Fixing the bankruptcy code

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Five years later the Indian Insolvency and Bankruptcy Code (“IBC”) became ineffective. After close to a decade worth of deliberations, the IBC became effective in 2016. It was supposed to address the country’s slow bankruptcy process resolutions, low recovery percents, and slow bankruptcy resolution. The NCLT, National Company Law Tribunal, observed the shortcomings in June 2016. Anil Aggarwal an industrialist approved Videocon Industries’ sale. But, the NCLT noticed that Twin Star wasn’t paying much’ and that the 99.28% “haircut” that operational creditors were being forced to pay was closer to a complete haircut than a shave. The NCLT noticed that, out of Rs 64-838 crore in claims, only Rs 2962 was paid. That is a mere 4.5%. Many operational creditors which include many MSMEs (micro and small enterprises), won’t get 0.72 percentage of what they claimed.

IBC replaced several recovery/resolution acts that were in place prior to 2016. It had two main objectives. The first was to speed up bankruptcy proceedings so that banks can clear their balances and get new credit. The second was for legal loopholes to be closed by owners of failing corporations to wipe away their debt while still having control over the company.  Visit https://bankruptcyhq.com/ for more details about bankruptcy

One of its most striking features was the speed at which cases were resolved. IBC cases were closed within 180 days. The number of cases was then revised to 330 in June 2019. A second purpose was to increase creditor recovery percentages to minimize any losses in bankruptcy cases. Ironic, given the NCLT’s observation about the sale Videocon Industries. This is especially pertinent for financial creditors, who might experience reduced lending capacity as a result. The Bankruptcy Law Reforms Committee (which wrote IBC) observed in 2015 that creditors who realize they have weak rights, and a low rate of collection, are reluctant to lend. India’s lending to India is concentrated within a small number of large companies with low failure rate. According to data from India’s Insolvency and Bankruptcy Board, resolution proceedings took six-years on average before IBC. There was a recovery ratio of about 22 percent. The government claims that this rate has been increased to approximately 43% by the IBC. Jayant Singhha, a former minister to finance, was the chairperson of a parliamentary panel which submitted its August Report to Parliament. The panel pointed out that IBC is failing to meet its goal to substantially improve recovery rates. Some lenders have had the need to take 95% haircuts.

The Assets

Although the IBC did fall short of its expectations, this led to a greater number of cases being in close proximity, which established a clear framework that creditors could use to commence legal proceedings against NCLT. Arvind Pandagariya, ex-vicechairperson of NitiAayog Professor of Economics at Columbia University, is one major proponent and supporter of IBC.

Jet Airways was an outstanding success story. Due to its large debt pile, the airline went bankrupt on April 19, 2019. In June 2018, the NCLT accepted a resolution proposal by Kalrock Capital UK, Murari Lal jalan, an UAE-based businessman, to restart the airline. It proposed that the consortium pay Rs 1.200 crore to creditors over five-years as part of its offer. The consortium will be the owner of 89.8%. Banks will get 9.5% and employees, 0.5%. The public shareholding in the company will decrease to 0.2%. Negotiations are in progress between Canada’s Government and the consortium to restore the airline’s airport slots as also air traffic rights that were originally allocated to other airlines after its collapse. Panagariya stated that Jet Airways was a shining example of IBC success. “Without the IBC, airline assets could have died. The IBC has tightened their grip on promoters. A sound system should allow creditors to access legal counsel in the case that borrowers don’t pay their obligations. Jet Airways cabin crew members and ground staff asked for an appellate tribunal to halt the resolution plan. The appeal was brought up because of concerns regarding the pending salaries, retirement benefits and other issues.

“The IBC’s success with Jet Airways is an outstanding example. All the airline’s assets wouldn’t have survived without it.

– Arvind Panagariya (ex-vice-chairperson, NITI Aayog)

Essar represented the largest IBC recovery. The firm was owed money by the State Bank of India. They recovered close to 92 percent from the claims of Rs49,000 Crore in December 2019. ArcelorMittal acquired the firm following a consortium of ArcelorMittal Luxembourg, Sumitomo Metal Corporation of Japan, and Sumitomo Metal Corporation of Japan. Alvarez & Marsal resigned to run the company for nine months. Although not the most financially competitive bid, it had the greatest experience in restructuring. Alvarez & Marsal orchestrated a turnaround for Essar Steel’s production that led to the ArcelorMittal/NSSMC Consortium increasing its bid to Rs 42,000 crore from Rs 29,000.

The Liabilities

However, IBC’s successes were marred by delayed case closures, low recovery levels, and banks being forced accept large haircuts on their claims.

Alvarez & Marsal India found an average recovery rate of 43-50% for FY 2017 & 2018, with timelines that extend well beyond this time limit. The NCLT resolved 277 cases in September 2020. This includes litigation. In FY 2020, around 480 cases were added each quarter. According to the report this could mean that it could take six more years to get rid of the backlog. REDD Intelligence showed that 48% (of the 4,300+ IBC borrowers) were liquidated. Half of the rest were liquidated under 314 days. REDD Intelligence says that only half of those who were sold had their bankruptcy proceedings finished in under 425 days. These aren’t terrible results. With the exceptions of very rare cases, creditors have had poor recovery rates. Macquarie (an investment banker/financial management firm) states that overall recovery rates for creditors are just 24%. This is in direct contradiction to what the government claims.

