Does the reluctance of Jet Airways’ creditors to pursue bankruptcy proceedings point to turbulence in the insolvency regime? Rebecca Abraham reports

The story of grounded airline Jet Airways has taken several twists and turns in recent weeks. Since the airline defaulted on loans due on 31 December 2018, its creditors, led by State Bank of India, have taken charge, and efforts to find a buyer are on.

At stake are not only the livelihoods of the airline’s 23,000 employees but also about `84 billion (US$1.2 billion) that banks are seeking to recover.

The elephant in the room in the Jet Airways saga appears to be the Insolvency and Bankruptcy Code, 2016 (IBC). Despite the IBC’s promise of a time-bound process that gives creditors the upper hand in their relationship with debtors, there appears to be little appetite to push the airline into bankruptcy proceedings.

Reports have suggested that creditors have resisted referring the company for insolvency resolution, and the National Company Law Tribunal (NCLT) has been kept conspicuously at arm’s length.

Some observers see this as an indication of rising cynicism among creditors about recovering bad debts through the IBC. According to a banker who did not want to be named, banks are increasingly seeking alternate avenues for the resolution of insolvencies in the hope of realizing more value in a shorter period of time.

PLAYING THE SYSTEM

Questions about the ability to realize the real value of assets through the IBC process have existed ever since the first resolution order was made by the NCLT in August 2017. That order – which related to Synergies Dooray Automotive – was passed within the 180-day time limit for approval of resolution plans, and saw the lenders in question settling for 94% less than their total claim.

This gave rise to concerns over the extent of the haircut involved, and also triggered allegations that the promoters of Synergies Dooray Automotive had played the system. Minority creditor Edelweiss Asset Reconstruction filed a petition alleging that Synergies Casting, a related party of Synergies Dooray, had bought out the loans from various creditors at a minor consideration and transferred them to Millennium Finance, which the petitioner alleged was acting as a proxy for the promoters.

To address this and similar concerns in other cases, section 29A was added to the IBC in November 2017, preventing defaulting promoters and related persons from bidding for assets. But this new twist in the insolvency process has increased the challenge of adhering to deadlines and triggered considerable litigation regarding the eligibility of resolution applicants.

A notable case in which section 29A played a vital role is the long-running and high-profile saga over the insolvency of Essar Steel, which was one of 12 big defaulters on a list of non-performing accounts compiled by the Reserve Bank of India in June 2017 that were to be referred immediately for bankruptcy proceedings. It was first admitted for resolution under the IBC more than 600 days ago and has since become emblematic of the near impossibility of adhering to the 270-day timeline (180 days plus a 90-day extension) in a system where high-stakes legal battles cannot be curbed and delays in the courts are endemic.

“If parliament has prescribed a 270-day timeline … all involved, including the judiciary, need to work to ensure that the timelines are met and respected,” says Mohit Saraf, a senior partner at L&L Partners, which has advised and acted on several of the more complex insolvency matters. “They have to appreciate that this is a commercial problem involving companies that have a limited shelf life, and if disputes are not resolved swiftly then the companies will cease to be viable concerns and bidders will lose interest,” he says.

Jet airways bankruptcyData in the most recent quarterly newsletter of the Insolvency and Bankruptcy Board of India (IBBI), the country’s insolvency regulator, reveal that of the 1,858 companies admitted to the resolution process between December 2016 and the end of March this year, only 152 have had their insolvency applications closed or settled. Ninety-one have been withdrawn, 378 have ended in liquidation and 94 have seen the approval of resolution plans.

The resolution processes in the remaining 1,143 companies are ongoing. As for the 12 big defaulters identified in June 2017 by the Reserve Bank of India, only six have been resolved to date.

UNFORESEEN TWISTS

Besides fears of a long, drawn-out process, protracted litigation and steep haircuts, creditors face additional challenges. The latest to encounter some unexpected twists appears to be Swedish telecom equipment maker Ericsson. After a long legal battle, debt-laden Indian telco Reliance Communications was forced to pay `4.6 billion of the `5.5 billion owed to Ericsson in a Supreme Court-monitored settlement on 18 April.

The settlement was hailed as a victory for the Swedish company, which used the IBC, and its own status as an operational creditor, as a negotiating tool to recover unpaid dues. The company was paid just as Reliance Communications’ promoter, Anil Ambani, was to be sent to prison for failing to honour a personal guarantee (he subsequently avoided prison after being bailed out by his older brother, Mukesh Ambani).

However, this may be a short-lived victory for Ericsson, as Reliance Communications has since opted to restart its bankruptcy proceedings. And in a bemusing turn of events, Ericsson may now have to repay the money it won.

The IBC prohibits preferential payments to some creditors, and Ericsson would have to line up with other creditors – financial and operational – before its claim is settled using the so-called waterfall mechanism for the distribution of proceeds from liquidated assets, as specified in section 53 of the IBC. The National Company Law Appellate Tribunal (NCLAT) has indicated that Ericsson may be required to return what it had won.

