Introduction
The appeal in the case of Times Innovative Media Ltd. v. Pawan Kumar Aggarwal[i] was brought before the National Company Law Appellate Tribunal (‘NCLAT’). It challenged an order issued by the Mumbai bench of the National Company Law Tribunal (‘NCLT’), which denied the Times Innovative Media Ltd.’s (‘Appellant’) request for prioritizing its operational debt (‘OD’) over a financial creditor’s (‘FC’) claim in the liquidation process of a corporate debtor (‘CD’). The dispute centered on the interpretation of s. 53 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), particularly whether a related party unsecured FC should rank lower than operational creditors (‘OCs’) in the distribution of liquidation assets under the waterfall mechanism of the IBC.
Brief Facts
The Corporate Insolvency Resolution Process (‘CIRP’) was initiated against Brand Connect Communications (India) Private Limited on 27.03.2018, and subsequently, liquidation was ordered on 28.01.2019. The Appellant., filed a claim as an OC for an amount of approximately Rs. 2,57,24,248, while the respondent, Pawan Kumar Aggarwal, a former director of the CD, filed a claim as an unsecured FC for approximately Rs. 50,56,051.
The Appellant objected to the liquidator’s decision to prioritize the FC’s claim over its OD, citing that the FC was a related party due to a previous directorship, thus warranting a lower priority in distribution. Additionally, the FC held a 51% stake in the CD and lent monies to the CD. Thus, he was also an FC coming under the purview of s. 5(24)(a).
The Appellant argued that the FC should be classified as an equity shareholder because of its relationship with the CD, placing the FC’s claim lower in the distribution order under s. 53(1)(h).
The NCLT rejected the objection, holding that s. 53 of the IBC does not differentiate between related and unrelated unsecured FCs. Consequently, the related party's FC was correctly placed above the OC in the liquidation waterfall. The Appellant then subsequently appealed to the NCLAT.
Issues
Whether s. 53 of the IBC allows OCs to prioritise distribution over related party unsecured FCs in a liquidation process?
Whether the status of a FC as a related party affect its ranking in the waterfall mechanism for the distribution of liquidation assets?
Held
The NCLAT upheld the NCLT’s decision, affirming that the liquidator’s actions complied with s. 53 of the IBC. The appellate tribunal held that:
S. 53 of the IBC governs the order of priority for distributing assets in a liquidation. It establishes a hierarchy where financial debts owed to unsecured creditors rank above ODs. The provision does not distinguish between related and unrelated unsecured FCs, implying that all unsecured FCs hold a superior claim to OCs. The Appellant’s argument that the FC, being a related party, should be treated as an equity shareholder (ranked lower in the distribution order) was found to lack merit.
In the case of Swiss Ribbons Pvt. Ltd. v. Union of India[ii], the constitutionality of s. 53 was upheld, emphasizing the rationale for distinguishing financial debts and ODs. The Apex Court recognized that FCs, including unsecured ones, play a critical role in infusing capital into the economy, justifying their higher priority in liquidation.
NCLAT also referred to Shailesh Sangani v. Joel Cardoso[iii], where the Appellate Tribunal was of the view that loans advanced by directors or promoters to a CD constitute a financial debt, even if no interest provision exists, thereby establishing the FC’s claim under the IBC.
NCLAT further noted that the definition of ‘financial debt’ under s. 5(8) does not exclude debts arising from transactions with related parties. While related parties are restricted in other capacities, such as voting rights in the Committee of Creditors (‘CoCs’) as per s. 21 or ineligibility under s. 29A, these limitations do not affect their classification as FCs for liquidation.
The Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 explicitly allow related parties to file claims as FCs. There is no provision in the regulations suggesting that a related party FC should be treated differently from other unsecured FCs in the liquidation distribution hierarchy.
Therefore, it was finally held that s. 53 does not envisage any difference between unsecured debtors and related party unsecured FCs; however, in order of priority in the distribution of assets in the liquidation process, financial debts owed to unsecured creditors rank higher than the debt of OCs and, therefore, the liquidator was not wrong in placing related party unsecured FCs ahead of OCs in waterfall mechanism.
Our Analysis
The NCLAT’s interpretation of s. 53 aligns with the legislative intent to prioritize FCs over OCs, thus reinforcing the objective of promoting economic growth and credit availability. This ruling clearly shows that the courts aim to foster a stable financial environment where credit markets can thrive, ensuring that lenders have confidence in the legal protection of their claims.
Furthermore, the ruling clarifies the distinct roles of FCs and OCs within the insolvency framework. It emphasizes that while OCs contribute to the CD’s operations, FCs provide essential funding that sustains economic activity. Consequently, prioritizing FCs in liquidation is a policy choice to maintain credit availability and reduce systemic risks.
The NCLAT also appropriately distinguished issues concerning the resolution process from those relevant to liquidation. Unlike the resolution stage, where the CoC exercises commercial discretion in approving plans, liquidation follows a statutory distribution order. The arguments related to related party preferences or perceived inequities in distribution should be addressed through regulatory reforms or at the stage of resolution planning rather than by altering the liquidation hierarchy.
End Notes
[i] 2024 SCC OnLine NCLAT 1108 dated 19.09.2024.
[ii] (2019) 4 SCC 17.
[iii] (2019) SCC OnLine NCLAT 52.
Authored by Muskaan Jain, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.