Financial Debt and Operational Debt under IBC

The Insolvency and Bankruptcy Code, 2016 (IBC) has transformed the framework of insolvency law in India. Before its enactment, multiple laws dealt with recovery, restructuring, and liquidation, often leading to delay and confusion. The Code consolidated these processes and introduced a creditor-driven insolvency regime.

A key feature of the IBC is the classification of creditors into two broad categories: financial creditors and operational creditors. This classification is not only definitional but also determines rights in the insolvency process, particularly in the Committee of Creditors (CoC), voting power, and order of repayment. Understanding the difference between financial debt and operational debt is therefore critical.

What is Financial Debt?

Section 5(8) of the IBC defines financial debt as a debt, along with interest (if any), which is disbursed against the consideration for the time value of money.

This phrase “time value of money” means that the lender parts with money today with the expectation of getting something more in return in the future, usually in the form of interest or return.

The section lists various kinds of transactions that qualify as financial debt. These include:

• Money borrowed against payment of interest.
• Amounts raised through acceptance credit facilities or dematerialised equivalents.
• Issue of bonds, notes, debentures, or similar instruments.
• Liabilities arising from finance or capital leases.
• Receivables sold or discounted, except when sold on non-recourse basis.
• Forward sale or purchase agreements having commercial effect of borrowing.
• Amounts raised from allottees in real estate projects.
• Derivative transactions, valued at market price.
• Counter-indemnity obligations relating to guarantees, bonds, or letters of credit.
• Liabilities in respect of guarantees or indemnities for such financial debts.

Case Laws on Financial Debt

1. Swiss Ribbons Pvt. Ltd. v. Union of India (2019) – The Supreme Court explained that financial debt is money disbursed against the consideration for time value of money.
2. Vipul Ltd. v. Solitaire Buildmart Pvt. Ltd. (2020) – A joint development agreement was not considered financial debt since it was a contract of reciprocal rights, not borrowing.
3. Phoenix Arc Pvt. Ltd. v. Spade Financial Services Ltd. (2021) – Collusive transactions will not be treated as financial debt. The Court emphasised that related parties should not misuse their position in the CoC.
4. Magicon Impex Pvt. Ltd. (2021, NCLT Delhi) – Security deposit carrying interest was held to be financial debt as it had the commercial effect of borrowing.
5. Recovery Certificate Cases – The Supreme Court held that a debt crystallised into a recovery certificate also qualifies as financial debt. Excluding such debts would defeat the object of the IBC.

Examples of Financial Debt

• Term loans taken from banks.
• Debentures issued by a company.
• Home buyers’ advances in a real estate project.
• Security deposits carrying interest.

What is Operational Debt?

Section 5(21) of the IBC defines operational debt as a claim in respect of:

• Provision of goods or services, including employment, or
• Dues payable under any law to the Central Government, State Government, or local authority.

Operational debt thus covers payments to suppliers, service providers, employees, and statutory authorities.

Case Laws on Operational Debt

1. Swiss Ribbons Pvt. Ltd. v. Union of India (2019) – Confirmed that operational debt includes dues for goods and services, employment, and statutory payments.
2. Kolkata Municipal Corporation v. Union of India (2021) – Municipal tax dues were treated as operational debt.
3. Chipsan Aviation Pvt. Ltd. v. Punj Llyod Aviation Ltd. (2022, NCLAT) – Advance payment of Rs. 60 lakh was held to be operational debt, even without a formal contract, since it related to provision of services.
4. Pioneer Urban Land and Infrastructure Ltd. v. Union of India (2019) – Advance payments made for goods or services were treated as operational debt.
5. Pr. DGIT v. Synergies Dooray Automotive Ltd. (2019, NCLAT) – Statutory dues like income tax and VAT are operational debts.

Examples of Operational Debt

• Unpaid invoices for raw materials.
• Salary dues to employees.
• Pending GST or income tax dues.
• Advance payments made for supply of goods/services.

Difference Between Financial Debt and Operational Debt

The Insolvency and Bankruptcy Code, 2016 (IBC) creates a structured framework for resolving insolvency in India. One of its most significant features is the classification of creditors into two categories – financial creditors and operational creditors. The classification is not merely academic; it has direct consequences on who drives the resolution process, the rights available to creditors, and the order of repayment.

The Code provides statutory definitions in Section 5(8) for financial debt and Section 5(21) for operational debt. Judicial interpretation has further clarified the scope of these provisions.

Definition

• Financial Debt is defined under Section 5(8) of the IBC as money disbursed against the consideration for the time value of money. This means that money is lent today with the expectation of repayment along with interest or some return in the future.
• Operational Debt, under Section 5(21), means a claim in respect of goods or services (including employment) or dues payable under law to the Central or State Government or local authority. It covers trade debts, wages, and statutory liabilities.

Examples

• Financial Debt includes bank loans, debentures, bonds, advances from home buyers in real estate projects, and derivative transactions. For instance, when a company raises funds through debentures or accepts a term loan from a bank, it creates financial debt.
• Operational Debt includes unpaid supplier invoices, employee salaries, and statutory dues such as income tax, GST, or municipal taxes. For example, if a company fails to pay its raw material supplier or does not deposit tax dues, these claims fall under operational debt.

Nature of Creditor

• Financial Creditors are typically banks, financial institutions, debenture-holders, or home buyers. Their relationship with the corporate debtor is primarily financial in nature, involving lending of money for consideration.
• Operational Creditors are suppliers, employees, service providers, and statutory authorities. Their relationship arises from the supply of goods or services or imposition of statutory dues.

Role in CIRP

A crucial difference arises in the Corporate Insolvency Resolution Process (CIRP):

• Financial Creditors form the Committee of Creditors (CoC), which has complete control over the resolution process. They examine and approve resolution plans with voting rights proportional to the amount of their debt.
• Operational Creditors do not form part of the CoC. They may file claims before the Resolution Professional and are entitled to receive payments under the resolution plan, but they do not control the process.

Voting Rights

• Financial Creditors have voting rights in the CoC and play the decisive role in approving or rejecting resolution plans.
• Operational Creditors have no voting rights in the CoC, although they are entitled to raise their claims.

Repayment Priority

During liquidation, Section 53 of the IBC prescribes a waterfall mechanism:

• Financial Creditors enjoy higher priority in repayment, ranking above operational creditors.
• Operational Creditors are placed lower in the repayment order, meaning their recovery percentage is generally lesser.

Important Judicial Principles

1. Collusive Transactions Not Financial Debt – The IBC excludes sham arrangements to prevent manipulation (Phoenix Arc case).
2. Assured Returns Not Always Financial Debt – Merely promising assured return does not make it financial debt unless there is real disbursement against time value of money (Devesh Singh v. Mega Soft).
3. Unsecured Loans Without Interest – Loans without consideration for time value of money do not qualify as financial debt (Vishwa Nath Singh v. Visa Drugs).
4. Flat Buyers as Financial Creditors – Home buyers’ advances are treated as financial debt, giving them status as financial creditors (Anil Mahindroo v. Earth Iconic Infrastructure).
5. Arbitral Awards and Pre-existing Disputes – If an arbitral award is under challenge, the debt remains disputed and cannot trigger CIRP (K. Kishan v. Vijay Nirman Co.).

Conclusion

The classification of debt under the IBC into financial and operational categories has far-reaching consequences. Financial debt focuses on money lent against time value, while operational debt covers trade and statutory dues. Judicial interpretations by the Supreme Court, NCLAT, and NCLT have gradually clarified grey areas such as treatment of recovery certificates, collusive transactions, assured returns, unsecured loans, and advance payments.