How Do We Put Bad Loan Resolution In India On Fast Track?

On the first anniversary of the first case of loan default being filed at the National Company Law Tribunal, or NCLT, the Insolvency and Bankruptcy Code (IBC), which is supposed to tackle India’s Rs10 trillion of bad loans, is in the news for more than one reason.

ICICI Bank Ltd, the nation’s second largest private lender by assets, had approached the NCLT against Innoventive Industries Ltd, a Pune-based steel products maker, on 7 December 2016. The case was admitted on 7 January.

Innoventive Industries is facing liquidation after a committee of creditors rejected a couple of resolution plans, including one from the company’s promoters. The decision to liquidate the company’s assets was taken in a meeting of the creditors in October.

Meanwhile, the Indian government has recently passed an ordinance that significantly amends the original Insolvency and Bankruptcy Code. The objective is to plug a loophole in the law that allowed wilful defaulters to re-purchase their stressed assets at a discounted price.

While the intention seems to be well-meaning, the blanket ban closes the doors for promoters who are not wilful defaulters but victims of external developments. Besides, this also limits prospective buyers, particularly for thousands of small and medium enterprises (while large assets will continue to attract strategic investors and distress funds). This will kill competition and banks will end up facing deeper haircuts and lose more money.

(A wilful default occurs when an industrial unit defaults in meeting its repayment obligations to the lender even when it has the capacity to honour the obligations or has siphoned off the funds. It also can happen when a unit has not utilized the finance for the specific purpose for which the money has been raised, or has defaulted in meeting its repayment obligations to the lender and at the same time disposed of the movable/immovable assets offered as security for a term loan without the knowledge of the lenders. Of course, the identification of the wilful default should be made keeping in view the track record of the borrowers and not on the basis of isolated transactions. In sum, when a default is intentional, deliberate and calculated, it gets the tag of wilful default.)

Even before the debate on the ordinance dies down, the NCLT decision to dismiss the board of Unitech Ltd, a leading real estate company, and directing the ministry of corporate affairs to nominate 10 directors on its board opens up another chapter. The newly appointed directors will oversee the recovery of assets and refunds of close to 5,000 homebuyers from what was once India’s second largest real estate firm under the directive of the Supreme Court.

Innoventive Industries had a debt of around Rs955 crore at the end of September 2016. The liquidation value could be in the range of Rs130-140 crore. Going by the media reports, the promoters of Innoventive Industries, along with a financial investor, had offered to infuse up to Rs180 crore in the company against a 75% haircut by the banks.

An external bidder, too, had proposed a one-time settlement against a haircut of 88%, but neither of them cut ice with the lender. While the final word in this case is yet to be heard, the lenders to Synergies-Dooray Automotive, an auto ancillary company that was dragged to NCLT, are to get back Rs54 crore, just about 6% of their exposure of Rs972 crore. The creditors are Exim Bank, boutique financial services firm Millennium Finance Ltd, auto ancillary firm Synergies Castings Ltd, and Alchemist Asset Reconstruction Co. Ltd. Incidentally, Exim Bank had transferred its share of loan to Edelweiss Asset Reconstruction Co. Ltd.

The Reserve Bank of India (RBI) in June had first directed the banks to take the 12 largest loan defaulters, accounting for one-fourth of the industry’s bad loans, to NCLT. It followed that up with another list of 26 defaulters. The Indian central bank wants the lenders to start the process of debt resolution against them before initiating bankruptcy proceedings. These accounts are to be first resolved through any of the RBI’s existing bad loan resolution schemes and only those cases which are not resolved this way should be taken to NCLT under the bankruptcy route by the end of December. At least 60% of the outstanding amount in these accounts has already been classified as non-performing on the books of the banks.

The banks need to set aside 50% of the loan amount as likely losses for all bad loans referred to NCLT under the bankruptcy code. RBI has also directed the banks to set aside 100% for those cases which are not resolved under insolvency proceedings and are forced into liquidation.

It is clear that after the recognition of bad assets, resolution should be faster as otherwise the lenders will suffer for long. The banks have been aggressively pushing for resolution and for some of the large cases of bad loans, they have already lined up a slew of investors.

Overall, there are two types of investors—strategic investors and distress funds. Typically, the funds will always offer less than the strategic investors as they would warehouse the assets and look for an investor at a later stage to offload their exposures and make money.

For textile company Alok Industries Ltd, I am told, there are at least three strategic investors—Arvind Mills Ltd, Sutlej Textiles and Industries Ltd and Reliance Industries Ltd—and a leading private investment firm, TPG, in the fray. Similarly, for Monnet Ispat Ltd—Tata Steel Ltd, JSW Steel Ltd, Shyam Steel Ltd and Vedanta Ltd, besides Edelweiss’s ARC arm, are showing interest. Vedanta, which plans to enter the steel segment, is also interested in Electrosteel Steel Ltd (other bidders are Tata Steel and JSW Steel) and Bhushan Steel Ltd (other bidders are ArcelorMittal and Tata Sons Ltd).

Two roadblocks

While the Synergies-Dooray Automotive case is not good news for the lending community and the ordinance even queers the pitch further, there are two other critical issues that have been hindering the resolution process.

One of them is the competition norm. Under the Competition Commission of India rule, no single company can enjoy more than 40% share in any market. This prevents some of the existing steel makers from bidding for any steel asset. I understand that the bankers are seeking a three-year waiver from this clause from the Competition Commission.

An even bigger road block is related to income tax. A waiver of interest and principal payment is a deemed income under the Indian income tax law and is taxable. For instance, if a company has an outstanding loan of Rs26,000 crore and the settlement is done at Rs10,000 crore, the new owner of the company supposedly gains Rs16,000 crore and is expected to pay minimum alternative tax, or MAT, at the rate of 23% on this amount. To that extent, its cost of acquisition goes up and makes the deal that much more expensive.

One way of sorting this out is adjusting the so-called deemed income against the accumulated loss of the defaulting company. In this case, if the company has an accumulated loss of Rs12,000 crore, for the prospective buyer, the taxable income comes down from Rs16,000 crore to Rs4,000 crore, and to that extent, the tax payment and the cost of acquisition goes down.

A one-time benefit was earlier given under the Sick Industrial Companies Act, or SICA, when such companies were referred to the Board for Industrial and Financial Reconstruction, or BIFR, for resolution. Unless this bit is taken care of, IBC will be an extremely slow lane to recovery.

Post Script

Meanwhile, the promoters of Recorders and Medicare Systems Pvt. Ltd, a Haryana-based medical equipment maker, have challenged the IBC amendment through an ordinance, arguing that the amendment has not differentiated between genuine promoters and wilful defaulters. They also argued that the ordinance should not apply to companies nearing the end of insolvency proceedings. The Chandigarh bench of the NCLT granted the company more time to maintain its operations, instead of immediately facing liquidation. The case will be heard on 25 January.

This column first appeared in www.livemint.com

To read his earlier columns, please log onto www.bankerstrust.in

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His latest book, From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures has just been released.

His Twitter handle is @tamalbandyo.