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Fixing the bankruptcy code – The Big Story News

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Five years after it was implemented, the efficacy of India’s Insolvency and Bankruptcy Code (IBC) has fallen short of expectations. Passed in 2016 after nearly a decade of deliberations, the IBC was touted as a solution for the country’s slow bankruptcy resolution processes and low recovery percentages. What lays bare its inadequacies is an observation by the NCLT (National Company Law Tribunal) in June this year. While approving the sale of Videocon Industries to Twin Star Technologies, owned by industrialist Anil Agarwal, it noted that Twin Star was paying ‘almost nothing’ for the purchase, and that the 99.28 per cent ‘haircut’ (loss, in banking parlance) that operational creditors were being forced to accept was closer to a ‘tonsure, or total shave’ than a haircut. The NCLT noted that against the total claims of Rs 64,838 crore, the resolution only provided Rs 2,962 crore, or 4.5 per cent. Many operational creditors—a large percentage of which are MSME (micro, small and medium enterprises)—will get as little as 0.72 per cent of their claimed amounts.

In 2016, the IBC replaced a host of previous recovery/ resolution acts in place to deal with bankrupt firms, including the Sick Industrial Companies Act, 1985, and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993. It had two stated objectives—first, to quickly process bankruptcy proceedings, allowing banks to clear up their balance sheets, free up credit and start lending again, and second, to close the legal loopholes being misused by the owners of failing businesses to wipe away their debt while retaining control of their companies.

One of the most crucial aspects of the IBC was that it was intended to speed up the resolution process, with cases to be closed in 180 days (revised to 330 days in July 2019). Another was to improve debt-recovery percentages to minimise the losses creditors faced in bankruptcy cases—ironic, given the NCLT’s observation on the sale of Videocon Industries. This is especially significant for financial creditors, who see diminished lending capacities as a result of such losses. In 2015, the Bankruptcy Law Reforms Committee, which drafted the IBC, noted that ‘when creditors know they have weak rights resulting in a low recovery rate, they are averse to lend. Hence, lending in India is concentrated in a few large companies that have a low probability of failure’. According to data available with the Insolvency and Bankruptcy Board of India (up to 2019), resolution proceedings took an average of six years to complete before the IBC, with a recovery rate of about 22 per cent. The government claims the IBC has pushed that up to about 43 per cent. Nonetheless, a parliamentary panel chaired by Jayant Sinha, former minister of state for finance, in a report submitted to Parliament in August, noted that the IBC is not fulfilling its objective of significantly improving recovery rates, with lenders being forced to take haircuts as high as 95 per cent in some cases.

The Assets

While the IBC has not lived up to expectations, it has nonetheless led to an increase in the number of cases being closed, establishing a clear framework for creditors to initiate legal proceedings against defaulters before the NCLT. “The situation is enormously improved,” says Arvind Panagariya, former vice-chairperson of the Niti Aayog and Professor of Economics at Columbia University, and one of the chief proponents of the IBC.

Among the biggest success stories is the resolution of Jet Airways, which collapsed under its debt pile in April 2019. In June this year, the NCLT approved a resolution plan by a consortium of UK-based Kalrock Capital and Murari Lal Jalan, a UAE-based businessman, to restart the airline. The consortium has proposed paying Rs 1,200 crore to creditors over five years as part of its bid. Under the plan, the consortium will hold 89.8 per cent of the restructured airline, banks will get 9.5 per cent, employees will get 0.5 per cent, while public shareholding will reduce to 0.2 per cent. Negotiations are ongoing between the government and the consortium over the reinstatement of the airline’s former airport slots and air traffic rights, which were allotted to other carriers after its collapse. “The resolution of the Jet Airways case is a good example of [the success of the IBC],” says Panagariya. “Without it, the assets of the airline would have withered away. The IBC has tightened the screws on promoters. Under any good system, creditors must have a legal recourse if borrowers do not meet their repayment obligations.” However, in August, the cabin and ground staff of Jet Airways moved an appellate tribunal seeking a stay on the resolution plan over concerns related to pending salaries and retirement benefits.

‘The Jet Airways case is a good example of the success of the IBC. Without it, the airline’s assets would have withered away’

– Arvind Panagariya, Former vice-chairperson, NITI Aayog

One of the largest recoveries the IBC facilitated was in the Essar Steel case. In December 2019, the firm’s financial creditors, led by the State Bank of India (SBI), recovered nearly 92 per cent of their Rs 49,000 crore worth of claims, after a consortium of the Luxembourg-based ArcelorMittal and Japan’s Nippon Steel and Sumitomo Metal Corporation (NSSMC) agreed to take over the company. The restructuring firm chosen to operate the company during its nine months in insolvency proceedings was Alvarez & Marsal; though its bid was not the most cost competitive, it had the most experience in restructuring. This proved a good choice—Alvarez & Marsal scripted a turnaround in Essar Steel’s productivity that led to the ArcelorMittal-NSSMC consortium raising its bid from Rs 29,000 crore to Rs 42,000 crore.

The Liabilities

The IBC’s successes, however, have been marred by delays in case closure, low recovery rates and banks being forced to accept massive haircuts on their claims.

A report by Alvarez & Marsal India noted that between FY 2017 and FY 2019, recoveries averaged around 43-50 per cent, with timelines extending well beyond the mandated period. Of the 277 cases resolved at the NCLT as of September 2020, the average time for resolution, including litigation, has been 440 days. In FY 2020, around 480 new cases were filed every quarter—the report estimates the backlog could take as long as six years to process. An analysis by REDD Intelligence says that of the 4,300+ debtors that have been through insolvency proceedings under the IBC, 48 per cent were liquidated, half of them in under 314 days. Of the 13 per cent that were sold, half exited bankruptcy proceedings in less than 425 days—the firm says that these are not bad outcomes. However, barring a few cases, the recovery rate for creditors has been abysmal. In contrast to the government’s claims, investment bank and financial services firm Macquarie says that the overall recovery rate is just 24 per cent.

