It was supposed to be the magic pill that would revitalise the Indian banking system, curing the $210-billion bad loan problem. Instead, the Insolvency and Bankruptcy Code (IBC) is creating more chaos and confusion rather than clarity and clean-up.
It’s not a joke — the IBC is heralded as the biggest reform in the Indian banking sector thus far. Introduced in 2016, the IBC replaced existing schemes such as Corporate Debt Resolution (CDR) and Strategic Debt Restructuring (SDR). Under the IBC, stressed assets are referred to the National Company Law Tribunal (NCLT) to find a resolution for their insolvency, failing which they will be sent to liquidation. As a first step, in June 2017, the Reserve Bank of India drew up a list of 12 large accounts, which made up 25% of the industry’s gross non-performing assets (NPAs), for resolution under the IBC. It included names such as Essar Steel, Bhushan Steel, Binani Cement among others. A 270-day deadline was set for lenders to find a resolution plan. With deadlines ending this month, we finally have one resolution to show.
Tata Steel has taken a controlling stake of 72.65% in Bhushan Steel after settling 35,200 crore of the loans owed by the latter. The lenders, who will hold 12.25% of Bhushan Steel, have taken a 37% haircut on their outstanding loans (56,079 crore). SBI, which has the highest exposure of 12,872 crore to Bhushan Steel followed by PNB (4,904 crore) and ICICI Bank (2,499 crore), will see its profits bump up during the first quarter of FY19 due to provision write-backs as the asset turns standard in its books. Tata Steel will now deal with lawsuits filed by L&T, that wants to be treated as a secured creditor, and the erstwhile promoter, Neeraj Singhal, who has challenged Tata Steel’s eligibility as a bidder under Section 29A. Being the first case to be successfully resolved under IBC, Bhushan Steel is probably a silver lining among several murky clouds. All the 11 pending cases have a sob story of their own. Vedanta’s 5,320-crore-bid for Electrosteel is under the NCLT scanner because it implies a haircut of 60% for the lenders. The total exposure of the banks to Electrosteel stands at nearly 14,000 crore.
The cases of Essar Steel, Bhushan Power & Steel, and Binani Cement have also turned into a slugfest between bidders. Moreover, where steel assets have drawn a lot of interest from bidders (see: Centre of attraction), have no potential bidders. Lanco Infratech was among the companies listed by the RBI in its second list that came out in 2017-end. The list, which accounts for 15% of bad loans, includes companies such as Videocon, Orchid Pharma and Ruchi Soya. Apart from large corporate houses, around 500 small and medium companies have been referred to the NCLT and are under various stages of resolution. Their fate looks even more ominous, with a majority of them finding no takers. Only 60 of the lot have been able to find a resolution or have been sent for liquidation. While bidders fighting over assets is definitely a good problem for the lenders, the numerous litigation by companies who end up on the losing side, promoters, and even employees seem to be delay tactics to derail the process. Can the IBC live up to its promise?
The banking sector has seen its fair share of reforms over the years. The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (Sarfaesi Act), allowed secured lenders to take over the management of the company, but it wasn’t effective in recovering bad loans since banks didn’t have the bandwidth to run the companies. Next came CDR, which gave borrowers more time to repay the loans, but it worked only in a few cases where the defaulters wanted to repay. SDR and the Scheme for Sustainable Structuring of Stressed Assets (S4A) even gave banks the power to convert their debt into equity. However, as owners, they had to keep the assets running till they found buyers. In a downturn, this wasn’t an easy task.
Much of the bad loans problem, in fact, took root when evergreening of loans — where both the tenure and interest rates were allowed to be restructured — was permitted under CDR. This led to postponements instead of resolution of issues. In 2015, RBI decided that there should be a fair recognition of accounts and these turned into NPAs, leading to their multi-fold increase. Thus, the IBC was introduced to address the NPA situation in a more decisive manner.
While clear-cut processes have been put in place under IBC and timelines are definite, execution is lagging, resolutions seem hard to come by, and bankers are anxious about big haircuts. According to a report by CLSA in March 2018, the haircut on NCLT cases will range from 20% to 90%.
