A recent judgement by a bankruptcy appeals court on a plea challenging ArcelorMittal’s eligibility to buy Essar Steel India Ltd equating financial and operational creditors in insolvency-related claims threatens to become a deal-breaker for distressed assets deals in India.
Many distressed assets investors purchase bad loans of stricken companies from financial creditors, expecting to profit in the insolvency process. So far, financial creditors have enjoyed a greater share of insolvency claims compared to operational creditors. The ruling of the National Company Law Appellate Tribunal (NCLAT) will diminish these investors’ returns and prompt them to stay off distressed deals, multiple people connected with the sector said.
Several overseas investors who were in talks to invest in distressed debt in India are having a rethink after the NCLAT judgement, these people said. On 5 July, while approving ArcelorMittal’s ₹42,000-crore bid for Essar Steel, Justice S.J. Mukhopadhaya of NCLAT directed a higher payout to Essar Steel’s operational creditors, treating them on par with secured lenders. Exactly a week later, Essar Steel’s lenders led by State Bank of India challenged the ruling in the Supreme Court.
As per the judgement, of the ₹42,000 crore on offer, financial creditors will receive ₹30,030 crore and operational creditors about ₹12,000 crore, comprising about 60.7% of their admitted claims. The secured creditors would have recovered 90% of their loans in the original resolution plan.
“Several potential investors who were in talks to acquire portions of the loans have now backed out," said a member on Essar Steel’s committee of creditors. “Many of these investors have decided to wait to see the outcome of the Supreme Court appeal before they invest any more money. The funds invested in Essar Steel bought out banks’ exposures at 80 cents to a dollar. With the NCLAT judgement, their recovery will fall to about 60 cents."
“The idea that secured creditors shall rank ahead of unsecured creditors is a key pillar of global finance. It allows banks to lend to companies and individuals at lower rates of interest because they know that their loan is secured and should the borrower default on that loan, the lender’s losses are mitigated," said Theron Alldis, Asia Loan Trader at SC Lowy, a Hong Kong-based distressed assets investor that has bought Essar Steel’s bad loans from Axis Bank and Bank of Baroda.
“But now you’re effectively saying it doesn’t matter if you’re secured, you’re going to be treated the same as an unsecured creditor. That just means borrowing rates for everybody will go up in the future because your banks and lenders can’t rely on protecting their losses," Alldis said.
Shantanu Nalavadi, managing director, India Resurgence Fund, agreed. IndiaRF is a joint venture between Piramal Enterprises and Bain Capital Credit and invests in distressed assets and special situations in India. “Obviously, Essar Steel judgement is not only impairing value for secured lenders but has allowed claims of operational creditors that were above what the resolution professional had admitted," he said. “Now, secured lenders are on the same footing as unsecured creditors, operational creditors and even contingent liabilities."