MUMBAI : There was a palpable sense of relief across corporate India when the Supreme Court gave its stamp of approval to ArcerlorMittal’s takeover of the troubled Essar Steel under the debt resolution process of the Insolvency and Bankruptcy Code (IBC). In a big victory for the three-year-old legislation, the court upheld the principle of financial creditors having primacy over unsecured and operational creditors.
But this victory has come after a long wait. At 841 days and counting, Essar Steel has taken way above the mandated timeline of 270 days to close a case that has come for insolvency. In the meantime, commodity prices have tempered, lenders lost more than two years of time value, while the new buyer had to lock in capital (that remained idle) for a long time.
‘Faster resolutions and value maximization’ are the two stated objectives of the IBC. As the Essar Steel case shows us, we are far from achieving either. With a few exceptions, the story of the past three years has been one of many legal battles— corporate defaulter versus creditors; between competing bidders; financial creditors versus operational creditors; and defaulter versus bidders.
Deep-pocketed powerful corporates in India have managed to indefinitely delay the corporate insolvency resolution process (CIRP), and evade repercussions (at least for now), by continuously putting the IBC to test in the court of law.
Infrastructure challenges also continue and challenge the efficiency of tribunals to dispose cases quickly. The 27 National Company Law Tribunal (NCLT) benches handle roughly 15,000 active cases (555 cases per bench). The government is strengthening the NCLT benches, but change is taking time.
Value discovery has been a concern. In fact, for every one case resolved, four cases end up in liquidation, where the recovery falls down sharply to 15-25% of the book. This raises the question around quality of assets that enter the insolvency process, and the ability of the resolution professionals and creditors to preserve the quality of asset upon transfer of control and close a transaction.
IBC has failed to live up to expectations. The government is trying to resolve matters: amendments, clarifications, nudging the lenders, and marketing it overseas as a great opportunity for investors. It has amended the IBC thrice in the last three years (the latest being in July 2019) and each time there is an attempt to strengthen the law.
That said, it is time to think outside the box to make IBC more resilient and sustainable, amid continuous headwinds. What should IBC Ver 2.0 look like?
The track record
Most agree IBC has been a well-intentioned legislation backed by strong intent from the government to tackle ‘bad credit’. Anil Agarwal, founder & chairman of Vedanta Resources Limited which acquired Electrosteel Steels Ltd (ESL), called IBC a “very good system" in an interview with Mint in September.
Agarwal adds that in order to realize the benefits of IBC, the time taken to find and implement resolutions has to come down drastically. “It is taking very long (to complete). Competent people must come and contribute to make sure that the process is completed on time. And this (reducing delays) is very important because banks, promoters and bidders—everyone—are suffering. IBC, as a system is very good, but it needs to be relooked to ensure it is crisp and delivers result," he said.
As of June 2019, 2,162 cases were admitted for corporate insolvency. Of this, 1,292 (59.8%) cases are ongoing and 870 (40.2%) are closed. Of the closed cases, 475 (54.59%) are headed for liquidation and just 120 cases (13.79%) have been resolved under the IBC. Clearly, there are only a small proportion of successful resolutions under IBC.
Recoveries in well-managed companies, especially in steel sector, have been encouraging. Overall, average recovery from 120-odd cases resolved under the IBC is 42.78% compared to 26%, under the erstwhile SICA (Sick Industrial Companies Act) regime (pre-IBC era). “Government has so far played a proactive role in de-cluttering any ambiguities," says Sanjeev Krishan, partner and deals leader, PwC
The mindset change
To be sure, IBC has been able to do the unthinkable—put Indian corporates on tenterhooks. The memo was simple: either pay up your debts to the banks in a stipulated time frame or get ready to be liquidated or acquired. In her speech in Rajya Sabha on IBC amendments in July 2019, finance minister Nirmala Sitharaman stressed that IBC has affected a “behavioural change" in corporate sector.
IBC has indeed set alarm bells ringing with almost every debt-stricken company trying its hand at debt restructuring or putting up distressed assets on sale. India’s crème de la crème could no more walk away from their debt without facing consequences. This triggered a fear among promoters of losing control of their firms and being banned from bidding for other distressed assets. In fact, IBC actually recoded business relationships in India.
It also unleashed corporate animal spirits—outdoing each other via bids, or pursuing a back-door entry or even challenging the law in some cases in pursuit of the asset. With interest from global stressed asset investors, deep-pocketed institutional investors and corporates trying to make the most of this once-in-a-lifetime opportunity, IBC accounted for a third of domestic mergers and acquisition in terms of volume and value in 2018.
Haigreve Khaitan, partner, Khaitan & Co says, “The biggest change IBC has brought about is cultural. Irrespective of how big the corporate is, the law is being enforced."
