IBC represented a big change in the power equation between creditors and debtors. Before the code was enacted, lenders were at the mercy of big borrowers. The plethora of laws that was supposed to resolve stressed assets only resulted in interminable delays in the courts. According to World Bank statistics, it took an average of 4.3 years to resolve a soured account. Lenders recovered an average of 26.4 cents to the dollar. These were among the poorest numbers in emerging economies.
The new framework is supposed to change all that. It is a timebound process. Cases once admitted are supposed to be resolved within 270 days; if not, companies go into liquidation. During the resolution process, management control is taken away from promoters and vested with a resolution professional.
“In my view, the whole debtor-creditor relationship will undergo a change and this is positive from the perspective of improving the credit culture of the country. This will lead to better availability of credit and eventually help in improving the ease of doing business," said R. Subramaniakumar, managing director and chief executive officer at Indian Overseas Bank.
Since the code came into being, at least 2,434 fresh cases have been filed before the National Company Law Tribunal (NCLT) till 30 November and at least 2,304 cases seeking the winding-up of companies have been transferred from various high courts. Of these, 2,750 cases have been disposed of and 1,988 cases were pending during the period under review (as of December), according to a reply to the Lok Sabha by the minister of state for finance, Shiv Pratap Shukla.
Still, a year after its introduction, the code remains a work in progress. It has teething troubles and requires constants tweaks, as indeed all new laws do. Despite the recent amendments to the code, and regulation changes by the Insolvency and Bankruptcy Board of India, there are still several gray areas in the code. The government has set up a committee to review its functioning. The committee has started work and called for comments from stakeholders to identify issues impeding the efficiency of the IBC resolution and liquidation framework.
Of haircuts and liquidation
This year will see the resolution of the 12 big cases identified by the Reserve Bank of India (RBI) for early resolution under the framework. These cases will approach their 270-day deadline in the next few months.
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. Subsequently, in the second quarter of this financial year, banks referred the 12 big cases identified by RBI—which make up close to one-quarter of the Indian banking system’s stressed assets of Rs10 trillion—to the NCLT. By the end of December, lenders had referred (or were in the process of referring) another 28 large cases to bankruptcy court.
The hesitation also stems from the fact that the code is yet to prove its efficacy. Indeed, the first case to be resolved under the new framework set off jitters among lenders.
Synergies Dooray Automotive Ltd, a maker of alloy wheels for cars, the first case to be resolved under the new regime, saw lenders take a 94% haircut. They recovered only Rs54 crore against a claim amount of Rs972 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 about Rs130-140 crore, which translates to less than 10% of its total debt.
“One single (Synergies Dooray) case cannot become guidance for future. That I would treat as an exception. As far as NCLT is concerned, each case is different and the claim on the particular borrower is different, enterprise value will be different," said Rajnish Kumar, chairman, State Bank of India, in a media teleconference on 5 October. “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 resolution is a better option than liquidation. As far as liquidation is concerned, our recovery will be the lowest. That’s why the decision will be based on what will derive the maximum value for the bank."
Barring errant promoters
The Synergies Dooray case also gained notoriety after Edelweiss Asset Reconstruction Co., one of the firm’s creditors, challenged the resolution. The arguments went like this: The resolution plan for Synergies Dooray involved merging the company with Synergies Castings Ltd, a creditor and related party. Synergies Casting, which had held 75% of debt of the defaulter, transferred a significant chunk of loans to a non-related party called Millennium Finance Ltd.
This, according to Edelweiss, enabled Synergies Castings to put in place a proxy in the committee of creditors and diluted Edelweiss’s voting share. This transfer of debt is illegal, Edelweiss contended.
The prospect of promoters coming back into control of their companies and at steep discounts prompted the government to issue an ordinance in November. The amendment barred wilful promoters and errant promoters of defaulting companies, and their related and connected parties, from bidding for stressed assets in the resolution process.
While the intent of the amendment was lauded, it also came under criticism for poor drafting.
“The ordinance is very wide; it seems to debar many people in India. Related party (definition) is very vague and everyone could be a related party," said Renuka Sane, associate professor, National Institute of Public Finance and Policy at New Delhi. There were fears that private equity firms and those whose primary business was dealing in distressed assets would be barred. Some experts expressed concern that barring some bidders would reduce the recovery rates of these stressed assets. This was particularly so for defaults in micro, small and medium enterprises (MSMEs), where the promoter was often the only bidder. Most MSMEs saw disruption in their cash flows because they were not paid on time by large companies, to whom they provided services, according to bankers.
“Most promoters of small and medium business are nowhere close to wilful defaulters. Their ability to repay has been crippled because their bills have not been cleared by clients. In this case, taking their company away and not giving them a chance to get back the unit seems unfair," said a banker with a mid-sized public sector bank.
In December, however, the bill replacing the ordinance diluted some of these strictures to strike a balance in the trade-off between punishing wilful defaulters and ensuring a more effective insolvency process. The bill allows defaulting promoters to bid provided they repay the dues in a month to make their loan account operational and the resolution happens within the overall time frame specified in the code. The bill also allows asset reconstruction companies, alternative investment funds (AIFs) such as private equity funds and banks to participate in the bidding process.
