Introducing a modern bankruptcy framework is one of the most significant reforms put in place by the Government of India. It has won praise from multilateral institutions such as the World Bank and the International Monetary Fund and is one of the prime reasons, amongst others, for India’s big 30-notch leap up the ease of doing business rankings.
The Insolvency and Bankruptcy Code (IBC) represented a big change in the power equation between creditors and debtors. Before the code was enacted, lenders were at the mercy of gigantic borrowers. The whole debtor-creditor relationship is undergoing a change and this is positive from the perspective of improving the credit culture of the country.
RBI’s war on NPAs- Two wickets down from filthy Dozen
We are in the critical phase right now that would decide the efficacy and success of the IBC, where various resolution plans adopted by the Committee of Creditors (CoC) are being put to litmus test by various unsuccessful resolution applicants and operational creditors before the various benches of the National Company Law Tribunal. The challenges to the process include transparency in the resolution process to haircuts and other allied issues. One of the key features of the IBC is that timelines are sacrosanct.
On April 17, with NCLT giving its final nod, Vedanta formally became the first company to successfully take-over a bankrupt company under the newly enforced IBC law and that too well before the deadline. While Vedanta formally bags Electrosteel Steels, Tata Steel was the first successful bidder under the IBC for Bhushan Steel, which recently got the final nod from NCLT. There are three other bankrupt companies that are on the verge of getting resolved.
The Insolvency and Bankruptcy Code, which passed by the Parliament hardly two years ago, became bona fide operational when the Central issued much-awaited ordinance to amend the Banking Regulation Act so as to infused RBI with legislative powers to initiate insolvency proceedings for recovery of bad loans. The ordinance authorises the RBI to issue directions to any banking company to initiate Insolvency Resolution Process in respect of a default under the provisions of the Insolvency and Bankruptcy Code.
The RBI in last June under its newly vested power released the list of ‘filthy Dozen’ of the companies who were big corporate defaulters. These 12 companies constituted 25% of India’s total NPAs, and were named for immediate resolution under the IBC which has a 270 day deadline (9 months). These companies had bad loans in some cases as high as Rs. 45,000 Crore. And that’s not it, in December, the regulator came up with a list of another 28 companies after giving them six months window for amicable resolution.
Hitting the nail on the head- Will promoters block the path?
The company promoters, who have led their firms to bankruptcy, could try to manipulate the system again to retain control directly or indirectly.
The lenders and the NPA resolution mechanism also go after the promoters to recover as much monies as possible, including through unmasking of corporate veils, searching for assets globally and establishing proof of any diversion of funds and initiating criminal proceedings to create a deterrence. Forensic audits are being undertaken to establish any fund diversion and identification of benami properties of the promoters in India and abroad. Efforts are also undertaken to trace fund transfers through shell companies.
As no promoter would like to lose the control, the Government moved swiftly to ensure that individuals who run the company to the ground do not get the ownership back at a discounted price, while bank takes haircuts. The executive order amending the Insolvency and Bankruptcy Code has placed restrictions on not only willful defaulters and those involved in fraudulent transactions but also on entities that have defaulted on loan payments for more than a year and those connected to them. Later passed in the Parliament, the Section 29A of the IBC made it clear, once you make your company an NPA account, you better find out a way to pay up or be ready to lose the Ownership.
Section 29A became a testing ground in the insolvency case of Essar Steel. The only two bidders’ namely Numetal Mauritius and ArcelorMittal were found ineligible under Section 29A for past NPA connections, and their bids were rejected. Later the Ahmadabad bench of the NCLT has ordered the Resolution Professional and the Committee of Creditors of the beleaguered company to reconsider the bids submitted by Numetal and ArcelorMittal. The bench is of the opinion that not giving enough time to applicants for rectifying the ground of disqualification also contravenes the IBC and is also against the law of the land.
Since the Indian business environment is typically promoter-driven, it will not be easy to achieve resolution without involving promoter in some way in the resolution process.
The Government has got out of a tricky situation but the solution leaves a lot to be desired. The harsh restrictions on entities eligible to bid for companies under the Insolvency and Bankruptcy Code is like cutting one’s nose to spite the face. It could in all likelihood lead to fewer bids and of lower value as it eliminates a potential bidder by default. Lower bids means banks will have to sacrifice more of the money they are owed and take larger losses, and the burden gets shifted ultimately to the taxpayer.
This amendment seems to have been introduced to assuage concerns that fraudulent promoters will get a backdoor entry to control firms at a steep discount. Public anger with the likes of Vijay Mallya who has run away without answering allegations of diverting funds and siphoning money is huge. Keeping out promoters may protect the Government from accusations of crony capitalism but it is a body blow to banks seeking to extract the most paise out of every rupee of loans in default.
Barring willful defaulters is just optics. Which banker would consider approving a plan that is presented by a known willful defaulter? In any case, RBI rules prevent banks and financial institutions from doing business with such fraudulent promoters. The capital markets regulator too has barred willful defaulters from raising public funds and taking control of listed entities.
