Introduction :

Creditors play a focal role in the financial sector, acting as economic contributors whose contributions are integral to the operation of businesses and overall the financial system. Creditors furnish loans or provide goods and services on credit with an expectation of repayment from the debtors.

In the Indian context, the gravity of the creditors is underscored by the legislative frameworks such as Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993  (RDDBFI Act), and the Insolvency and Bankruptcy Code, 2016 (IBC). These instruments enables  creditors with tools to safeguard their interests and recover dues orderly.

The SARFAESI Act, 2002, provides creditors, particularly banks and financial institutions, with the power to take possession and sell secured assets of default borrowers without intervention of the court. This aerodynamic process expedites the recovery of non-performing assets and empowers the position of the creditors in securing their interests.

The RDDBFI Act, 1993, on the other hand, set up tribunals for the accelerated adjudication and recovery of debts due to banks and financial institutions.  It provides a legal plan of action for the creditors to resolve disputes and recover outstanding dues through DRT and DRAT, contributing to a more efficient debt recovery procedure.

The IBC, a comprehensive legislature, transforms the insolvency and debt resolution landscape. Empowering the creditors with a structural approach to resolve financial distress and also ensures a time-bound process through mechanisms such as the Corporate Insolvency Resolution Process (CIRP means the process which will help a struggling company sort out its financial troubles and find a route to repay its debts). Under IBC, the constitution of the Committee of Creditors (CoC) allows the creditors to  decide the fate of the distressed company during insolvency.

In essence, creditors go beyond being banks and financial institutions aiming for repayment, they represent a crucial mechanism for recovering dues.

Meaning of the term “Creditor”

According to Section 3(10), Insolvency and Bankruptcy Code, 2016, creditor means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree holder. In simple terms a creditor is the one who trusts or gives credit, correlative to the debtor.

This broad definition has encompassed certain types of creditors, namely financial creditors, an operational creditor, a secured creditor, an unsecured creditor. Understanding financial creditors, an operational creditor, a secured creditor, an unsecured creditor is crucial as to protect and safeguard their interest plus recover outstanding due from defaulter the SARFAESI Act, RDDBFI Act and IBC are implemented.  Firstly let's examine these four creditors individually to gain a clearer understanding.

1. Financial Creditor : According to Section 5(7) of IBC, 2016, Financial creditor means “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to”. The term financial creditor has not been defined under SARFAESI Act and RDDBFI Act. Financial creditor is an entity, particularly banks and financial institutions, that lends money to the borrower and whereby the borrower promises to repay the borrowed amount along with any applicable interest within a frame time period.
2. An Operational Creditor: According to Section 5(20) of IBC, 2016, An Operational Creditor means “ a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred”.  The term Operational Creditor is defined only in IBC. An Operational Creditor is an individual or entity that has provided goods and / or services to a company and is entitled to receive payment for those goods and services. Unlike financial creditors, who provide loans, operational creditors are involved in day-to-day business transactions.
3. Secured creditor: According to Section 2(1) (ze) of the SARFAESI Act, 2002, Secured Creditor means “any bank or financial institution or any consortium or group of banks or financial institutions and includes :
4. Debenture trustee appointed by any bank or financial institution ; or
5. Securitisation company or reconstruction company, whether acting as such or managing a trust set up by such securitisation company or reconstruction company for the securitisation or reconstruction, as the case may be ; or
6. Any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by  any borrower of any financial assistance.”

AND

According  to Section 3(30), of IBC, 2016 , Secured Creditor means “a creditor in favour of whom security interest is created”.

A secured creditor is an individual or entity that holds a security interest or collateral against a loan or credit extended to a borrower. In easy terms, when someone leads money or provides credit, a secured creditor takes steps to secure the repayment of that debt by obtaining a security interest in the borrower’s assets. This security interest gives the creditor a legal claim over specific interest and gives the credito a legal claim over specific assets if the borrower fails to repay the debts as agreed.

