It’s been over three years since the Modi government instituted the Insolvency and Bankruptcy Code, to deal with stubborn defaulters.
Despite its disciplining powers, the Code, however, does have some areas of improvement.
With the judiciary, RBI, banks and the government now working in tandem, the winner clearly is propriety.
What Has IBC Achieved So Far?
It’s little over three years since the Insolvency and Bankruptcy (IBC) Code has come into being. The IBC was preceded and followed by the host of regulatory measures by the Modi government such as enablers for banks to offload stressed assets and increased provisioning for banks’ investments in security receipts (SRs) among others.
IBC was positioned as a remedial measure to the then prevailing crony capitalism practices in the Indian banking and governance systems, and to address the deep rooted malaise in the Indian banking sector by extricating about Rs 10 lakh crore worth debt stuck in industries such as steel, cement, infrastructure financing, housing et cetera. Given this, the IBC was thought of as the most well-intentioned, as also an ambitious piece of economic legislation in the country.
An IBC performance review points to the fact that this piece of legislation has so far fared better than all previous attempts at resolution of Non-Performing Assets (NPAs) at the pre-admission, and admission stages.
IBC is forcing behavioural changes in the borrowers by way of instilling financial discipline and also much- needed accountability, primarily driven by fear of losing control of companies, leading to the resolution of higher number of cases at the pre-admission stage.
As per the Insolvency and Bankruptcy Board of India (IBBI), since the inception of this code, around 4,400-odd cases have been disposed of at the pre-admission stage and the amount apparently settled was a little over 2 lakh crores.
As per data available with the Reserve Bank of India (RBI) and IBBI, the average recovery rate for 90-odd cases resolved in IBC till March 2019 was 43 per cent higher than all the previous mechanisms  such as Debt Recovery Tribunal (DRT), Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFEASI) and Lok Adalat.
As per recent reports in the media, the total bad loan recoveries in FY 2018-19 was pegged at ₹70,000 crore.
In a nutshell, three years down the line, IBC has achieved stupendous success on many counts. However, there have been glaring misses too. All said, the proof of the pudding is in the eating and hence, to test the efficacy of this piece of legislation, the best way would be to analyse a few cases that went through the IBC process over the past three years and see what worked and what didn’t.
Let’s begin by looking at some of the challenges with the current IBC framework. The primary challenge with IBC that threatens to undermine its core objectives pertains to cases overshooting resolution timeframes by a big margin, as witnessed in the case of Bhushan Steel and Essar Steel.
The average resolution time for 94 resolved cases under IBC was 324 days, which is better than all the previous mechanisms, but certainly falls short on the stipulated IBC insolvency resolution target of 270 days.
Equally worrisome is the fact that of the total 1,100-odd cases outstanding with IBC as of March 2019, around 32 per cent are pending for more than 270 days. Other shortcomings which came to the fore were:
1. The lack of a group insolvency process in light of the Videocon and IL&FS cases.
2. Haziness/regulatory gap so far as delisting norms and rights of equity shareholders in the IBC process was concerned as was evident from the Vedanta-Electrosteel case.
3. The extent of funds to be paid out to operational creditors as part of the resolution plan becoming as in the case of Essar, Binani Cement (As many as 70 operational creditors of Binani Cement had also formed a forum to claim their dues.
4. Infrastructural bottlenecks leading to resolutions taking more than the stipulated time period of 270 days.
The RBI, in its June 2019 advisory, has tried to address some of the other challenges such as a pre-IBC consensual regulation framework for business owner, banker and new investor(s) sitting together.
Another lacuna in the existing framework, which could drastically cut down the number of cases getting enlisted with an already over-burdened National Company Law Tribunal (NCLT), pertains to the development of a robust bankruptcy procedure, where a restructure plan is agreed upon in advance (also known as pre-pack insolvency) of a company declaring insolvency.
However, there is a counter view prevailing among experts that such a mechanism should be considered only in a mature legal environment where there is a sound code of conduct applicable to Insolvency Resolution Professionals (IRPs).
Challenges Uncovered In 3 years of IBC
Let’s begin by taking a closer look at the Essar Steel insolvency saga. The steel manufacturer’s was among the first 12 cases selected by the Reserve Bank of India (RBI) to be resolved under the IBC. This case lingered on for more than 500 days (vis-à-vis stipulated 270 days as per IBC) due to a variety of reasons.
Another disadvantage was that, being amongst the initial few cases to go through the newly crafted IBC law, everything could be challenged by the borrowers and lenders, which actually took place. For example, immediately after insolvency proceedings were initiated against them, Essar (ESIL) moved the Gujarat High Court against the proceedings initiated by its lenders led by the State Bank of India. The case was disposed of by the High Court.
A few months later, the Resolution Professional (RP) held Numetal and ArcelorMittal bids ineligible. The companies challenged the rejection in the NCLT. Subsequently, an intense legal battle followed. In October 2018, Essar Steel Asia Holdings (ESAHL), fearing loss of control over the firm, offered a settlement proposal wherein it would repay the entire debt of Rs 54,389 crore.
If this wasn’t enough, Operational Creditors (OCs) filed petitions challenging ArcelorMittal’s plan. Standard Chartered filed a separate petition against ArcelorMittal's plan.
NCLT approved ArcelorMittal’s Rs 42,000 crore bid for Essar Steel in March 2019. Subsequently, an Essar Steel’s majority shareholder moved NCLT seeking rejection of ArcelorMittal’s Rs 42,000 crore bid of the bankrupt company, alleging that its promoter Lakshmi Mittal hid his association with loan defaulting firms run by his brothers, which made his firm ineligible to participate in insolvency proceedings.
