Insolvency and Bankruptcy Code left far too much room for interpretation

Given how high the stakes are for promoters for whom their companies are their only identity and for bidders who are hoping to take a competitor out, litigation should have been expected

To understand how protracted recovering money through sale of assets has become for banks, read some of the newspaper headlines relating to the insolvency cases in the last few days: “Electrosteel: NCLT asks Tata Steel, Vedanta, IRP to file counter-plea”: Business Standard (March 9); “L&T moves NCLT to be declared secured creditor in Bhushan Steel Insolvency”: Mint (March 9); “Essar Steel: Lenders defer meet due to indecision on eligibility of bids”: Moneycontrol (March 5); “BDO takes IRPs of Bhushan Power, Jyoti Structures to court”: The Economic Times (March 4).
 
The question to then ask is, will anything get done? The answer depends on whom you speak to. The most cynical will argue that India has gone through similar moments in the past. Beginning with the Board of Industrial and Financial Restructuring (BIFR), Asset Reconstruction Companies (ARCs), Debt Recovery Tribunals (DRTs), Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR), Joint Lenders Forum (JLF), Scheme for Sustainable Structuring of Stressed Assets (S4A), all were hailed as hoovers that will cleanse the banks of bad debts. Like the others before, the insolvency code will come a cropper. An alternate – and equally cynical view is these are just teething issues. That the promoters of companies in defaultare using this to buy time, hoping that the looming electoral cycle may bring change, and the ‘system’ might turn less hostile – maybe even revert to the old way of doing things. Still others might say that this change is for real, and the issues being raised — who is eligible (Electrosteel and Essar Steel), the role of secured versus unsecured creditors (Bhushan), who is hired for the resolution — the firm or the individual (Bhushan Power and Jyoti Structures), are all relevant questions to ask, if the insolvency code is to be survive as the preferred mechanism for debt resolution in the long-term. 
 
Given how high the stakes are for ‘promoters’ for whom ‘their companies’ are their only identity and for bidders who are hoping to take a competitor out while at the same time add capacity at a compelling price, litigation should have been expected. Yet, the regulation left far too much room for interpretation. The most intractable issue remains, who is eligible to bid for these distressed companies?
 
The existing promoters cannot bid for their own companies facing bankruptcy — it risked changing the entire political discourse. But what about others? Is ArcelorMittal ineligible to bid for Essar Steel because ArcelorMittal and its promoters held shares (sold before it bid), in two defaulting companies Uttam Galva Steel and KazStroy Service of Kazakhstan, which in turn had a 100 per cent stake in KSS Petron that turned an NPA in 2015. But they are also shareholders in HPCL-Mittal Energy (Guru Gobind Singh Refinery), whose expansion will be funded by the same banks. Numetal, which has put in a competing bid, may not have defaulted, but its consortium members include VTB Bank. In 2014, the European Union Council had restricted some Russian companies, including VTB Bank, from accessing its market and the US Treasury Department prohibited US persons from dealing with VTB Bank. Should these constitute a disqualification in the Essar Steel auction? Under current regulation they don’t. And as of now one of the beneficiaries in the consortium is Rewant Ruia. He is from the promoter family of Essar Steel. Children should not be punished for the sins of their fathers — but you need to be convinced that they are not acting for their fathers.
 

Illustration by Binay Sinha

The Insolvency and Bankruptcy Code (IBC), prohibits bidding by entities if either they or their subsidiaries have been convicted having been found guilty and handed out sentencing under criminal laws for an offence punishable for more than two years. Both Tata Steel and Vedanta have been convicted in the UK and Zambia, respectively, and may be ineligible to bid. Are banks better-off if neither can bid?
 
There are other questions that are being asked as we immerse ourselves in this process. What if the second highest bidder were to top the bid by the highest bidder – as Ultratech has offered to do? Will it be considered? What if one bidder offers more to the unsecured lenders while the other to the secured lenders (secured lenders call the shots, and this is what L&T’s case boils down too). Should rejected bidders be told why their bid is being rejected and if yes, will this not become the subject matter of another dispute? The banks have a 180-plus-90-day timeframe. But will NCLT respond in a timely manner?
 
While the above are all relevant for the NCLT cases, for the myriad others there are three other issues that need immediate focus.
 
One is the capacity of the banks to handle this avalanche of cases. The three executive board members are finding themselves short of time to deal with this rush of bad debt and with running the bank – growing the balance sheet, capital to be raised, risk and control systems strengthened, technology to be selected, unions to be dealt with, parliamentary committees to be answered. New loans are the obvious casualty. And as we are seeing green shoots of growth, these need nurturing, and lending needs to be back on the agenda. Capacity needs to be created at the board level at the earliest.
 
Two, banks need to change the way they behave. They for the most see themselves as lenders and not as shareholders. Equity ownership gives them power to make change. I am not just talking about companies like Gammon India (where banks own 63 per cent) or IVRCL (55 per cent), Jaiprakash Power (49 per cent) or Monnet Ispat Energy (47 per cent), but even companies where they now have small equity holdings. They need to take their stewardship responsibilities seriously and help set the agenda – and board meetings, with other shareholders and stakeholders. They can transfer these responsibilities to their asset management arms or contract others in the market to do so.
 
And three, for cases outside the NCLT, write-offs and financial engineering is only half the battle.Banks need to look beyond numbers and take the necessary steps to strengthen the company boards and their accountability, improve internal controls, and increase overall transparency and disclosure. They need to agree on a development plan with promoters and managements, and to convert some aspects of the development plan into prerequisites of restructuring or covenants, that can then be monitored along with the financial parameters. A focus on systems, processes, and the accompanying change in the way borrowers address stakeholder rights, will be the best insurance against another episode of debt defaults.

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The author is with Institutional Investor Advisory Services (IiAS). Views are personal. Twitter handle @amittandon_in