Why India's Insolvency and Bankruptcy Code is Slowly Imploding

Long delays and endless litigation are making banks less keen on the IBC for the resolution of bad loans.

An industrialist, who has keen interest in the resolution of bad loans, told me that banks are no longer keen on the shining new bankruptcy law – Insolvency and Bankruptcy Code (IBC) – to recover bad loans. He says that banks prefer to find other solutions because of long delays and endless litigation, often leading to an outcome that is no better than what could have been achieved through negotiation.

According to him, the government has told bankers to work hard to avoid the liquidation route, because that fetches a pittance. So, banks now prefer to negotiate with promoters and are turning a blind eye to bids from absconding promoters or their front companies.

This indicates that the bankruptcy law will rapidly go the way of all previous legislations and debt recovery mechanisms that failed to help lenders recover bad loans. And, bankers in collusion with borrowers, supported by politicians, will ensure that banks will keep writing off bad loans and the exchequer will bail them out through repeated recapitalisation.

In other words, you and I will continue to pay for the massive bad loans of big industrialists, farmers and anyone else whose outstanding debt is condoned by the our politicians.

Bad loans of Indian banks are estimated at Rs 10 lakh crore or more. Moreover, banks have been routinely cleaning up their books through massive ‘technical write-offs’, knowing full well that there will be almost no recovery in most cases. This is done as a tax-saving measure with full support from the finance ministry. Such write-offs are massive.

Gamed from the Start

Despite assertions of having rooted out corruption, many corrupt bankers have been complicit in gaming the IBC from the very beginning. In November 2017, the Insolvency and Bankruptcy Board of India (IBBI) published detailed guidelines on how creditors should evaluate bids. It asked the committee of creditors (CoC) to carry out due diligence to ensure that each resolution plan is viable, to avoid plans that may ‘lead to liquidation, post-resolution’, and ensure that persons submitting the plan ‘are credible’. This guidance was promptly ignored.

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As Debashis Basu wrote in November 2017, “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.” In September 2017, he had written about how the bankruptcy process was gamed from the very first resolution of Synergies Dooray Automotive Ltd.

However, all these clues were buried under the orchestrated hoopla and social media celebration by government ministers after the bidding wars led to a few successful resolutions such as Bhushan Steel, Monnet Ispat & Energy, Electrosteels and Binani Cement. Barring the keen interest among leading industrialists to acquire Essar Steel and Bhushan Power , the average recovery, in most cases, is below 25% and there are simply no buyers for many basket cases.

Of the first 12 accounts referred to bankruptcy proceedings, Bhushan Steel, Electrosteels Steel, Jyoti Structures and Alok Industries found buyers. Lanco Infratech and ABG Shipyard have gone into liquidation, while Amtek Auto also seems headed that way.

Essar Steel, Bhushan Power and Jaypee Infratech are embroiled in endless litigation. The only serious bidder for Jaypee Infratech, which owes Rs 9,782 crore to creditors, is State owned NBCC Ltd, which has made a complex and conditional bid that does not seem to give lenders much hope of recovery.

The lenders of Era Infrastructure Engineering (debt in excess of Rs 17,000 crore including subsidiaries/special purpose vehicles) are still struggling to find a workable resolution, since the group has arbitration awards with regard to the money owed to it by various entities, including the National Highway Authority of India.

IBC seems headed the way of many other failed laws such as SICABIFRSARFAESI and others; of the 1,484 cases admitted, only 40 have been closed.

Let’s take a look at specific cases that are likely to derail IBC.

Liberty’s Games: London-based Liberty House, headed by Sanjeev Gupta, was one of the big movers & shakers in the bankruptcy business three years ago. It was always rumoured in business circles that Liberty House had no plan to hold on to the companies after getting them cheap. Now, Sanjay Gupta has messed up the resolution process and obstructed serious bidders in his three winning bids for ABG Shipyard, Amtek Auto and Adhunik Metaliks.

ABG Shipyard: On 25th April, NCLT (National Company Law Tribunal) ordered the liquidation of ABG Shipyard after Liberty House failed to pay up the small upfront fee on its Rs 5,200-crore bid. ABG Shipyard owes a massive Rs 18,245 crore to a consortium of 22 lenders, led by ICICI Bank. They would be lucky to recover even Rs 2,200 crore, on liquidation.

Amtek Auto: Liberty House won Amtek Auto with an offer of Rs 4,400 crore in July 2018. After it failed to pay up, NCLT’s Chandigarh bench recommended prosecution and allowed it to withdraw the bid after imposing a cost on it. On 4th May, IBBI filed a criminal complaint against Liberty House under Section 74(3) of IBC which, provides for prosecution and punishment including a jail term of up to five years and a penalty of up to Rs 1crore.

