IBC was positioned as a game changer and perhaps “the ultimate” tool to address the menace of NPAs which has plagued our economy. Since inception, the Indian Banking Industry has never looked so fragile and vulnerable at the backdrop of increasingly alarming quantum of toxic debt which to my mind is one of the biggest reasons of slowdown in recent years. Pegged with overwhelming expectations from stakeholders and Authorities the much awaited IBC initiative was launched a couple of years back essentially to clean up the Bank’s NPA mess and to gradually help them come back on track into active lending mode along with potentially providing the much needed boost to investor confidence percolating down to the Bond Market.
However one should have contemplated that this transition from the era of SARFESI, BIFR, DRT characterised by dismal recovery rates of 10-15% to a progressive framework like IBC promising a 50% recovery (if not more) in a time bound manner, bringing about radical changes in the resolution process was never going to be easy. At the cost of sounding judgemental let me share my perspective on where we stand and what to expect going forward along with some insights on the implication of IBC so far.
Where do we stand?
As far as the current situation goes, NPAs of Indian Banks stands at an alarming INR 9.99 Trillion (GNPA ratio of 10.15%) as on 30thSeptember 2018 posing one of the biggest challenge currently faced by the Indian economy. Since implementation of IBC two years ago, it is worthwhile assessing to what extent the following two key objectives have been achieved:
- Time bound process and efficient resolution
- Maximize the value of recovery of stressed assets
Although India has managed to improve its ranking in both the World Bank’s Ease of Doing Business as well as the World Economic Forum’s Competitiveness Index, World Bank Data shows that India still performs poorly on the time taken for debt resolution not only in comparison with the developed G7 countries but also in comparison with other BRICS countries. IBC specifies a time bound process of 180 days extendable to 270 days from the time of appointment of RP. My sense is this was supposed to be an aspirational target set by Authorities which would perhaps put us in the top league of nations in terms of resolutions of debt in a time bound manner.
As of September 30, 2018, about 29% of the ongoing cases of Corporate Insolvency Resolution Process (CIRP) cases have already crossed the deadline of 270 days, while another 20 per cent have crossed the 180-day timeline. As on September 30th 2018, 1198 cases have been admitted under IBC by the National Company Law Tribunal (NCLT). Out of which only 52 cases (4%) have been resolved with a total recovery of nearly Rs 71,000 Crore, 212 cases (18%) faced liquidation, 118 cases (10%) were closed by appeal/review and as many as 816 cases (68%) are still ongoing. The average recovery in the cases resolved is about 45% which could be primarily attributed to the asset heavy nature of these businesses.
One of the major hurdles being faced in speedy resolution of the CIRP cases is inadequate infrastructure at NCLT, procedural inefficiencies and legal hurdles.
Nearly 6,000 petitions have been filed under IBC at NCLT until now. To address this there are only 11 NCLT benches across the country which are catering to these petitions as well as other cases. Over the next couple of years I expect a cascading effect of financial stress on the vendors of some of these large Insolvent companies and business groups. I expect the number of petitions to increase 3-4 times over the next couple of years in comparison to the last two years further stressing the already stretched bandwidth of the NCLT framework unless expanded.
Evolution of IBC and its Implications
Since implementation, IBC has been continuously evolving with four amendments already enacted. Some of the key amendments include, Voting threshold required by Committee of Creditors (CoC) reduced from 75% to 66% in the larger interest of achieving timely resolution. Home buyers have been included under Creditors to make the process fairer to all the stakeholders. Relief measures are provided for MSME promoters. Withdrawal of admitted petition is allowed with 90% voting of CoC. Under the fourth amendment, operational creditors are given priority over financial creditors under a resolution plan while the priority to pay the liquidation value to dissenting financial creditors is done away with. The role for Insolvency and Bankruptcy Board of India (IBBI)has to continue to provide continuous engagement and development of the IBC over the next few years to ensure timely and efficient resolution process.
The RBI mandated the top twelve cases to be resolved under IBC but these cases have faced legal issues right from the beginning and at every stage of the resolution process. In hindsight, it appears that a better approach would have been to take-up medium sized cases for resolution under IBC before taking up the high profile top twelve cases which are not only big but also complicated. Such an approach could have perhaps helped in fine tuning of the IBC before larger cases are taken up. Value erosion in some of the large cases has generated a negative impact on investment climate in several sectors and I fear it may ultimately lead to re-rating of some of these core sectors like Power, EPC etc. downwards further impacting the economy.
Removing Ambiguity going forward
The amendments enacted so far have been inspired by various on-going and past cases but some of these amendments have led to ambiguity. Thus, it is important to analyse the upcoming cases of CIRP and Liquidation in a much more practical approach in line with the current business dynamics rather than just being regimental.