While the total loss will be less than 60%, the first list, comprising Bhushan Steel, Essar Steel and Binani Cement, is likely to see better recovery rates of 52% than the second one. For the second list of 35 companies, whose loans aggregate to about 1.3 lakh crore, the haircut is expected to be around 68% (see: The buzz cut).
Tightening the screws
Even as the IBC battles all kinds of challenges, RBI has been tweaking the norms. In February 2018, the central bank came up with a revised framework for distressed assets, directing banks to initiate a resolution plan at the first instance of default in cases where the exposure is over 2,000 crore. The banks have 180 days to implement a resolution, failing which the asset will be referred to the NCLT, and bankruptcy proceedings will begin. Additionally, the moment the loan is referred to the NCLT, banks need to make a provision of 50% on the loan and 100% if the asset faces liquidation. If the bank is able to garner more money from the sale of assets that was provisioned, it can be written back as profits.
The default rules may seem stringent, but bankers and industry insiders feel it will ensure better discipline among all parties involved. “Banks will no longer chase topline growth, the focus will be on risk-adjusted return on capital. The quality of assets will thereby improve,” says Rajnish Kumar, chairman, SBI. On the other side of the spectrum, the risk of losing their company is likely to keep promoters in check. “For the first time, the promoters are running a real risk of losing their companies. Banks, too, will have to change their culture and proactively look for a resolution since the regulator is keen on keeping the process time-bound,” says Siby Antony, CMD, Edelweiss Asset Reconstruction Company, which became the second largest lender in Essar Steel after SBI by aggregating debt from six banks. “It will bring about better discipline among both borrowers and lenders and there will be early detection of problems,” he says. According to Antony, ARCs such as Edelweiss, who successfully turned around Karaikal Port (when Edelweiss took over Karaikal Port in 2015, it had an Ebitda of 60 crore, which has more than tripled to 200 crore in FY18) and Ballarpur Industries (the company had zero Ebitda in 2017, and is now clocking a monthly Ebitda of 45 crore within a year’s time), can play a significant role in the resolution process. But the said discipline doesn’t come easy to a majority of Indian promoters. “Many Indian promoters have no regard for financial covenants. Overseas, investors take covenants seriously and missing even one of them is a serious offence. Even over-levered financing of the projects, in a few cases as high as 80:20 in favour of debt, will shift more towards equity,” says Prateek Diwan, executive director, Arpwood Capital, who has worked on almost half of the first dirty dozen IBC cases.
While the expectations are high, the first few cases will be the litmus test for the IBC. Binani Cement, for instance, will test the sanctity of the IBC. Under its initial resolution, Committee of Creditors (CoC) had accepted Dalmia Bharat’s bid of 6,750 crore. UltraTech, which initially offered 6,570 crore, increased its bid by 700 crore and agreed for the full settlement of creditors’ dues before the CoC’s decision came. That set the stage for a long tussle. Alleging that the sale to Dalmia Bharat-Bain Capital combine was not transparent, UltraTech made an offer to Binani Industries to buy 98.43% in its cement arm, provided the insolvency process was terminated. After approaching the NCLT to terminate the proceedings, Binani even made an offer to repay creditors within two weeks and moved the Supreme Court to seek permission for an out-of-court settlement. The Supreme Court, however, refused the move, saying companies cannot bypass the code and referred the case back to the NCLT. Not giving up, UltraTech has now increased its offer by another 700 crore to 7,990 crore, widening the gap between its bid and Dalmia’s by 1,290 crore.
In its latest offer, UltraTech assures to pay all creditors in full, including vendors, barring related party transactions of Binani Cement promoters. Dalmia Bharat, on the other hand, had offered to settle the dues of operational creditors assessed by the administrator at 503 crore for 151 crore. UltraTech has offered to pay 443 crore. Given the number play, the Kolkata bench of bankruptcy court has directed banks to look at UltraTech’s revised bid, adding a new twist in the tale. The court, in its decision, said that the CoC is bound to ensure value maximisation for Binani shareholders and lenders. Thus, if a revised offer is higher than H1 bidder and satisfies the claims of all stakeholders, then it must be considered.
