RESOLVE OR PERISH
The new insolvency code offers hope to banks reeling from outsize bad loans, but other legal hurdles remain
The new insolvency code allows banks a way out of outsize bad loans, with riders
On July 17, the Gujarat High Court rejected a plea by Essar Steel challenging a Reserve Bank of India (RBI) circular asking banks to recover loans taken by the steel major—by making use of the Insolvency and Bankruptcy Code, 2016. Eleven other firms were also named in the circular. Some have outstanding loans ranging from Rs 5,165 crore to Rs 44,479 crore, according to figures published by the All India Bank Employees’ Association. Essar had contended that RBI’s order was ‘improper’, as it was already at an advanced stage of loan restructuring. But even as Essar was fighting its case in court, sources say the government had finalised a new list of indebted companies, 500 of them, whose cases would be referred to the National Company Law Tribunal (NCLT) under the insolvency code.
Insolvency is the state of being unable to pay one’s debts, which could lead to legal consequences for the insolvent entity—in this case, large Indian corporate houses. The HC order was eagerly awaited by corporates, bankers, consultants and legal experts alike, as it sets a precedent for all future cases under the new law, in a country where proceedings under the insolvency and bankruptcy code are at a nascent and untested stage.
Bad loans have become the bane of the Indian banking system, threatening to undermine the health of stateowned banks and endangering the government’s plans to put the economy back on track by reviving major infrastructure projects. Many companies, especially in the infrastructure, mining and telecom sectors, borrowed cheaply in the boom years before the global financial crisis of 2008 to fund massive infrastructure projects. Several of these projects suffered delays due to red tape, issues relating to natural resource allocation and corruption, leading the companies to default on their loans. As a result, the non performing assets (NPAs)—banking jargon for bad loans—of listed public and private sector banks ballooned to Rs 7.7 lakh crore in March 2017, according to a report by Bloomberg Quint.
These NPAs have forced banks to go slow on issuing loans to certain sectors—such as infrastructure, real estate and retail—as well as consumer loans that are considered risky, leading to a persistent undersupply of credit. Of late, banks have also been advised to set aside higher provisions for NPAs, which has eroded the profitability of several state-owned banks by tying up their available funds. With the government firming up its drive against the pile-up in the Indian banking system, the Essar Steel case is likely one of many that will be fought in the courts as corporate houses come to terms with the new and arguably more definitive insolvency code. In this case, Essar Steel is likely to move the Supreme Court against the HC order, but given that the courts are already overburdened, insolvency proceedings could be painfully long.
A New Remedy
In May, the Centre issued an ordinance amending the Banking Regulation Act, 1949, to help banks quickly recover NPAs from defaulters. The ordinance empowered 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 amended law also empowered the central bank to set up ‘oversight panels’ to shield bankers from later action by regulatory agencies looking into loan recasts—a recalculation of the loan value and the payments required—which was one of the purported reasons that banks hesitated thus far to take firm action against defaulters.
On June 12, the RBI took another step in its bid to resolve the crisis. Its internal advisory committee identified 12 corporate accounts that each owed at least Rs 5,000 crore, of which threefifths had been classified as non-performing as of March 31, 2016. The RBI then recommended that these loans be recovered via insolvency proceedings under the newly enacted insolvency and bankruptcy code. These borrowers have defaulted on loans close to Rs 1,75,000 crore, around a quarter of the total pile of bad loans, and will be referred to the NCLT. The RBI has not made public the names of these defaulters or the sizes of their unpaid debts. However, a newsletter circulated by the All India Bank Employees’ Association claims that the top defaulters include Bhushan Steel (Rs 44,478 crore), Bhushan Power and Steel (Rs 37,248 crore), Lanco Infrastructure (Rs 44,364 crore), Essar Steel (Rs 37,284 crore) and Alok Industries (Rs 22,075 crore) (see chart: Race to the Bottom). Bankers say that State Bank of India (SBI), India’s largest lender, has issued loans to six of these 12 companies. Punjab National Bank,
ICICI Bank, Union Bank, IDBI Bank and Corporation Bank have also issued loans to these companies. These loans dwarf the Rs 9,000 crore of repayments owed by the now defunct Kingfisher Airlines and its flamboyant onetime chairperson, Vijay Mallya.
A Strong Signal
On July 4, the NCLT issued its first approval to an application to begin insolvency proceedings under the new bankruptcy guidelines. The application was filed by SBI against Jyoti Structures Ltd, a power infrastructure company. Jyoti’s current total debt, according to NCLT filings, is in the region of Rs 7,000 crore, of which about Rs 1,601 crore is owed to SBI.
