Banks are beginning to see the light at the end of the lending tunnel, but the challenges facing investors are still daunting. Rebecca Abraham reports

As the clean-up of the balance sheets of lenders continues, and with nearly US$210 billion of stressed assets up for grabs, investors have been circling companies that are on the verge of bankruptcy.

In the latest example of private equity funds tapping into opportunity in the distressed asset space, Blackstone Group recently announced that it would be investing at least US$150 million in Mumbai-based International Asset Reconstruction.

GOING FOR A SONG

Action has been fast and furious ever since the Insolvency and Bankruptcy Code (IBC) came into force at the end of 2016. The code gives financial and operational creditors the right to file for insolvency following a default of ₹100,000 (US$1,460) or above. As a result the National Company Law Tribunal (NCLT) has admitted about 750 cases, of which about 40 relate to companies referred for insolvency action by lenders after the Reserve Bank of India (RBI) directed them to do so. Most were from the infrastructure and power sectors.

On 18 May, a subsidiary of Tata Steel, Bamnipal Steel, announced that it had successfully completed the acquisition of a controlling stake of 72.65% in Bhushan Steel, which was one of the first 12 defaulters notified by the RBI in June 2017. While Bhushan Steel had defaulted on ₹560 billion, reports suggest that lenders received ₹352 billion to settle their dues and a 12.27% stake in the company.

Tata Steel’s successful acquisition of Bhushan Steel is the first big win for the IBC regime, and much is being made of how it has transformed sentiment. Yet legal challenges abound for investors looking to acquire assets through this route.

MULTIPLE HURDLES

“This is a new law and to an extent there is a lack of clarity with respect to certain aspects,” says Sumant Batra, a partner at Kesar Dass B & Associates who is advising on several of the insolvencies that are currently making their way through the system. “Till such time as the jurisprudence on this develops we will continue to face some disruption, and stakeholders will go to court being aggrieved by the decision making process or by the process itself … one can see [this] in all the cases across the spectrum.”

Sumant-Batra-Partner-Kesar-Dass-B-&-Associates

The bankruptcy and eventual successful resolution of Bhushan Steel is a case in point. While considering this case, the NCLT received pleas from: the employees of Bhushan Steel; Larsen & Toubro, which as an operational creditor sought priority over the company’s secured creditors in recovery of its dues; and Bhushan Energy, which sought to continue its power purchase agreement with Bhushan Steel.

The employees of Bhushan Steel had unsuccessfully argued before the NCLT that Tata Steel was not eligible under section 29A of the IBC. Section 29A, which was introduced in an amendment to the IBC, is a restrictive provision and any person falling within the negative list it prescribes is not eligible to submit a resolution plan.

Most commentators agree that section 29A is perhaps the most challenging provision of the IBC.

A WALK THROUGH FIRE?

Amit Aggarwal, a Mumbai-based partner at SNG & Partners, says, “demonstrating that the resolution applicant is not connected with the promoters and the senior management of the company is one area where he/she has to walk through fire.”

Amit-Aggarwal-Partner-SNG-&-Partners

Section 29A provides four layers of ineligibility, including where a person, acting jointly or in concert with a person suffering from a first, second or third layer of ineligibility, becomes ineligible.

“There is a limited pool of promoters and, this being India, everybody is related to everybody, so most bidders fall foul of 29A,” says Pooja Mahajan, a partner at Chandhiok & Associates, adding that it is “very challenging to ensure compliance of this provision”.

Taking note of the challenges posed by section 29A especially to micro, small and medium-sized enterprises (MSME), the government’s insolvency law committee, in its recent report, recommended that “since usually only promoters of an MSME are likely to be interested in acquiring it”, applicability of section 29A be restricted such that it only disqualifies wilful defaulters from bidding for MSMEs.

Pooja-Mahajan-Partner-Chandhiok-&-Associates

The insolvency law committee also recommended that in order to streamline 29A, “only those who contributed to defaults of the company, or are otherwise undesirable, are rendered ineligible”.

A STITCH IN TIME? 

A BRIEF PRIMER ON HOW THE INSOLVENCY AND BANKRUPTCY CODE WORKS

The Insolvency and Bankruptcy Code, 2016 (IBC), came into effect in December 2016. It covers individuals, companies, limited liability partnerships and partnership firms. Provisions for insolvency resolution and bankruptcy for individuals and partnerships are yet to be notified. The IBC does not, however, apply to entities in the financial sector such as banks and insurance companies.

The Insolvency and Bankruptcy Board of India (IBBI) is the regulator for overseeing insolvencies. A number of rules and regulations have been notified to create the institutions and professionals necessary for the process. Disputes that arise are referred to the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal. In a typical insolvency all classes of creditors – financial and operational – can trigger the process in case of non-payment of a valid claim.

The IBC provides for a standstill period during which stakeholders – concerned creditors and promoters – have the time to reach a common resolution plan. Following this a resolution professional is appointed, who invites resolution plans. The resolution plan that is put together needs to be approved by 65% of the committee of creditors, which comprises financial creditors.

The resolution plan, once agreed, needs to be sanctioned by the adjudicating authority, which for companies and other limited liability entities is the NCLT. If a resolution plan is not approved within 180 days, extendable to 270 days, the IBC provides for compulsory liquidation of the company. The IBC also provides for a fast-track insolvency resolution process, which can be initiated for smaller companies. It allows only 90 days – extendable by 45 days – in which a resolution plan has to be negotiated and agreed.

Data provided in the government’s Economic Survey 2017-18 show that more than 1,300 insolvency first information utilities have also started functioning. More than 525 corporate insolvency professionals are registered under three insolvency professional agencies, and insolvencies have been admitted across all 11 of the NCLT benches. In addition, 108 voluntary liquidation proceedings and one fast-track corporate insolvency resolution process have been initiated.

TIMELINES ALL IMPORTANT

The timelines built into the IBC are seen as crucial for its success, and early signs suggest that all parties are working to adhere to them.

In the ruling in JK Jute Mills Co Ltd v M/s Surendra Trading Co, the National Company Law Appellate Tribunal (NCLAT) said time is the essence of the IBC. Yet while the IBC stipulates 14 days for the NCLT to admit or reject an application for initiation of the insolvency resolution process, the tribunal held that this period is not mandatory.

The crucial 180 days within which the resolution professional has to complete the process has also been crossed in at least one case, Jaypee Infratech. Unlike most other cases, which were business-to-business companies, this one involved thousands of homebuyers. After the constitutional validity of the IBC was challenged, alleging that it did not recognize the rights of the homebuyers, the Supreme Court recently stayed orders passed by the NCLT, including one passed in August 2017, initiating the insolvency process.

It’s early days for the IBC and questions are still being asked about whether the NCLT and NCLAT have the capacity to hear the cases coming their way. Questions are also being asked about whether there are enough bidders for the distressed assets.

The one big difference between the IBC and most other insolvency regimes is that the management of the company is immediately replaced. The jury is still out on whether this will prove to be the Achilles heel of the Indian regime.

Court’s role in insolvency cases