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India’s new economic reform and its terrific results

Essar Steel: This is just a representational image.

by Sumeet Mehta

October 26, 2018 will remain the day that witnessed the biggest success of the Insolvency and Bankruptcy Code. This was the day when the beleaguered Essar Steel agreed to repay its Rs 54,389-core loans to its financial creditors and lenders.

If media reports have to be believed then Essar Steel may be ready to repay Rs 60,000 crore to close the deal and retain control over the steel company set up by the Ruia family.

This also is a desperate attempt by the Ruia family in order to draft all efforts of Laxmi Mittal-owned ArcelorMittal to buy out Essar Steel.

The Insolvency and Bankruptcy Code, 2016 is a revolutionary economic reform initiated by Prime Minister Narendra Modi. This legislation was pushed by Prime Minister Modi to address the issue of resolving bad loans (called Non-Performing Assets or NPAs) that riddled the financial health and sustainability of state-owned banks.

Banks, especially public sector banks (also called PSU banks) that are owned by the government through the President of India and controlled by the Union Ministry of Finance, were overburdened by bad loans not repaid by many borrowers.

By virtue of this legislation, banks and financial institutions are empowered to sell the undertaking to the highest bidder to recover the outstanding loan and interest. This means the promoters of defaulter companies stand to lose control over their companies.

One of the reasons for this legislation was to handle sale of the defaulter borrower as a going concern, instead of piecemeal liquidation of assets. This is because a going concern entity can fetch more value on account of valuation of its business compared to sale of individual assets.

This has also paved the way for consolidation in the industry by way of mergers and acquisitions, which was a catalyst for banks to extract premium valuations for buyers of these debt-ridden enterprises.

To initiate this process of recovering bad loans, India’s central bank – the Reserve Bank of India – identified top 12 borrowers. These 12 borrowers accounted for 25 per cent of the total bad loans of all the banks. The process was routed through National Company Law Tribunal.

In the first major success, Essar Steel has agreed to pay Rs 54,389 crores to its financial creditors and lenders and bring the company out of IBC.

This is a pathbreaking deal because the same borrowers – the Ruia family – were not able to repay the debt before the legislation of the IBC.

The whole story from not being able to repay the loans to announcing repayment of Rs 54,389 crores sounds like a thriller that can take you on a rollercoaster ride.

After legislation of the IBC, the process was mired with litigation with Ruias challenging the Reserve Bank of India’s right and powers to sell Essar Steel. In June 2017, banks initiated proceedings to sell off Essar Steel and in July Ruias appealed to the Gujarat High Court challenging the rights and powers of the banks to initiate this action.

However, NCLT admitted the insolvency petition against Essar Steel in August 2017. This is when the Ruias were forced to place a bid for their own company by joining hands with a Russian financier, VTB Bank, and forming NuMetal Ltd in Mauritius and its subsidiary in India.

In November 2017, the government amended the IBC and barred defaulters from bidding for any company under the IBC. By virtue of this amendment, the government was able to reject proposals of Laxmi Mittal-led ArcelorMittal and VTB Bank-led joint venture with the Ruias’ NuMetal from bidding for Essar Steel.

This was because ArcellorMittal-owned Uttam Galva Steel and Ruia-owned Essar Steel were defaulters.

Thereafter ArcellorMittal joined hands with Nippon Steel to form a consortium to bid for Essar Steel, and the Ruias and VTB Bank invited Jindal-owned JSW Steel and Anil Agarwal-owned Vedanta Group to join hands to retain their control over Essar Steel.

Action-packed drama continued in the courtrooms after NCLT ordered ArcellorMittal to repay outstandings of Uttam Galva Steel and KSS Petron to be eligible to bid for Essar Steel. At the same time NCLT allowed NuMetal to bid for Essar Steel. This resulted in ArcellorMittal knocking the doors of the Supreme Court against this NCLT order.

In its landmark judgment on October 3, 2018, the Supreme Court ruled that both ArcellorMittal and NuMetal would be allowed to bid for Essar Steel after they clear all their outstanding dues. In other words, this judgment forced the Ruias to first repay all the debt to retain control over their company.

This was the trigger for the Ruias to pull out of NCLT and repay the debts. This also resulted in ArcellorMittal presenting its intent of repaying all outstandings if they were allowed to bid for Essar Steel.

From NuMetal’s first bid for Rs 17,000 crores as against ArcellorMittal’s first bid for Rs 30,000 crores, Ruias have now agreed to repay Rs 54,389 crores to retain control over Essar Steel.

In other words, the Supreme Court has laid a precedent through this judgment: that  the existing management of a company will have to repay its outstanding loans in full instead of bidding at a discount to buy their beleaguered company.

In the same order, the Supreme Court has set yet another precedent: that any existing defaulter cannot bid for any takeover under IBC. Hence, this one judgment is a landmark one with two very important and path–breaking precedents that offers clarity on how the IBC would function in the future.

If this is not enough, as many as 2,100 companies with NPAs aggregating to Rs  83,000 crore have repaid their outstanding loans in order to retain control over their companies. This was solely done out of fear in order to not lose their companies. If a ‘draconian’ law like the IBC was not legislated, would promoters come forward to repay their outstandings?

If the Insolvency and Bankruptcy Code is managed well,
defaulting promoters will not get away with fraud and
banks will not be forced to bear huge losses

This is a major indicator of success of the IBC. We have to closely watch how IBC is managed and helps in recovering more than Rs 10 lakh crore of NPAs of 38 listed banks.

If IBC is properly managed, the tendency of promoters to not repay loans and defraud banks and later buy out their own enterprises at a fraction of the price, thereby forcing banks to take a huge haircut, would permanently end and we would see more responsible and accountable entrepreneurship.

There is a popular saying – Communist till one becomes rich, and atheist until the aircraft crashes. To this we can add yet another altruism: Capitalist till the business goes bankrupt.

Once the business starts facing problems and loan repayment becomes a problem, these capitalists turn into socialists making virtuous claims of how many people are employed because of their efforts and how many families are surviving due to their company.

A strict and result-oriented IBC will end all these frivolous arguments like, ‘we are providing employment to thousands and anything happening to our company will render these people jobless and families will be pushed into poverty. Banks must therefore take a haircut and entertain our wrong practices’.

Entrepreneurs and capitalists will become more responsible and should be taken to task if their actions are hurting the banks and financial institutions. Entrepreneurs and capitalists must not be allowed to become ‘good Samaritan socialists’ when they negotiate with banks to cajole them on taking a haircut on loans advanced to such opportunists.

Sumeet Mehta is a Chartered Accountant with wide experience in corporate finance, strategic corporate advisory, investment research and investment advisory.