Defending the IBC, Panagariya says that one reason for the massive haircuts banks have had to accept is poor lending decisions by these same banks. He argues that losses in bankruptcy proceedings do not imply that the IBC is to blame—rather, he says that this is proof why it is essential to reform the public sector banking system, including through privatisation.

However, the IBC has come in for a lot of flak, with many examples of it failing in its core purposes—speeding up insolvency proceedings and improving recovery percentages. The success of cases like Essar Steel appears to be the exception rather than the norm; according to the Alvarez & Marsal report, only 52 per cent of the 4,008 cases filed with the NCLT until September 2020 have been closed. It adds that the many litigations initiated by stakeholders have slowed the process, as have administrative delays by the NCLT itself, and that inconsistencies in judgments have also cast a cloud over the results.

Other cases that have led to bad publicity for the IBC include the resolution of Ruchi Soya Industries, which owed Rs 9,345 crore to a group of creditors led by SBI. The resolution saw an approval for the Baba Ramdev-led Patanjali Ayurved acquiring Ruchi Soya at a roughly 55 per cent haircut, paying about Rs 4,350 crore. Patanjali won the bid after Adani Wilmar withdrew from the running, citing delays in the resolution process and a consequent deterioration of assets. To pay for the deal, Patanjali borrowed about Rs 3,200 crore from a consortium of banks led by SBI, despite the fact that about Rs 1,800 crore of Ruchi Soya’s debt was owed to SBI.

Another case that has made headlines is the resolution plan for Siva Industries and Holdings. In this, the committee of lenders had agreed to a one-time settlement offer of Rs 323 crore from R.C.K. Vallal, the father of the firm’s promoter, C. Sivasankaran, against debts of Rs 4,863 crore—a recovery of just about 6.5 per cent—and was ready to withdraw its bankruptcy case against the promoter. However, the Chennai bench of the NCLT recently rejected the settlement offer, saying the proposal was not in conformity with the provisions of the IBC. The tribunal has ordered the company to be liquidated. The NCLT had admitted proceedings against the company in 2019 after IDBI Bank Ltd filed a case.

Endless Delays

According to the Alvarez & Marsal report, when it comes to the quick resolution of bankruptcy cases, the NCLT benches in Delhi and Mumbai, which are dealing with the highest number of insolvency cases, have an average resolution time of 475 days, compared with the national average of 440 days. The Kolkata and Bengaluru benches fare better, averaging 339 days and 352 days, respectively. The Cuttack bench has the worst record, averaging 613 days; the Jaipur bench has the best, averaging 288 days.

Legal appeals are a major factor when it comes to delays—when appeals go beyond the NCLT to the National Company Law Appellate Tribunal (NCLAT) or the Supreme Court, resolution times have been seen to increase sharply. In a sample of 23 cases with aggregate claims of Rs 1.02 lakh crore that saw appeals bypassing the NCLT, the average resolution time increased to 751 days. Recovery percentages fell sharply as well, to 15-25 per cent, against the average of about 40 per cent as of September 2020. These delays also pulled down the revenues of companies involved in these proceedings. The Alvarez & Marsal report notes that the revenues of four companies in this sample—Alok Industries, Orchid Pharma, Ruchi Soya and Uttam Value Steel—fell 64 per cent, 16 per cent, 17 per cent and 23 per cent, respectively. Three companies—Bhushan Steel, Electrosteel Steels and Monnet Ispat—saw their revenues increasing, by 22 per cent, 55 per cent and 35 per cent, respectively, though these were largely driven by increases in the price of steel in the same period.

‘NCLT benches are very understaffed, and many members who retired recently were eligible for extensions’

– Ranjana Roy Gawai, Managing Partner, RRG & Associates

Explaining the delays, corporate lawyer Ranjana Roy Gawai, who also works on bankruptcy cases, says that the NCLT courts and tribunals are heavily understaffed. There are about 13 NCLT benches across India, with total bench strength of 26, against a targeted 63. “Many members who retired recently were eligible for extensions, but the process to grant them extensions didn’t begin on time, and everyone retired,” she explains. “The pandemic has only aggravated the backlog.” Though there have been amendments to de-clog the NCLT—including decriminalising several offences under the Companies Act and increasing the financial jurisdiction of regional directors from Rs 5 lakh to Rs 25 lakh so that fewer cases end up reaching the NCLT—the impact of these measures is yet to be seen.

A parliamentary panel has also flagged the staff shortages, noting that the NCLT benches and the NCLAT are ‘seriously under-staffed and under-funded’, resulting in a massive backlog of critical cases. Rajiv Mantri, managing director of Navam Capital and founder of the New Delhi-based think-tank India Enterprise Council, also highlights the need for judges presiding over insolvency cases to have economic and financial expertise. Most NCLT courts have judges deputed there from other courts. “Judges should have some economic training. There is a need for specialised knowledge while assessing these types of cases,” he argues. Similarly, Supreme Court lawyer Abhinav Mukerji, also an additional advocate general of Himachal Pradesh and standing counsel, Bihar, highlights the need for specialists to oversee these cases.

The IBC has made a good beginning in establishing a clear process for insolvency proceedings and giving creditors more rights. However, for it to become an effective resolution and recovery mechanism, the political leadership needs to show greater commitment in filling vacancies, initiating reforms in public sector banks and bringing about uniformity in judgments and speedy resolutions. Simultaneously, it must also ensure that it preserves the spirit of entrepreneurship. Unless this happens, the new code will remain just a mirror image of earlier laws, with all their shortcomings.

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