Urgency to fix India’s bankruptcy code

Ever since a bankrupt Seven Hills was admitted into the corporate insolvency resolution process (CIRP) in April 2018, the Brihanmumbai Municipal Corporation (BMC)—which owns the land where the hospital stands—has switched sides on how it wants the case resolved.

Seven Hills owes a clutch of lenders, chiefly JM Financial Asset Reconstruction Company, about ₹1,357 crore and owes the BMC a further ₹140 crore in unpaid rent. The BMC had initially agreed to lenders selling the hospital to B.R. Shetty’s New Medical Centre, in a resolution plan where all creditors would get about two-thirds of their outstanding dues. But it later backtracked in court, opposing the commercial sale of public land rights.

For Seven Hills’ lenders, the uncertainty has only increased. “We have run the entire resolution process thrice since 2018, but the case still isn’t resolved," a person involved in the hospital’s bankruptcy proceedings told Mint. “The BMC opposed the resolution when the hospital was not used. Now that it runs successfully as a public hospital, banks are nervous the BMC will take it over permanently and lenders will have to completely write off their dues."

Last December, fresh off the successful sale of bankrupt Essar Steel to ArcelorMittal for a $5.7-billion settlement, Mint reported in this page that the case had tested the mettle of the recent Insolvency and Bankruptcy Code (IBC). Essar Steel was among the original “dirty dozen" of large corporate defaulters listed by the Reserve Bank of India. Publicly-owned banks with massive bad loans on their books hoped that the case would pave the way for speedy bankruptcy resolution in India.

A year on, much of that hope seems to have been in vain—Seven Hills is just one of the many examples where resolution attempts are frequently stymied.

To be fair, a few high-profile and systemically important cases continue to find solutions within IBC, like the bankruptcy of Jet Airways or the ongoing resolution of Dewan Housing Finance Corp. Ltd (DHFL). But even under the glare of public interest, these have taken over 18 months.

But for the vast majority of Indian businesses that head to bankruptcy, the IBC is a ponderous judicial process; petitions continue to pile up at the bankruptcy benches spread across the country, waiting to be admitted into insolvency, while cases already in the system take months to be heard.

With lenders receiving lower than expected amounts in settlement except in a handful of headline cases, the payments offered to resolution professionals have reduced over the last year, creating a scarcity of talent. Besides this is the general loss of appetite among buyers to take over new capacity through stressed asset acquisitions at a time when both consumer demand and access to credit are limited.

These problems have been pushed to the background for now, given that the Centre has temporarily suspended the admission of new cases for all of FY21, given the recessionary effects of the pandemic. But while this has slowed the number of new cases, a backlog that runs into thousands hasn’t been resolved and the law’s 270-day resolution deadline appears to mean little.

These faults with the IBC have to be fixed quickly. Public sector banks are preparing for another explosion of bad loans from April and the IBC suspension does little to keep this flood of defaults contained. Bad loans are expected to show up in hospitality, aviation, real estate and small business, with their second-degree effects and job losses cascading into retail loans, putting bank exposure on home and vehicle mortgages, credit cards and microfinance at risk. Banks have been ramping up their provisioning for non-performing assets since the June quarter.

The nuts and bolts

It’s become clear now that the IBC is not working well," a senior executive who recently retired from State Bank of India told Mint. SBI is often the lead banker in a consortium of public lenders to large corporate debtors and has often found that other banks, with smaller resolution teams, fail to keep up with its speed.

“Since the lockdown, processes have become worse. Committee of creditors (CoC) has tried to meet through video conferences but very often, senior officers don’t attend the online meetings because they’re not taken seriously. So the CoC’s approval gets delayed. Once a resolution plan reaches court, it’s out of our control. Every decision is challenged these days, with many frivolous claims," he added.

This problem of “frivolous claims", most often by promoters, runs the gamut from the free use of the Limitation Act to prevent creditors from acknowledging past debt to challenges to questioning the credentials of buyout offers. Finally, as a case winds through several courts, the buyer often loses interest, which results in a higher proportion of assets now being sent to liquidation than in previous years.

“The biggest challenge in IBC is getting your insolvency petition admitted. Even before new petitions were suspended in March, we had cases that have been pending for admission for over 12 months," said R.K. Bansal, managing director and chief executive officer, Edelweiss Asset Reconstruction Co. He added that even once all claims against the resolution are settled, simple court orders take time.

