CoC Constitution under IBC: Related Party Exclusion Cases

The committee of creditors decides the fate of the company, so who sits on it is often contested. Questions test the related party exclusion and its exception for banks that converted debt into equity, attempts to shed related party status just before the process, creditors who are both financial and operational, and companies with no independent financial creditors at all. Each is answered below in four steps.

1. The Law in Brief

Membership, section 21(2). The interim resolution professional constitutes the committee of all financial creditors of the corporate debtor, after collating claims.
Related parties. A financial creditor that is a related party of the debtor under section 5(24) has no right of representation, participation or voting, unless it is a regulated financial creditor that became a related party only by converting or substituting debt into equity before the commencement date (provisos to section 21(2))
Voting share, section 5(28). Each member votes in proportion to its financial debt; consortium members vote separately (section 21(3))
No financial creditors. Where there are none, or all are related parties, the committee consists of the eighteen largest operational creditors by value and one representative each of workmen and employees (Regulation 16 of the CIRP Regulations)

Is the creditor a member of the committee?

Figure 1: Is the creditor a member of the committee?

2. Can a Holding Company or Converting Bank Sit on the CoC?

Facts

AB Ltd owes ₹40 crore to its holding company, CD Ltd, under an inter-corporate loan, and ₹120 crore to EF Bank. Two years before the CIRP, under a restructuring scheme, EF Bank converted part of its loan into equity and now holds 26 per cent of AB Ltd's shares. The interim resolution professional excludes both CD Ltd and EF Bank from the committee as related parties. Both object. Decide.

Issue. Whether CD Ltd and EF Bank are excluded from the committee as related parties.
Law. Under section 5(24), a holding company of the corporate debtor, and any person controlling more than twenty per cent of its voting rights, is a related party. The first proviso to section 21(2) excludes related party financial creditors. The second proviso, inserted in 2018, saves a financial creditor regulated by a financial sector regulator that is a related party solely because it converted or substituted debt into equity shares or instruments convertible into equity shares before the insolvency commencement date.
Application. CD Ltd is the holding company and falls squarely within the exclusion. EF Bank is a related party only because its 26 per cent stake came from converting its loan under a restructuring scheme, and it is regulated by the RBI.
Conclusion. CD Ltd is excluded from the committee, though its claim may be admitted and dealt with in the plan. EF Bank must be included, with voting share in proportion to its remaining financial debt.

3. Can a Creditor Shed Related Party Status to Join the CoC?

Facts

GH Finance Pvt Ltd was owned by the wife of JK Ltd's managing director and had lent ₹30 crore to JK Ltd. Three weeks before a creditor filed for JK Ltd's insolvency, the wife sold all her shares in GH Finance to a family friend at face value. GH Finance's loans to JK Ltd had been made without security, at low interest and with repeated extensions. GH Finance claims a seat in the committee as an unrelated financial creditor. Decide.

Issue. Whether a creditor that has ceased to be a related party before the CIRP, and whose debt bears signs of collusion, may sit on the committee.
Law. In Phoenix ARC v Spade Financial Services (2021), the Supreme Court held that related party status is ordinarily judged when the committee is constituted, but where a creditor was a related party and ceased to be one in order to circumvent the proviso, it must still be excluded, because the purpose of the exclusion is to keep out those who would act for the promoters. The Court also held that transactions that are collusive are not genuine financial debts at all.
Application. GH Finance was a related party through the managing director's wife. The sale of her shares just before the filing, to a family friend at face value, points to an attempt to shed that status. The loan terms suggest the transactions were not at arm's length.
Conclusion. GH Finance should be excluded from the committee. If the NCLT finds the loans collusive, the claim may not be admitted as a financial debt at all.

Special cases in constituting the committee

Figure 2: Special cases in constituting the committee

4. How Does a Dual Creditor Vote in the CoC?

Facts

LM Ltd, in a CIRP, owes NO Ltd ₹10 crore under a term loan and ₹6 crore for supplies of raw material. Separately, PQ Bank bought from a supplier the right to ₹4 crore of LM Ltd's unpaid invoices under a factoring arrangement. Both NO Ltd and PQ Bank claim voting shares for their entire claims. Advise the resolution professional.

Issue. How a creditor holding both financial and operational debt, and a bank holding assigned operational debt, are treated in the committee.
Law. Under section 21(4), a person who is both a financial and an operational creditor is a financial creditor only to the extent of the financial debt, with voting share in proportion to it. Under section 21(5), where an operational creditor has assigned or legally transferred an operational debt to a financial creditor, the assignee is treated as an operational creditor to that extent.
Application. NO Ltd's term loan of ₹10 crore is financial debt; its ₹6 crore for supplies is operational debt. PQ Bank acquired operational debt, which does not become financial debt because a bank now holds it.
Conclusion. NO Ltd sits on the committee with voting share based on ₹10 crore only, and claims the ₹6 crore as an operational creditor. PQ Bank has no voting share for the factored invoices and is treated as an operational creditor for ₹4 crore, unless it is also owed financial debt by LM Ltd.

5. Who Forms the CoC When All Lenders Are Related?

Facts

RS Ltd, a trading company, was funded entirely by loans from its promoters' group companies, all related parties. It owes ₹25 crore to some forty suppliers, salaries to its employees and wages to its workmen. On admission, the interim resolution professional asks how the committee should be constituted. Advise.

Issue. How the committee is constituted where all financial creditors are related parties.
Law. Regulation 16 of the CIRP Regulations provides that where the corporate debtor has no financial creditors, or all its financial creditors are related parties, the committee shall consist of the eighteen largest operational creditors by value, one representative elected by all workmen and one representative elected by all employees. If there are fewer than eighteen operational creditors, all of them are included.
Application. All of RS Ltd's financial creditors are excluded as related parties. It has some forty operational creditors, plus workmen and employees.
Conclusion. The committee should comprise the eighteen largest suppliers by value, with a representative of the workmen and one of the employees, voting in proportion to their debts. The promoters' group companies have no seat.

⚠ Exam trap

Only financial creditors sit on the committee. Related parties are excluded, except a regulated lender that became one only by converting debt into equity before the commencement date. A creditor that sheds related party status to get a seat is still excluded (Phoenix ARC, 2021). A dual creditor votes only for its financial debt (s. 21(4)); assigned operational debt stays operational (s. 21(5)). With no independent financial creditors, use Regulation 16. Operational creditors with at least ten per cent of the debt may attend without voting (s. 24(3)).

6. Frequently Asked Questions

Can a related party financial creditor still apply under section 7?

Yes. The exclusion concerns only the committee; it may initiate the CIRP and file its claim, which is admitted if genuine.

Is the committee fixed once constituted?

No. It is reconstituted if claims are admitted or revised later, so that voting shares reflect the current list of financial debts.

Who represents homebuyers in the committee?

An authorised representative chosen by the class, who votes for the whole class (sections 21(6A) and 25A; Topic 99).

7. Related Topics

Topic 25: Committee of Creditors. Constitution and voting.
Topic 26: Related Party Creditors. The exclusion in detail.
Topic 110: CoC Voting under IBC. 51, 66 and 90 per cent decisions.