Now that the general elections are done and dusted and the National Democratic Alliance (NDA) is back in the saddle with a huge majority, it is time go about fixing some of its good initiatives that have been floundering seriously.
One of these is the Insolvency and Bankruptcy Code (IBC) which got off to a thundering start with the recovery of Rs80,000 crore—the bulk of it from a few mega steel and power companies that were wilful defaulters. It also gave India a big and rather artificial jump on the World Bank’s Ease of Doing Business ranking.
So, fixing it ought to be a priority. Unfortunately, if the steel sector gave the IBC process a boost, it is the same sector that is also raising questions about how the new statute is being gamed.
Essar Steel, the biggest wilful defaulter, has found ways to drag the resolution process by 530 days, through repeated legal challenges in multiple forums and jurisdictions, more than double the resolution ceiling of 180-270 days prescribed under the statute. Meanwhile, as part of our tinkering with bad debt resolution architecture, we seem to be regressing. Consider the implications of the new circular of the Reserve Bank of India (RBI) of 7th June.
This circular has been hailed as pragmatic and flexible by corporate India. Essentially, the power companies, who owe banks over Rs2 lakh crore, said that their outstanding debt was often because state electricity boards had failed to make payments. The Supreme Court also agreed that RBI could not have a one-size-fits-all policy and struck down the controversial 12 February 2018 circular which forced banks to start insolvency proceedings even if there was a one day lag in repayment beyond 180 days.
Indeed, the new circular does appear to have several checks & balances and is workable if RBI supervises bailout deals like a hawk. It asks lenders to have board-approved policies with clear timelines for handling defaults; requires lenders to have a mandatory inter-creditor agreement to determine the procedure, rules and implementation of resolution plans; permits resolution to be initiated with the assent of 75% of the lenders in value and 60% in number; requires graded higher provisioning as a deterrent for lenders delaying insolvency proceedings; and offers claw-back of provisions as a carrot, when the process is started. The circular also says that fraudulent and wilful defaulters will remain ineligible for restructuring and that RBI retains the power to direct action in specific cases.
Gaming the System All Over Again
Unfortunately, many fear that these provisions will be gamed to restart the process of ever-greening bad loans all over again. Many resolution professionals (RPs), who have faced significant harassment from lenders due to their unwillingness to go along with dubious deals with promoters, are unconvinced. They say the timelines of the 7th June circular provides plenty of ‘flexibility’ to game the system. They are also deeply sceptical about another provision which says that accounts above Rs100 crore will require independent evaluation by a credit rating agency (and two rating agencies, when the amount exceeds Rs500 crore).
So long as the promoters pay rating agencies and they are not held to stricter standards of accountability, the evaluation will only end up certifying shady deals. We already know how Indian companies ‘fix’ valuations during mergers & acquisitions through friendly auditors and even get them ratified by courts.
In fact, a disillusioned former banker, who has done a sterling job as an RP, says, “The new RBI circular seems to have gone back to the old CDR (corporate debt restructuring) days. There is no longer any incentive to change ownership of stressed companies.”
Pre-packaged Collusion?
As it is, the current resolution process under IBC is faltering. Only four out of the first 12 references to the IBC have been resolved, writes Amitabh Kant, CEO of NITI Ayog. While Essar Steel is the worst case, the others have also been pending for 470 days. Mr Kant estimates the loss of income to lenders, due to IBC-related delays, at a hefty Rs4,000 crore.
The ministry of corporate affairs (MCA) is, apparently, working on a ‘pre-packaged bankruptcy scheme’, which, Mr Kant writes, would “give a stressed company the option to prepare a financial reorganisation plan with the approval of a minimum of two-thirds of its creditors (and shareholders) before the filing of an insolvency application before the NCLT (National Company Law Tribunal). Its advantage is that the lenders are already on board, so it can bypass processes and interventions, therefore, transcending delays and pendency.”
This sounds good on the face of it, but the devil is usually in the detail. A lot would depend on how the package is implemented. A pre-packaged arrangement would work when there are interested buyers for a business, as a going concern and the interest and principal outstanding is not ridiculously large, because of rampant diversion of funds.
What happens in the Indian situation, where existing promoters are working overtime to retain their companies after forcing lenders to accept a huge haircut? How will it prevent collusive deals, often brokered by the RP?
What happens in a scenario like Sterling Biotech and Sterling SEZ, where the majority of lenders are on board to accept a 45% settlement from promoters who are absconding and have been accused of money laundering and worse?
Banks claim that this settlement will not impinge on investigations and criminal action against promoters, but it is hard to believe that they will pay up and also return to face a jail term. In any case, with the Enforcement Directorate attaching Rs 9,778 crore of property and assets of the Sandasera brothers, it will be interesting to see if their long-distance settlement offer will still stand.
Another example is the failed deal to revive Jet Airways, at the end of March 2019. Lenders had virtually allowed Naresh Goyal to dictate the bailout plan, where he would disembark temporarily, but could be back on board if he found a willing investor. Fortunately, this brazen bailout failed.
It is fairly common knowledge that many promoters have struck deals with overseas investors and institutions to ‘front’ a bid in the resolution process. This allows them to negotiate a sharp haircut and continue to run the company by proxy. The biggest challenge of a pre-packed resolution is to ensure enough of checks & balances to prevent such deal-making which is fairly common in smaller resolution cases.
At the same time, we need the government to proactively help the good guys; thisis also not happening. The best example is Renuka Sugars, which remains specifically disqualified under the RBI’s, ostensibly flexible, 7th June circular. This smacks of petulance and capriciousness. The government’s silence on this matter punches holes in its claim to have made it easier to do business.
For decades now, every major investigation and bailout has either been dictated or stopped by ‘instructions’ from the highest executive office in the country. The NDA government has a new innings for initiating action against several companies that were seen as too influential to be touched. It is also far more focused on the optics. And a failed bankruptcy law and Essar Steel resolution would make for very bad optics. It could also cause India’s ranking in the coveted Ease of Doing Business to slide, since failed resolutions are not easy to hide. Let’s hope these factors lead to positive actions.
Banks are also to blame if borrowers become bankrupt. Banks' supervision is somewhat lax and even when borrowers turn defaulters, the lenders take their own time to nurse them back to health. When the corporates find that their lenders are easy-going and do not quickly arrive at any plan to discipline them, they take advantage of lenders' lenience. Even borrowers who at first default against their will on account of market conditions, turn into willful defaulters. The present situation is like a doctor giving careless treatment to his patient. When the situation becomes serious and the patient arrives at the hospital in an ambulance, then a consortium of doctors is formed to deliberate on how to save the patient's life. -Dr KS Rao, former CGM, SBI.
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