Mumbai: As the Insolvency and Bankruptcy Code (IBC) completes its second anniversary, it is proving to be every bit the game changer it was hailed to be. Some of the largest and most complex cases in the banking system are in the process of being resolved, with the lenders expecting to make significant recoveries, albeit with a haircut.

As things stand, there is a clear visibility on the resolution of the Reserve Bank of India’s (RBI) so-called dirty dozen, a group of 12 corporate defaulters, which accounted for the single-largest share of non-performing assets, amounting to 2.77 trillion.

In May, debt-laden Bhushan Steel Ltd earned the distinction of being the first successful resolution under the IBC, when it was acquired by Tata Steel. The NCLT on Thursday approved the bid of AION Capital-JSW Steel to acquire Monnet Ispat & Energy Ltd. Others such as Essar Steel, Monnet Ispat, Alok Industries and Amtek Auto have also received significant buyer interest and are likely to witness a change in ownership sometime soon. Outside the dirty dozen, Binani Cement’s bankruptcy resolution process grabbed eyeballs, with binding bids from several suitors. The highest bid exceeded Binani Cement’s total outstanding debt. Although the decision on the final ownership of the company is sub-judice, instances such as these prove beyond doubt that that for both banks and defaulting promoters, status quo was no longer an option under IBC.

The journey so far

There had been several concerted efforts to resolve the bad loans problem before the IBC became operational on 21 July 2016. However, resolution mechanisms such as strategic debt restructuring (SDR) and sustainable structuring of stressed assets (S4A), made little difference. Industry watchers say the failure of these schemes stems primarily from the reluctance of creditors (mainly public sector banks or PSBs) to approve haircuts in distressed asset deals, often a prerequisite for a resolution.

“The bankers were apprehensive and, in many cases rightfully so, as they could have been held liable for selling the asset too cheap and be accused of complicity and corruption," said a managing director of a public sector bank, requesting anonymity. “Now, the IBC has ensured that buyers acquire cleaned-up assets without any hidden liability. Bankers are also protected by the law to approve transactions for values considered optimum, without any fear of being hauled up by regulatory agencies for alleged corruption."

Besides, mindful of the impediments in successful resolutions, the government and RBI have worked towards creating a level playing field by effecting changes not only to the bankruptcy laws (amended in 2017 to prevent corporate defaulters from bidding for distressed assets), but also to the entire ecosystem. One such measure was to raise the minimum upfront payment by asset reconstruction companies (ARC) from 5% to 15%, which discourages the use of ARC platforms by lenders for long-term warehousing of bad loans without any resolution. The fear of errant promoters playing the system to their advantage has also been addressed by a fair margin.

While the insolvency regulations have stopped defaulting promoters from bidding for any distressed asset, the involvement of multiple stakeholders in the resolution process has ensured transparency and propriety, so much so that even when decisions were challenged in court, it passed legal scrutiny. In the case of Essar Steel, for instance, Numetal had to drop Rewant Ruia as a shareholder as he was closely related to the promoters of the debt-laden steel major, to remain eligible for the bid.

Investing in a perfect storm

With the dirty dozen potentially out of the way, the focus has turned to the new cases. As per industry estimates, cases involving 150 firms, each owing at least 2,000 crore, need to be resolved by August, else, they will be referred to the National Company Law Tribunal (NCLT) for bankruptcy proceedings. Industry watchers say there was a high probability that a large number of these cases will finally end up in the NCLT.

While some of these cases are expected to be resolved through a change in ownership, many are expected to be liquidated. This, in turn, will bring in vulture funds and strategic buyers, who have been patiently waiting on the sidelines, instead of bidding for the distressed firms, to snap them up at cheaper prices when the liquidation process begins. Such dealmakers include foreign and domestic distressed asset funds, including Edelweiss, Blackstone, KKR, Piramal-Bain and Aion Capital among the old guard, and newer entrants such as Varde Partners, Blackrock group, Cerberus Capital and Oaktree Capital. Among existing funds, many have already set up ARCs to acquire loans from lenders, which is part of their overall distressed assets play in India.

The IBC is also proving to be a credible deterrent for defaulting promoters, who run the risk of losing their assets. This, in turn, has opened up opportunities for distressed and special situation funds, which can refinance and close the funding gap between bank credit and internal cash flows. Sample this: India Resurgent Fund (IRF), a joint venture between Bain Capital Credit and Piramal Enterprises, recently bought out the entire debt of Chennai-based Archean Chemical Industries from a consortium of PSBs. Mint reported on 4 June that IRF had invested about 800 crore in the company, in a mix of debt and equity, to help the company restructure its cash flows. The structured deal involves an annual interest of 16% on debt, as well as on equity through a share of the Ebitda on attaining certain milestones.

The road ahead

Recently, the government agreed to a five-pronged strategy proposed by the Sunil Mehta Committee to resolve the bad loans mess. Project Sashakt is aimed at retaining the value of the asset through operational turnaround.

Under the scheme, bad loans of up to 50 crore are required to be resolved within 90 days by the bank. For loans of 50-500 crore, banks will have to enter into an inter-creditor agreement, authorizing the lead bank to implement a resolution plan within 180 days, which includes appointing turnaround specialists. If the lead bank does not complete the process in time, the asset would be referred to the NCLT. For loans above 500 crore, the committee has recommended setting up an independent asset management company (AMC), supported by institutional funding or an alternative investment fund (AIF).

Industry experts say that though the intent is right, there are still a few unanswered questions. “Will the AMCs be truly independent or still be an off balance sheet subsidiary of the lenders," says Ravi Chachra, co-founder, Eight Capital Management Llc, an India-focused distressed assets fund. “To attract foreign and domestic institutional investors, the loans have to be transferred/sold to the AMC at enticing prices. Moreover, the governance of the AMC has to be pristine and investment decision-making framework has to be clearly defined, so that there is alignment of interest between the professional manager of the fund and the stakeholders, including investors and lenders."

According to Anurag Das, adviser, Blackstone India Stressed Assets and CEO-designate, IARC, there are a few gaps that merit attention. “Creditor classes need separation; clubbing divergent interests into the same voting class is leading to inefficiency and some malpractices. Next, there needs to be a strong focus on much better collation and early dissemination of information. As yet, unduly tedious procedures and unreasonable costs are limiting investor participation. Also, creditors need to ensure resolution process rises above statutory minimum thresholds towards achieving better outcomes."

Despite the concerns, if the AMC model is successful, it will act as a market maker in distressed asset deals. However, there should be some clarity on who will manage the resolution process.

Unlike in IBC, where the appointment of a resolution professional is a statutory requirement, there has not been any word on who will manage the entire resolution process of cases under Project Sashakt. Besides, the government must find ways in the IBC mechanism to bail out smaller operational creditors from acute distress when bigger firms fail to pay up.

IBC is still a work in progress, but in all probability it could prove to be the key to solving India’s bad loans mess.

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