Massive expansion and investments, primarily funded through bank loans (despite a weak promoters’ equity base), has given rise to companies which have overleveraged their balance sheets. Coupled with the economic slow-down, industry conditions and global financial crisis in the past, this led to these companies becoming financially stressed. While, certain companies were able to sustain themselves through swapping loans, many have already reached a point where they have financially broken down. Bhushan Steel, Lanco, Essar Steel, Kingfisher, Monnet Ispat and Alok Industries, are just a few reported examples of such broken down stories.
The rise in the number of non-performing assets (“NPAs”) was therefore an inevitable consequence. The past decades have seen various legislations and schemes being introduced from time to time to deal with the issue of debt recovery from corporates such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993; the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”); the Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”), the insolvency/winding up process provided under the Companies Act, 1956 and later Companies Act, 2013; and the Corporate Debt Restructuring Scheme and the Strategic Debt Restructuring Scheme introduced by RBI.
The Insolvency and Bankruptcy Code, 2016 (“Insolvency Code”), enacted to consolidate the laws in India relating to reorganization and insolvency resolution process for all forms of corporate entities including individuals, in a time bound manner, has now become the latest game changer. With the amendments introduced by Banking Regulation (Amendment) Ordinance, 2017, followed by the subsequent Central Government’s order dated May 5, 2017, the Reserve Bank of Indian (“RBI”) was authorized to issue directions to banks to initiate insolvency resolution process in respect of defaults, under the Insolvency Code, and to issue directions with respect to stressed assets.
This led to the formulation of an Internal Advisory Committee (“IAC”) by RBI to advise it on cases that may be considered for reference for resolution under the Insolvency Code. Focusing on large stressed accounts at this stage, the IAC has recommended resolution of all accounts with fund and non-fund based outstanding amount greater than Rs. 5000 crores with 60% or more classified as NPAs by banks as of March 31, 2016, and noted that 12 accounts (aggregating about 25% of the current gross NPAs) would qualify for immediate reference under the Insolvency Code. For other NPAs, the IAC has recommended that banks should finalize a resolution plan within 6 months and if a viable resolution plan is not agreed upon within such period, banks should be required to file for insolvency proceedings under the Insolvency Code. Based on IAC’s recommendations, RBI issued directions to certain banks for referring the 12 accounts to initiate the insolvency process under the Code and thereafter followed by a second list of 28 defaulters.
The legislative intent of the Insolvency Code was to streamline the insolvency resolution and liquidation process by providing a consolidated mechanism and platform to ensure smooth and easy debt recovery, which appeared to be a useful tool to address the issue of NPAs. However, an issue which recently came into the limelight was the ability of promoters to bid for their own defaulting companies. This invited criticism on the ground of possible misuse of the insolvency resolution process by defaulting promoters.
Under the Insolvency Code, the insolvency resolution professional is required to “invite prospective lenders, investors, and any other persons to put forward resolution plans”. In view thereof, promoters were also able to bid for their debtor companies ‘as any other person’. Take for instance the case where the National Company Law Tribunal admitted the insolvency application filed by the debtor company (Synergies-Dooray Automotive Limited) and vide its order dated August 2, 2017, approved the resolution plan of Synergies Castings Limited where the cost of the scheme (i.e. the proposed payments to creditors and insolvency process cost) was Rs. 54 crores while the company owed Rs. 972 crores to the lenders. This has been challenged by its financial creditor, Edelweiss Asset Reconstruction Co. Ltd., before the National Company Law Appellate Tribunal, for alleged fraud by the debtor company as per media reports and is currently pending final adjudication. Another example is that of Essar Steel Limited’s insolvency resolution, where reportedly one of its own promoters has also submitted its expression of interest and intends to file its resolution plan.
With bidding for major companies like Essar Steel, Bhushan Steel, Bhushan Steel and Power, Alok Industries Ltd., Monnet Ispat and Energy Limited to apparently start soon as part of insolvency proceedings, the above instances led to big industry players (often those intending to bid for such stressed assets) questioning the credibility of the insolvency process if the existing promoters were able to re-acquire their own defaulting companies with a major haircut.
What followed was the passing of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 by the Government on November 23, 2017 (“Ordinance”). This Ordinance primarily disqualifies a person from submitting a resolution plan if such person, or any other person acting jointly with such person, or any person who is a promoter or in the management or control of such person:
- is an undischarged insolvent;
- has been identified as a wilful defaulter in accordance with RBI guidelines;
- whose account is classified as an NPA and a period of 1 year or more has lapsed from the date of such classification and who has failed to make payment of all overdue amounts with interest thereon;
- has been convicted for any offence punishable with imprisonment for 2 years or more;
- has been disqualified to act as a director under the Companies Act, 2013;
- has been prohibited by the Securities and Exchange Board of India from trading in securities or accessing the securities market;
- has indulged in preferential transaction, undervalued transaction or fraudulent transaction in respect of which NCLT has passed an order under the Insolvency Code;
- has executed an enforceable guarantee in favour of a creditor, in respect of a corporate debtor under the insolvency resolution process or liquidation under the Insolvency Code;
- where any connected person in respect of such person meets any of the criteria specified in the above categories.1
- has been subject to any disability corresponding to the aforesaid categories under any law in a jurisdiction outside India.