It is the wider restriction that bites. Promoters might get their comeuppance but will it serve the purpose of efficiently resolving the stressed assets in the system? Lenders might not feel the pain now. Currently, the steel cycle is trending up and there is a lot of interest in steel assets, which make up the RBI’s first list. So, barring promoters is unlikely to hurt. But imagine if most of the big cases undergoing bankruptcy were thermal power assets. These are unlikely to get the same buying interest. Apart from the big cases, there are dozens more mid-tier firms which are entering the resolution process and are unlikely to find as many bidders. In these cases, if the promoter too is barred, they will probably go straight into liquidation. Such promoters have been barred from buying the asset under liquidation too. Then prepare for lower liquidation values too.
Simply put, in some cases, it is in the best interest of creditors to take a sacrifice on the loan and give the asset back to the promoter instead of selling it for scrap value. Indeed, that is the very objective of the code. In a recent judgment, the NCLAT said that, “It is made clear that Insolvency Resolution Process is not a recovery proceeding to recover the dues of the creditors.” Essentially, the code is to ensure that a firm continues as a going concern once it undergoes the resolution process.
Of course, there is the moral hazard issue in allowing promoters to bid. A promoter hoping to win back control at a steeper discount once his firm undergoes the bankruptcy process is less likely to cooperate with bankers in the lender’s forum using other debt restructuring mechanisms. But then, such founders are also taking a risk that rivals and other interested parties won’t outbid them.
This is not to say that the Code is flawless. Removing flaws in the IBC for instance, clarifying that buyers won’t be subject to tax on buying assets at a discount is welcome move. But by barring a section of potential bidders, the Government may have undermined the ability of banks to maximize value from the process.
Restrictions on bidders for bankrupt firms are good optics, but sub-optimal fix. While it looks like Section 29A is making it a bumpy ride, it is, in fact, required to cleanse the messed up banking system.
Of haircuts and liquidation
Initially, banks were hesitant to use this tool, fearing large haircuts, or sacrifices on loan and interest payments, which could put them in the cross hairs of vigilance agencies. The Government, through the agency of the central bank, had to goad lenders to resolve their largest bad accounts using the new system.
Synergies Dooray Automotive Ltd, a maker of alloy wheels for cars, the first case to be resolved under the new regime, saw lenders take almost 94% haircut. They recovered only Rs. 54 crore (approx.) against a claim amount of Rs. 972 Crore.
Innoventive Industries Ltd, a Pune based steel products maker, the first case that was filed under the code, is facing liquidation after a Committee of Creditors (CoC) rejected two resolution plans, including one from the company’s promoters. The liquidation value for the company is approx. Rs. 140 Crore, again which translates to less than 10% of its total debt.
However, one single case cannot become guidance for future. As far as NCLT is concerned, each case is different and the claim on the particular borrower is different, enterprise value will be different. So when we go to the NCLT for resolution, we have to look at the enterprise value, we have to look how many buyers are there in the market, what is the value they are putting, whether a resolution is a better option than liquidation etc. As far as liquidation is concerned, recovery will be the lowest. That’s why the decision will be based on what will derive the maximum value for the bank.
Insolvency Resolution Professional: Peek into international perspective
Another area where the new framework has been facing some teething troubles is on the role of Insolvency Resolution Professionals (IRPs), who take control of a stressed company after it is admitted under the bankruptcy process. Insolvency process cannot be imagined without the involvement of an IRP who in many respects is the lynch pin of the process; the link between the court, creditors, and the debtor.
IRPs have faced multiple challenges from promoters and creditors. Often, the courts had to step in to protect IRPs from promoters.
Two such examples are Rolex Cycles Pvt. Ltd. and AML Steel Ltd., where the NCLT benches in Chandigarh and Chennai, respectively, took a stern view of the bullying tactics by promoters. The NCLT issued a warning to the promoters and ordered police protection for the IRPs. In the case of Rolex, which was taken to NCLT by Hero Cycles Ltd. the IRP was not allowed to enter the site to make an assessment of the company’s assets. And in case of AML Steel, the IRP informed NCLT that he has facing stout resistance from the debtor.
The NCLT judgments are helpful to an extent. But an individual can only do so much. That is why in a majority of large resolution cases, the IRP is one individual but he/she is propped up by big consultancy firms and a huge team supports for the day-to-day functions which includes the depiction of a resolution plan. For instance, Sumit Binani, IRP for Monnet Ispat and Energy Ltd. is supported by Grant Thornton Advisory Pvt. Ltd. The challenge from creditors is in the form of resolving inter-creditor disputes and the creditors need to be in control all the time.
Still, in many cases, the fear of liquidation is forcing stakeholders to cooperate to find a viable solution. So far the approach of bankers has been very positive and supportive of the IBC process and all stakeholders remain keen for a viable resolution. The path to resolution focuses on maximizing value as compared to the path to liquidation which is a worst-case option where all stakeholders have ultimately more to lose and less to gain.