In fact, the Reserve Bank of India’s (RBI) direction to the banks to go after the ‘dirty dozen’—the list of 12 companies that make up 25% of the non-performing assets (NPA)—was a monumental step in changing the psyche of lenders and promoters. Prior to this, lenders were hesitant to go after big corporates, but this changed quickly. And the fear of losing control set in—insolvent corporates are reaching out to potential investors for fresh funds to settle their outstanding dues or negotiating a restructuring plan. Driven by fear of insolvency action and losing control of their assets, debtors who were earlier unwilling to repay, paid back ₹1.1 lakh crore to banks by October 2018.
The pushback
IBC is a very ambitious and powerful piece of legislation. And while that is good, it is also the reason why there is so much pushback from both the creditors and promoters. As a result, jurisprudence is getting created, and this implies a lot of confusion: confusion that grows every-day," says Ravi Chachra, founding partner of Eight Capital, which deals in distressed assets.
Opposition by lenders to the RBI’s 12 February 2018 circular to set a deadline to refer cases for insolvency is one such instance of pushback. The intention of IBC was to come up with speedy resolution. In contrast, the judiciary always prioritizes maximizing value over efficiency and speed. Therefore, during the early days of the IBC law, it was established that the 270 day-timeline never includes ‘objection time’ in NCLT. In theory, this implies there is no difference between Sick Industrial Companies Act (SICA) and IBC: that is, both can go on forever.
As Sanjeev Krishan, points out, the biggest challenge for IBC at present is that there is too much litigation. Although the number of benches and judges has been increased, the duration of acquisition and the opportunity cost involved is demoralizing for potential acquirers.
Consider the tortuous case of Essar Steel. At first, the insolvency petition was challenged by the company. That case was dismissed. Then, during the bidding process it was discovered that one of the bidders had relationship with the promoters. Third, when the bid from ArcelorMittal was about to be accepted by the committee of creditors (COC), existing promoters of Essar Steel made another offer for full settlement (perplexing, because if the promoters had the funds, why was the company facing bankruptcy in the first place).
After that was rejected, an unsuccessful legal case followed. Then, there was dispute between operational creditors and financial creditors over distribution of proceeds and that led to an amendment to the IBC. More than 27 months have lapsed, with zero value to any stakeholder.
As PWC’s Krishan weighs in, “In a democracy, everyone has the right to approach courts. But if there could be a mechanism to dispose of frivolous cases or cases in which legal precedence is set, it could truly reinvigorate the distressed deal landscape in India."
A matter of time
It goes without saying that cases have taken too much time. Of the 1,292 current cases as on 30 June 2019, 445 cases (34.44%) are ongoing for more than the mandated 270 days. And, of the top 12 largest ‘dirty dozen’ debtors, just one resolution happened within the mandated 270 days; 4 are ongoing for more than two years now and 2 are headed for liquidation. The remainder are resolved with time period exceeding the mandated 270 days.
The legal challenges continue. Recent amendment by the government to complete resolutions within 330 days, including legal objections, has been stayed by the Supreme Court. “It seems like for every three steps forward, we take three backwards," says Chachra.
Increasingly, fund managers are seeking deal opportunities outside NCLT. They are backing one-time-settlement offers by credible promoters or acquiring and consolidating loans from banks and then restructuring the debt. It is difficult for fund managers to allocate capital for insolvency cases , without knowing an approximate timeline. “NCLT cleans the balance sheet of companies. But at present, there is certainty of checking in, but no certainty of checking out— much like in the famous song Hotel California by Eagles," says Ravi Chachra.
He goes on to explain: “As insolvency cases unraveled, investors increasingly believed that corporate insolvency resolution process (CRIP) is not ready for primetime. Most funds are not keen on bidding for NCLT cases anymore, except in small, pre-packaged deals. Funds love to block their returns, over a specified period of time, and CIRP will be unattractive if they cannot invest and divest on time."
The new IBC
The real challenge is in the courts that are hearing cases against its amendments introducing a 330-day limit, including time for litigation, for implementing the resolution plan. The Ministry of Corporate Affairs has taken a strong stand.
At this point, one might hope that the judiciary will consider the economic and commercial implications of the said amendments, and give ‘time’ as much priority as ‘value.’ After all, time is value. A mechanism is needed wherein cases can be filtered and disposed quickly if it is against the spirit and letter of IBC.
With the proposed tightening of the time limit, institutions are also being strengthened. As on October 2019, NCLT benches have been increased to 27, from 16 earlier this year. Insolvency professionals have gone up from 1,107 in 2017 to 2,800 and registered valuers from 162 in 2018 to 2,300 now. The Insolvency and Bankruptcy Board of India has also initiated an awareness campaign.
According to The Economic Times, the government is planning to introduce e-bidding to reduce the timeline, improve transparency and reduce potential litigation. While e-bidding has been implemented in coal mine and solar and wind power auctions, its introduction in a quasi-legal process such as IBC will certainly be a first.
Clearly, most experts believe that implementation is where IBC falls short. The road ahead requires behavioural change of other stakeholders—creditors, debtors, bidders, the judiciary. They need to be on board for IBC to achieve its true potential.