While Binani Cement’s CoC has asked Dalmia Bharat to match UltraTech’s revised offer, the company is unlikely to do so, stating that the deal was nearly 3x the liquidation value of 2,300 crore. The CoC, therefore, is likely to go with UltraTech’s bid. “While the deal value does increase, it shows utter disregard for the process. If they felt the asset was worth nearly 8,000 crore, why didn’t they put that as their first bid? Given that the bids were so close, would they have revised their bid if they had won?” asks an advisor on the deal.
The IBC does allow creditors to negotiate with the highest bidder for a better price, but Dalmia Bharat promoters are miffed. “You have to respect the process. The rules are very clearly laid out for all the players in the game. If UltraTech wins, every unsuccessful bidder could approach errant promoters and strike a deal to fund the repayment of the liabilities with banks,” argues Mahendra Singhi, group CEO, Dalmia Bharat.
Another case that is turning into a big tussle between bidders is Essar Steel, which owes more than 49,000 crore to over 30 banks. Initially both bidders — ArcelorMittal and Numetal — were declared ineligible according to Section 29A that bars promoters and related parties of companies with NPAs of over 12 months, or having pending regulatory issues, or criminal proceedings against them to bid for their own companies or others referred to the NCLT.
ArcelorMittal had a minority stake in Uttam Galva and KSS Petron, which had unpaid dues of over 7,000 crore, and Essar Steel promoter Ravi Ruia’s son was a beneficiary of a trust which held 25% equity in Numetal Mauritius when the first bid was submitted, rendering them ineligible. Thus, the creditors called in for a second round of bids. The NCLT then ruled that the first round of bids needed to be reviewed by the CoC and both parties have to be given time to repay their dues in order to become eligible. The CoC has since asked both the companies to clear their dues.
ArcelorMittal has already parked 7,000 crore in SBI’s escrow account in London to become eligible for the bid. At least in the case of Uttam Galva, these are dues that the banks have been chasing for more than five years now. While Arcelor’s bid of 32,000 crore proposes a 35% haircut, the banks get closure for two long-standing NPAs. Numetal, which had earlier contested that the second round of bidding should not be considered, has now changed its stance and wants it to be considered. Since the first bid, Ruia-controlled trust’s stake in Numetal has been sold to JSW to make the Numetal consortium eligible for the bid. The Numetal consortium has increased its bid to 37,000 crore as against its earlier bid of 19,000 crore, putting it ahead of Arcelor, which now wants the NCLT to consider the first round of bids only.
While creditors will meet to decide the eligibility of both the bidders, the deadline for resolution has been extended for a month. “As there is maximisation of value for all stakeholders, I don’t see why there is such a fuss being made on revised bids. You have to understand that bankruptcy is complex and the idea is to find the best possible resolution,” says an advisor of a company that has been allowed to rebid.
In both the cases of Binani Cement and Essar Steel, bidding matches for assets have resulted in better realisation for the creditors and that is a welcome sign. In the case of Binani Cement, the lenders are likely to walk with the recovery of almost all their dues thanks to UltraTech’s relentless pursuit. And, in the case of Essar Steel and its associated cases, the banks are looking at a recovery of at least 39,000 crore and that is no small change to begin with despite the many contentious twists in both cases.
Bring on the professionals
Meanwhile, resolution professionals are emerging as a new breed even though the firms they belong to cannot be part of the process right now. Their gamut of responsibilities include management of the company, facilitating the formation of the CoC, validating the claims of various operational creditors, conducting forensic audits to cull out related party transactions and evaluating the resolution plans under the IBC till the company can find a successful bidder approved by the NCLT. While these individuals have the backing of the big four consulting firms who form the back-office for the resolution process, finding a resolution with the 270-day timeframe is proving to be a tough task.
However, the NCLT has, in more than one instance, overruled the decision of the resolution professionals. In the case of Bhushan Power & Steel, Tata Steel had emerged as the highest bidder. But UK-based Liberty House, which also made a bid for the company after the deadline, questioned the CoC decision to reject its bid. Its appeal is on the ground that the resolution professional had accepted both ArcelorMittal’s and its own application for expression of interest after the expiry of the deadline, which meant it wasn’t sacrosanct. Liberty had submitted an initial expression of interest and sought additional time, submitting its bid on February 20, post the February 8 deadline.