These moves have undoubtedly brought welcome respite to creditors. “The government’s decision has empowered the RBI and created a situation where the creditors are in control, not the debtors,” says Ashish Chhawchharia, partner, recovery & reorganisation, Grant Thornton. Another positive is that the new law is time bound. Once a company begins the insolvency resolution process with the NCLT, it has six months to find a resolution and pay back part of the loan to remain in business.
While bankers can rejoice that the measure will send a strong signal to erring corporates, those on the insolvency radar are seeking legal means to delay the process. Essar Steel, for instance, has even argued before the high court that it should not be treated on par with the 11 other companies mentioned in the RBI circular. Many of those 11 are in dire financial straits, with some of them even defunct. Essar Steel is still operational, and has an annual turnover of Rs 20,000 crore. In a recent interview, Prashant Ruia, CEO, Essar Group, phrased the argument as: “Based on our performance in the last 15 months... we believe that we should be included in the second category of 488 companies, which have been provided a period of six months to restructure the loan, and not be expressly sent to the NCLT with the potential risks of a deterioration in the operations of the company.”
The Time Factor
If the 12 big cases are resolved, lenders and borrowers will likely be encouraged to find ways to resolve the remaining outstanding debts. But that is easier said than done. Earlier attempts to resolve such cases between banks and corporates failed because both sides found it hard to reach a consensus, says Madan Sabnavis, chief economist with Care Ratings. “The borrowers wanted the banks to take a haircut (reduce the due amount) to restructure the outstanding part of the loan,” he says. “The banks, on the other hand, would have wanted to get the highest possible price.”
Under the new process, once the
NCLT approves the beginning of insolvency proceedings, an interim ‘insolvency professional’ is appointed to take control of the assets of the indebted company and form a creditors’ committee. This committee then appoints a professional to oversee the process, and can even choose to rejig the management of the indebted company. The committee then has to come up with a resolution plan that 75 per cent of the creditors approve of, or else decide to liquidate the company’s assets. If the resolution plan is not accepted by the NCLT, or no plan is formed within 180 days (a 90 day extension can also be granted), the company goes into liquidation—its business operations are brought to an end and its assets are divided among creditors and shareholders. “Liquidation will be the last resort,” says Sabnavis. “Nobody wants the company to come to an end, with its assets sold off to someone else.”
The new code’s teeth lie in the fact that it is time bound—a resolution has to be found before the deadline is up, else the company’s assets are liquidated to repay the loan. Experts say that India’s new insolvency and bankruptcy law has been inspired by a similar law in the UK, which has been in place for 30 years.
The Challenges
Since this is the first time in modern India’s financial history that such an attempt is being made to deal with NPAs in a time-bound manner, no one is sure of what’s in store, or what legal loopholes indebted companies might be able to make use of. For instance, if a company moves the courts to challenge a decision by the creditor’s committee, and the court proceedings continue past the 270day deadline imposed by the NCLT, does that mean the company will be automatically liquidated, or will a court-granted extension be valid to extend the NCLT’s deadlines? Matters like these are yet to be resolved.
Another problem is that in the Indian context, there is no concept of a ‘bad bank’—a financial entity created specifically to buy up NPAs from lenders before they are restructured—though such ideas have been discussed for many years now. In the absence of such financial institutions, India is in the unique situation where the central bank is itself involved in the process. Essar Steel has already contended in court that it is inappropriate for the RBI to decide which debts have to be dealt with on a priority basis. However, experts say there is merit in the RBI’s decision to choose the largest defaulters for its first list of companies directed to begin insolvency proceedings.
Another issue relates to the liquidation of indebted companies. For example, in the case of a company in the power sector, even the selling of assets could prove a painfully long task for a lack of potential buyers. And with companies taking such problems to the courts, the process could be even longer. “In India, almost anything can go to court and get held up,” says Sabnavis.
Moreover, India does not currently have the financial ecosystem to effectively deal with insolvency and bankruptcy cases. The ecosystem would comprise insolvency benches for the NCLT and insolvency professionals who are trained and certified. SBI chairman Arundhati Bhattacharya recently made this point while in Kolkata, adding that the bank is not “rushing” to settle its stressed accounts under the new law.
The stage has been set for one of the biggest resolution processes in corporate India to begin, this time promising to be more definitive and time bound. Even so, it will no doubt be a long and excruciating experience for the participants.