The case got dragged into the Supreme Court of India due to allegations and counter allegations between two bidders on their validity and eligibility.
The blessing in disguise in the Essar case, although delayed much beyond the stipulated 270 days, has been that the questions raised by the defaulters around locus standi of the National Company Law Tribunal (NCLT), the validity of IBC as a law and to some extent the eligibility (who should be allowed as bidders) have largely been put to rest. This should certainly help expedite other resolutions under the IBC.
The government and the legislature have been proactive in their approach to clarify further on the practical workings of the IBC. Special amendments like Section 29-A (which disqualifies the defaulter from bidding for its asset at a discounted price) was brought in because of issues relating to the Essar steel case. The Supreme Court, in its judgment, not only interpreted but also laid down the law with respect to Section 29-A of the Code. IBC as a whole taught the promoter-shareholders to be mindful of the debt that saddles their companies.
Defaulting promoters run the risk of losing control of their assets. The promoter family of Essar Steel tried in more ways than one to regain control of their firm, but they did not succeed. This alone shall be a lesson for promoters to ensure that debts don’t accumulate and are serviced on time.
Bhushan Power and Steel, which is also a part of RBI’s list of 12 biggest defaulters, has been before the tribunal for 520 days. In this case, JSW was allowed to make a second bid, which was accepted. Tata Steel argued that JSW shouldn’t have been allowed to offer a second, completely revised bid.
This decision by the National Company Law Appellate Tribunal (NCLAT), although favouring the rights of creditors to negotiate better terms with the resolution applicants, in fact, contributed to the delay in the entire process much beyond the stipulated resolution timeframe of 270 days.
Videocon (as also the IL&FS) case has highlighted another gap in the existing IBC framework. The current legal framework does not facilitate insolvency resolution and liquidation of corporate debtors across a group. The idea behind ‘group insolvency’ is to have a framework that allows multiple entities of a group facing insolvency to be clubbed at a single court for resolution.
The two main group companies of Videocon, Videocon Industries Ltd (VIL) and Videocon Telecommunication Ltd (VTL), owe approximately Rs 59,000 crore and Rs 27,000 crore respectively, which is a staggering Rs. 86,000 crore to Indian banks, led by SBI.
If operational creditor dues are added, it totals to over Rs. 90,000 crore. Similarly, Infrastructure Leasing & Financial Services Ltd. (IL&FS) has over 169 group companies. The important point to note is, six of these contribute over 60 per cent of the consolidated assets of the company.
If these subsidiaries are dealt with in an independent manner and the lenders do not have much recourse to these assets, they don’t stand to recover much from the parent organisation. The NCLT order in the IL&FS case noted that unfortunately, the IBC doesn’t provide for a joint resolution of group companies.
This is necessary, the tribunal said, because the resolution of the parent and group companies as a whole is inextricably linked to the resolution of each of these companies.
The case of Electrosteel has brought out another regulatory gap in delisting and minority shareholder rights. Vedanta, which is a successful bidder in Electrosteel, has brought in a fresh equity of Rs 1,800 crore, thus giving it 90 per cent stake in Electrosteel. This also meant that the existing equity got reduced to 10 per cent. The existing stakeholders in Electrosteel got reduced to minority shareholders in the new set up.
A framework is needed to decide whether there should be an exit formulation for equity stakeholders, what the terms and conditions surrounding it should be, how to deal with delisting (there is no delisting norm today, and that’s a regulatory gap), how to maintain minimum public shareholding et cetera.
Equity as a legal instrument continues to remain valid and, therefore, it does need a framework on how the insolvency process will deal with it. Currently, this is required to be dealt through the comprehensiveness of the resolution plan — there could be at least three situations here:
1. Existing equity is wiped off the acquirer.
2. Existing equity diluted (Vedanta-electrosteel case).
3. Existing equity preserved.
The next shortcoming of IBC as highlighted in the Binani case is that more often than not, Operational Creditors (OCs) with lower value claims are left in the lurch with their claims either getting rejected or not satisfied, while financial creditors (who undoubtedly have higher value claims and naturally a higher stake in the process) get both a seat at the decision making COC table as well as a pay-out (sometimes with a haircut, of course).
However, OCs are quite often individuals and small businesses, to whom the value of the debt is much more; and accordingly, the rejection of the claim would have a much more impact on their balance sheets.
Maybe, the legislature could consider providing benefits to registered Medium, Small and Micro Enterprises (MSMEs) and start-ups in terms of liquidation preference waterfall. Given this, the government needs to take further steps to empower OCs with voting powers on the resolution plan.
Way Forward For IBC
In spite of its intense judicial scrutiny in the last three years, leading to constant evolution of the IBC, it is still a work in progress. To its credit, the government has been very proactive in ensuring that feedback is constantly evaluated and implemented, as reflected in some of the recent amendments such as:
1. Homebuyers being treated at par with financial creditors (they can also take builders to the bankruptcy court),
2. Lenders being able to decide turnaround or liquidation by 66 per cent vote, down from 75 per cent, widening the pool for bidders by redefining entities disqualified from bidding for bankrupt firms,
3. Facilitating exit opportunities to corporate debtors for better settlement outside IBC by allowing withdrawal of application admitted under IBC by approval of 90 per cent lenders among other things.
The RBI’s June 2019 circular underlining its intent to work in tandem with the judiciary and banks to address the issues around stressed assets is a welcome step. In the coming days, one could hope to see further evolution of the IBC in the light of the above observations.