The NCLT then ruled that the bid couldn’t be rejected based on a deadline fixed by the resolution professional and ordered the creditors to evaluate Liberty’s bid as well. Currently, Liberty’s bid at 18,500 crore is the highest, trumping Tata Steel’s offer of 17,000 crore and JSW’s offer at 11,000 crore. At the bankruptcy court, Tata Steel’s appeal says that Liberty House was nothing but a proxy for the debtor, and their only objective was to derail the resolution process.
Despite its setback in the case of Bhushan Power & Steel, Tata Steel managed to win the bid to buy out the stressed assets of Bhushan Steel, outbidding JSW Steel’s 28,000 crore offer. “We put in a very competitive bid,” says Seshagiri Rao, joint managing director and group chief financial officer of JSW Steel, “but their bid was far more aggressive. They have iron mines in Odisha, where the ore needs to be taken out before its license expiry in 2030, thus, they might be able to derive better synergies by having an additional asset there.”
L&T, one of Bhushan Steel’s creditors, however, has objected to Tata Steel’s resolution plan, where it had suggested that operational creditors would get 200 crore and then an additional 1,000 crore on a preferential basis. JSW Steel owes L&T 900 crore and is demanding that it be deemed as a secured creditor. In the waterfall repayment plan under the IBC, operational creditors rank below financial creditors and haven’t seen good pay-offs so far (see: The waterfall effect). This has led to several litigation being filed by the operational creditors. The good news is that operational creditors can now take errant companies who refuse to clear dues on time like in the case of Reliance Communications where Ericsson’s insolvency plea against the former has been allowed by the NCLT in a bid to recover its unpaid dues of 1,155 crore.
That apart, there are questions about whether the approach of picking the highest bidder in itself is appropriate. “I feel the process gives a lot more weightage to upfront payments for secured creditors or operating creditors. Thus, the highest bid always wins rather than the turnaround strategy suggested in the resolution plan and the amount of equity that the new investors will bring in. To the secured creditors, the synergies that a new investor brings are not of relevance,” says Rao. Bankers, he says, look for faster resolutions and smaller haircuts on their loans. JSW had bid for three out of the five steel plants up for sale, and its sole bid on Monnet Ispat & Energy along with private equity fund AION was accepted by the creditors and cleared by the Competition Commission of India but the NCLT is yet to give its approval and has sought a written resolution plan from JSW. There has been criticism around the deal, with people saying it gives a back door entry to Monnet’s existing promoter, Sandeep Jajodia, since Sajjan Jindal’s sister is married to him.
Plugging the holes
Errant Indian promoters are known to find and make the most of loopholes in the law. Till the Section 29A amendment came into force, promoters who ran their companies to the ground were able to buy back their own company at 30% or lower, forcing banks to take a huge cut on their loans. The idea of the amendment was to make it harder for owners to regain control of businesses without first settling their dues. While the move has managed to keep some larger defaulters at bay, it is posing a huge problem in the cases of smaller and medium enterprises where there are mostly no bidders. Also, given the legal tangles these cases are attracting and the haircuts (in some cases more than 80%), it is tempting for banks to let them go to liquidation instead of answering queries from the NCLT. “We will be creating a new graveyard for sick companies in India and that was not the objective of the IBC,” says Eshwar Karra, CEO, Phoenix ARC, which manages nearly a $1-billion worth of stressed assets. In most of the smaller companies, it is only the promoters who are interested in reviving the company. “If the company gets into trouble due to cyclic downturns in the business, it is not fair to penalise the promoter. In fact, a lot of them borrow loans at a higher cost to fund working capital and get into the debt trap. If the business is viable and has a good promoter at the helm, banks can work with asset reconstruction companies to revive the operations,” says Sridhar Ramachandran, chief investment officer at IndiaNivesh Renaissance Fund, which specialises in helping small and mid-cap companies turnaround operations.
