Essar Steel Case: Why Centre Must Ensure Law to Protect Creditors

Govt must take on responsibility to protect smalltime creditors from being cheated.

While the Supreme Court verdict – overturning the freewheeling interpretation of inter-se priority of creditors in the Essar Steel case by the National Company Law Appellate Tribunal (NCLAT) – is welcome, at the same time, one’s heart bleeds for the helpless unsecured creditors.

The SC reiterated the well-known principle of ‘priority of creditors’, with secured creditors always figuring first. They were dislodged from their perch when the NCLAT, under the Insolvency and Bankruptcy Code (IBC), held that all creditors — whether secured or unsecured, operational or financial — must be treated on par in distribution of the sale proceeds received from the highest bidder.

To be sure, the SC had read the law as it is. It could not have gone beyond it and come to the rescue of the unsecured creditors. That responsibility vests with the central government. It cannot let them stew in their own juice.

One cannot condemn them with disdain to face the consequences for having supplied goods or services or finance without security.

How Vulnerable MSME Suppliers Can Be Protected

Often, suppliers are driven into such a seemingly reckless course due to competition. Buyers often take advantage of fierce competition, and buy goods and services for which payment is deferred, and no security is offered. The suppliers cannot and don’t demur. Under the IBC, while operational creditors and home buyers have been accommodated in the committee of creditors, they do not have the power to change the order of payment in their favour, in case of paucity of funds to pay off all the creditors. With over 60 percent haircut even for the secured creditors, often the unsecured creditors are left holding the can.

What the central government must do is to enact a law that gives them some feeling of security.

As it is, under the Micro, Small and Medium Enterprises (MSMEs) Development Act, 2006, small suppliers get compound interest at the bank rate specified by the RBI, should the buyer delay payment beyond the contractual period or in its absence beyond 45 days.

Despite the seemingly solemn provisions of this law, the lot of the MSME suppliers remains vulnerable. The government must make a more comprehensive and all-inclusive law that dangles the carrot for prompt payment to unsecured creditors while coming down heavily with a stick for delayed payment.

And this law should address the concerns of all unsecured creditors, small or big, operational creditors or home buyers.

Operational Creditors Shouldn’t Be Left in the Lurch

But operational creditors are not in a position to insist on security or letter of credit or any other meaningful security before supplying goods or services. They should not be left in the lurch.

For payment or delivery ahead of schedule, there can be a small income tax rebate. And such a rebate must be proportional to the invoice value. Should there be a delay beyond the contractual period or in its absence beyond 45 days from the date of supply of goods or services, a penal, compound, deterrent and exemplary interest of 18 percent per annum must be made payable, which for good measure should not be tax deductible.

Lest the buyer invents excuses including quality issues, a special commercial court must be set up under the proposed law to take up the matter swiftly.

If the reasons for delay are found to be flimsy, the penal interest should be doubled. And to discourage excuses, payment of 50 percent of the disputed invoice must be a precondition to allow the buyer entry into the portals of the special court. If he fails the special court should have the power to pass an ex parte order with his properties being attached.

The short point is: banks and financial institutions have the organisation and wherewithal to insist on security, though often these precautions prove inadequate as the saga of mind-boggling NPAs of Indian banks show. But operational creditors are not in a position to insist on security or letter of credit or any other meaningful security before supplying goods or services. They should not be left in the lurch.

(S. Murlidharan is a Chartered Account, and has also written extensively for The Hindu Business Line between 1996 through 2013, and later started contributing regularly to Firstpost on a range of issues like business, economic, tax. He is currently based in Chennai. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)