL CREDITOR SUB-CLASSIFICATION

This post is authored by Asmita Singh, 3rd year B.A. LL.B. (Honours) student at NLU, Jodhpur.

I. Introduction

The Insolvency and Bankruptcy Code, 2016 (“IBC”), was introduced to ease corporate insolvency while ensuring fairness to all stakeholders. But in practice, it has almost exclusively benefitted financial creditors at the cost of operational creditors with minimal recoveries and no decision-making power in the process. The recent National Company Law Appellate Tribunal (“NCLAT”) judgement in NCC Ltd. v. Golden Jubilee Hotels Pvt. Ltd. , (“NCC Ltd.”)has revived debates over the IBC’s creditor hierarchy, specifically the sub-classification of operational creditors.

This ruling has implications on selective preferential treatment of operational creditors and its consequences. It classified lease creditors as “Special Operational Creditors”, who got full recoveries while others were subjected to severe write-downs. Without any clear legislative guidance, such classifications create inconsistencies and further fragments an already unequal framework. This also raises questions about whether such distinctions will lead to more creditors seeking similar preferential treatment, complicating insolvency proceedings further.

This article will explore how sub-classification makes insolvency complex, creates ambiguity, and dilutes IBC’s fundamental principles. It will also look at global best practices and suggests reforms to make the insolvency resolution process more predictable and fair.

II. The Unequal Footing of Operational Creditors in India

The IBC structurally favours financial creditors by giving them exclusive voting rights in the Committee of Creditors (“CoC”) under Section 21, while operational creditors, though crucial for a company’s survival, are excluded from decision-making. This exclusion is further compounded by Section 53, which subordinates operational creditor claims in the waterfall mechanism, leaving them with minimal recoveries and little recourse to negotiate better terms. This lack of representation in insolvency proceedings diminishes their bargaining power, and prevents them from influencing restructuring decisions that that could help sustain their businesses. In effect, operational creditors are left at the mercy of decisions that may disproportionately favour secured lenders at their expense.

In  Swiss Ribbons Pvt. Ltd. v. Union of India, the SC upheld this framework, stating that financial creditors are better equipped to evaluate business and negotiate restructuring terms. But this rationale ignores the fact that operational creditors—suppliers, service providers, and employees—are vital for the businesses and should not be totally excluded from insolvency decisions.

Their exclusion from the CoC not only weakens their recovery prospects but also creates a ripple effect. Small suppliers and service providers often operate on thin margins, which leads them to face severe financial distress when their dues are sidelined in insolvency resolutions. This, in turn, can result in cascading defaults, harming both individual businesses and the overall stability of trade and supply chains.

Further, in Essar Steel India Ltd. v. Satish Kumar Gupta, the SC held that “equitable treatment” does not mean “equal treatment”. While financial creditors can be prioritized, the SC observed that the differential treatment among creditors must be justified. However, India’s insolvency framework consolidates decision-making power with financial creditors, which can further entrench the marginalization of operational creditors. This imbalance heightens the risk of resolution plans that systematically disadvantage operational creditors, leaving minimal recourse for them in the process.

III. The NCC Ltd. Judgment: A Step Forward or Back?

On 11th December 2024, the NCLAT in the NCC Ltd. matter approved a resolution plan which introduced a controversial sub-classification among operational creditors. The case was brought by an operational creditor challenging a resolution plan that gave a pittance to them, and substantial recoveries to the financial creditors. The tribunal reaffirmed that operational creditors must receive at least the liquidation value of their claims under Section 30(2)(b), IBC.

A significant aspect of the ruling was its treatment of lease creditors, particularly the Telangana State Tourism Corporation Limited (“TSTCL”), which was classified as a “Special Operational Creditor”. TSTCL received a full recovery while other operational creditors were left with little to none. The tribunal justified this by stating that lease creditors play an indispensable role in the business of the corporate debtor. However, this raises concerns the question of whether such preferential treatment is justified, more importantly, whether it risks setting a precedent for further fragmentation within the category of operational creditors. It could also encourage attempts by creditors to seek similar classifications, leading to inconsistency and unpredictability in insolvency resolution.

Moreover, an arbitral award in the case held that the debtor was entitled to recover money from TSTCL, instead of owing it. If an entity that owes money to the debtor can still receive full recovery, it questions the legitimacy of creditor classifications made by the CoC. It also raises doubts about whether its full recovery as a Special Operational Creditoraligns with insolvency law’s principle of equitable treatment.