Sanjeev Gupta and three top executives have been summoned by a special court for ‘wilful’ breach of the resolution plan and asked to be present at the next hearing on 11th July. Liberty House, in turn, has accused the resolution professional and Amtek Auto’s previous owners of misrepresenting facts in the information memorandum. It remains to be seen if it can make the claim stick, when it has reneged on two other bids.

Adhunik Metaliks Ltd: Here, too, Liberty House has missed multiple deadlines to pay up the Rs 410 crore as an upfront cash payment. It hasn’t officially withdrawn its bid, but finds varied excuses to delay the payment. Adhunik Metaliks owes Rs 5,371 crore to lenders. Here, Liberty House has certainly derailed a proper resolution because Adhunik had other serious bidders wanting to acquire the company.

Sterling Biotech: As we have written earlier, here is a group that is under investigation by multiple agencies, including the Central Bureau of Investigation (CBI) and enforcement directorate (ED), for fraud, diversion of funds, money laundering and other offences. The four promoters –Nitin, Chetak and Dipti Sandesara and Hitesh Patel — are absconding from India. And, yet, bankers, led by Andhra Bank, attempted to withdraw the two main group companies from the resolution process.

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The Sterling group owes over Rs 15,600 crore to its financial and operational creditors. While the flagship Sterling Biotech owes over Rs 7,500 crore to lenders, sister concern Sterling SEZ owes over Rs 8,100 crore. The Sandesaras, who are facing criminal investigation, had the gall to make an offer, from their safe hiding place overseas, to settle their loans by paying less than 45% of what they owe the banks. In two separate cases, NCLT has severely reprimanded the resolution professional as well as bankers for failing to make full disclosures to the court.

In Sterling SEZ, NCLT had first allowed the withdrawal from insolvency, but later recalled its order on 26th April and directed government to take punitive action against the senior officials of the lenders for misleading the Tribunal with a withdrawal plea.

The brazenness of the Sterling proposal and the alacrity with which banks attempted to accept it is all the more controversial because the Sandesara family is perceived to be close to the ruling government and the controversial CBI special director Rakesh Asthana.

Ushdev International: In what is considered a Liberty House-like case, a Singaporean bidder wants to acquire Ushdev International, a steel trading firm that ran up a fat debt of Rs 3,450 crore. The company was founded by late Vijay Gupta and promoters held a 54% stake.

On 6th May, NCLT’s Mumbai bench asked the potential investor to submit an affidavit with regard to his offer to pay Rs 200 crore upfront to acquire the company. At least one leading bank has objected to the move. They expect the company to fetch Rs 900 crore, on liquidation. While we wait to see what happens next, business circles believe this is just a proxy bid. It will be a travesty of the IBC, if industrialists get to retain control with nearly 2/3rd of their debt wiped out. Although and amendment to the IBC is supposed to prevent promoters from bidding for their companies, Indian businessmen have been working hard to game the system and appear to be succeeding, going by the next case.

Gemini Communications: According to a report in BloombergQuint, National Company Law Appellate Tribunal (NCLAT) may have permitted a backdoor re-entry by the promoters in Gemini Communications Limited. The NCLAT order in this case says, “A scheme of compromise must be considered first at the liquidation stage before the assets of the company can be liquidated. But it hasn’t explicitly stated whether such a scheme can be proposed by promoters, who are barred to participate in the resolution process even at the liquidation stage under the IBC.”

The promoters of Gemini have reportedly offered Rs 30 crore as part of the compromise, as against the liquidation value of Rs 3 crore. Although Section 29A of IBC, explicitly bars promoter of defaulting companies from bidding, a couple of Supreme Court judgements are being cited by legal experts to justify this in compromise cases.

If the promoters of Gemini Communications manage to force such a compromise, Essar Steel is bound to fight for similar treatment. The Ruias are already in the Supreme Court using every possible argument and loophole to stop Arcelor Mittal from acquiring the company. As in most cases mentioned above, nobody is asking about the source of their money or their failure to pay up until the company was on the verge of being acquired.

The initial success of IBC was mainly due to the Modi government’s determination to bring crony capitalists, who have defrauded the banking system, to book. In less than three years, that determination seems to have eroded substantially. The fate of the Act now depends on the composition and leadership of the new government that is voted in, on 23rd May. The way the Act has been diluted by strange judgements, multiple amendments and collusions with bankers, it will take Herculean political will to make IBC work any better than the previous failed laws.

This article was originally published on Moneylife India.