Financial Creditor under IBC

The Insolvency and Bankruptcy Code, 2016 (IBC) introduced a comprehensive and unified framework for resolving insolvencies in India, which previously were scattered across multiple laws. Among its many innovations, the IBC established clear categories of creditors, notably including “financial creditors.”

Who is a Financial Creditor under IBC?

A financial creditor, as per Section 5(7) of the IBC, is a person to whom a financial debt is owed. This definition also extends to persons to whom such debt has been legally assigned or transferred.

Therefore, a financial creditor could be the original lender or someone who has subsequently acquired the rights to the debt. What distinguishes financial creditors from other creditors is the nature of the debt owed to them, which must qualify as a “financial debt.”

Financial Creditor under Section 5(7) of the IBC

Section 5(7) of the IBC defines a financial creditor as “a person to whom a financial debt is owed, including a person to whom such debt has been legitimately assigned or transferred.” To determine whether a person is a financial creditor, the debt owed to that person must come within the definition of “Financial Debt” as outlined in Section 5(8) of the IBC.

Under Section 5(8) of the IBC, a financial debt is defined as: “a debt together with interest, if any, that is distributed against the consideration for time worth of money and includes:

• money borrowed against interest payment.
• Any money raised through acceptance under an acceptance credit arrangement, or its dematerialized counterpart.
• Any sum raised by a note purchase facility or the issuance of bonds, notes, debentures, loan stock, or a comparable instrument.
• The amount of any liability related to a lease or hire purchase agreement that is deemed a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed.
• Receivables sold or discounted, excluding those sold on a non-recourse basis.
• Any sum raised through any other transaction, such as a forward sale or purchase agreement, that has the commercial impact of a loan.
• Any counter-indemnity duty relating to a bank or financial institution’s guarantee, indemnity, bond, documented letter of credit, or other instrument.
• The amount of any responsibility relating to any guarantee or indemnification for any of the items listed in sub – clauses (a) – (h) of this clause “.

Understanding Financial Debt

To qualify someone as a financial creditor, it is essential to understand what constitutes a financial debt under the IBC. Section 5(8) provides a broad definition that encompasses various forms of debt, provided they share a common characteristic: they are disbursed against the consideration for the time value of money. This definition includes, but is not limited to, the following:

• Money borrowed against the payment of interest: This is the most straightforward example of a financial debt, where money is lent with an agreement to pay back the principal amount along with interest.
• Acceptance credit arrangements: These are agreements where money is raised through accepting bills of exchange, a common practice in trade financing.
• Issuance of financial instruments: This includes raising money through bonds, notes, debentures, loan stock or any similar instruments that represent a borrowing.
• Liabilities under lease agreements: Specifically, those considered as finance or capital leases under applicable accounting standards, where the lessee assumes substantially all the risks and rewards of ownership.
• Receivables sold or discounted: Except for non-recourse sales, where the seller’s right to collect receivables is sold or discounted.
• Transactions with the commercial effect of borrowing: This catch-all category includes any transaction that, although not borrowing in the traditional sense, creates a financial liability similar to a loan.
• Guarantees and indemnities: Liabilities arising from guarantees or indemnities provided in connection with any of the above forms of debt.

The Significance of Being a Financial Creditor

Financial creditors play a pivotal role in the insolvency resolution process under the IBC. They have the right to initiate an insolvency resolution process against a corporate debtor by applying to the National Company Law Tribunal (NCLT).

Furthermore, financial creditors are part of the Committee of Creditors (CoC), a body that has significant powers in deciding the fate of the insolvent entity, including the approval of resolution plans and the decision to liquidate the entity.

The distinction between financial and operational creditors (those to whom an operational debt is owed) is crucial since it determines the rights and priorities under the IBC. Financial creditors, given their role in providing capital based on the time value of money, are often seen as having a more significant stake in the financial health and recovery of the debtor, which is reflected in their rights under the IBC.

Judicial Interpretation and Developments

The definition of financial creditors and financial debt has been subject to judicial scrutiny, with courts in India interpreting these terms to address the complexities of modern financial transactions.

For instance, the Supreme Court of India has held in several cases that the interpretation of financial debt must consider the substance of the transaction over its form, ensuring that the IBC’s provisions are applied in a manner that fulfils its objectives.

Final Words

Financial creditors are central to the insolvency resolution process under the IBC, with their rights and responsibilities clearly delineated by the law. The broad definition of financial debt ensures that various forms of financial arrangements are covered, reflecting the complexities of modern finance.

As the IBC evolves through legislative amendments and judicial interpretations, the understanding of who qualifies as a financial creditor may also expand, adapting to new financial innovations. Understanding the nuances of financial creditors under the IBC is essential for stakeholders in the insolvency and bankruptcy domain, as it shapes the insolvency resolution landscape in India.