Uninvoked guarantees put lenders, investors in a fix
Potential buyers of distressed firms may have to keep bigger war chest than expected
Mumbai: The bankruptcy resolution process has a joker in the pack in the form of uninvoked corporate guarantees, muddying valuations, forcing banks to book losses, and bringing the appellate tribunal into the picture.
Many firms had extended corporate guarantees to healthy subsidiaries based on which they got bank loans; but the parents themselves defaulted and went to the resolution process.
When banks filed their claims, the resolution professionals rejected them. The appeals court National Company Law Appellate Tribunal (NCLAT) has since clubbed these cases. The dispute has held up the resolution process of at least three accounts clubbed by NCLAT that have collectively defaulted about Rs10,000 crore. The guarantees are Rs2,000 crore in the case of Edu Smart Services, Rs2,000 crore in Binani Cement Ltd and Rs625 crore in JEKPL Pvt. Ltd.
Potential buyers who had hoped to buy distressed companies at throwaway prices will have to keep a bigger war chest than previously expected due to these guarantees.
In many cases, the subsidiaries are still paying dues and, hence, the corporate guarantees that the parents provided are still alive.
“A corporate guarantee that has not been invoked remains a contingent liability, and the investors will have to take this into account while they value the companies at the time of bidding,” said Bahram Vakil, co-founder of AZB and Partners, who was also one of the authors of the Insolvency and Bankruptcy Code (IBC). “The potential investors will have two choices—either they have to ensure that the guarantees are extinguished/released by the lenders (which is unlikely) or the potential buyers will have to keep these guarantees in mind at the time of valuation of the company.”
Currently, the valuations of such distressed assets are in limbo where those companies have given corporate guarantees towards their subsidiaries and those subsidiaries are paying lenders on time.
“Uninvoked corporate guarantees in many cases are greater than the dues of other financial creditors, and if the banks who lent against guarantees become part of the committee of creditors (CoC), this could change the decision-making dynamics within the CoC, since voting share is proportional to a number of claims,” said Zubin Mehta, partner at law firm Veritas Legal. “Due to this, and divergence of views on this issue, financial creditors may not favour including issuers of such uninvoked corporate guarantees in the CoC. But, at the same time, the creditors in the CoC and prospective investors would expect lenders to abide by the decisions that CoC takes with regards to the defaulted company to ensure the proper implementation of the plan.”
In December, the Allahabad bench of National Company Law Tribunal (NCLT) had rejected a plea from Exim Bank to its claim of Rs625 crore on JEKPL Pvt. Ltd to be treated as financial debt which was actually a corporate guarantee. In this case, the bank had invoked its claim almost two weeks after the initiation of the resolution process. The adjudicating authority had already declared the moratorium period, and, hence, they were not made part of the CoC.
“It is clear that corporate guarantee which has not been invoked before the commencement of insolvency process cannot be considered as debt,” observed NCLT, while rejecting the Exim Bank’s claim. Similarly, Axis Bank lost its claim of Rs397 crore against Edu Smart Services in the New Delhi bench of NCLT. The country’s third largest private sector lender had provided a loan to Educomp Solutions where its subsidiary Edu Smart Services was the corporate guarantor. In this case too, the bankruptcy court had admitted the insolvency petition filed by DBS Bank on 27 June 2017, and after that, Axis Bank had sent its claim on 11 July 2017. The resolution professional rejected the claim, saying the guarantee was not invoked at the time of filing the case. In the third case, IDBI Bank had lent to subsidiaries of Binani Cement Ltd where the parent company was a corporate guarantor. However, the claim of around Rs2,000 crore was rejected by the interim resolution professional.
NCLAT has clubbed all these cases together. However, many experts are of the view that irrespective of appellate tribunal’s ruling, potential investors eyeing stressed assets will have to keep the provision of such contingent liabilities.
“The bid submitted by the resolution aspirant (potential new owner of the company) under insolvency will take into account the contingency on account of the corporate guarantee furnished by the company which is facing insolvency,” said Jyoti Singh, insolvency and dispute partner at law firm Phoenix Legal.