What are the Rights Available to Unsecured Creditors Under the Insolvency & Bankruptcy Code?

Introduction

• In some cases, when a company to whom they have provided goods is declared insolvent, unsecured creditors are unsure of their situation. 
• This is especially true when a large debtor’s bankruptcy has an impact on small enterprises.
• When they learn that a significant client has filed for bankruptcy, many small business owners promptly write off the debt. 

Who is an Unsecured Creditor?

Unsecured creditors are those who have no security in place to recoup their obligations, and they make up the majority of people who owe money. In terms of payment priority in liquidation, they follow preferential creditors (including secondary preferential creditors).

Additionally, there is frequently a sense that the “little guy” has no rights at all and is defenceless. However, this is not the case because under Corporate Law, regardless of the size of the company or the amount of the debt, all unsecured creditors are given the same protection. An Unsecured Creditor actually has a number of proactive options at their disposal to actively participate in the winding-up process.

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What are the other types of creditors specified under the Insolvency Code?

1) Secured Creditors- A secured creditor is one who has a security interest established in their favour. In order to secure the performance of the borrower’s or debtor’s obligations, a security interest is a right, title, interest, or claim in property that is created in favour of or for the benefit of the creditor.

 Whose interest is intended to be secured by the creation of such interest, right, title, or claim in the property mortgaged, hypothecated, charged or assigned, or otherwise alienated? However, such interest must be without a guarantee of performance.

2) Unsecured Creditors– Unsecured creditors, unlike secured creditors, have rights, interests, or other benefits generated in their favour in the debtor’s property that allow them to seize it. Unsecured creditors do not. They lack the protection of rights, titles, or interests in any property or other kind of collateral security in exchange for the amount owing to them. Creditors of zero-coupon bonds, which are unsecured loans with no interest, are also unsecured creditors.

Following is a further classification of secured and unsecured creditors:

1. A Financial Creditor is defined in Section 5(7) of Part II of the International Business Code as a person or institution to whom a financial debt is owed, including a person to whom the debt has been legally transferred.
2. Operational Creditor– According to Section 5(20) of Part II of the Code, an operational creditor is anyone who is owed money, including workers and employees who have been lawfully assigned the debt.
3. A creditor that neither belongs to the financial sector nor the operational sector (vide press release dated 16th August 2017 by Insolvency and Bankruptcy Board of India).

While an operational creditor is an unsecured creditor, a financial creditor might be either a secured or an unsecured creditor.

What are the remedies available to creditors under the Insolvency & Bankruptcy Code?

1. Corporate Insolvency Resolution Process– Under Chapter II of Part II of the IBC, the “Corporate Insolvency Resolution” Process (“CIRP”) may be started by a financial creditor, an operational creditor, or the defaulting corporate debtor itself. 

Only when a company owes at least Rs. 1 lakh may the corporate insolvency resolution process be started. 

The application for corporate insolvency resolution by the financial creditor(s) is covered in Section 7 of Part II of the Code. Operational creditors may submit the application in accordance with Part II of the Code, sections 8 or 9. Individually or collectively, financial creditors (whether secured or unsecured) may submit a CIRP application to the relevant NCLT.

2. Debt recovery by operational creditors– An operational creditor must give the corporate debtor a demand notice or a copy of the invoice for the outstanding debts before sending anything else. The corporate debtor shall give the operational creditor written notification of the demand within ten (10) days of receipt of the demand notice.

• Send a copy of the electronic transfer receipt or a copy of the record of the operational creditor’s check cashed to notify them of the repayment of any outstanding operational debt, the existence of any dispute, the status of any pending legal action, or the status of any pending arbitration proceedings.
• Only operational creditors with uncontested obligations may file a CIRP.

However, an applicant for disputed claims may also be a financial creditor.

3. Payment of Liquidation Proceeds– The procedure for distributing the proceeds of the IBC’s liquidation has established the priority order for the settlement of debts and obligations. The following is the order of preference:

• The wages and any unpaid dues of employees other than workmen for a period of 12 months prior to the commencement of liquidation proceedings shall rank equally after the payment of all insolvency resolution process costs and liquidation expenses, 
• Debts and dues (a) of workmen* for the period of 24 months prior to the commencement of liquidation proceedings, and (b) owed to a secured creditor where the security for the debt. 
• the wages and any unpaid dues of non-workmen employees for a period of 12 months prior to the start of the liquidation proceedings, financial debts of unsecured creditors, dues and debts of (a) the Central and State Government, if any, and (b) secured creditors for any amount being unpaid under the enforcement of security interest, 
• any other remaining debts and dues, 
• last in the order of preference is the owners’ capital – first paid to the preference share.

Therefore, these are the rights & remedies available to an unsecured creditor. With the advent of the Code, any creditor may file a CIRP with the help of a Business Lawyer. 

Conclusion

The 2016 passage of the Insolvency and Bankruptcy Code, as well as subsequent amendments, was a commendable step toward dealing with business-related insolvencies and bankruptcies. The prior prohibitions were dispersed under many statutes, and the process to request redress included drawn-out, difficult judicial battles that were frequently insufficient. 

As opposed to the previous system, the IBC 2016 and its amendments created a single law on insolvency resolution for individuals, partnership firms, and corporate debtors. Take online legal advice from a corporate lawyer in case of any money-related matters.