Why NCLAT verdict on Essar Steel needs a review

Radhika Merwin BL Research Bureau | Updated on July 16, 2019

BusinessLine digs into the 116-page order to find out

The recent National Company Law Appellate Tribunal (NCLAT) order in the Essar Steel case — that has upheld ArcelorMittal’s bid but put secured creditors on par with operational creditors — has rattled bankers and threatens to undermine the sanctity of the Insolvency and Bankruptcy Code (IBC).

Secured financial creditors will now have to contend with a lower 65 per cent share in Arcelor’s ₹42,000-crore offer for Essar Steel, against over 90 per cent proposed by the Committee of Creditors (CoC).

According to the NCLAT, secured, unsecured financial creditors (with claims equal to or more than ₹10 lakh) and operational creditors (claims equal to or more than ₹1 crore) — all should be paid about 60 per cent of their claims.

Essentially all classes of creditors have been treated identically by the NCLAT for the purpose of distribution of recovery proceeds. Such a judgment has gone against the basic tenets of repayment hierarchy, which accords priority to secured creditors.

The NCLAT has argued on three key points — commercial wisdom of CoC, equitable treatment of creditors and distribution of proceeds under resolution (as against liquidation).

Commercial wisdom

One of the key issues raised by the NCLAT is whether the CoC (comprising financial creditors) is empowered at all to distribute proceeds among various creditors.

According to the NCLAT, the Code clearly implies that the ‘Resolution Applicant’ (ArcelorMittal in this case) in its resolution plan must provide the amount it proposes to pay operational and financial creditors. But, of more importance is the question of the commercial wisdom of the CoC — once the resolution plan is approved by the CoC, can the adjudicating authority question it?

In the K Sashidhar vs Indian Overseas Bank (Supreme Court order February 5, 2019), it was held that the legislature has not endowed the adjudicating authority with the jurisdiction to evaluate the commercial decision of the CoC.

The NCLAT, in the Essar Steel case, has argued this by ruling that the distribution among financial creditors cannot be held to be purely commercial in nature (and, therefore, not beyond scrutiny).

The CoC is supposed to look into only commercial decisions — ascertaining whether the debtor is viable, coming up with a resolution plan, safeguarding value of assets, looking into the credibility of bidders. But then what forms part of the CoC’s commercial decisions is not laid down strictly in the Code and is open to interpretation.

Regulation 38 (1A) states that a resolution plan should include how it has dealt with the interests of all stakeholders. Under Section 30 (2) (b) of the IBC, the resolution professional (RP) has to examine whether the plan provides for the payment to operational creditors in a manner that it is not less than the amount to be paid to them in the event of a liquidation under Section 53 (which lays down the hierarchy of payment).

But none of these cited by the NCLAT, necessarily bars the CoC from deciding on the distribution of proceeds, as long as the operational creditor gets a minimum payment.



Minimum value

So, how do we ascertain distribution of proceeds to various creditors?

Here the NCLAT has ruled that Section 53 is irrelevant and the resolution applicant cannot take advantage of it to make distribution in favour of certain creditors. Distribution of proceeds during the resolution process cannot be equated with that under liquidation. While this may be true, without a guiding tenet (Section 53), it would be difficult to set aside an amount for an operational creditor. But it would be important to ensure equitable distribution.

While the original plan had given a raw deal to operational creditors, the NCLAT painting all creditors with the same brush is also flawed.

In the plan approved by the CoC, the RP had admitted operational creditors’ claims of ₹5,074 crore (against submitted ₹27,101 crore).

The NCLAT has bumped up the claims to be admitted for operational creditors to ₹19,719 crore — including claims of Gujarat Energy Transmission, Bharat Petroleum, Indian Oil, GAIL India, ONGC, NTPC, etc.

ArcelorMittal’s ₹42,000-crore offer works out to 60.7 per cent of total claims (financial and operational creditors) amounting to ₹69,192 crore; the NCLAT has assigned proceeds to all creditors in the same 60.7 per cent ratio.

Such a simplistic approach risks putting secured creditors in a worse situation under resolution than liquidation. Also, identical treatment of all creditors is fundamentally flawed.

In the oft-quoted SC ruling in the ‘Swiss Ribbons Pvt Ltd & Anr’ case, the SC had noted that “the objective of equitable treatment is based on the notion that creditors with similar legal rights should be treated fairly, receiving a distribution on their claim in accordance with their relative ranking and interests. This key objective recognises that all creditors do not need to be treated identically, but in a manner that reflects the different bargains they have struck with the debtor.”

The NCLAT has failed to acknowledge the fundamental requirement of equitability — equitable treatment of similar creditors and not all categories of creditors.

Published on July 16, 2019

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