J.R. Agro Industries P Limited vs. Swadisht Oils P Ltd. - Under the UNCITRAL Legislative Guide to Insolvency Law, clause 77 provides that “related persons claim to be subordinated to the claims of the ordinary unsecured claims.

NCLT Allahabad (24.07.2018) in J.R. Agro Industries P Limited V/s. Swadisht Oils P Ltd. [CA 59 of 2018 in CP 13/ALD/2017] held that;.

• The UNICITRAL legislative guide on the insolvency law, Para 61, provides that “the normal ranking of claims under the insolvency law is observed by the plan and that similarly ranked creditors are treated equally.

• It is important to point out that after approval of the resolution plan by the Adjudicating Authority, the resolution plan has binding effect on all the stakeholders, which includes operational creditors also. The operational creditors did not get the opportunity to vote in the COC, but the approved Resolution Plan is binding on them.

• “Notably, distinction under section 53 is a two-fold distinction – (i) secured /unsecured, and (ii) operational/financial. As regards secured creditors, it does not matter whether the creditor is financial or operational, since section 53(1)(b) uses the expression “secured,” and there is no indication as to the nature of debt (financial/operational) owed to such secured creditor. However, when it comes to unsecured creditors, unsecured financial creditors appear in the 4th rank; but unsecured operational creditors come in the 6th rank.”

• On perusal of the UNCITRAL Legislative Guide on Insolvency Law, it appears that the United Nations Commission on International Trade Law has rated the related persons claim subordinate to the claims below the rank of ordinary unsecured claims. Here, under I & B Code, 2016 unsecured financial creditors have been given priority over the claims of operational creditors.

• Under the UNCITRAL Legislative Guide to Insolvency Law, clause 77 provides that “related persons claim to be subordinated to the claims of the ordinary unsecured claims. They are rank inferior to the claims of other unsecured creditors, 

Excerpts of the order;

(Page 20/50)There is no bar on common promoters /directors to present resolution plan for the company undergoing the CIR process. The “related party” is barred from participating in the COC meetings and cannot vote, but they are not debarred from submitting a resolution plan. So far as the applicability of clause (a) of section 29 A is concerned, admittedly RLL is not an undischarged insolvent, hence the question of applicability of this clause to RLL does not arise.

(Page 24/50) The UNICITRAL legislative guide on the insolvency law, Para 61, provides that “the normal ranking of claims under the insolvency law is observed by the plan and that similarly ranked creditors are treated equally. Some insolvency laws permit classes of unsecured creditors that are not entitled to priority to consent, by vote of the requisite majority of the class, to ranking different from that applying to distribution in liquidation under the insolvency law. A class of ordinary unsecured creditors that will not be paid in full might consent, for example, to distribution to a class of subordinated claims or equity holders. Claims and expenses that are administrative claims or are entitled to be paid in priority are generally required to be paid in full for a re-organisation plan to be confirmed, except to the extent that the holder of  the claim or expense agrees to different treatment. Some laws require the court to assess additional matters, such as whether the plan can be considered to be fair in respect of those classes whose interest are modified or affected by the plan but which nevertheless have voted to approve the plan.”

In the UNICITRAL report, it is specifically mentioned that similarly ranked creditors are treated equally.

(Page 25/50) We are of the considered opinion that there should be no discrimination among the same class of creditors.

Explanation 1 of section 53 of the IB code provides that: “it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full;” All the operational creditors are rank equal. Therefore there should be no discrimination in distribution of the payment among the same class of creditors.

(Page 29/50) It is important to point out that after approval of the resolution plan by the Adjudicating Authority, the resolution plan has binding effect on all the stakeholders, which includes operational creditors also. The operational creditors did not get the opportunity to vote in the COC, but the approved Resolution Plan is binding on them.

(Page 33/50) “Notably, distinction under section 53 is a two-fold distinction – (i) secured /unsecured, and (ii) operational/financial. As regards secured creditors, it does not matter whether the creditor is financial or operational, since section 53(1)(b) uses the expression “secured,” and there is no indication as to the nature of debt (financial/operational) owed to such secured creditor. However, when it comes to unsecured creditors, unsecured financial creditors appear in the 4th rank; but unsecured operational creditors come in the 6th rank.”

(Page 34/50) The BLRC recommendation, as above, justifies the preferential treatment of unsecured financial creditors over government dues but does not provide any reasoning for not treating unsecured financial and operational creditors at par. As such, the priority given under section 53 fails to consider and appreciate the following: –

• (i) An economy runs not merely on the financial system, but on the system of supply of goods and services. Goods and services are supplied for credit, which is why operational creditors arise. Supply of goods and services on credit becomes a part of the working capital for the entity, which exactly serves the same purpose as served by financial lenders.

• (ii) Supply of goods and services on credit is a crucial part of the economy. The base of the economy of any country is its real sector; financial sector is important, but not at the cost of the real sector. Suppliers of goods and services, including MSMEs, are a part of the real sector.

• (iii) How will MSMEs continue to supply goods and services on credit to their customers, if they were to be told that if the customer goes into a default, all the money will go first to bankers, and money will be paid to the suppliers only if there is a surplus left?

For the reasons discussed above, the distinction between unsecured creditors, inter-se, under section 53 does not seem to be consistent with the umbrella objective of equitable treatment.

(Page 35/50) On perusal of the UNCITRAL Legislative Guide on Insolvency Law, it appears that the United Nations Commission on International Trade Law has rated the related persons claim subordinate to the claims below the rank of ordinary unsecured claims. Here, under I & B Code, 2016 unsecured financial creditors have been given priority over the claims of operational creditors. Operational creditors are also unsecured creditors, but the priority of claims of unsecured financial creditors over and above the claim of unsecured operational creditors is unique in I & B Code, 2016 only, whereas such distinction is not provided in Insolvency laws, prevalent in US, UK & Germany. United Nations Commission on International Law has specifically provided related parties claims rank lower to the other ordinary unsecured claims.

(Page 38/50) Under the UNCITRAL Legislative Guide to Insolvency Law, clause 77 provides that “related persons claim to be subordinated to the claims of the ordinary unsecured claims. They are rank inferior to the claims of other unsecured creditors, under I & B Code, 2016, unsecured financial creditors, even though that creditors happens to be a related party of the corporate debtor, are rank higher to the claims of operational creditors in water fall mechanism, which appears to be discriminatory.”

(Page-42/50) Since debt of Jya Finance and investment Ltd is an intragroup debt. The Jya finance and investment Ltd has always acted as a financial arm of the corporate debtor. In UNCITRAL legislative guide on insolvency law, such type of debt has been treated as an equity contribution rather than as an intra-group loan, with the consequence that intragroup obligations will rank lower priority than the same obligation between unrelated parties…….

(Page 46/50) Thus, we hold that the debt of Rs.36.6643 crore of Jay Finance & Investment Co. Ltd Crores, which is admittedly a related party of corporate debtor should fall in the category of “equity shareholders are partners” as provided in section 53(1)(h) of the Code. Their claim will be treated at par with equity shareholders are partners, who are other unsecured creditors they rank below the operational creditors of the corporate debtor.

(Page-49/50) Thus the intra group debt given by Jay Finance & Investment Co. Ltd, a related company of the corporate debtor be classified at par with other equity shareholder and partners as provided in water fall mechanism provided in Sec 53(1)(h) of the Code. It is further directed that all the operational creditor should be treated equally without being also classified by their ageing, i.e., without any discrimination of period of their outstanding dues.

 

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