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Rescuing IBC From Insolvency
The delighted promoters of Essar Steel saw the judgement as an opportunity to retain their company from the winning bid of ArcelorMittal. Banks and other secured creditors saw it as opening a Pandora’s box
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One of the Narendra Modi government’s most important structural financial reforms, the Insolvency and Bankruptcy Code (IBC), legislated in December 2016, has been saved in the nick of time. Much more needs to be done to rescue it from drowning in a sea of judicial ennui. For the moment though, disaster has been averted.
The trigger was the controversial verdict handed down by the National Company Law Appellate Tribunal (NCLAT) on ArcelorMittal’s bid to buy Essar Steel. The order has been stayed by the Supreme Court till the next hearing on August 7. After nearly 600 days of judicial back-and-forth, the NCLAT bench had ruled that unsecured operational creditors should be compensated on par with secured financial creditors in liquidation proceedings. This is not the norm in insolvency proceedings anywhere else in the world. The delighted promoters of Essar Steel saw the judgement as an opportunity to retain their company from the winning bid of ArcelorMittal. Banks and other secured creditors saw it as opening a Pandora’s box that could vitiate the entire IBC process.
“Why would a lender,” one banker asked, “bother to take a bankrupt company to the IBC if its secured loans were treated on par with unsecured vendors and other debts? The lender would rather go for direct debt restructuring as in the bad old days or just sell the debt to an asset reconstruction company (ARC). The IBC would be dead as a legislation to reform the entire insolvency and bankruptcy ecosystem.”
Corporate lawyer Shardul Shroff minced no words on the NCLAT verdict in an interview with CNBC TV18: “The overwhelming response that we have heard at conferences in New York, Hong Kong and Singapore, is that if this principle is unravelled and if they go ahead with giving equal priority between the unsecured creditor and the secured creditor, the entire attempt of the government of India to bring in new funds from international sources will completely dry up. Even in India I think the risk factor of an unsecured loan sharing equally with a secured debt will completely unravel this pricing principle of secured debt. The fact that your secured debt has a lower pricing and an unsecured debt has a higher pricing in terms of interest will be obliterated. That is going to cause untold harm to the banking sector. It will create reluctance in banks to get into schemes or plans where they would want their right specified and a right to resile from the consent that they have given if they do not get an approval of the National Company Law Tribunal (NCLT) or NCLAT. So it introduces an additional risk factor, which is contrary to the intent of the IBC. This is backward looking. We will become an island among all countries that have bankruptcy laws and this kind of variance between Indian interpretations of the law and what is happening elsewhere will actually regress India into an untouchable state.”
The government, to its credit and to the surprise of most, moved quickly to repair the damage done by the NCLAT judgement. A relieved Shroff told CNBC TV18 just days later that he welcomed the government’s proactive decision to amend the IBC: “It is extraordinary, the speed with which the government, the ministry of corporate affairs (MCA) and the Insolvency and Bankruptcy Board of India (IBBI) have acted in restraining the widespread damage to the investment climate in India because the stressed assets would be severely disturbed if this law was to continue. No investment would have come in. This is, therefore, welcome and it will address several of the issues that are pending in the Essar Steel case where appeals have been filed.”
The Union Cabinet did indeed move quickly to negate the potentially damaging impact of the NCLAT judgement on ArcelorMittal-Essar Steel. Bankers across the board had called the judgement “shocking”. On July 17, less than two weeks after the NCLAT order, the Cabinet approved eight amendments to the IBC to not only reverse the malign implications of the NCLAT judgement but make the IBC more effective overall.
A key amendment is that in future resolution of a debtor company must be completed within 330 days, including all legal challenges. The earlier deadline was 270 days but excluded the time taken for legal challenges. In the ArcelorMittal-Essar Steel case, those challenges have stretched the resolution process to over 600 days. Now the strict, all-encompassing deadline is 330 days. Had this amendment been in place earlier, ArcelorMittal’s Rs 42,000-crore bid to buy Essar Steel would have had to be completed – by law – nine months (270 days) ago.
Another key amendment approved by the Union Cabinet, which will become part of the bankruptcy code legislation, is fixing a “hierarchy” of creditors with secured lenders receiving highest priority. Unsecured creditors and operational creditors will receive a lower level of priority. This effectively nullifies the egregious NCLAT ruling.
Problems with the IBC though will not disappear with these remedial amendments. A resolution deadline of 330 days, inclusive of all legal and judicial loopholes, is good in precept but with the best of intentions – and often with the worst – it could be difficult in practice. To live up to its promise as a panacea for India’s chronic NPA affliction, the IBC ecosystem needs to be strengthened – more NCLT and NCLAT benches, better infrastructure, advanced training for resolution professionals (RPs) who play a key role as intermediaries in the IBC process, and strict action against promoters who seek to unlawfully cling to their bankrupt companies by making benami bids.
The IBC can still be a game-changer in India’s stressed banking and financial sector if the intent displayed in this clinical remark by Injeti Srinivas, Secretary in the ministry of corporate affairs, is honoured in letter and spirit: “We have proposed an overall time limit of 330 days for bankruptcy resolution which will cover all judicial processes and litigations. If it exceeds this limit, on the 331st day the corporate debtor will automatically go into liquidation.”
This single-minded interpretation of India’s bankruptcy code is needed if the country’s banking and financial sector has to be extricated from its deep-rooted NPA quagmire.