Introduction
One of the defining structural choices of the Insolvency and Bankruptcy Code, 2016 is the differentiation it draws between financial creditors and operational creditors. This distinction, which permeates the entire architecture of the Corporate Insolvency Resolution Process, determines who sits on the Committee of Creditors, who has voting rights on the resolution plan, who is entitled to what recovery in liquidation, and how the competing interests of different classes of stakeholders are balanced in a distressed company. Few aspects of the IBC have generated as much academic debate, judicial attention, and commercial controversy as this classification.
The advocates of the financial-operational distinction argue that it reflects a sound commercial logic: financial creditors such as banks, debenture holders, and other lenders have sophisticated monitoring capabilities, contractual relationships with the corporate debtor involving ongoing surveillance of financial covenants, and a structural incentive to maximise the going-concern value of the enterprise. Operational creditors, including suppliers, employees, and service providers, are typically transactional creditors who deal with the company at arm’s length and have neither the information nor the institutional capacity to participate meaningfully in a collective resolution process.
The critics, however, have a compelling counter-narrative. Operational creditors, particularly in the Indian context, are often MSMEs that have extended credit to large corporate borrowers on very thin margins and are utterly dependent on payment from those borrowers for their own survival. These creditors are not sophisticated participants who have priced insolvency risk into their contracts; they are frequently vendors and service providers who had no meaningful choice about the credit terms they extended. Excluding them from the Committee of Creditors and subordinating them in the liquidation waterfall, the critics argue, is economically unjust and treats similarly situated creditors differently without adequate justification.
Legal Framework
The IBC’s distinction between financial creditors and operational creditors begins with the definitional provisions in Section 5. A “financial creditor” is any person to whom a financial debt is owed, and a “financial debt” is defined as a debt along with interest, if any, disbursed against the consideration for the time value of money. The definition includes money borrowed, raised under any bond, note, debenture or loan stock, raised under any letter of credit (to the extent drawn and not reimbursed), raised under hire-purchase, as well as liabilities arising under derivative transactions, amounts raised under any other transaction having the commercial effect of borrowing, and in 2018, amounts due to homebuyers under a real estate project.
An “operational creditor” is a person to whom an operational debt is owed, and an “operational debt” is defined as a claim in respect of the provision of goods or services, employment, or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.
The operational consequences of this distinction are far-reaching. Under Section 21, the Committee of Creditors (CoC) consists exclusively of financial creditors. Operational creditors are not members of the CoC, though Section 24 allows an operational creditor with aggregate dues exceeding 10% of the total debt to attend CoC meetings without voting rights. Under Section 53, the waterfall mechanism for distribution of assets in liquidation places the insolvency resolution process costs first, then secured financial creditors (up to the extent of their security interest), then workmen’s dues and unsecured financial creditors, followed by government dues and operational creditor dues, with equity shareholders receiving whatever remains, if anything.
The 2021 Amendment introduced a modification to the CoC’s powers in approving resolution plans: the CoC may allocate amounts to operational creditors and other stakeholders beyond the Section 53 minimum, but this is discretionary and subject to the CoC’s commercial wisdom, a concept that has itself been extensively litigated.
Judicial Developments
The constitutional validity of the financial-operational distinction was directly challenged in Swiss Ribbons Private Limited v. Union of India (2019). The petitioners argued that the distinction violated Article 14 (right to equality) because it treated similarly situated creditors (all of whom were owed money by the same insolvent company) differently without rational justification. The Supreme Court rejected this challenge emphatically.
The Court in Swiss Ribbons held that financial creditors and operational creditors constitute different and distinct classes for the purposes of Article 14. Financial creditors, the Court observed, are typically in long-term financial relationships with the corporate debtor, have the expertise to evaluate the viability of resolution plans, and have an economic interest in the going-concern value of the enterprise. Operational creditors, by contrast, are typically short-term transactional creditors whose debt arises from ordinary business transactions. The court held that this difference in the nature of the relationship, the sophistication of the parties, and their stake in the enterprise justifies differential treatment.
The Court in Swiss Ribbons also addressed the specific concern about MSMEs acting as operational creditors, acknowledging that many operational creditors are small businesses. The Court noted that the IBC provides operational creditors with the right to file for insolvency, the right to receive the liquidation value of their claims in a resolution plan, and the right to attend (though not vote at) CoC meetings. These protections, the Court held, were adequate to sustain the classification.
The Supreme Court’s decision in Committee of Creditors of Essar Steel India Ltd v. Satish Kumar Gupta (2019) further reinforced the CoC’s authority over the resolution plan, including the plan’s allocation of amounts to different classes of creditors. The Court upheld the principle that the CoC’s commercial wisdom, exercised within the framework of the IBC, is not lightly interfered with by courts. However, the Court also held that a resolution plan must provide operational creditors with at least the liquidation value of their claims, creating a minimum floor for operational creditor recovery.
Post-Essar Steel, the NCLT and NCLAT have grappled with numerous cases where operational creditors have challenged resolution plans as providing less than liquidation value for their claims. These challenges have had mixed success, reflecting the evidentiary difficulty of establishing what the liquidation value of operational creditor claims actually is in a specific case.
Contemporary Issues and Analysis
The financial-operational creditor distinction continues to generate controversy, particularly in the context of large insolvencies where the gap between financial creditor recovery and operational creditor recovery has been stark. In several high-profile resolutions, financial creditors have received substantial recoveries (sometimes 40 to 60 paise on the rupee) while operational creditors have received minimal amounts, frequently just the statutory minimum required by Section 53.