This Ordinance is being touted by the Government as means to curb instances of fraud being perpetuated through abuse of the process under the Insolvency Code. However, this move is also being criticized by many as reducing the competitiveness of the bids (since promoters who could have upped the bidding have been taken out of the equation, which would ultimately result in lower proceeds for the lenders). In fact, as per certain analysts, this may even lead to a consolidation of power in the hands of few players (especially in the steel sector where various steel companies are being put under the auction hammer soon).
So, has the Government, in a knee-jerk reaction to prevent further controversies, oversimplified this issue by introducing blanket disqualifications as opposed to following a process of case to case determination by NCLT on credibility of resolution plans/bids submitted by the promoters?
The actual ramifications of this Ordinance would become clearer once the bidding results are out and the insolvency resolution plans are implemented. However, in the meanwhile, it is pertinent to note that the prohibition under the Ordinance is not limited to promoters who are wilful defaulters, but also includes within its purview, persons who have executed enforceable guarantees in favour of creditors in respect of the debtor company under the insolvency resolution process, and all of their connected persons. Therefore, even promoters who are not classified as wilful defaulters may be disqualified from submitting a resolution, and lose out on the opportunity of restructuring their company which may have been just a victim of adverse industry conditions. Debt resolution of small and medium enterprises may also become more challenging as there may not be many bidders, besides promoters, who would be interested in such companies. Valuations may in fact be lower as other bidders would tend to place lower bids and purchase the assets at the cheapest cost possible (as opposed to promoters who may have driven up the bid numbers given their personal attachment to the companies).
In addition to the recent developments under the Insolvency Code, the Government has also recently, announcing its approval of a recapitalization plan for infusing capital into public sector banks to the extent of Rs. 2,11,000 crores over the next 2 years, inter alia with the objective of cleaning up of NPAs. However, while this recapitalization may be a welcome move for the banks, one cannot resort to recapitalization alone to resolve the issue of NPAs.
Are there therefore other options that can be examined to address the looming issue of NPAs being faced by the banking sector? According to Ms. Sangeeta Gulati, President Finance of Kanodia Technoplast Ltd., “The reason why corporate debt restructuring and strategic debt restructuring failed to a certain extent earlier, was because companies wanted capital infusion to run while banks, who were already suffering, refused to further lend money to such companies which led to these companies being unable to come out of the self-sustaining / revival packages earlier provided by the Government. Some resolutions which can therefore be examined are:
Ø Introduction/Reinforcement of self-sustaining/revival package by the Promoters: One such example can be schemes such as the “5/25 refinancing scheme”, which provided for longer gestation periods for repayment loans with promoters being at the helm of the company’s affairs. In these schemes, promoters can be given the chance to seek for maximum amortisation period say up to 20-25 years, depending upon the nature of industry and viable business model. Although such schemes do not require intervention of the NCLT, however, routing the scheme through the NCLT as part of the insolvency resolution mechanism, may render such schemes more viable and enforceable as both promoters and banks / lenders would be required to adhere to certain haircuts, funded interest, moratorium period, new funding, etc. which may be agreed to before the NCLT and any non-compliance would be strictly dealt with.
Waiving off / changing management might also be helpful for certain companies but the same cannot be uniformly applied to all companies.
Ø Promoters’ personal guarantee: The above can be coupled with promoters’ personal guarantee wherein all the assets of promoters, whether in India, abroad, in trust, with family including children, shall be applied if the promoters are still defaulters.
Ø Involvement of Asset Reconstruction Companies: Extending/allowing asset reconstruction companies to control sick companies and banks to involve/sell distressed assets, can be another viable option”.
By appropriately implementing the aforesaid measures, the Government may be able to improve the conditions of debt ridden companies and the overall economy by adequately dealing with the issue of NPAs. While, it remains to be seen whether the Government’s attempt to implement these measures is going to be successful in adequately addressing the growing problem of NPAs, however, a positive and firm start has definitely been made in the right direction.
1The term “connected person” means (i) any person who is promoter or in management or control of the resolution applicant, (ii) any person who shall be the promoter or in management or control of the business of the corporate debtor during implementation of the resolution plan, or (iii) the holding, subsidiary or associate company or related party of a person referred in the first two categories.