This discrepancy reflects the need for stricter judicial scrutiny of creditor classifications and CoC decisions to align them with economic realities, rather than discretionary preferences. It also weakens the reasoning for granting full recovery to TSTCL, and invites questions about whether courts should intervene in the CoC’s decisions or leave it to their commercial wisdom. This debate is crucial for the future of insolvency jurisprudence in India, as unchecked discretion could undermine the IBC’s objective of equitable treatment among creditors.

IV. Global Approaches to Creditor Sub-Classification

The sub-classification of operational creditors highlights a broader issue in India’s insolvency regime—the lack of a structured approach to creditor classification. While financial creditors have control in decision-making, operational creditors are excluded from the CoC and subjected to inconsistent classifications without any statutory backing. On the other hand, other jurisdictions have structured systems to prevent arbitrary preferential treatment.

The UNCITRAL Legislative Guide on Insolvency Law (2005) states that all affected creditors should have a say in resolution plans to prevent dominant creditor classes from imposing terms unilaterally.

Similarly, the World Bank Principles for Effective Insolvency  emphasize structured participation to maintain fairness and predictability. Principle C7 discusses creditor involvement in insolvency proceedings, while Principles C14 and C15 stress the need for clear classification rules. Without safeguards, India’s insolvency framework is prone to ad hoc sub-classifications like in NCC Ltd., where some enjoy full recoveries and others face losses, setting a dangerous precedent.

Under the U.S. Bankruptcy Code (Chapter 11), creditors are classified into separate voting classes (11 U.S.C. § 1122), to prevent arbitrary grouping that can disadvantage certain creditors. The “fair and equitable” rule (11 U.S.C. § 1129(b)) ensures that if a dissenting class is crammed down, senior creditors must be paid in full before junior creditors receive anything.

Similarly, the UK Companies Act, 2006, under Part 26, has separate voting by creditor classes, so that restructuring decisions are not dictated solely by financial creditors alone. Additionally, Company Voluntary Arrangements (CVAs) under the Insolvency Act, 1986, require majority creditor approval, so that dominant creditor groups cannot impose terms unfairly. If such a framework existed in India, the sub-classification in NCC Ltd. would have faced greater scrutiny. Introducing such measures would ensure that each class of creditors has a meaningful say in the process based on the nature of their claims.

While challenges of appropriate classifications and further fragmentation in classes may arise, a well-defined framework would prevent arbitrary differentiation, ensuring more even handed treatment in insolvency proceedings.

V. The Path Forward: Reforms for Fairness

The systemic disadvantages faced by operational creditors require reforms, but any changes must balance creditor rights with insolvency efficiency. Critics argue that increasing their role could delay resolutions and create uncertainty for financial creditors. Generally, operational creditors have diverse interests, ranging from small vendors and suppliers to large, making it difficult to reach a unified front in insolvency proceedings. Unlike financial creditors, whose primary concern is recovery of loans, operational creditors often prioritize maintaining business continuity.

Giving them voting rights in the CoC may also lead to fragmented decision-making, and can make consensus on resolution plans difficult to achieve. Nonetheless, policymakers should ensure fairness for operational creditors alike while ensuring insolvency efficiency. For this, the following measures can be considered:

1. Legislative clarity on sub-classification: Amending the IBC to define when sub-classification of operational creditors is allowed, to ensure that such differentiation is based on economic necessity rather than arbitrary case-to-case discretion.

2. Limited voting rights for operational creditors: Operational creditors could be granted voting rights in the CoC, at least for matters directly affecting their recoveries. While full voting rights may not be feasible, representation in certain decisions would create a more balanced insolvency framework, so that their interests are not entirely sidelined. To prevent ambiguity about this limited scope, a skeletal legislative or regulatory guideline would be a positive step.

   
   

VI. Conclusion

The NCC Ltd. judgment highlights the necessity for reforms in India’s insolvency framework to achieve fair treatment for operational creditors. Although courts have attempted to reduce disparities, inconsistent interpretations and judgements continue to create uncertainty. This has led to unpredictable outcomes in insolvency proceedings. To prevent arbitrary sub-classifications and ensure fairness, legislative amendments should lay clear grounds and reasoning for creditor differentiation. A robust insolvency framework is not about fairness alone—it is essential for economic stability and investor confidence. Going forward, reforms must acknowledge operational creditors as integral stakeholders in insolvency proceedings, rather than passive recipients of restructuring outcomes.