IBC should build on the positives

Non-performing assets have been a problem for the banking sector for quite some time now. To curb this financial stress on the economy, Insolvency and Bankruptcy Code, 2016 (IBC) has been an island of hope for banks and financial lenders to realise their dues.

Even though the Code has had its own problems in its short run due to litigations and haircuts, it appears to be the most effective mechanism as on date to resolve the stressed assets in the system as per IBBI data as on December 31, 2023. Here it is also not out of point to mention that IBC, though intended to be a resolution mechanism, has remained a dominant law with a recovery of 40.3 per cent in 2022-23.

Prior efforts by banks

The period 2000-2008 saw tremendous growth in terms of expansion of industries due to the availability of credit. The tremors of 2008 recession along with several other challenges started showing up around 2014-15 and that led to a host of bank loans turning into NPAs.

The RBI, through a series of mechanisms in its different Master Circulars, tried to resolve the problem only to face very limited sector-specific success. The Strategic Debt Restructuring Scheme and the Scheme for Sustainable Structuring of Stressed Assets allowed banks to convert a part of their debt into equity and become a part of the management while running the company with the owner. These schemes never yielded good results however.

Some of the major roadblocks in the successful implementation of these schemes emanated from the stage of loan documentation, where the contracts lacked a provision for conversion of loan into equity and if such change had to be made it had to be done with the approval of the debtor. Even if banks were to transform a portion of the debt into equity without conducting a practical evaluation of its sustainability, it posed a significant obstacle as many stressed asset funds insisted on resolving the leverage problem before proceeding with the deal.

The IBC comes as the silver bullet in offering the solution which the above-mentioned circulars could never seek to achieve.

We assess the stories of one of the successful resolutions of a dirty dozen case i.e., Electrosteel Steels Ltd. The case presents a unique solution through resolution plan by the successful resolution applicant, Vedanta Star, by division of debt into sustainable and unsustainable debt, respectively.

The resolution plan carved out sustainable debt by making an upfront payment for the same. The unsustainable debt was transformed into equity shares in Electrosteel at a value of ₹10 per share (referred to as the “New Equity Shares”). These newly issued equity shares were distributed to the financial creditors in proportion to their respective portions of the unsustainable debt, serving as consideration. The recorded value of these new equity shares in the books of accounts matched the carrying value of the unsustainable debt.

This plan was approved by the Committee of Creditors (CoC) with 100 per cent majority which shows that during deliberations of the plan, the successful resolution applicant and the financial creditors were able to carve out a mutually beneficial solution to diversify the risks and capitalise on it with a resolution applicant of strong track record.

This was one of the rare cases in which the banks did take up a part of the equity which in the long run would help them realise gains when the equity appreciated under a successful new management. Results indicate that the value per share from going into negative in the year 2018 came back to positive and has done significantly well.

Rewarded by markets

Similar is the case of Ruchi Soya and a few others. An independent research done by IIM Ahmedabad states that listed companies having undergone resolution were well rewarded by the markets wherein their total market valuation has increased from about ₹2-lakh crore to ₹6-lakh crore in the post-resolution phase.

IBC has matured fairly well over the last 7-8 years due to active involvement from the government and many judicial precedents shaping the law, which now is not merely for recovery but for revival of the company in distress.

But the financial institutions in the CoC tend to prefer upfront cash payments or those that get over in the shortest period of time; without realising that they might be better off taking a small portion of equity.

While the counter argument is that it is not the business of banks to be invested in businesses as equity partners, the fact is that even giving credit to a certain business is based on the business model, management and projections.

Hence, when the CoC is confident that the company in distress is being acquired by a strong industry player with a proven track record, it is time they started considering taking a small portion of equity converted from sustainable debt. Unconventional resolution options and mechanisms need to be considered as we move forward.

The writer is a practising Advocate in Chennai and New Delhi and author of the book ‘Defaulter’s Paradise Lost’

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