1. Unsecured Creditor: The term “Unsecured Creditor” is not explicitly defined under SARFAESI Act, RDDBFI Act, and IBC. In general unsecured creditor means an individual or entity that has provided a loan to a borrower without obtaining specific collateral or security interest in return. Unlike secured creditors who have a claim on specific assets if the borrower defaults, unsecured creditors do not have a direct lien on any particular asset. Instead, unsecured creditors rely on the borrower’s general creditworthiness and trust that the borrowers will be repaid based on their overall capacity to meet financial obligations.

Examine the method by the which the creditors retrieve their outstanding dues from debtors:

The focal aspect of the procedural mechanism is determining the applicable Act for each creditor.

The provisions of “IBC” shall apply to-

1. any company incorporated under the Companies Act, 2013 or under any previous company law;
2. any other company governed by any special Act for the time being in force, except in so far as the said provisions are inconsistent with provisions of such special Act;
3. Any Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008;
4. such other body incorporated under any law for the time being in force, as the Central Government, by notification, specify in this behalf;
5. Personal guarantors to corporate debtors;
6. Partnership firms and proprietorship firms; and
7. Individual, other than persons referred to in clause (e).

The IBC constitutes a broad scope of applicability, encompassing companies, Limited Liability Partnerships (LLPs), personal guarantors, partnership firms, and proprietorship firms and in case they lend debt shall be called as corporate debtor. In particular, when financial creditors, such as banks and financial institutions, provide loans to corporate debtors and face defaults, they can invoke the provisions of the IBC. On the other hand, operational creditors, those providing goods and services on credit, also have the right to invoke the provisions of IBC.

Under Section 7 of IBC, the financial creditor can initiate corporate insolvency resolution process:

1. A financial creditor, alone or jointly with others, or a person authorised by the Central government, may file an application for corporate insolvency resolution when there is a default by the corporate debtor (CIRP commences when a company defaults on its debt, then the financial creditor, operational creditor, or the company itself files an application before the NCLT as mentioned under Section 6 of the IBC).
2. In certain cases, such as financial creditors referred to clauses (a) and (b) of sub-section (6A) of section 21, joint filing is required by not less than one hundred creditors in the same class or not less than ten percent of the total number of such creditors, whichever is less.
3. Applications not admitted on non-complying with first and second proviso by the adjudicating authority before the commencement of the IBC (Amendment) Act, 2020, need to be modified to comply with the requirement of the first and second proviso within 30 days, or they will be deemed withdrawn.
4. Default definition includes a financial debt default not only to the applicant financial creditor but to any other financial creditor of the corporate debtor.
5. The financial creditor must submit the application in the prescribed form and manner, accompanied by the specified fee.
6. Along with the application, the financial creditor must provide records of the default from an information utility or other evidence, propose an interim resolution professional, and furnish any other information species by the Board.
7. The Adjudicating Authority must, within fourteen days, ascertain the existence of a default based on records or evidence furnished by the financial creditor.
8. The Adjudicating Authority communicates the admission or rejection order within seven days to the financial creditor, the corporate debtor, or the financial creditor depending on the decision.
9. The corporate insolvency resolution process begins from the date of admission of the application.
10. If the application is rejected, the Adjudicating Authority provides an opportunity to rectify any defects within seven days.

This process ensures a systematic and legally guided approach to resolving insolvency issues involving financial creditors and corporate debtors. The aim of  CIRP is to find workable resolution for the  financial trouble faced by the company. The process involves the appointment of an Interim resolution Professional (IRF) who will manage the company’s affairs. A moratorium period is imposed to shed the company from legal proceedings, providing a root for resolution. Moratorium refers to the entire period of the IRP, it is ordered by the NCLT on the debtor’s operations. It is also known as the “claim period” when no judicial proceedings can be commenced. Then the Committee of Creditors (CoC) constituted where the financial creditor plays a key role in decision making, valuing and approving resolution plans. If the plan is not approved or if the CoC opts for it, the company may deal with liquidation as the last result. An insolvency professional administers the liquidation process. Lastly, the sale of the debtor’s assets are given out. 