A case in point is Bhushan Power and Steel, which JSW Steel, one of India’s largest steel firms, is waiting in the wings to take over. Bhushan was admitted into insolvency even before Essar Steel, but has been held up at the Supreme Court because its erstwhile promoter Sanjay Singhal is questioning JSW’s rights to profits earned by the asset during the three-year resolution process.

Separately, assets of the bankrupt steel mill have been attached by the Enforcement Directorate as part of a fraud and laundering investigation against Singhal. Neither has been settled thus far. JSW, understandably, doesn’t want to take over the asset with its ₹20,000-crore price tag unless it comes with a clean slate.

Another high-profile asset that has struggled is Amtek Auto, an auto components manufacturer that was also part of the dirty dozen. A seemingly successful acquisition spluttered to a halt this year because of a dispute over land.

US-based hedge fund Deccan Value Investors (DVI) invoked the force majeure clause on its resolution plan, citing deterioration of asset value and technical faults in a title deed for the land where the primary factory in Gurgaon is situated. This is the second time that Amtek’s sale has failed. In 2019, UK-based Liberty House didn’t follow through on its successful resolution plan, citing an immoderate difference between the book value and liquidation value of the plant.

Bansal believes that for the IBC to improve, courts must recognise that this is an “economic legislation" where financial decisions are taken by lenders. “The longer each decision takes, the more the asset deteriorates and higher the chances of pilferage. Bankruptcy courts must ensure that all insolvency petitions are admitted within 14 days of application."

The front professional

Another weak link in the IBC process is the role of the interim resolution professional (RP), who runs the asset attached to the corporate debtor during the period of resolution. The RP coordinates between the CoC, operational lenders, the promoters and prospective buyers. It’s a role that requires a battalion of support staff that an insufficient budget cannot hire, except in a few high-profile cases.

Ashish Rathi, who has served as RP and liquidator on a few IBC cases, sees any asset landing into insolvency akin to a critically-ill patient admitted to an ICU. “Their chances of survival are already low, greatly reducing the chance of revival and likelihood of liquidation. Recent statistics show that three-fourths of the companies under insolvency resolution yielding liquidation were sick/defunct to begin with," Rathi said.

When revival fails for such fundamental reasons, the law or the RP is perhaps not at fault. In many cases, a corporate debt restructuring or a one-time settlement outside IBC could probably offer a better value to lenders than the insolvency route, given of course, that the management and business model is still viable.

“RPs bear a lot of responsibility that come with many risks; they are personally liable for decisions taken in a resolution," Rathi adds. There are instances where RPs have been penalized or debarred for unethical conduct, so more are wary of taking on contentious cases now than before. So far, the registrations of about 20 RPs have been suspended or cancelled while another 20 have had to pay court-ordered penalties.

More importantly, RPs cannot manage large companies on their own—they are like CEOs who need entire teams to keep operations smooth and extract maximum value during resolution and to then pitch the asset to the right kind of buyer. Despite the work involved, there has been a drastic reduction in fees being paid to RPs. In a case like Essar Steel, the RP and his support team could have billed close to a crore of rupees a month; today, an asset of that size would only be allowed a fourth of that value.

M.S. Sahoo, chairperson of the Insolvency and Bankruptcy Board of India (IBBI), believes we need to give the code time to mature. “One needs to appreciate that India did not have any capacity to implement a market-led insolvency regime. The code and the underlying reform was a journey into unchartered territory. The law had to be laid down, infrastructure to be created, capacity to be built, professions and markets and practices had to be developed," he said.

“I am extremely happy to say that there is a sincere effort by all concerned—government and the judiciary—to address the issues and difficulties expeditiously," he added.

Sahoo points to the addition of individual insolvency, making personal guarantors of corporate debtors liable as a step forward for the IBC. Anil Ambani, for instance, is fighting claims on debt of the ADAG group that he had guaranteed. “Provisions relating to personal guarantors are facing challenges before several high courts. IBBI has sought a transfer of these petitions to the Supreme Court to arrive at finality of judicial determination at the earliest," he added.

In conclusion

Veterans of the stressed asset business in India are calling for changes to how bankruptcy is resolved, mimicking the Western model where defaulters are allowed to bring their own solutions, including a pre-pack model where promoters can negotiate with creditors and bring in outside investors. The IBBI has recommended a 90-day pre-pack resolution option for faster results in a report last month to the ministry of corporate affairs. Whatever be the fixes, time is clearly running out.