On September 19, 2024, the National Company Law Appellate Tribunal in the case of Times Innovative Media Limited v. Pawan Kumar Aggarwal (Liquidator) held that operational creditors cannot claim priority over unsecured financial creditors in liquidation.

Brief Facts:

1. Vide Order dated March 27, 2018, the Corporate Insolvency Resolution Process (“CIRP”) was initiated against the Corporate Debtor, Messrs. Brand Connect Communications (India) Private Limited.
2. On January 28, 2019, the Adjudicating Authority directed liquidation of the Corporate Debtor.
3. The Respondent No. 2/ ex-director of the Corporate Debtor, who was the financial creditor of the Corporate Debtor and the Appellant/ operational creditor had filed their respective claims during the CIRP and before the liquidator. The claim of the Appellant/ operational creditor was admitted during CIRP, however, in the liquidation process, the Appellant/ operational creditor raised an objection in relation to the priority of payment over the payment to Respondent No. 2/ ex-director of the Corporate Debtor. The claim of the Respondent No. 2/ ex-director of the Corporate Debtor was admitted as that of an unsecured financial creditor.
4. In the stakeholders’ consultation meeting, the liquidator had informed that as per Section 53 of the Insolvency and Bankruptcy Code, 2016 (“Code”), the Respondent No. 2/ ex-director of the Corporate Debtor may get priority over the Appellant/ operational creditor in the distribution of the liquidation estate.
5. Against such observation in the meeting, the Appellant/ operational creditor raised an objection that he should be given preference over the Respondent No. 2/ ex-director of the Corporate Debtor, who was an unsecured financial creditor of the Corporate Debtor.
6. The objection was rejected by way of an order dated September 3, 2021 passed by the liquidator. The order dated September 3, 2021 was challenged before the Adjudicating Authority, which was also dismissed vide the impugned judgment dated April 24, 2024.       

Submission of parties:

A. Appellant:

1. The Respondent No. 2/ ex-director of the Corporate Debtor, being a related party cannot be given priority in distribution of proceeds of liquidation assets of the Corporate Debtor, ahead of the Appellant/ operational creditor.
2. The Respondent No. 2/ ex-director of the Corporate Debtor has to be treated as an equity shareholder and a related party of the Corporate Debtor, and therefore, he is not entitled to a priority in the waterfall mechanism under Section 53 of the Code, as he wears two hats, i.e., promoter/director/ equity shareholder and a financial creditor. Therefore, he ought to be considered under the hat of an equity shareholder. 

B. Liquidator:

1. The inclusion of the Respondent No. 2/ ex-director of the Corporate Debtor as an unsecured financial creditor in the list of stakeholders was never challenged, thus, rendering it final. The objection was raised only after the stakeholders’ consultation meeting.
2. The Respondent No. 2/ ex-director of the Corporate Debtor had advanced the loan on February 2, 2011 and thereafter, had resigned as a director on October 1, 2013 and thus, the Respondent No. 2/ ex-director of the Corporate Debtor cannot fall within the ambit of a related party of the Corporate Debtor.
3. Section 53 of the Code does not envisage any difference between an unsecured financial creditor, i.e., the Appellant/ operational creditor and a related party unsecured financial creditor, i.e., the Respondent No. 2/ ex-director of the Corporate Debtor.

C. Respondent No. 2 (supporting the case of liquidator): 

1. The loan was advanced by the Respondent No. 2/ ex-director of the Corporate Debtor in 2011 to 2012, which loan had been partly repaid by the Corporate Debtor.
2. The financial debt of the Respondent No. 2/ ex-director of the Corporate Debtor was admitted and he was treated as an unsecured financial creditor, which was never challenged.

Issue:

Whether the Appellant/ operational creditor has a right of priority in payment of distribution of the liquidation estate of the Corporate Debtor over the Respondent No. 2/ ex-director of the Corporate Debtor, who was an unsecured financial creditor?

Decision:

It was held that financial debts owed to unsecured creditors rank higher than debts of operational creditors. The Appellant/ operational creditor cannot claim any priority in the distribution of the assets of the Corporate Debtor as compared to unsecured financial creditor, who was the Appellant/ ex-director in the present case.

Analysis:

The present judgment makes it abundantly clear that a director of a corporate debtor, who has advanced a loan to the corporate debtor during his tenure as a director of the corporate debtor but later ceases to be a director of the corporate debtor, would be treated as an unsecured financial creditor and shall have priority in the distribution of the assets of the Corporate Debtor over an operational creditor.

Please find attached a copy of the judgement.

This update has been contributed by Namitha Mathews (Partner) and Poorva Pant (Principal Associate).

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