“As the system is new, challenges will be there. But the government has been proactive in evolution of the code, taking into account views of all stakeholders. I think in a quarter or two the system will be well matured," said Subramaniakumar of Indian Overseas Bank.
The role of IRPs
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. 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 it was facing stout resistance from the debtor.
“The NCLT judgements 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 the IRPs in the day-to-day functions of the company and to draft a resolution plan," said a resolution professional who didn’t want to be named.
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," said Binani.
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, "said Vijay Kumar Iyer, the IRP for Bhushan Steel Ltd.
“We are seeing companies making efforts to repay and trying for a way out before the case is referred to NCLT. By and large, borrowers who are been taken to the NCLT are cooperating with IRPs because the resolution has to be in best interest of everyone," said R.K. Takkar, managing director and chief executive officer of UCO Bank.
Fixing gaps in the code
While bankers are still grappling with the framework and waiting for a string of successful resolutions, it remains a work in progress. The code has landed four times in the Supreme Court. In these cases, the apex court dealt with the legality of the code, showing that there are gaps which have to be plugged through amendments or changes in regulations.
One such change was to incorporate homebuyers as operational creditors. Earlier, home buyers as a category were not recognized as financial or operational creditors. The loophole in the code was first recognized by the Supreme Court in the insolvency case against Jaypee Infratech Ltd.
In a 9 August order passed by the Allahabad bench of NCLT, insolvency proceedings against Jaypee Infratech were initiated. This effectively left 32,000 homebuyers in a lurch. On 5 September, the apex court stayed the NCLT order to achieve a balance between the rights of homebuyers and other creditors. Since then, the apex court has initiated recovery for homebuyers of Unitech Ltd and Supertech Ltd through creation and maintenance of a designated website where homebuyers can specify if they wish for a refund or continue to wait for possession of flats.
The bankruptcy regulations were amended on 16 August and homebuyers can now file claims to get their dues from real estate companies. However, this takes care of homebuyers’ interests only to a certain extent.
“Now the bigger question which arises is where do creditors fall in the waterfall mechanism given in the IBC and what will be their ranking? Will they fall in the category of trustees whose rights are reserved on liquid assets for resolution process? Will home buyers get the status of secured creditors? These are the questions that are still to be addressed," said Satwinder Singh, partner at Vaish Associates, a law firm
Another recent case of aggrieved homebuyers is the case filed on 20 September by 107 homebuyers in the Supreme Court against an order of the National Company Law Tribunal (NCLT) that admitted Bank of Baroda’s insolvency petition against Amrapali Silicon City project in Noida.
“The creditor in control model has its own constraints. Many of the issues being experienced under the new Indian insolvency regime emanates from this basic construct. The tension between secured creditors and flat-buyers in the real estate sector is one such example," said Pratik Datta, a policy researcher and Chevening Weidenfeld Hoffmann Scholar, University of Oxford.
Experts say that clear legality has developed only on matters relating to admission of the matters. The Supreme Court ruled that IBC takes precedence over state laws.
Some judgements by National Company Law Appellate Tribunal (NCLAT) have also clarified that the admission of an insolvency plea is a judicial process and thus is not time-bound; however the resolution is administrative and has to adhere to the 180-day timeline. According to bankers and legal experts, the jurisprudence concerning the resolution plan for companies, liquidation process, issues concerning claims, valuation, rights and duties of the insolvency professionals is likely to evolve with time.
Much is left to be done. For instance, recent rulings by two NCLT benches—in Hyderabad and Mumbai—have added to the confusion. The Hyderabad bench passed a resolution which was approved by 66.67% members of the CoC and the Mumbai bench ruled that 75% is sacrosanct.
The regulatory interplay
Regulatory turf wars are not uncommon when multiple regulators are regulating the same entity. So far, the Insolvency and Bankruptcy Board of India (IBBI) has got support from other regulators, barring a few hiccups.
For instance, the Securities and Exchange Board of India (Sebi) on 21 June exempted buyers of shares in distressed firms from the requirement of making an open offer even if the purchase triggers such an event under the takeover code. A dispensation is needed from the Competition Act to ensure a resolution plan is approved by the Competition Commission of India (CCI) and is not termed as violating terms of the act, said Manish Aggarwal, a partner at KPMG India.
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 6 January, the Central Board of Direct Taxes eased rules for insolvent companies.
The only hiccup was on sharing financial data of default with the Information Utility (IU), under the Insolvency and Bankruptcy Code 2016, are envisaged to collate all information about a debtor, which in turn will help in establishing default as well as verifying claims of creditors. In September 2017, the Insolvency and Bankruptcy Board of India (IBBI) registered National e-Governance Services Limited (NeSL) as the first IU.
Banks and other financial institutions were reluctant in sharing data with the NeSL as they needed a clearer sense from RBI. The confusion was cleared on 19 December when RBI directed its regulated institutes to share information with the IU.
Now, all eyes are on the committee which has been set up to suggest tweaks to code.
Utpal Bhaskar and Priyanka Mittal in Delhi contributed to the story.