Creditors are very important in the worlds of business and finance because they keep the flow of money and trust between entities going. Borrowing and lending are what make economic interactions possible, whether they are between a person, a business, or the government. Of these relationships are creditors, or people who lend money, goods, or services with the expectation that they will be paid back.
When it comes to debt recovery and going bankrupt, it's especially important to know who your creditors are, how they work, and what their legal standing is. This article talks about what creditors are, what their roles are, the different kinds of creditors, and how the Insolvency and Bankruptcy Code (IBC), 2016 in India treats creditors.
Who is a Creditor?
A creditor is a person, business, or organisation that has given credit or lent money to the debtor. As agreed, the creditor wants to be paid back with the principal amount plus any interest or fees.
Creditors are available in both personal and business finance. Creditors include, for instance, a bank that gives someone a home loan or a supplier who gives a manufacturer raw materials on credit terms.
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Types of Creditors
Creditors can be broadly classified into two major categories based on the nature of their relationship with the debtor:
1. Secured Creditors
With collateral, secured creditors lend money or provide goods or services. Thus, they have a legal claim (lien) on the thing the borrower pledged as security. In case of default, the secured creditor can take the asset or sell it to get the money back.
Examples:
Banks offering loans against property
Car financing companies
2. Unsecured Creditors
It's not possible for these creditors to hold any security or collateral. They can only be sure of something if the borrower promises to pay back. Unsecured creditors are paid after secured creditors and other claims that come before them if the business goes bankrupt.
Examples:
Credit card issuers
Suppliers offering trade credit without collateral
Role of Creditors in Financial Systems
Creditors play a crucial role in sustaining economic activity and business growth. Their primary roles include:
Providing Capital and Resources: Businesses and people can run their lives without creditors because they lend money or extend credit. This lets the business grow, buy things, and make capital investments.
Enforcing Financial Discipline: Creditors impose financial discipline on debtors through legal agreements and repayment obligations. Accountability and smart borrowing are encouraged by this structure.
Monitoring Risk: Creditors often check a borrower's creditworthiness, look into their background, and keep an eye on how well they pay back their loans. This helps keep the whole financial system stable.
Classification of Creditors under the Insolvency and Bankruptcy Code (IBC), 2016
The Insolvency and Bankruptcy Code (IBC) was made law in India to make the process of going bankrupt easier for individuals, partnerships, and businesses. Creditors are very important to the IBC framework. The IBC divides creditors into two main groups:
1. Financial Creditors
A Financial Creditor is anyone to whom a financial debt is owed, even if the debt has been legally assigned or transferred. This definition comes from Section 5(7) of the Insolvency and Bankruptcy Code. These are the creditors who have given the business debtor any kind of loan or credit. Most of the time, their claims are backed by loan agreements and facilities that pay interest.
Examples: Banks, bondholders, debenture holders
2. Operational Creditors
An operational creditor is someone who is owed money, even if that debt has been legally given to someone else or assigned. This is what Section 5(20) of the Insolvency and Bankruptcy Code says. These are businesses or people who provided goods or services to the debtor but have not been paid.
Examples: Vendors, suppliers, employees (for unpaid wages)
3. Committee of Creditors (CoC)
Section 21 of the Insolvency and Bankruptcy Code says that all financial creditors must come together to form the CoC. It lists their rights, such as the right to vote and the power to make decisions during the CIRP. The CoC is made up of financial creditors and is formed during CIRP. It has the power to decide whether the debtor company should be brought back to life or shut down. People who are operational creditors can make statements, but they usually can't vote.
Key Legal Sections Pertaining to Creditors under IBC
This part talks about the important parts of the Insolvency and Bankruptcy Code (IBC) that explain and set rules for the rights and actions of different types of creditors.
1. Initiation of Corporate Insolvency Resolution Process (CIRP)
Section 6: Specifies who may initiate CIRP, including financial creditors, operational creditors, and the corporate debtor itself.
Section 7: Details the procedure for initiation of CIRP by a financial creditor.
Section 8: Outlines the process for an operational creditor to deliver a demand notice for unpaid operational debt.
Section 9: Provides the procedure for an operational creditor to apply for initiation of CIRP following non-payment after the demand notice.
2. Resolution Plan and Approval
Section 30: Stipulates that the resolution professional must present the resolution plan to the CoC for approval.
Section 31: States that once the resolution plan is approved by the CoC and the Adjudicating Authority, it becomes binding on all stakeholders, including creditors.
3. Liquidation Process
Section 53: Details the distribution waterfall during liquidation, prioritizing insolvency resolution costs, followed by secured creditors, workmen dues, and then operational creditors.
Waterfall Mechanism under IBC: In case of liquidation, the IBC defines a priority order in which the creditors are repaid:
Insolvency resolution costs and liquidation costs
Secured creditors (who relinquish security) and workmen dues
Employees (unpaid dues for 12 months)
Unsecured financial creditors
Government dues
Operational creditors (other than employees)
Preference shareholders
Equity shareholders or owners
In a nutshell,
Creditors are an important part of both small and large economies. They give people the credit they need to buy things, make investments, and grow. But their risks need to be managed with legal protections and good ways to settle disagreements.
In India, the IBC has improved the situation of creditors, especially financial creditors, by providing a structured, time-bound way to deal with bankruptcy and get back debts. In today's credit-driven economy, it's important for business and finance professionals to understand the rights and classifications of creditors under the IBC.
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FAQs on Creditors
Q1. Can individuals be creditors?
Yes, individuals can act as creditors when they lend money or goods to another party.
Q2. What is a trade creditor?
A trade creditor supplies goods or services to a business on credit and expects payment at a later date.
Q3. What is the Committee of Creditors (CoC)?
The CoC is a group of financial creditors in IBC proceedings that votes on the resolution plan or liquidation.
Q4. What happens to creditors during liquidation under IBC?
Creditors are paid in a priority order defined by IBC’s waterfall mechanism, with secured creditors first.
Q5. What legal rights do creditors have?
Creditors can enforce contracts, initiate insolvency proceedings, and claim assets in default scenarios.
Q6. Why is it important to differentiate between types of creditors?
Because their rights, recovery priorities, and roles in insolvency resolution vary significantly.
