Two- and-a-half years after the Indian central bank took the highly unusual step of directing banks to put 12 large corporate debtors into bankruptcy, the most closely watched of the “distressed dozen” cases has finally been resolved.
With the Supreme Court in New Delhi clearing the decks for the sale of Essar Steel India Ltd., the Ruia family has accepted defeat. Control of the 10 million-tons-a-year integrated plant in western India will pass to ArcelorMittal, which will pay banks 420 billion rupees ($5.9 billion), or 90% of their claims.
This final episode of a drawn-out legal saga, in which the Ruias made multiple attempts to hold on to their prized asset, was a nail-biter. At the last moment, the bankruptcy tribunal’s appellate authority had inexplicably jumped into the fray and ordered that more of ArcelorMittal’s money be given out to unsecured operational creditors and less to secured financial lenders.
Getting the Distribution Right
India’s $200-billion-plus bad debt mess is starting to attract serious global capital from pension and sovereign funds. Had expected recovery rates of 90% shriveled to 60%, private equity funds assembling this stock of patient money to take over secured lenders’ exposure would have fled. Thankfully, the court restored the power of the creditors’ committee to decide who gets what.
It’s been a costly delay. When the Reserve Bank of India referred large cases to new bankruptcy tribunals, it was hoping to solve 25% of the country’s bad-loan problem in 270 days. There was interest among potential buyers, particularly for steel plants, because global metals demand was stabilizing. But with missed deadlines, lengthy litigation and suspected fraud holding back asset sales, liquidation has emerged as the default option, with only 15% of closed insolvency cases ending in a resolution plan.
A lot has changed in India’s corporate distress landscape between 2016, when India promulgated its bankruptcy law, and now. For one thing, global demand for steel — and steel assets — is starting to sag. That isn’t all. With practically all sectors of India’s economy facing a demand funk, there’s trouble everywhere from real estate and roads to power and telecom.
Each industry comes with its own unique challenges. In residential real estate, it’s the homeowners’ interest that makes creditor coordination difficult. In telecom, the difficulty comes from exorbitant government demands for spectrum fees. The danger of a voluntary bankruptcy filing by Vodafone Idea Ltd. has everyone from investors to the government worried. The mobile operator posted a $7.1 billion quarterly loss, the worst in India’s corporate history.
Buyout Firms Are In
A new complexity is that creditor institutions themselves — from shadow lenders to small deposit-taking banks — are becoming insolvent, prompting India to extend the bankruptcy law to nonbank lenders as well. This quick fix would further weigh on a system creaking under its case load. A steel plant can preserve value through a lengthy in-court bankruptcy by utilizing its fixed capacity. A lender has to continuously make new loans to stay in business. Without the trust of the financial markets, its enterprise value very rapidly falls to zero. Early liquidation is the best possible outcome for an insolvent lender’s creditors seeking to extract value, but it’s also the scenario that poses the biggest risk to stability of the existing financial system.
The current law can’t solve this dichotomy. Rather than overburdening it, India must keep the bankruptcy tribunal focused on what it can actually handle. A recent example of overreach is the start of an insolvency petition against Aviva Plc’s local life insurance joint venture for not paying its landlord. Such things used to happen in Indonesia, where a Jakarta commercial court declared Canadian insurance firm Manulife Financial Corp.’s Indonesian unit bankrupt in 2002, and followed it up two years later by holding Prudential Plc’s local business insolvent. A higher court had to reverse those rulings.
By setting right the balance between secured and unsecured lenders, the Essar judgment has scored a win above all for common sense. The verdict will rekindle hope in the integrity of India’s bankruptcy process, but it will take a lot more work to allay concerns about its effectiveness.