EDIT: JOLT FOR ERRANT PROMOTERS

Amendments to the insolvency code will send a strong signal

The presidential assent to the Ordinance effecting crucial changes to the Insolvency and Bankruptcy Code is a bold and clever step towards ensuring that the process of resolving bad loans is not gamed by promoters, who have either defaulted wilfully in the past or have not been paying up in time. The government knew it could not legally impose a blanket ban on promoters from participating in the insolvency process, so it did the next best thing by bringing in important caveats that would prevent errant promoters from misusing the insolvency law to regain control of the companies that are being sold. According to the Ordinance, corporate entities, promoters, and associate companies undergoing insolvency resolution or liquidation under the Code will not be eligible for bidding for the stressed assets. This essentially rules out any promoter with a weak credit history from taking part in the resolution process. The new Code explicitly states that wilful defaulters and promoters of companies whose borrowings have been classified as non-performing assets (NPAs) for a year or more and that are unable to pay overdue amounts, including interest and other charges, are barred from repurchasing their assets.

To be sure, the growing mountain of NPAs in India’s banking system has been one of the biggest structural hurdles holding back economic recovery. Rising NPAs – at last count, they were pegged at ~10 lakh crore – not only hit the profitability of the banks, particularly public sector banks, which account for almost 90 per cent of bank NPAs, but also robbed them of their ability to lend afresh, thus jamming the economic growth engine. And valuable corporate assets that could have been put to productive use were locked up due to the lack of a speedy resolution process. The Reserve Bank of India’s all-out war against NPAs began in January 2015 when the central bank came up with rules for early recognition of stressed assets and punitive provisioning. Till then, banks were happily ever-greening bad loans of many promoters through last-minute technical adjustments. To its credit, the government legislated the Insolvency and Bankruptcy Code, which became operational last year. However, as the process got under way, there were concerns that the very same promoters who had, sometimes wilfully, defaulted in the first place, could wrest back the control of the companies that had run aground. These worries grew deeper after the RBI, in June, selected 12 big defaulters, which accounted for almost a quarter of the gross NPAs, and referred them for bankruptcy proceedings in the National Company Law Tribunal (NCLT). In many of the 300-odd cases before the NCLT, the original promoters were also interested in re-bidding for the companies.

The immediate impact of this Ordinance will be a bar on all the 12 big promoters who are at the forefront of the insolvency resolution process. But it also lays down the marker for all others down the line — pay up and make your asset standard or lose the company. In that sense, the Ordinance should reinforce people’s faith in the insolvency resolution process. However, certain challenges remain. Such a stiff rebuff of the existing promoters may lead to a spate of litigation and bring down the overall price of the stressed assets. Similarly, the government needs to be watchful of competing firms misusing the amended law to undermine each other and subvert the insolvency resolution process.