Under Section 8 of IBC provides Insolvency Resolution by an Operational Creditor:

1. When there is a default, an operational creditor can issue a demand notice ( a “demand notice” refers to a notice served by an operational creditor to the corporate debtor, demanding payment for the operational debt for which the default has occurred) for the unpaid operational debt. This notice, along with a copy of the invoice, should request payment in the manner prescribed by the regulations.
2. Upon receiving the demand notice or invoice, the corporate debtor must, within ten days, informs the operational creditor about:

-(i) Any existing dispute or the record of a pending suit or arbitration related to the dispute before the receipt of the notice or invoice.

-(ii) The payment of the unpaid operational debt, which can be demonstrated by providing an attested copy of the electronic transfer record from the corporate debtor's bank account or an arrest copy of the record showing that the operational creditor has encashed a cheque issued by the corporate debtor.

Under Section 9 of the IBC, application for initiation of corporate insolvency resolution process by an operational creditor:

1. If, after ten days from the delivery of the notice or invoice demanding payment, the operational creditor does not receive payment or notice of a dispute from the corporate debtor, the operational creditor can submit an application to the Adjudicating Authority (NCLT) to initiate a corporate insolvency resolution process.
2. The application, submitted in the prescribed form with the required fee as may be prescribed.
3. The operational creditor, along with the application furnish:

-(i) A copy of the invoice or demand notice sent to the corporate debtor.

-(ii) A certificate from the financial institutions maintaining accounts of the operational creditor confirming the non-payment by the corporate debtor.

-(iii) A certificate from the financial institutions maintaining accounts of the operational creditor confirming the non-payment by the corporate debtor.

-(iv) Optionally, a copy of any record from an information utility confirming the non-payment.

-(v) Any other proof or information prescribed to demonstrate the non-payment.

1. The operational creditor, initiating the process, can propose a resolution professional to act as an interim resolution professional.
2. Within fourteen days of receiving the application:

-(i) The Adjudicating Authority (NCLT) admits the application if certain conditions are met, and the corporate insolvency resolution process commences.

-(ii) The Adjudicating Authority (NCLT) rejects the application if certain conditions are not met, and communicates the decision to the operational creditor and the corporate debtor. If rejection is due to incomplete application, the Authority provides an opportunity to rectify the defects within seven days.

1. The corporate insolvency resolution process officially begins from the date of  admission of the application. This process ensures a structured approach for operational creditors to seek resolution when facing non-payment from corporate debtors.

If CIRP has not resulted in resolution, the company may resort to liquidation as a final option. Notably, financial creditors can either be classified as secured creditor and unsecured creditor, however an operational creditor is always classified as unsecured creditor. Financial and operational creditors are part of the Committee of Creditors (CoC) during the CIRP. However, the rights  and voting shares in the CoC vary. Financial creditors, especially secured creditors, often have a higher voting share compared to unsecured financial creditor and operational creditors when it comes to approval or rejection of resolution plans. The distribution of proceeds during the resolution process also follows a specific order, and the secured financial creditors have unquestionable priority.  It appears to involve significant disparity. This disparity among financial and operational creditors was challenged in the above matter.

In the case of Swiss Ribbons (P) Ltd. v. Union of India (2019) 4 Supreme Court Cases 17, the Hon’ble Supreme Court addressed the constitutional validity of such distinguishing between financial creditors and operational creditors, questioning whether such differentiation breaches Article 14 (Equality before Law) of the Indian Constitution. The Court justified these differences by highlighting that financial creditors, particularly banks and financial institutions possess superior abilities to assess business viability compared to operational creditors, which primarily deals with goods and services. The judgement asserted that this distinction is reasonable, as financial creditors play a more focal role in evaluating the feasibility of a business, and therefore, it does not infringe upon Article 14.

