Learnings from the IBC process | One of the RBI's First 12

Disclaimer: I was directly involved as an investment banker at Avendus Capital, advising the consortium of investors, bidding for a majority stake in one of 12 cases admitted to the RBI under the IBC process. I strictly intend not to disclose any new/market sensitive information relating to the company/transaction in this post. The below thoughts are broad in nature & entirely my own, based on my experience with the IBC process & interactions with its multiple stakeholders.

Admission to NCLT court

The first list of 12 large cases to be referred to the NCLT court was released by the RBI in June, 2017. The formal admission took place only in July, 2017. Going by the account size following were the exposures of the "dozen" as reported in the snap below:

Evolution of the IBC- Pretty Early Days

Being in the first lot of the cases under the Insolvency & Bankruptcy Code (IBC or "the Code") process, with no formal precedents, the learning for the Investors & all stakeholders was colossal for all 12 cases. Despite there being strict guidelines around the procedure by the Insolvency & Bankruptcy Board of India (IBBI), the process is still in its infancy to say the least.

In the course of the first 6 months of the process from July - Dec 2017/Jan 2018, (later extended by another 90 days to Mar 2018), a lot evolved in the Code and consequently the ecosystem. Following details my thoughts from being a part of that ecosystem & also the learning that came along with:

1: Doing Away with Bankers' Accountability

One of the most beautiful achievements of the IBC, as was widely echoed by all investors & lenders alike, is that the onus of decision making moves from bankers to the court. This is relevant particularly because bank branches or RMs (Relationship Managers) of these large accounts have so far feared that the decision making on haircuts would come back to haunt them years later. Note that, this is today as true for private sector banks as for the PSBs.

IBC by virtue of making it a court driven process absolves any particular individual, by way of placing a legal ring-fence on the decision taken by the Committee of Creditors (CoC) that gets a stamp of the NCLT court. There doesn't exist any further scope of a dissenting party challenging the merits of the order subsequently.

2. Deadlines are a welcome!

What makes IBC most inspiring for investors, promoters & employees alike is the strict deadline stipulated for resolution of the cases being admitted (at least on paper). All the other schemes put forth, such as DRT or BIFR were hugely unsuccessful pertaining to this single absolute factor. Insolvency cases in India have been infamously known to drag for 4 years on average- a figure often thrown around following the World Bank study released in 2014.

In such case, a severe blow is dealt to the operations in the company & consequently the equity value that the business commands from incoming investors. It becomes increasingly tough to command a composite value of all of a company's assets that hasn't been in operation for quite some time & would instead command no more than the strip value of its individual assets. The value of the business gets eroded significantly with each passing month, also blowing up the haircut for the lenders. The same is particularly felt for EPC businesses, where each deadline missed would further stress the receivables from one project used to fund the expenses of another, in the absence of an external working capital support till the IBC process was underway.

3. Courts not for exercising Commercial Wisdom

A significant gap that became apparent in the first few months, was the existence of multiple avenues statutorily provided for, at which appeals could be heard. Even after a resolution is passed by the CoC, there exists a potential opportunity for a dissenting party to derail the process by appealing in a subsequent court (NCLT/ NCLAT/ SC).

In the IBC, the spirit of the statute provides for subject matters of appeal that relate to non-compliance of the bids with the guidelines or a particular legal process not having been followed. That's it! Courts do not have the power to comment on the merits of the case, but rather just the compliance with the law. However, there have been multiple instances where a dissenting party, mostly a creditor would move the higher court, even after a 66% (earlier 75%) approval of the CoC, thereby creating a fresh chaos. Also,

What's more unsettling then is the fact that the clock stops on 270 days, once a matter is under appeal.

The process then tends to make us reminisce of the SARFAESI or DRT days leaving it at an indefinite abeyance. While all such appeals have received a verdict sooner than later so far, restricting the subject matters of appeals is a matter of priority so as to enable the promised timelines to be adhered to in a sacrosanct matter.

4. Institutions still not mature enough to take Equity calls

In the process of pitching to scores of investor groups in the process, a common point of discussion for the potential investors was the underlying asset cover for their investments. While it does make sense for a creditor or even a structured fund, when equity investors start by looking to protect their downside, it tends to defeat the purpose of their very existence.

What's expected of the investors coming in to turn around a distressed business, is to reap super-normal potential gains by virtue of investing at a lower than market value of the assets, negotiate refinancing with the CoC, provide working capital support, beef up the stalled operations and enjoy the above normal returns to be reaped commensurate to the above normal risks taken by virtue of investing in a distressed asset.

A common theme that came up instead while pitching the idea to many of the distressed focused "equity" shops was the curiosity of the value of the underlying assets that they might have a claim over, should the process go south ways. This as an investment parameter is widely agreed to be of paramount importance in all the debt or structured credit investments. It in fact might also relate to many of the "Infrastructure style" investments, where equity holders might recover part of their investments through subsequent sale of underlying assets. However, entering into an IBC auction with this as the first checkpoint doesn't make much of a sense. The potential investors need to believe in the story of the business they are bidding for as that stands to give them supernormal returns, as against protecting themselves solely in case of another distressed sale down the line. Hope that the ecosystem stands to mature though, from an increasing number of foreign distressed/ vulture funds setting shops in India, specializing in the "turn & flip" skills.

5. Process to streamline Working Capital infusion missing in the IBC

This flows from a previous point I had made regarding the loss of business value with each passing month. The current provisions merit that companies admitted to the NCLT court under the IBC process have their bank support restricted as the Resolution Professional (RP) tends to record & freeze the outstanding liabilities of all potential creditors. This however tends to hinder the ongoing operations at the company, which are a must in order to preserve the value that the business commands.

It is therefore required within an IBC process for a set of investors to pump in working capital & the matter to be taken up with the CoC by the RP. An uncertainty however now exists within the investors regarding the treatment of this working capital debt in the Liability Waterfall. It makes sense then to have the CoC agree to place the Working Capital costs right at the top in the "Insolvency Process Costs" bucket. This would serve to incentivize such WC to be infused into the business, to keep the wheels churning for the business & not leave it to stagnate & lose value for the duration of 270 days that the process goes on.

Conclusion

IBC is clearly moving things in the right direction by way of providing a statutory framework within which an entire account lying unattended to for years, is methodically studied, bid for, debated upon & a decision taken on, all within a stipulated timeline of 270 days at the most. This provides a fresh breath to the non-promoter investors & lenders alike, providing them with a time bound legal reprieve.

That said, the process is still evolving every day with each case contributing to educate everyone involved of a missing nuance. It would be helpful to have a comprehensive updated readable repository of the latest orders. Currently the orders passed by the 11 NCLT courts are available only in scanned form, which would cause someone to have to browse through tens of pages to understand the rationale behind any particular one.

However it is too early to pressurize the IBC or to celebrate its success either. As suggested by Raghuram Rajan in his interview with CNBC yesterday when asked about IBC, SARFAESI had seen an initial success too, before being clogged down in appeals & counter-appeals that dropped down the recovery rates thereon. It is thus important for all stakeholders involved to wait & allow the process to evolve itself, while not undermining the salient features or the spirit which the IBC stands for, in any case.