On 4th July, instead of a celebratory statement at successfully navigating the penultimate hurdle in its bid to acquire Essar Steel, Arcelor Mittal issued a cryptic one-line press release: “We note today’s ruling by the NCLAT (National Company Law Appellate Tribunal). We need to review the full written order to understand any implications on completion of the transaction.”
The ruling is not shattering for Arcelor Mittal. Having run the gauntlet of innumerable legal challenges by the Ruia group, it is clearly prepared for the issue to go up to the Supreme Court (SC) for a final verdict.
However bankers, who have been waiting for over 530 days and counting, are preparing to challenge the order in SC.
The reason? The NCLAT order has puts secured and unsecured creditors almost on par. It suggests that lenders of secured loans do not have drastically superior rights to the money from the resolution process; they will have to share it more equitably with operational creditors as well.
Bankers argue that the judgement is disastrous because it calls into question how credit markets work and how risk is priced.
There is, indeed, great merit in this view and I started out agreeing with it. However, applying it rigidly, without taking into account the peculiarities of the Indian situation, would also be grossly unfair to operational creditors.
The story would have been different if banks had been prudent about their lending practices, not turned a blind eye to rampant diversion of funds, giving in to ‘phone’ calls from Delhi to allow repeated debt restructuring (with no claw back), massive write-offs, permit interest outstanding to pile up and, right at the beginning, turn a Nelsons’ eye to a massive padding of project costs.
One banker told us how a Rs800-crore project had been inflated to Rs1,300 crore and then to Rs2,000 crore in a group company by one of those involved in this very litigation. Banks, usually public sector banks (PSBs), have been complicit in this mischief.
We have also seen how PSBs lent over Rs15,000 crore to Prashant and Ravi Ruia in Essar Investments against personal guarantees that are not backed by any significant security.
Should operational creditors, who play a critical role in keeping the businesses running, pay a bigger price when the corrupt nexus between bankers-business-politicians goes unpunished?
Justice SJ Mukhopadhyaya’s order on 4th July has refused to allow the committee of creditors (COC), comprising bankers and asset reconstruction companies, to corner almost the entire Rs42,000 crore offered by Arcelor Mittal. The order disposed a large number of petitions, including those of a wide spectrum of operational creditors, whose continued association with the company after the resolution process began has kept Essar Steel going.
The NCLAT order, in deciding to safeguard the rights of the operational creditors (including workmen, employees, and the large number of trade- and services-related creditors) notes that they are larger in number than financial creditors and are not fully listed. It asks the COC to take help from a professional and ensure distribution based on the percentage decided by the bench. This has been provided in a tabulated form.
There was another issue which is, in fact, to the credit of operational creditors who kept the company going and even earned a profit. Financial creditors had argued that the reason why ‘operational creditors’ were not assigned any claim in the resolution process was because they had done “business worth Rs55,000 crore during the pendency of the resolution.”
There was also a discussion on how the profit earned during the pendency of resolution should be distributed; both financial creditors as well as the bidder, ArcelorMittal had laid a claim to it.
The NCLAT order asks the RP (resolution professional) to file an affidavit providing details of this profit and distribute it among all financial and operational creditors on a pro rata basis.
There is, however, one legitimate issue that needs to be clearly resolved. A person familiar with the resolution says, “the order has left open a path for those trade creditors, not settled by this order, to renew their claims after the deal closes and Arcelor Mittal takes over Essar Steel. That would pose a huge problem, because the aggregate number of trade creditors, by value, is large. If the order does not provide for a clean break and clear acquisition, Arcelor Mittal could end up paying a higher cost and remain engaged in endless and expensive litigation.”
That would cast a huge shadow on the entire IBC (Insolvency and Bankruptcy Code) process for larger companies, especially at a time when the long delay and never-ending litigation in Essar Steel is a matter of great embarrassment for the government which had promised swift resolution.
While we wait for the Supreme Court to clarify issues raised by the NCLAT order, it is important to note that the IBC has evolved and been amended fairly quickly to plug loopholes and provide clarity on issues while taking into account the Indian reality.
In November 2017, after the very first and flawed resolution of Synergies Dooray Automotive Ltd, Debashis Basu wrote in the Business Standard, “One of the many flaws of the badly drafted IBC and the whole new bankruptcy architecture is that it did not take into account the very Indian possibility that promoters (and others) will try to game the system in many obvious ways.”
IBC was amended twice since then. In 2018, it was amended to safeguard home-owners, who were left in a lurch by large realty companies, although they were making regular payments and held a signed agreement promising ownership to specific properties. The legislature, as well as the SC, backed them, despite vociferous protests and lobbying by lenders and builders who had argued that it would irrevocably damage the bankruptcy process. This issue is still open. Real estate companies have filed over 140 petitions challenging constitutional validity of this amendment.
Another amendment to Section 2 made the IBC applicable to personal guarantors of corporate debtors and proprietorship firms and Section 29 A was also inserted to prevent defaulters from bidding for their own assets.
In recent months, NCLAT and SC have both provided the much needed clarity with regard to statutory dues claimed by revenue agencies. In the past, exorbitant tax claims and litigation by revenue agencies had always played spoilers to any corporate resolution.
In the Monnet Ispat case, SC (August 2018) held categorically that provisions of Section 238 of IBC will override anything inconsistent contained in any other enactment, including the Income-tax Act.
In the Raj Oil Mills case, NCLAT, in a combined order (March 2019), decided that all statutory dues owed to revenue agencies would be treated as operational debt.
The order said, “As the income tax, value added tax and other statutory dues arising out of the existing law arises when the company is operational, we hold such statutory dues has direct nexus with operation of the company. For the said reason also, we hold that all statutory dues including ‘income tax’, ‘value added tax’ come within the meaning of operational debt.” It, however, allowed these agencies to initiate the resolution process to recover their dues.
A final resolution of the Essar Steel case is important, not only to set at rest issues raised by the 4th July NCLAT order, but also to signal that resolution provides a better alternative to liquidation, which will entail far bigger losses to lenders.
Indian PSBs’ bad loans stand at a massive Rs10 lakh crore+ and the NCLT is already bogged down with just 1,860 companies admitted for resolution so far, while an estimated 12,000 more await admission.
The task is humungous and it is important for everyone to ensure that it works at a time when several distressed asset companies from around the world remain interested in acquiring Indian companies and can provide an exit to our beleaguered lenders.