SBI’s Kumar concurs, saying that the NCLT should be the last resort for SMEs. “It is best for the SMEs and the lenders to find a resolution within the stipulated time. You can have one-time settlements or enter into an agreement with ARCs for the sale of assets. RBI has given a lot of flexibility in finding an option,” he says. While some bankers argue that the 180-day time frame is not enough, Kumar says, “If the stipulated time is one year, then they will say 18 months is better. There is never enough time. Not all cases under bankruptcy are complex and you can always get an extension if it is.” Like Kumar, many feel putting a timeframe pushes both parties to find a resolution since both the borrowers and the lenders don’t want to go for liquidation. In case of companies such as Alok Industries, where the sole bid from Reliance Industries was rejected by the creditors, the company going into liquidation will see 18,000 people lose their livelihood. “Companies and banks are barely getting their heads around resolution. Liquidation will open a whole can of worms. Handling workmen displacement can be very tricky let alone winding up the company and selling the assets to different boxes. It is a Pandora’s box waiting to be opened,” says Shardul Shroff, chairman, Shardul Amarchand Mangaldas & Co.
Indian banks traditionally have a bad track record of recovering assets. For the past four years, PSUs could recover a little more than 10% of the bad loans written off. That came to a measly 29,343 crore of the 2.72 lakh crore worth of bad loans. “Banks have been trying their best to improve their recovery rates but the power of lenders has been very limited until now. Even site visits for prospective buyers were challenging. You couldn’t force promoters to undertake the sale of assets to repay their loans,” says Diwan.
The IBC is hoping to change all that. “The intent of the IBC is well-founded. As a country, we haven’t been very successful in resolving NPAs and hopefully this will change with the implementation of the code,” says Karra. For the IBC to emerge as a powerful tool for bankers, ground rules have to be clear and stringent in terms of meeting deadlines and following processes. “While in large cases, a standard solution may not work, it is important for the NCLT to set a precedent and follow it instead of letting every stakeholder file litigation cases against resolution professionals or creditors, and more importantly, not get bullied by large corporates to twist cases in their favour. Value maximisation should be a priority, but, at the same time, it shouldn’t make a mockery of the code,” says a lawyer representing PSU banks.
The delay in the first few cases under the NCLT is a cause for concern but chinks are being ironed out. It is paramount for the IBC to not only penalise delaying tactics and deals within deals, but also establish a process that offers some predictability in resolution instead of fuelling the existing chaos. The code has, without any doubt, been established for bankers to realise maximum value. However, if there is no sanctity attached to the timeline or the process of these bids, constant rebids allow potential buyers to sit on the fence and assess what the bids are like and then jump in unfairly. Even worse, it allows promoters to collude with other interested parties to come up with frivolous bids to delay the process. “In cases where creditors foresee active bidding, an open auction could be a more transparent way to realise maximum value like they did in the case of telecom spectrum auctions,” says Shroff. Multiple avenues can be explored, but for the code to have some bite and be taken seriously, there is a definite need to set a strong precedent in these initial cases. “While the NCLT has been quite effective in terms of process and hearings, a lot of time that should be spent on resolution is being spent on qualification and eligibility issues of bidders. There must be a lot more focus on bringing down these challenges,” says Shroff. “The answer lies in offering better terms of bidding and bringing a screening aspect for eligibility other than Section 29A.” So, another amendment is in the works that allows genuine promoters of SMEs to participate in the bidding process. A list of offences that will keep promoters permanently off the list is being mulled over rather than a blanket ban. Apart from lowering the voting majority from 75% to 66% for critical decisions that will bring in faster resolutions, there is also a plan to allow financial institutions such as NBFCs and private equity funds to participate in the process, bringing them on par with banks. Even if the recovery rates then drop from the expected 57% for the first two lists of large companies to about 30-40%, it is still better than the current rate of recovery. Just the threat of being yanked to the bankruptcy code should result in better recovery for Indian banks. In countries such as China and Brazil, where bankruptcy laws were introduced in 2005 and 2007 respectively, recovery rates have increased considerably from 18.80% to 33.4% in China and 12.6% to 26.3% in Brazil, and there is no reason why India should not follow suit.
“In due course IBC will become the most water-tight code with every clause being tested. In every country where bankruptcy laws were introduced, it has taken time to stabilise. In India, the process will be faster with precedents being set in some of the large complex cases. We just have to give it some time,” says Antony.
Indian banks are looking towards a better FY19 as few of the initial cases among the dirty dozen should get resolved by June 2018 quarter. With the successful resolution of Binani Cement, the Finance Ministry is looking to recover nearly 100,000 crore from the rest of the 11 cases on its first list. That is a good first step.