The situation may be a reflection of the fact that the IBC is intended first and foremost as a mechanism for rehabilitating distressed companies. Underscoring this stance, MS Sahoo, the head of the IBBI, said in a recent article in BusinessLine that the “primary focus” of India’s bankruptcy regime “is revival of an ailing firm, while recovery by creditors is an incidental outcome”.

PARADISE LOST

Despite its flaws, the IBC deserves praise for bringing about a transformation in Indian companies’ attitude towards their creditors. The fear of losing control of a company, or the prospect of a protracted legal battle, is forcing many companies to repay their debts before insolvency proceedings begin.

As Rajeev Choubey, the legal director at ACC, a LafargeHolcim company, says: “There is a clear-cut paradigm shift in how corporates deal with operational and financial creditors”.

Jet Airways’ creditorsThe IBC replaced a complex bankruptcy regime that comprised multiple laws and forums for debt recovery. Insolvencies in industrial companies, for instance, were governed by a law that had been repealed in 2003 – the Sick Industrial Companies (Special Provisions) Act, 1985 – but which continued to apply as it had not been replaced. As a result, winding up an ailing company could take more than four years, and lenders re-covered only around 20% of what they were owed once a default took place. This changed when the IBC, which applies to all companies except those in the financial sector such as banks and insurance companies, came into effect.

Nearly three years from the enactment of the IBC, many of the key legal questions regarding its implementation have been clarified. The IBC has also been credited with boosting the flow of financial resources to the commercial sector as a result of debts being repaid, and in January this year, in a landmark ruling of the Supreme Court, it withstood a constitutionality challenge.

Ruling in Swiss Ribbons Private Limited & Anr v Union of India & Ors, the Supreme Court said the code is “a legislation which deals with economic matters and, in the larger sense, deals with the economy of the country as a whole”.

Referring to the code as an “experiment”, the Supreme Court said it was to be “judged by the generality of its provisions and not by so-called crudities and inequities that have been pointed out by the petitioners”.

The court said: “To stay experimentation in things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences to the nation.” And in a shot in the arm for the IBC, the court added: “The defaulter’s paradise is lost.”

EVOLVING JURISPRUDENCE

It has been reported that a remodeling of the code may be in the works, with provisions being made for mediation as a mechanism for the resolution of insolvencies. The inclusion of a mediation mechanism, as is commonplace in developed jurisdictions such as the US, may alleviate the pressure on deadlines. Given the fates of India’s previous insolvency laws – including the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, which were consigned to the legislative scrapheap after being replaced by the IBC – the future of the code remains to be seen.

For now, those who have a front-row seat for the insolvency battles raging across the country may well agree with H Jayesh, the managing partner of Mumbai-based law firm Juris Corp, who says: “The more things change the more they remain the same … the ability of the Indian system to delay matters and invent work for lawyers never ceases to surprise.”

Jet Airways’ bankruptcyIn the face of such headwinds, there may be long delays before the future of India’s insolvency regime – and that of Jet Airways – becomes clear

QUESTION OF CONSTITUTIONALITY

In Swiss Ribbons Private Limited & Anr v Union of India & Ors, the Supreme Court recently held that the distinction made between financial creditors and operational creditors in the Insolvency and Bankruptcy Code, 2016 (IBC), does not violate the principle of equality enshrined in the Indian constitution.

While there is no room to doubt this, it may be true that financial creditors have a better understanding of the business and the viability of the corporate debtor on account of information gathered by them prior to lending and a long-term interest based on the large amount of loans that are involved.

However, in order to maintain an entity as a going concern it is essential that its operations run smoothly. This, in turn, implies that the operational creditors play a key role and it would not be erroneous to state that finances and operations go hand in hand for a going concern. Therefore, financial creditors and operational creditors should have equal status.

The implied objective of the IBC is the economic development of the country as a whole. However, the expressed objective of the code, which is time-bound insolvency resolution to maximize of the value of the assets, balancing interests of various stakeholders, promotion of entrepreneurship and the availability of credit, should also be upheld.

With respect to the debate on the constitutionality of section 29A of the IBC, a person who may be a related party of the promoter, as defined under section 5(24) and 5(24A) of the IBC, need not be a connected person as set out in the explanation provided in section 29A of the code. Therefore, the person should be permitted to participate. The fact that the judgment uses the words “cannot possibly be disqualified under section 29A(j)” leaves room for questioning disqualifications. However, permitting such persons to participate in the resolution process is to ensure maximization of the value of assets.

Further, it is a fact that if promoters are permitted to participate in the resolution process they may try to recover the enterprise at a rebate. It was to pre-empt this that sub-section (c) was inserted in section 29A. This proviso, however, should be made applicable to only those promoters whose misconduct led the corporate debtor to run into defaults. This may have been a failed argument in the judgment, but is practical and is legally sound value and is aligned with the objectives of the IBC.

Pranav Shroff, is an assistant manager in the law department of Axis Bank. The views expressed here are personal.