Then a case at the Adjudicating Authority (NCLT) against the corporate debtor by an operational creditor  has no value? They are not entitled to any advantage or benefits at the end of the process?

Section 53 of the IBC,

The distribution prioritisation is as follows:

1. Insolvency Resolution Process Costs and Liquidation Costs:

-Costs incurred during the insolvency resolution process and liquidation are paid in full.

2. Equal Ranking Debts:

-(i) Workmen’s dues for the twenty-four months preceding the liquidation commencement date (An Operation Creditor).

-(ii) Debts owed to secured creditors if they have relinquished security as per Section 52. (Financial Creditor)

Wages and Dues to Employees:

-Wages and any unpaid dues to employees (other than workmen) for the twelve months preceding the liquidation commencement date.

Wages and Dues to Employees:

-Wages and any unpaid dues to employees (other than workmen) for the twelve months preceding the liquidation commencement date.

Financial Debts to Unsecured Creditors:

-Financial debts owed to unsecured creditors.

Equal Ranking Dues:

-(i) Amounts due to the Central Government and STate Government, including amounts related to the Consolidated Fund of India and the Consolidated Fund of a State for the preceding two years.

-(ii) Debts owed to a secured creditor for any amount unpaid following the enforcement of security interest.

1. Remaining Debts and Dues:

-Any remaining debts and dues.

1. Preference Shareholders:

-If applicable, preference shareholders.

1. Equity Shareholders or Partners:

-Equity shareholders or partners, as the case may be.

1. Contractual Arrangements:

-Any contractual arrangements between recipients with equal ranking  that disrupt the order of priority under subsection (1) shall be disregarded by the liquidator.

2. Liquidator's Fees:

- The fees payable to the liquidator are deducted proportionately from the proceeds allotted to each class of recipients under subsection (1), and the distribution to relevant recipients occurs after such deductions.

The structured order of priority in liquidation proceedings, where operational creditors, specially those representing workermen’s due, are given precedence before addressing the claims of financial creditors.

RDDBFI Act, 1993 and SARFAESI Act, 2002:

Loans are financial tools that serve the diverse needs of both individuals and companies, as they are meant to drive overall economic prosperity. The concern arises when the borrower fails to fulfil the obligation of repaying it. To address the concern, the government has enacted major Acts such as SARFAESI Act, 2002 and  Recovery of Debts due to Bank and Financial Institution Act, 1993 (RDDBFI Act). The Securitization and Reconstruction of Financial Asset and Enforcement of Security Interest Act, 2002 (SARFAESI ACT of 2002) for recovery of default loans was governed by the legislation of Recovery of Debts due to Banks and Financial institution Act, 1993 (RDDBFI Act). SARFAESI Act, 2002 is a new Act enacted by the Central Government to empower the banks and financial institutions to take possession of the secured asset in an authorised manner to recover the defaulted loan. SARFAESI Act, 2002 has not replaced RDDBFI Act, 1993. The matters pertaining to RDDBFI Act and SARFAESI Act are instituted before Debt Recovery Tribunal (DRT).

The provisions of “RDDBFI Act, 1993” shall apply to -

Section 1(4) of the RDDBFI Act

….(4) The provisions of this Act shall not apply where the amount of debt due to any bank or financial institution or to a consortium of banks or financial institutions is less than ten lakh rupees or such other amount, being not less than one lakh rupees, as the Central Government may, by notification, specify…..

The provisions of “SARFAESI Act, 2002” shall apply to -

“When the borrower defaults loans and the asset becomes a non-performing asset then the respective bank or financial institution after enforcing security can claim the remaining amount under RDDBFI Act which is in surplus of Rupees 1 lakh”.

Another dissimilarity between SARFAESI Act and RDDBFI Act is that SARFAESI is applicable to secured creditors only whereas the RDDBFI Act is relevant to secured and unsecured creditors.

