Do creditor committees in insolvency cases need an oversight body?

The CoC, which steers the corporate debtor through the insolvency process, mainly comprises financial creditors (FCs)—primarily commercial banks—that hold the majority of claims. Operational creditors (OCs) are included only if their claims account for at least 10% of the total, a rarity. The latter typically play a limited role in negotiations. FCs hold considerable power and are assumed to possess the commercial acumen to make key decisions such as selecting resolution applicants, allocating proceeds, working out ways to maximize the corporate debtor’s value and deciding between resolution and liquidation.

Also Read: IBC reforms: Let’s strengthen the Code as a key growth enabler

However, this assumption of commercial wisdom has been challenged. The Jet Airways case illustrates the issue. Once a leading airline with assets worth ₹15,000 crore, Jet was sent into liquidation in November 2024—five years after entering insolvency. The CoC-selected Jalan-Kalrock Consortium failed to implement the approved resolution plan. Delays, partly due to exceptions granted by the National Company Law Appellate Tribunal, eroded its asset value until the Supreme Court intervened, ordering liquidation. The episode highlighted the risks of self-regulation and need for structural reform.

Our academic research has shown a pattern of opportunism among FCs, which generally recover a higher proportion of their claims than OCs. The inequality is most severe in large insolvencies with minor OC claims. Interestingly, in smaller cases with high post-liquidation value proceeds, OCs with significant claims often receive more equitable treatment than in larger cases. The relative size and proportion of OC claims influence FC generosity, especially when liquidation values are exceeded by the realized proceeds—as seen in the Jet Airways case.

Empirical data reveals FCs selectively show generosity—it’s more likely when they expect large haircuts even after claiming all proceeds or when OC claims are too small to justify litigation or delay. Larger OCs tend to be treated better, likely due to their strategic importance for revival or their status as key bank clients. The potential for high-stakes litigation may also influence this behaviour.

Smaller OCs often settle for sub-par deals to avoid prolonged delays. As asset values decline over time, these creditors bear disproportionate losses. In economies where small producers cannot pass on inflation through higher prices, insolvency laws must better protect OCs to prevent a double blow: shrinking margins and poor bankruptcy recoveries.

Also Read: Jet Airways’ liquidation wasn’t the ideal way out of insolvency

Our paper published in The B.E. Journal of Theoretical Economics showed that in the tripartite dynamic between FCs, OCs and the corporate debtor, the interests of the latter two are generally aligned, while FC preferences diverge—except in cases where OC claims are negligible. FC-dominated CoCs often adopt division rules that minimize their losses, which, while rational in the short term, can hurt firm profitability, output and OC payouts. This reflects a broader trade-off between short-term recovery for FCs and long-term economic interests.

Including OCs in the CoC poses challenges. It risks prolonging resolutions and reducing asset value. The Bankruptcy Law Reforms Committee rightly warned that smaller OCs could take short-sighted positions, undermining resolution efforts. Giving OCs a right to dissent may also backfire as it could enable hold-ups.

An oversight body might not solve the problem either. Such a body could increase subjectivity and bureaucracy, exacerbating an already slow resolution process. Average resolution time was 761 days, as of April-June 2024—already a concern. Additional layers of governance may worsen outcomes.

We proposed a more practical solution in a paper published in the Global Finance Journal, the adoption of a ‘Quasi-Absolute Priority Rule’ (Quasi-APR). This norm could set a minimum payout threshold for OCs, preventing small vendors from being wiped out—an outcome that risks ripple effects of distress throughout the economy. Under the Quasi-APR, the liquidation value of secured assets is used first to repay secured creditors. Their residual claims are then treated on par with those of unsecured creditors, including OCs. The proceeds that remain are divided proportionally based on residual claims.

Also Read: Reform agenda: What India must do to get private sector investment going

The record shows that in many cases, especially small insolvencies with minor OC claims, FCs have already provided payouts exceeding the Quasi-APR. In such scenarios, CoCs likely recognized the critical role of OCs in a successful re-organization. This lends credibility to the Quasi-APR as a fair baseline for OC payouts.

The Supreme Court’s recent intervention is welcome for recognizing CoC shortcomings. However, the answer is not additional bureaucracy, but clear rule-of-thumb principles that promote fairness and efficiency. The Quasi-APR offers a straightforward and enforceable approach to improve outcomes without further slowing the process. Its adoption could reduce inequities, increase predictability and safeguard the interests of smaller stakeholders, which are often the most vulnerable in bankruptcy proceedings.

The authors are professors, MDI Gurgaon.