Why the Essar Steel case pushed Modi govt to give more teeth to bankruptcy code

Insolvency and Bankruptcy Code allows 180 days for insolvency proceedings, with one 90-day extension. Essar Steel resolution has crossed 600 days.

Signage for Essar Steel Ltd. is displayed as workers load items onto a truck at the company's Pune Facility in Maharashtra | Dhiraj Singh | Bloomberg

New Delhi: The Narendra Modi government moved quickly this week to approve major changes to the Insolvency and Bankruptcy Code and give the signature reform measure more teeth.

The changes, once approved by Parliament, are expected to provide major relief to banks as they aim to give preference to secured lenders during the resolution process, among others.

The Insolvency and Bankruptcy Code or IBC is only three years old but the government’s hand was forced by the frustrating resolution experience of banks in the case of Essar Steel.

The Mumbai-based company was one of the 12 defaulters identified by the Reserve Bank of India (RBI) in June 2017. Insolvency proceedings were initiated against it at the National Company Law Tribunal (NCLT) the same month.

However, the case has been flitting between NCLT, high court, National Company Law Appellate Tribunal (NCLAT) and the Supreme Court. The battle is set to move on to the Supreme Court again, with the consortium of lenders led by State Bank of India having filed a petition in the top court challenging the last NCLAT order.

The petition was filed before the Modi government cleared the changes to the law. The Supreme Court hearing is on 22 July.

Throughout the process, several concerns have been raised regarding the tribunals’ treatment of operational creditors vis-à-vis financial creditors as well as of different classes of financial creditors.

Additionally, legal disputes, counter offers and changing rules have stretched the case for two years now despite a 270-day deadline, frustrating one of the major purposes of the IBC.

Delay proving costly for banks

The IBC was launched as a big-ticket, much-lauded initiative to tackle bad debt in a quick manner. To this end, the resolution deadline was kept short to check the endemic delays associated with bankruptcy proceedings in India.

The code lays down a 180-day deadline for conclusion of the process, with only one 90-day extension allowed. However, the Essar Steel resolution has already crossed 600 days, with hearings having taken place at every judicial level in the country.

Right after the initiation of the proceedings, Essar Steel moved the Gujarat High Court challenging the same. The high court issued notice to RBI and restrained NCLT from conducting any further proceedings against the company.

After this petition was disposed of, NCLT Ahmedabad admitted the insolvency petition against Essar Steel, appointing Satish Kumar Gupta from Alvarez & Marsal India as Interim Resolution Professional. Gupta then invited bids for the resolution process.

Mauritius-based Numetal Ltd and Luxembourg-based ArcelorMittal India Ltd submitted their bids in the first round, but they were held ineligible by Gupta. Both the companies challenged their disqualification in the NCLT.

The eligibility question of Numetal and ArcelorMittal reached the Supreme Court, which put the question to rest, while also laying down important precedents for pending and future insolvency cases. Both the companies filed fresh bids.

Meanwhile, Essar Steel’s majority shareholder, Essar Steel Asia Holdings Ltd (ESAHL) offered a settlement proposal to repay the entire debt of Rs 54,389 crore. However, disqualification under Section 29A was introduced as an amendment to the code, laying down that bidders cannot be connected to other defaulting entities.

The SBI-led Committee of Creditors (CoC) approved ArcelorMittal’s bid of Rs 42,000 crore with 92 per cent majority vote. Under the code, the CoC, comprising only financial creditors, is tasked with taking all decisions pertaining to the revival and implementation of an effective resolution plan.

While the bid was approved by NCLT Ahmedabad as well as NCLAT, the latter modified the resolution plan — a step which has become a matter of much debate now.

The case has remained stuck in the maze of litigation over the past two years, dragging its feet despite the 270-day deadline mandated by law.

This inordinate delay in the process is proving costly for the banks, which are not only losing precious capital but also interest income. The interest to be paid by the company stops once the insolvency case is accepted by the NCLT.

It has been estimated that each day of delay is costing lenders a staggering Rs 17 crore in interest losses.

Treating financial creditors as one class

The resolution plan in the case categorised the distribution of amounts among the financial creditors under four sub-divisions i.e. secured financial creditors, having charge on project assets; secured financial creditors, having no charge on project assets; unsecured financial creditors, with admitted claims less than Rs 10 lakh; and unsecured financial creditors, with admitted claims equal to or above Rs 10 lakh.

