Lenders wary of using IBC for debt resolution over creditors' parity

The National Company Law Tribunal (NCLAT) order that cleared ArcelorMittal’s bid for Essar Steel and sought to put financial and operational creditors on a par has put bankers in a dilemma: To use or not to use the Insolvency and Bankruptcy Code (IBC) for resolution of debt.

The order, instead of bringing down the curtains on an almost two-year corporate insolvency resolution process for Essar, has split the IBC ecosystem and sent lenders knocking on the door of the Supreme Court (SC). A senior official of the State Bank of India (SBI) said the ruling was a huge negative for the IBC. SBI, which has the largest exposure to Essar, has filed an appeal in the SC on behalf of the committee of creditors. 

Other bankers are rallying behind SBI. “As bankers, we all support SBI’s petition. The SC had earlier rejected the plea by operational creditors seeking parity with secured financial creditors,” said Mrutyunjay Mahapatra, managing director (MD) and chief executive officer (CEO), Syndicate Bank.

UCO Bank MD and CEO A K Goel echoed his views. “As a bank, we feel if operational and financial creditors are treated in the same way, the very purpose of the IBC is defeated,” said Goel.One of the top lenders to Essar minced no words in saying that this would mean the end of the road for the IBC. 

“There are many options for recovery, according to the RBI circular of June 7 — selling debt to asset reconstruction companies, restructuring and even change of management. Then why should banks opt for the IBC? If the SC carries through this order, the IBC would remain as just a threat for promoters,” the lender said. 

The appellate tribunal ruling has put a different class of creditors — financial vis-à-vis operational creditors as also secured and unsecured financial creditors — on a par and proposed an equitable distribution of the bid amount. 

The verdict not only means sacrificing a large portion — from 91.99 per cent to 60.7 per cent of Rs 42,000 crore — in one of the prized assets under the IBC by the secured lenders, but experts point out there is likely to be a wider import on other cases and the Code at large. 

As Rajnish Kumar, SBI chairman, said recently, the NCLAT verdict would discourage banks from taking stressed asset cases to the insolvency process. 

He also said the two different classes of creditors would be recognised by the Companies Act and even under Section 230 when any scheme of arrangement is filed. The voting is different for different classes of creditors. Mohit Saraf, senior partner, L&L Partners, pointed out the order had the potential of turning India’s dream of a $5-trillion economy hazy, while setting a precedent for other IBC cases. 

Saraf said the order had put the rights of secured creditors under threat, which was against the jurisprudence of India, and a couple of foreign banks had already put funding of projects on hold. 

“The finance minister in her Budget speech acknowledged that to get to $5 trillion, there is a need for massive investment. Typically, any project is funded by 70 per cent debt and 30 per cent equity. A major fallout of the order is that companies in India will not be able to mobilise 70 per cent debt, as secured creditors will not commit funds unless their priority is protected,” added Saraf.  

The order, at one level, could also incentivise liquidation, believes Suharsh Sinha, partner AZB & Partners.  Financial creditors would rather enforce security at the first sign of financial distress in a firm or choose to vote for liquidation since in both cases they would stand to make higher recoveries as opposed to a resolution plan under the NCLAT’s formulation, said Sinha.

The NCLAT has also made it clear that since it (Essar) is not a distribution of assets from the proceeds of sale of liquidation, the resolution applicant cannot take advantage of Section 53 to determine the manner in which distribution of the proposed upfront payment is to be made. 

Section 53 refers to a waterfall mechanism for distribution of assets in the event of liquidation. 

Sudipta Routh, partner, IndusLaw, however, said there was no bar in the IBC if a resolution applicant were to use the same waterfall specified in Section 53. “As long as the operational creditor gets at least liquidation value, it is the resolution applicant’s prerogative,” said Routh.

Routh also pointed out that the IBC was an economic legislation and the NCLAT’s jurisdiction was narrow. “The NCLAT has gone ahead of itself and the problem is that the moment you expand the jurisdiction, it will be up for challenge. Where there is an inordinate delay, the deadline will only get stretched and there will be an erosion of value,” said Routh. Indeed, Essar and some other cases on the Reserve Bank of India’s first list of non-performing assets are close to completing two years of the Corporate Insolvency Resolution Process. But the debate around parity between financial and operational creditors still appears to be a rallying point in many of the cases. 

In the Swiss Ribbons case, Routh pointed out that the SC had already settled the debate around discrimination between financial and operational creditors. That ‘discrimination’ passed constitutional muster, with the SC clearly refusing to entertain notions of apparent ‘crudities or inequalities’ invalidating the overarching economic objective, said Routh.

Swiss Ribbons also happens to be one of the cases that the NCLAT has referred to in its order. The order cited the United Nations Commission on International Trade Law Guidelines mentioned by the SC for ensuring equitable treatment of similarly situated creditors.

Advocate Anand Varma — who represented eight operational creditors in the Essar case — explained that the Swiss Ribbons case had many parts. The primary principle was equitable distribution between financial and operational creditors. “A resolution caters to everyone, not just a handful of secured creditors,” pointed out Varma. Varma pointed to the Binani case, where the appellate tribunal had taken into consideration the viability and feasibility of the resolution plan and said it was necessary to balance the financial creditors and operational creditors, while emphasising on maximisation of assets of the corporate debtor.

Khaitan & Co Senior Partner N G Khaitan, too, said the NCLAT order, while bringing in clarity on the bankruptcy law, protected the rights of operational creditors. “It is a very positive judgment,” said Khaitan.

Over to SC now to decide whether some creditors are more equal than others.

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