The ordinance effectively reduces the number of potential bidders for any company put through the resolution process, and the fact that promoters can’t bid also means that bids could get lower than necessary.
And bankers are not amused.
The changes to the Insolvency and Bankruptcy Code (IBC), inserted by the ordinance signed by President Ram Nath Kovind into law on 23 November, are interesting for two reasons. One, it is obvious that the need for change was driven by largely political considerations. The National Democratic Alliance (NDA) government does not want to be seen as backing the return of old promoters who defaulted on large loans to banks. Two, the ordinance inserts an eligibility criterion for bidders in the resolution process at the National Company Law Tribunal, which will effectively reduce the number of bidders, and lenders may finally get a lower price after the process is over.
A new section 29A makes some persons ineligible to bid for the assets put up for auction during the resolution process. The exclusions include “wilful defaulters; those who have their accounts classified as non-performing assets (NPAs) for one year or more and are unable to settle their overdue amounts, including interest thereon and charges relating to the account before submission of the Resolution Plan; those who have executed an enforceable guarantee in favour of a creditor, in respect of a corporate debtor undergoing a corporate insolvency resolution process or liquidation process under the code; and ‘connected persons’ to the above, such as those who are promoters or in management of control of the Resolution Applicant, or will be promoters or in management of control of the corporate debtor during the implementation of the Resolution Plan, the holding company, subsidiary company, associate company or related party of the above referred persons.”
That’s a whole lot of exclusions. Says the press note issued after the ordinance became law: “The ordinance aims at putting in place safeguards to prevent unscrupulous, undesirable persons from misusing or vitiating the provisions of the code.”
The old promoters can bid, but only if they restore their status on old loans to standard – that is, they become a “performing asset” in banks’ books. But this hardly seems likely, since promoters would then have to pay crores to restore their loans to standard status, and then bid again for the assets.
The ordinance effectively reduces the number of potential bidders for any company put through the resolution process, and the fact that promoters can’t bid also means that bids could get lower than necessary. Bankers are not amused, and State Bank of India chairman Rajnish Kumar put it best, when he said: “We don’t mind haircuts, but we don’t want to go bald.”
However, it is pertinent to understand the political impulse behind putting in this rider to the insolvency resolution process. In August this year, the NCLT allowed Synergies Castings to acquire Synergies-Dooray Automotive for Rs 54 crore after owing banks upto Rs 900 crore. This money is to be paid over five years, with Rs 20 crore coming upfront. The decision sent shockwaves in Delhi for a simple reason. If promoters who defaulted end up re-acquiring their assets for a pittance, it essentially sends out the message that you can run a company to the ground, default on loans and still buy it back for a fraction of the loan outstandings during insolvency proceedings. Politicians would have to go red in the face explaining how a defaulting company is back in the old hands.
It is never a good idea to change the law after seeing one such case that made you go red in the face. One should look deeper and check if more such cases will happen.
One reason loan resolutions are happening at a fraction of loan outstandings is the time element in resolution: bad loans tend to bloat out of shape due to the slow pace of resolution. If a loan recovery takes 15 years to end, the overdues would have multiplied several-fold only due to accruing interest. Thus, loans of a few hundred crores end up bloating to several times that size due to the sheer accumulation of interest dues and interest on interest dues. Put another way, the large gap between loans due and what is finally paid for resolving insolvencies is partly illusory, and not the real value of the loan being written off. It also means that as resolution processes get faster under the new Insolvency and Bankruptcy Code (IBC), the actual amount of default will be lower, and the gap between loan outstanding and final resolution amount lower. Since the whole purpose of the IBC is to speed up resolution and recover some of the trapped money, increasing the speed of resolution will itself make things better.
The problem for bankers is that without the promoters participating in the process, bids for assets may be even lower than expected, since the new bidders may well choose to pay even less.
One need not dismiss the political fears about handing back companies to their old promoters, but clearly there must be a differentiation between wilful defaulters – those who could have paid but didn’t – and those who merely made the wrong business bets, took on excess loans, and/or were victims of changed operating conditions due to global or local factors. None of the 12 big default cases referred to the NCLT at the instance of the Reserve Bank of India earlier this year, and who account for a fourth or the bad loans of the banking system, most of them steel companies, has been declared a wilful defaulter. It does not make sense to punish both promoters and bankers merely because seeing the old promoters back at the helm sends a bad signal politically.
A way out could be to allow non-wilful defaulters to bid, and if theirs happen to be higher than the rest, they can be mandated to pay, say, 10 per cent more to regain control of their former assets. Another option could be to give lenders the power to decline permission to specific promoters to bid, if they are not worthy of running the company anymore, but this would be a subjective assessment, and allegations of banks being partial will surely surface at some time. A third alternative would be to ask the losing bidders to match the winning bids of the old promoter, and let the bidding process continue for some more time. This could improve realisations for banks. Yet another deterrent to old promoters coming back could be a requirement that they pay the entire price upfront, and not over several years, as was the case with Synergies Castings, which got its company back for Rs 54 crore, and a five-year period in which to pay the amount.
The political impact of any decision is not unimportant, but there is no reason why the interests of lenders should be compromised due to this.