Under the RDDBFI Act, 1993, the initiation of filing an application is undertaken by the secured creditor or unsecured creditor with an application called O.A (Original Application) on account of default by the borrower payment. Whereas under SARFAESI Act, the initiation of filing an application is undertaken by the default borrower with an application called S.A (Securitisation Application). Once the secured asset of the default borrower is recognised as “non-performing asset” the financial creditors can initiate proceedings against the default borrower. Asset is recognised as non-performing asset on missing 3 (three) instalments by the borrowers. Failing of payment by the obligated borrower for 90 days will declare the defaulted borrower secured asset as non-performing asset. Under SARFAESI, Act, declaration of non-performing asset “Demand Notice” under Section 13(2) is sent to the default borrower. An opportunity to settle outstanding due is given to the defaulter within 60 days from the date of receiving of such notice. On non-payment Section 13(4) Physical Possession of the secured asset is sent to the debtor this power is obtained by the financial institution from the Chief Metropolitan Magistrate or District Magistrate. If the borrower now can contest the possession before the DRT through S.A. application within 45 days from receiving the notice of physical possession.  The Auctioning initiation is taken by the banks or financial institutions after symbolic possession occupied by them. About auction of secured assets, it is the rule of  Security Interest (Enforcement) Rules, 2002 for notifying the default borrower about auction through sale auction notice. On condition of movable asset under Rule 6 and on condition of immovable asset under Rule 8 of the Security Interest (Enforcement) Rules, 2002. The sale of both movable assets and immovable assets may happen through methods like obtaining quotes, inviting tenders, public auctions, or private treaties. The authorised officer must serve a sale notice to the borrower for the sale, along with publication in 2 leading newspapers one among should be in vernacular language (Regional Language). After successful auction by the bank or financial institution a certificate of sale is issued upon payment, that establishes the purchaser’s title.

Agricultural land are exempted under SARFAESI Act

The Supreme Court in K. Sreedhar v. Rous Constructions Pvt. Ltd 2023 SCC OnLine SC 13, held only a secured property used as agricultural land can be exempted under SARFAESI Act and the Hon’ble Apex Court sets aside Telangana High Court's order.

Creditors recovering outstanding dues from “Guarantor / Guarantors”.

In the realm of lending under RDDBFI Act, SARFAESI Act, IBC mainly three parties come into play where the lead shall be borrower, followed by the financial creditor, and often, another crucial member / members known as Guarantor/s. The guarantor’s pivotal role is to step into the shoes of the borrower once borrower is categories under the character of defaulter.

Liability of Personal Guarantor / Guarantors under IBC.

Lalit Kumar Jain v. Union of India, (2021) 9 SCC 321 : 2021 SCC OnLine SC 396. It is held that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. As held by this Court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.

Liability of Guarantor under SARFAESI Act.

The following provision under SARFAESI Act, 2002 empowers the banks or financial institutions to take action against the guarantor, once the borrower defaults on obligations. Section 13 (2) of the SARFAESI Act empowers the banks and financial institutions the way of taking action against the default borrower and Section 13(11) authorises the banks and financial institutions to take action against the guarantor / guarantors.

……………..…..

          “13(2) Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under sub-section (4).     

……………..…..

          (4) In case the borrower fails to discharge his liability in full within the period specified in sub-section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:—

(a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset;

(b) take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset;

(c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;

(d) require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.”

……………..…..

(11) Without prejudice to the rights conferred on the secured creditor under or by this section, the secured creditor shall be entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measured specifies in clauses (a) to (d) of sub-section (4) in relation to the secured assets under this Act.

The Act under the Section 13 (17) mentions the liability of guarantor / guarantors on default on behalf of the borrower. Initially, the bank will target the secured asset to recover the outstanding amount through auction. If  through auction procedure the outstanding dues are not fully covered by the bank and financial institution then they shall pursue to recover from the guarantor.

Conclusion:

The RDDBFI Act and SARFAESI Act, facilitate debt recovery by financial institutions, while IBC provides a comprehensive legislation for insolvency resolution and liquidation. Together, these three legislations are contributing to well-round financial stability in India.

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