Is IBC in ICU?

Senior judges need briefings on economy-wide consequences of their decisions

The overall Indian economic picture has been gloomy for the past several quarters. Discussions on whether the downturn in growth is cyclical or structural distracts attention from specific issues. Abstracting from wider concerns this article focusses on the need to raise long-term lending from current levels to get economic growth back on track. Public sector banks (PSBs) continue to be hesitant about providing project funding or even extending short-term credit to non-banking financial companies (NBFCs).  

The Reserve Bank of India’s (RBI’s) “Report on Trend & Progress of Banking in India 2018-19” dated December 24, 2019 mentions that “although the time limit for resolution under the Insolvency and Bankruptcy Code (IBC) has been recently extended to 330 days, some cases are delayed beyond the limit partly reflecting repeated litigations”. According to the same RBI report “faster resolution of stressed assets remains key to the revival of the banking system” and credit growth for PSBs has been “well below that for private banks in the last few years”. Further, according to this RBI report, the gross stock of non-performing assets for PSBs, as of end September 2019, was about 12 per cent of total advances. This number needs to be well below 10 per cent for PSBs to raise long-term lending levels. For better oversight India should have just two well capitalised PSBs. However, that discussion can be left for another day. 

The central government has made reassuring noises that the IBC is working well. However, the current cautious posture of PSBs indicates that there are continuing concerns about credit risk and ex-post indictment of bank managers by government’s investigative agencies. In most cases of financial sector fraud it is difficult to prove guilt. Consequently, as investigations about criminality continue, the practical course of action is for assets to be retained as going concerns to not only keep employees on the rolls but also to attract alternative investors. 

Several promoters after overstating their borrowing needs, complicate resolution processes through never-ending legal challenges. They object to appointments of resolution professionals (RPs) on grounds of insufficient qualifications or bias and seek to create differences among members of the committees of creditors (CoCs). If these stratagems fail, sponsor-borrowers file for relief with the National Company Law Appellate Tribunal (NCLAT) and finally the Supreme Court. 

The Essar Steel debt default case should be taught at Indian law and business schools. In this instance creditors accepted the Arcelor-Mittal bid of about Rs 42,000 crore for Essar Steel and the National Company Law Tribunal (NCLT) approved this change in ownership in March 2019. Essar appealed against the NCLT decision that 90 per cent out of Arcelor’s offer would go to financial creditors with the NCLAT. The NCLAT ruled that secured financial creditors should be treated on a par with operational creditors thus restricting what was to be repaid to financial creditors to 65 per cent of the Rs 42,000 crore. In a significant November 14 judgment, the Supreme Court reversed the NCLAT ruling and stipulated that lenders can decide on the distribution of assets in insolvency cases. This Supreme Court decision has finally cleared the way for Arcelor-Mittal to acquire Essar Steel and rescued the IBC from “Intensive Care”. 

Each case of default is different in terms of the complexities involved. Erstwhile promoters try to complicate matters to prevent sale of their assets to anyone other than themselves at discounted prices and free of debt. The NCLAT judgment in the Essar Steel case indicates that former owners have the stamina and the resources to keep fighting to retain their assets. India’s justice system seems to favour promoter-borrowers on the grounds that businesses should remain functional to protect workers. In principle there can be no quarrel with this objective. However, such an understanding should not be applied inflexibly as there are more sustainable and less costly ways to help shop-floor workers. 

The IBC is no longer in intensive care but it is still in hospital and needs close attention to return to robust health. This involves reducing interminable delays in CoCs coming up with an agreed framework for accepting write-downs on loans and the squabbling about the credentials of RPs. An examination of other cases, for example, Bhushan Power & Steel indicates that delays also arise because of perceived conflicts between IBC and earlier legislation, e.g. sequestering of assets pending investigations into wrongdoing under the Prevention of Money Laundering Act of 2002. As of December 2019, a total of about 1,500 IBC related cases are pending with CoCs, RPs and courts. 

Government’s response to judicial differences in interpretation of the IBC and perceived inconsistencies with other legislation has been to amend the IBC repeatedly. There is no way that all ambiguities in valuations and who gets what proportion of final sale prices can be resolved by continuously amending the IBC. The Supreme Court, NCLT and NCLAT judges would benefit from in-depth briefings from subject specialists about the nature and consequences of specific insolvencies. Experienced Justices may bristle at the thought that they need to take time to better understand the economy wide fallout of large insolvencies and the ways in which promoters and other interested parties try to game the system. Given the objective, which is the larger public good, the Supreme Court should consider mandating such briefings prior to judgments being passed. 

To summarise, it is more than abundantly clear from recurrent cases of bankruptcies due to misjudgements and outright fraud that financial intermediation in India needs to be regulated better and instances of insolvencies resolved faster. The RBI should prod banks and NBFCs to act with greater probity and urgency. The Supreme Court on its part should reinstate the February 12, 2018, RBI circular which decreed shorter deadlines for creditors to take instances of default to NCLTs. As is the case for liberty, the price for prudent banking is eternal vigilance combined with a better understanding of the financial and economic issues involved.   

The writer is a former ambassador and World Bank treasury professional;  j.bhagwati@gmail.com