The Regulatory Interplay
Regulatory turf wars are not exceptional when multiple regulators are regulating the same sector. So far, the Insolvency and Bankruptcy Board of India has got support from other regulators, barring a few hiccups. For instance, the SEBI on June 21 exempted buyers of shares in debt-laden companies from the requirement of making an open offer even if the purchase triggers such an event under the Takeover Code.
Similarly, a resolution plan could attract minimum alternate tax (MAT) at the rate of 18.5% on the portion of debt written off because that could be seen as income. On January 06, the Central Board of Direct Taxes eased rules for insolvent companies.
Resolving the IBC and CCI conundrum: Considering the pressure of the timeline, one of the interpretations that were discussed initially was that since the IBC has a non-obstante clause, the resolution plan adopted by the CoC would not require approvals from other regulators like the Competition Commission of India (CCI). There were reports to suggest that representations have been made to do away with the requirement of the CCI approval in the case of transactions which are contemplated under the resolution plan.
Having said that, there is no statutory pronouncement on this issue either by the Insolvency and Bankruptcy Board of India or the Government which did away with the requirement of a statutory approval from the CCI. A transaction or series of transactions contemplated under the resolution plan may have adverse effect on competition in the market. The power of the CCI to make appropriate modifications or stall such transactions must not be abrogated under any circumstances. As such, one of the key thought processes behind the noise of doing away with the CCI approval is also the time which may be taken by the CCI to review the transactions, and whether such time taken would blend with the time prescribed under the IBC. The CCI, to a great extent, has put those concerns to rest by clearing a transaction, wherein Rajputana Properties, a subsidiary of Dalmia Cement, had proposed to acquire 80% of Binani Cements. That the said transaction was cleared by the CCI within 24 days is a testament to the fact that it cleared the transaction on a fast-track mode and allayed a lot of industry concerns.
An excellent start, but a mixed upshot
Even as the IBC has been conceived with the right intent to seek resolution on distressed assets in a time-bound manner, what data collected by ICRA show that as against amount claimed by lenders, highest bidders have offered between 25% and 43% in case of top four bankrupt steel companies.
But when there are cases of loan-ever greening and banks choosing not to identify accounts as NPAs, the steel industry have seen strong bids from a lot of leading domestic and international players in the sector. What’s worrying is disappointing participation in some sectors.
The two EPC (Engineering, Procurement, Construction) companies on the list, namely Lanco Infratech Limited and Jyoti Structures Limited, have seen limited bidding interest. The shipbuilding industry is another example of a sector plagued with sector-specific issues.
Second Amendment in IBC: a few dilutions, and a lot more speed
The Government by its second ordinance has hit the refresh button on the 2 year old Insolvency and Bankruptcy Code by bringing in a bunch of amendments to it, as per the recommendations of a panel, for speeding up its use in getting the highest value from an asset in the shortest possible time, and that is really the core spirit of the law. The dilution of the insolvency and bankruptcy code is perhaps a small price to pay, which make life easier for smaller players on either side.
The ordinance is to ensure that the code should not penalize smaller players on either side in its bid to keep the insolvency process of big corporations strictly legitimate. The masterstroke in the amendment is, in case of real estate companies, treating home buyers at par with secured creditors serving a dual purpose of keeping citizens happy ahead of a general election and also hitting all the right notes at a social level. Of course, this would not go down well with other side as Banks now have to take bigger haircuts due to the additional claimants.
Another significant amendment is the dilution of restriction imposed under Section 29A to leave out micro, small and medium enterprises, as the more labor-intensive small businesses do not find interest from bidders and would eventually go into liquidation.
The ordinance also facilitates speed up decision-making as an approval of only 66% of lenders as against the earlier 75% is required for critical decisions while to approve regular transactions, approval from only 51% lenders is required.
Overall the ordinance ensures speeding up of the process in getting the highest value from an asset in the shortest possible time
More NPAs are approaching but it’s all right.
On February 12, in a late night diktat, the RBI ordered a complete and immediate overhaul of the stressed asset resolution framework, setting a strict 90 days deadline for classification of defaulting accounts as NPAs and the 180 days deadline for their resolution by immediately withdrawing existing schemes.
Further, the central bank asked that starting February 23, all banks will identify defaults weekly make a disclosure every Friday to the RBI credit registry. The RBI has withdrawn existing norms such as Corporate Debt Restructuring Scheme, Joint Lenders’ Forum (JLF) and Strategic Debt Restructuring Scheme (SDR).
The RBI has also warned lenders of ‘stringent supervisory’ if they take any action with an intent to conceal the actual status of the accounts. The RBI has asked lenders to identify stress in loan accounts immediately on default and classifying stressed assets as special mention accounts (SMA). And once a lender identifies a default, all lenders singly or jointly will be initiating steps to cure the default.
After the IBC, the gross NPA of the banks were supposed to go down but a new framework with a strict deadline would mean the recognition of new NPAs in next six months, which could nullify the progress so far. But it also means that the process of bank-clean up will take place in an organized and time-bound manner.
With the major Rs. 36,400 Crore buyout of debt-ridden Bhushan Steel by a Tata Group company and many more to come under the government’s IBC reform, India’s gains a strong footing in its war against NPAs.