Panagariya defended IBC by arguing the poor lending decisions made in the banks are one cause of the huge haircuts banks must take. Panagariya argues that although losses in bankruptcy proceedings might not necessarily be attributed to the IBC, this is proof that reforming government sector banks, including privatization, will prove crucial.

However, the IBC has been criticized because it failed to achieve its core purpose. Its primary function is to speed insolvency proceedings up and increase recovery percentages. Essar Steel cases are a rare exception. According to Alvarez & Marsal reports, 52% were concluded from the 4,008 NCLT filings up to September 2020. The process has been slowed by numerous litigations. Also, delays caused in part by NCLT administrative delays. Finally, inconsistent judgments have cast doubt upon the final results.

Ruchi Soya Industries received bad press for its resolution. Ruchi Soya Industries owed Rs.9 345 crore, to a group which was led by SBI. This resolution approved Patanjali Soya Industries owned by Baba Ramdev to buy Ruchi Soya for an approximate 5% haircut and Rs 4,350crore. Adani Wilmar who had pulled out during the bidding process due delays in resolutions, and a deterioration to assets, declared that Patanjali would win. Patanjali borrowed nearly Rs 3200 crore to finance the deal from the SBI consortium of banks. RuchiSoya was owed nearly Rs 1,800crore.

Siva Industries and Holdings are another example. The lenders’ group reached an agreement to receive Rs 323 Million from R.C.K. As a once-off settlement, the lenders’ committee had reached an agreement to accept Rs 323 million from R.C.K. C. Sivasankaran Vallal – father of promoter – was able restructure his debts at Rs 4863 crore. Also, the NCLT was willing he to withdraw the bankruptcy suit against him. Recently, the NCLT Chennai bench rejected settlement. It stated that it was not consistent with the IBC. The tribunal ordered that the company be liquidated. After IDBI Bank Ltd filed action, NCLT admitted proceedings against this firm in 2019.

Endless Delays

Alvarez & Marsal’s report found that the NCLT courts of Delhi & Mumbai, which handle the largest number of insolvency matters, had an average resolution time 475 days compared against the national standard at 440 days. The average turnaround time between the Bengaluru bench and Kolkata bench was 339 days, 352 day, and respectively. Cuttack benches have one of the worst records at 613 days. Jaipur benches’ record is the best, with an average of 288 consecutive days.

Legal appeals could cause delays. When appeals reach beyond NCLT to National Company Law Appellate Tribunal (NCLAT), or the Supreme Court it is common for resolution times to increase. 23 cases worth more than Rs. 1,000,000 crore were settled in an average of 751 days. As of September 2020, recovery percentages were at a sharp decline, with 15-25% of cases resolving in a median of 751 days. This is compared to an average of 40%. This delayed recovery resulted in lower revenues at the affected companies. Alvarez & Marsal reports on revenues for four of the companies in this sample: Alok Industries. Ruchi Soya. Ruchi Pharma. Uttam value steel.–64%, 16%, 17% and 23 percent, respectively. Bhushan Steel (Electrosteel Steels), Monnet Ispat and Monnet Steel saw their revenue increase by 22%-55% or 35%, respectively. This was due primarily to the increase in steel price.

‘NCLT benches lack sufficient staffing, so many members who are retired now can apply for extensions.

– Ranjana Roy Gawai, Managing Partner, RRG & Associates

Ranjana is a corporate and bankruptcy lawyer. She states that the NCLT tribunal judges and magistrates are severely understaffed. There are around 13 NCLT bench in India with a total 26. This compares to a targeted of 63. “Numerous members who had just retired were eligible for extensions. However, extensions were not granted on schedule. Everyone retired.” she says. “The backlog was worsened by the pandemic,” she says. Although amendments have been made to declog NCLT (including decriminalizing some offences under Companies Act; and increasing financial authority of regional directors to Rs 5. lakh to R 25. lakh to ensure that fewer cases reach NCLT), the impact of these changes is yet to be determined.

The topic of staff shortages was brought up before a parliamentary panel. The panel observed that the NCLT benches (and NCLAT), are “seriously over-staffed” with “under-funded”, which leads to an inordinate number of important cases. Rajiv Mantri -Managingdirector of Navam Capital (New Delhi-based thinktank) emphasizes that judges presiding on insolvency matters must have both economic as well as financial knowledge. NCLT courts frequently appoint judges drawn from other courts. “Judges must be trained in economics. He stated that “specialist knowledge is required to evaluate these types case.” Abhinav Molkerji, a Supreme Court Lawyer, is also an Additional Advocategeneral of Himachal Pradesh.

The IBC makes a solid start, establishing a clear process as well as giving creditors more rights. It must have a more efficient resolution process and recovery mechanism. However, the political leaders need to show more commitment to filling vacant positions and initiating reforms in the public sector bank system. They must bring about uniformity as well as fast resolutions. It must preserve the spirit of entrepreneurship. Without this, it is just another mirror for the previous laws, all their faults.

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