Mounting Stress

Is IBC, 2016, the best option for stressed asset resolution?

Stressed advances in the banking sector are to the tune of Rs 12 trillion at present. Of this, Rs 4 trillion is covered by the first two lists of defaulters promulgated by the Reserve Bank of India. The third list is likely to account for another Rs 3 trillion. The Insolvency and Bankruptcy Code [IBC], 2016, which was introduced for the speedy resolution of stressed assets, has changed the dynamics from “debtor in possession” to “creditor in control”. The IBC has served two purposes. First, it has given control to the creditors, something which was missing earlier. Second, it has forced the promoters to discuss and negotiate with the lenders. For the first time, there is fear of liquidation among promoters. Due to the clubbing of old cases with new ones, the number of cases admitted to the National Company Law Tribunal (NCLT) is very high. On a stand-alone basis, of the 800 cases admitted to the NCLT, 32 have been resolved and another 136 cases have gone for liquidation. Since the introduction of the IBC, a large number of corporate debtors, rather than seeing revival, have been pushed into liquidation. The orders of liquidation pertain to historical cases too.

IBC for infrastructure

Though the IBC is a game changer, it is not the ultimate solution to the problem of stressed assets across sectors. Companies in the steel industry have been referred to the NCLT and are undergoing insolvency proceedings. However, the resolution of stressed assets in sectors such as roads cannot be done through the IBC alone. Not all cases have asset value. Industries where the underlying assets do not hold much value will not find any resolution either through the IBC or outside the code. The IBC may work well for commodity-based industries, but may not render the desired results for those industries where there is substantial involvement of promoters, high brand value, or for engineering, procurement and construction (EPC) companies.

As far as the infrastructure sector is concerned, it can be split into two segments – the EPC space and the road and power sectors. The value of EPC businesses is driven by the order book, the firm’s pre-qualifications (PQs) and its key personnel. Most EPC contracts provide for clauses which enable their clients to terminate project agreements upon commencement of insolvency proceedings. Upon termination of project agreements, clients of EPC companies invoke their performance bank guarantees, thereby further increasing their liabilities and the financial exposure of the creditors. Given the takeover of management by the resolution professional, the EPC firm is unlikely to bid for any infrastructure projects using its PQs, as this would increase the liability of the company. It creates uneasiness among key personnel and they often decide not to continue their engagement with these companies. Large-scale exodus of key personnel severely impacts the execution of ongoing projects, which in turn results in termination of contracts by clients and invocation of bank guarantees. The aforementioned complexities and issues surrounding the insolvency resolution of an EPC company severely limit the number of prospective resolution applicants during the insolvency process. The committee of creditors may therefore order such an EPC company to be liquidated. These issues also persist during liquidation. Therefore, lenders have to evaluate on a case-to-case basis whether the invocation of the IBC for an EPC company would be advisable as compared with resolution outside the IBC. Further, the outcome in the case of Coastal Projects Limited, IVRCL Infrastructures and Projects Limited and Era Infrastructure, which have been admitted under the IBC, will provide guidance to lenders in invoking the IBC in the future.

In the power and road sectors, the offtake contract, whether in the form of a power purchase agreement or a tolling concession, is dependent on policy decisions and the regulatory framework. The tariff or toll changes according to social and economic requirements. For instance, in the case of election politics, there are toll exemptions and tariff waivers/reductions. These are sector-agnostic issues. In such cases, the actual revenue from a pool of power and road assets may differ from what was estimated earlier. With regard to the power sector, the stress is in the distribution segment. The discoms, in turn, pass this stress to other players in the value chain. However, it is the generation companies that are being referred to the NCLT and not the discoms. There are external factors as well which affect the power sector. These include the poor performance of Coal India Limited, transportation of inadequate quantities of coal by the railways, waiver of agricultural loans, and involvement of government agencies. Due to these issues, power projects are not attractive for overseas investors. Therefore, the stress in the power sector is an inter-sectoral issue with a lot of ramifications. Projects with coal linkages in place, requisite clearances secured, and power purchase agreements signed have become stressed due to external factors. Thus, it is not right to punish the promoters. Currently, promoters with accounts classified as non-performing assets for more than one year are not eligible to submit a resolution plan under Section 29A of the IBC. Therefore, such matters need to be taken up on a case-to-case basis. Meanwhile, there are some projects which have not been developed due to mismanagement or time and cost overruns. These need to be dealt with in a different manner.

Conclusion

A payment default, whatever the reason behind it, must be rectified at the earliest. The idea is to instill financial discipline in the system both at the lender’s level as well as the debtor’s level. If a company is defaulting on its payments to the lenders and a resolution plan is not forthcoming, then it should be allotted to the next best bidder to ensure that national resources are not left idle. According to a recent FICCI study, 67-70 per cent of the banks agree that the IBC has expedited the recovery process.

The recoveries made by banks and financial institutions under the IBC in 2018-19 will give the real picture of the extent of the code’s contribution towards the resolution of stressed assets. Although the IBC has made a strong political and economic statement in that it aims at finding a resolution, the country should not end up with too many companies being liquidated. Earlier, restructuring took place in an informal set-up. However, the IBC has provided a legal set-up – once a resolution plan is approved, it is binding on all stakeholders. Though the code has all the ingredients in place to provide a resolution, in each case one needs to ask whether the IBC is the best solution for resolution.

Based on a panel discussion among

J.K. Shivan, Chief General Manager, SARG, State Bank of India; Jayant Kawale, Managing Director, RattanIndia Power; Raj Kumar Bansal, Managing Director and CEO, Edelweiss Asset Reconstruction Company; Ajay Shaw, Partner, DSK Legal; and Girish Rawat, Partner, Dhir & Dhir Associates, at a recent India Infrastructure conference

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