The asymmetry in outcomes is not merely an ethical concern; it has economic consequences. Operational creditors to a distressed company are frequently themselves MSMEs or small businesses. When these creditors receive minimal recovery in insolvency, the financial distress of the insolvent company propagates down the supply chain, creating a cascading insolvency effect. Several MSME sector surveys conducted between 2020 and 2024 have documented this spillover effect, noting that operational creditor losses in large corporate insolvencies have themselves pushed MSME creditors into financial distress.
The treatment of workmen and employees as operational creditors has also attracted significant criticism. While Section 53 does provide workmen’s dues (subject to a 24-month cap on provident fund dues) with priority over unsecured financial creditors, the practical reality is that in most large insolvencies, workmen have received less than full settlement of their claims. The argument that workers are operationally equivalent to trade creditors and should therefore share the operational creditor category with sophisticated business creditors is a troubling conflation that the IBC makes for administrative convenience.
The CoC’s discretion under the 2021 Amendment to allocate amounts to operational creditors beyond the Section 53 minimum has not, in practice, translated into significantly better outcomes for operational creditors. CoC members, acting as sophisticated institutional creditors with their own recovery targets and regulatory pressures, have generally used their discretion conservatively.
Comparative and International Perspective
The United Kingdom’s Insolvency Act, 1986 has its own creditor hierarchy, but it does not draw a structural distinction equivalent to India’s financial-operational divide for purposes of committee participation. In a UK administration, all creditors may submit claims, and the administrator (unlike India’s Resolution Professional) has independent statutory duties to all creditors. There is no equivalent of the CoC exclusively composed of financial creditors. The pre-Enterprise Act 2002 regime gave floating charge holders (typically banks) a de facto veto over administration, but the 2002 Act reforms reduced this through independent administration appointments.
The US Chapter 11 framework provides a more nuanced creditor classification system. Creditors are divided into classes, and each class votes separately on the reorganisation plan. Secured creditors form their own class; unsecured creditors (including both trade creditors and unsecured financial creditors) may form one or more classes. Importantly, the absolute priority rule requires that each class receive at least as much as it would receive in liquidation before a lower-ranked class receives anything, and the plan may be confirmed over the objection of a dissenting class through the “cramdown” provisions. This system, while complex, allows for a more granular calibration of creditor rights than the Indian two-class system.
The Australian Corporations Act’s voluntary administration framework does not draw a sharp financial-operational creditor distinction for purposes of administrator governance. The committee of inspection may include both secured and unsecured creditors. This reflects a different philosophy: the administrator is an independent officer serving all creditors, not a supervised manager accountable primarily to one class.
Practical and Policy Implications
The practical implications of the financial-operational creditor hierarchy are felt most acutely in sectors with extensive supply chains. In manufacturing, retail, and infrastructure insolvencies, the value locked up in operational creditor claims can be substantial, and the signal sent to the supplier ecosystem by the treatment of operational creditors in insolvency shapes future credit behaviour. Suppliers to large companies are increasingly requiring advance payments or reduced credit terms precisely because they cannot trust that they will receive fair treatment in the event of their customer’s insolvency.
This behavioral change in supplier credit terms has economic costs: it reduces working capital efficiency, increases transaction costs, and may impede the growth of large supply chain anchors. The IBC’s design choice, while analytically defensible from a financial economics perspective, has real-world consequences for how credit flows in the Indian economy.
For the banking sector, the CoC-dominated process has generally been seen as a success in terms of recovery rates for secured financial creditors, which are substantially higher under the IBC than under the previous SARFAESI and DRT frameworks. Banks have therefore resisted changes to the CoC’s composition or authority.
Suggestions and Reforms
Reform of the financial-operational creditor distinction should be calibrated and targeted rather than wholesale. A complete abolition of the distinction, or the inclusion of all operational creditors in the CoC, would create governance challenges given the potentially large and disparate nature of the operational creditor class in large insolvencies.
More targeted reforms include: mandatory representation of the largest operational creditor (by value of claim) on the CoC as a non-voting but participating member with information rights and the right to object to plan provisions; a minimum guaranteed recovery floor for operational creditors set at a higher percentage than liquidation value, perhaps at 20% of the admitted claim; and a separate resolution procedure for workmen and employees that treats their claims as a distinct category with specific governance protections.
Additionally, the IBBI should develop clearer guidelines for the CoC’s exercise of discretion in allocating amounts to operational creditors above the liquidation value floor, including factors to be considered and the documentation required to demonstrate that the CoC has genuinely considered operational creditor interests.
Conclusion
The financial-operational creditor distinction remains one of the IBC’s most debated structural features. The Supreme Court’s validation of the distinction in Swiss Ribbons has settled the constitutional question, but it has not resolved the underlying commercial and policy tensions. The practical consequences of the hierarchy, particularly for MSME operational creditors and for workmen, continue to raise legitimate concerns about the fairness and completeness of the IBC’s protection of all stakeholder interests.
The challenge for reform is to preserve the efficiency and decisiveness that the CoC-dominated process has brought to corporate insolvency resolution while ensuring that operational creditors, who are often among the most economically vulnerable parties to an insolvency, receive treatment that reflects both their legal rights and their legitimate economic interests. This balance requires not just legal reform but a cultural shift in how CoC members exercise their considerable statutory discretion.