Inspite of the four amendments effected to IBC ambiguity and legal challenges still remain in the resolution process. Given the importance that IBC has attained in the last two years and its potential impact, we cannot afford to be complacent about the relevant iterations and changes that needs to be brought about to improve its effectiveness. For example, it is not clear whether the Resolution Professional is liable to conduct an independent scrutiny of the eligibility of the Resolution Applicant under Section 29 (A) of the IBC or he can rely on the affidavit submitted under Section 30(1).
The definition of related party under Section 29 (A) is stretched too far thus excluding potential bidders who do not have a shared interest with the promoters. The period for which a potential bidder / promoter is ineligible to comeback as a stakeholder in the same company needs to be clarified. The creditors status did not fully address the problems of Home buyers as they stand fourth in the order of priority in the Waterfall Mechanism provided under Section 53 of the IBC.
The priority given to the payment of Operational Creditors (OCs) as per the fourth amendment over and above the Financial Creditors needs to be further refined and articulated
Suggestions & Way Forward
Given the exponential addition in the number of cases expected to be referred to NCLT under IBC it is imperative to create additional benches to minimize the delay in the resolution process.
As per the IBC, the insolvency procedure can be initiated by a creditor with a default of an amount as low as Rs 1 lakh, which opens up the NCLT to a lot of additional burden with cases filed by operational creditors as part of the recovery effort. Recent government initiatives which empower the Registrar of Companies to handle minor violations of the Companies Act eliminated the need to approach NCLT. This would help in reducing the work load on NCLT while providing faster process for minor issues.
New initiatives such as Samadhan and Sashakt which aim to encourage Pre-NCLT resolution for stressed companies may also lead to reducing the burden and effective utilization of the NCLT benches and avoid value diminishing due to delay in the resolution process at NCLT.
However these alternatives have so far panned out to be only of theoretical significance since the mood with senior Bankers seems to suggest that when it comes to taking haircut they prefer decision making through NCLT rather than sticking out their neck to endorse a resolution plan outside court process. This is ironical since Bankers are fully aware that Pre-NCLT solutions may clearly workout better in terms of overall recovery. Empowering decision making based on merit with Banks and Financial institutions to take such bold calls without the fear of being questioned by Investigative Authorities is one of the most significant takeaways and can go a long way in terms of de-clogging the NCLT ecosystem.
Training and support to Insolvency professionals is required to ensure that a high level of competence and professionalism is maintained in the resolution process. In my opinion it may not be a bad idea to assess the suitability of resolution professional based on his sectoral expertise and exposure of dealing with similar cases rather just banking on historical empanelment with CoC. Delays are also caused by procedural inefficiencies such as following the conventional internal processes for obtaining internal approvals for the resolution plan within each of the constituents of the Committee of Creditors (CoC). This needs to be streamlined within each of the Banks respectively according a Fasttrack approval and decision making process for IBC cases and also ensuring the decision makers to be a part of the CoC meetings when the resolution plan is being deliberated/negotiated with the Resolution Applicant.
Further legal hurdles are also contributing to the delays since stakeholders in several cases have moved to NCLAT and Supreme Court delaying the resolution process. In order to avoid inordinate delays there should be a hard stop on the review process and timelines, which unfortunately has lost essence in the current scenario given that more than half of the outstanding cases are expected to cross the prescribed deadline. It would be better to have a more realistic timeline, even if it is as long as one year to ensure consistency in the resolution process across cases and maximize the recovery value.
As per the provisions of IBC, in case of non-completion of the CIRP in 270 days, the adjudicating authority is required to pass an order to liquidate the corporate debtor. However, in most cases, the tribunal has further slowed down the process and extended the time period in the larger the interest of efficient resolution. Although the extensions are being granted with the right intention and aimed towards maximization of value, they are setting a bad precedent. Apart from the legal standpoint, with the stretched timelines the companies can lose sight of running business on a going concern basis leading to further value erosion. In a liquidation scenario with extended timelines the recovery value diminishes at a rapid pace and hence such a process needs to be executed in a robust and timely manner.
Experience across the world indicates that effective bankruptcy laws can help deepen the bond market. In countries such as Brazil, Russia, United Kingdom and China, the corporate bond market as a percentage of GDP has significantly increased after implementing bankruptcy reforms. The development of the nascent Indian bond market which is only about 17% of the GDP depends critically on the effective implementation of the IBC
To achieve the larger goals of the IBC to promote entrepreneurship and availability of credit and to improve ease of doing business in India and attract investment, it is imperative to swiftly address some of the above mentioned teething problems. However it is fair to conclude that irrespective of the time it takes for the process to stabilise the long term impact of the IBC initiative would certainly result in redeeming the Banking industry and infuse the much needed booster to the investor community and the Indian economy.
Sandeep Upadhyay, Managing Director (Infrastructure Advisory) at Centrum Capital also covers the Stressed asset resolution.