So, for instance, Standard Chartered Bank was categorised as an “unsecured financial creditor” because the security given to it against the financial assistance was not one of the project assets — any physical property belonging to Essar Steel. Standard Chartered Bank had given a loan to it on the basis of a security of shareholding in an offshore company instead.

According to the resolution plan, while other financial creditors were allowed 91.99 per cent of their claim amount, Standard Chartered Bank was only provided with 1.74 per cent of the claim amount on the grounds that “it has no charge on project assets” of Essar Steel.

Earlier this month on 4 July, the NCLAT ruled this to be “discriminatory”. It held that the financial creditors cannot be discriminated on the grounds of “secured” or “unsecured” for the purpose of “distribution of proposed amount amongst stakeholders in the ‘Resolution Plan’ by the ‘Resolution Applicant’”.

However, according to an advocate involved in the matter, the NCLAT’s decision is discriminatory, as it has sought to treat as equals two unequal classes of financial creditors.

The judgment would defeat the very objective of IBC — that it should favour resolution rather than liquidation, said the advocate who didn’t wish to be identified.

“The objective of IBC is resolution. But now, all the lenders who have a higher quality of security and are not willing to let go of their share to a lesser quality security financial creditor, they will not want to go through a resolution process and wait for a resolution plan.

“They would be sure that they will have to share their gains with the other parties. In this scenario, they will push for liquidation, because there they are bound to receive a better amount,” added the advocate.

Financial creditors vs operational creditors

Since the pronouncement of the NCLAT judgment, there has been an uproar against the appellate tribunal’s insistence on treating operational creditors on par with financial creditors.

Operational creditors are those who provide goods or services to the company and are owed money in lieu thereof. They usually have short-term credit arrangements, which are fulfilled once products/services are sold.

Financial creditors, like banks, lend money with long-term debt repayment schedules.

Essentially, operational creditors can choose to opt out, while financial creditors, who agree to accept a resolution plan to keep a company afloat, need to continue providing credit to the company.

The SBI-led CoC had decided to give 10 per cent to the operational creditors, while keeping 90 per cent to the secured creditors — themselves. This was in view of Section 30(2b) of the IBC, which states that the CoC’s plan should provide operational creditors with a value that they would receive in case of liquidation of the corporate debtor.

Section 31 of the code asserts that the NCLT “shall” accept the CoC’s plan if all conditions laid down under Section 30 are satisfied.

However, the NCLAT set aside this arrangement and directed the CoC to give 40 per cent to the operational creditors, “to safeguard” their rights and that of “other ‘financial creditors’”.

In doing so, the tribunal relied on its November 2018 judgment in the insolvency case concerning Binani Cement Ltd, in which it had ruled that operational creditors must get at least a similar treatment compared to the financial creditors. This judgment was upheld by the Supreme Court.

Before the pronouncement of the NCLAT judgment, financial creditors to Essar Steel were certain that tribunals can only recommend changes to a resolution plan, and that the IBC entrusts the final commercial decision to the CoC, as has been held by the Supreme Court in the past.

They had cited the NCLT’s order in the case which instead of modifying the resolution plan for Essar Steel chose to suggest that the plan be reworked to distribute ArcelorMittal’s Rs 42,000 crore settlement offer among the financial and operational creditors in the ratio of 85:15.

Lenders demand amendments

Naturally, treating them similarly evoked a sharp reaction from SBI chairman Rajnish Kumar. He expressed his disappointment with the stand taken by the NCLAT and was quoted as saying, “If secured creditors are given the same treatment as operational creditors, then it is a huge disincentive for secured creditors and an incentive for operational creditors.”

The lenders had mulled discussing the options with the Finance Ministry and pushing for amendments to the IBC to ensure that secured creditors receive priority in the process. The amendments to the code cleared by the Modi government Wednesday squarely aimed at clarifying some of the concerns raised after the NCLAT order in this case.

The amendments set 330 days as the maximum time allowed for the life-cycle of the resolution process, including litigation, and also seek to define the rights of the financial creditors who do not vote in favour of the resolution plan, as well as that of operational creditors.

Once hearing begins in the top court, the Ministry of Corporate Affairs might even file an impleadment application against the NCLAT judgment.