The Union cabinet’s approval of amendments to the Insolvency and Bankruptcy Code (IBC) to enhance its efficacy could bring relief to banks, foreign investors and others worried about the impact that quasi-judicial interpretations of the code’s grey areas might have on the country’s credit systems. Among the expected tweaks is a clarification on the hierarchy of creditors to be repaid once the insolvency of a company gone bust is resolved. Lenders had found their mood darkenin response to a recent National Company Law Appellate Tribunal (NCLAT) ruling in the bankruptcy case of Essar Steel. The tribunal, while approving ArcelorMittal’s bid to take over the company for ₹42,000 crore, had ordered that all its creditors be returned 60.7% of their respective outstanding claims, irrespective of whether the money they were owed was “secured" or not. That all creditors be treated on par for debt recovery might appear fair at first glance, but if such an “equal haircut" principle were to set a precedent for future cases, it would distort a credit market that operates on the logic of loan deals that vary both by interest charges levied and the contractual consequences of a default.
The rights of secured creditors are always held superior to those of unsecured ones. This is because they lend at lower rates in return for a claim on the debtor’s assets as collateral. So, in Essar Steel’s case, the state lenders left unpaid had the first right among creditors to the rescue funds offered by its buyer. Other non-employees owed money, such as operational creditors, had to come next in line. That’s how the repayment order is stacked globally. Denying banks this right could make them less willing to lend money at low interest rates. If they aren’t going to get any repayment priority, then they might as well charge more for the extra risk they bear. This could doom the very concept of collateral, and end up pushing up the borrowing costs of companies in general. Also, since the tribunal’s order was for an insolvency resolution, banks may resist pursuing debt recovery under the IBC, preferring to explore other options before pushing that button. This would work against the basic idea of the code as a reform, which was to ensure that a failed business does not stay stuck for years, and its assets and usable resources are swiftly redeployed.
Foreign investors in India’s still-nascent market for impaired debt had also been stunned by the tribunal’s order. A purchaser of stressed loans would pick up these assets at bargain prices only if they bear all the usual rights that ought to come with it. But if their repayment priority is withdrawn, then the risk-return ratio would weaken significantly, leaving such debt unattractive. For India, which is trying to deepen its debt markets and find buyers for stressed assets, a fundamental shift in the contours of a collateral-backed loan would be bad news. So it’s not just lenders, but everyone concerned about credit flows who would be relieved if the government acts to protect the commercial terms on which loans are usually advanced. Treating all creditors equitably does not mean that all variations in debtor obligations are overlooked. Creditors in the same category should have equal rights, while those in varied categories should have rights commensurate to the risk they take. We need respect for legitimate deals that are struck between borrowers and lenders.