ICCK

India moves to unblock sluggish bankruptcy process

Essar Steel among companies in crosshairs amid stepped-up push to clear out bad loans

Ten years ago, Essar Steel was leading a rush of Indian corporate investment, exuberantly funded by the country’s dominant state-owned banks.

It paid $1.6bn to buy Canada’s Algoma Steel, while pledging billions more to fund projects in Minnesota and Trinidad as well as a doubling of production at its flagship Indian mill to 8.5m tonnes a year.

Now, this unit of one of India’s best-known conglomerates is in the spotlight again — this time as the prime target of efforts to accelerate dramatically the resolution of bad loans clogging the banking sector.

The drive represents the first significant test of a landmark bankruptcy law passed last year, which bankers and investors in India view as a critical part of solving the bad-loan crisis. Amid a wave of defaults by companies in sectors from power to textiles, impaired loans accounted for 15 per cent of Indian bank assets at the end of March, according to Credit Suisse.

After gas supply problems and falling steel prices left it unable to service its loans, Essar Steel became one of 12 heavily indebted companies being dealt with by banks under India’s new insolvency law. They are doing so on instructions from the Reserve Bank of India, which in May was granted new powers by the government to force action against defaulting borrowers. 

The RBI is targeting a dozen companies with gross debts exceeding Rs50bn ($772m), at least 60 per cent of which were classified as non-performing at the end of the 2016 financial year. The dozen companies account for a quarter of Indian banks’ bad loans, says the central bank.

The intent is to end an era in which banks have repeatedly been lenient with defaulting companies, rather than launching a legal battle that could drag on for a decade or more. Under the new framework, if restructuring is not agreed within nine months of the insolvency law being invoked, a company will automatically go into liquidation. 

“It’s the first really capitalistic legislation for a long time, aimed at moving power from the equity to the debt, and allowing for the sharing of pain,” said Cyril Shroff, managing partner of Cyril Amarchand Mangaldas, an Indian law firm working on several of the 12 restructuring cases.

The law has been greeted as an attack on the perceived impunity of company “promoters”, or controlling shareholders, who maintained extravagant lifestyles as banks’ losses mounted.

“Every decade or so, taxpayers have had to recapitalise the state-controlled banks because the promoters have taken them to the cleaners,” said Saurabh Mukherjea, chief executive of Ambit Capital. “We’re beginning the journey here of saying to the promoters: ‘Don’t mess around with the banks’.”

Yet the optimism is tempered by caution, as the ultimate outcome remains unclear. Essar Steel has already filed a court petition against the RBI’s “arbitrary” action, according to media reports that have been confirmed by a person familiar with the situation.

The five steel companies among the 12 — Bhushan Steel, Bhushan Power & Steel, Electrosteel, Essar Steel and Monnet Ispat — are promising buyout targets for larger rivals such as Tata Steel, according to Ashish Gupta, head of India research at Credit Suisse.

However, it will be tough to find buyers for many of the companies, said Mythili Balasubramanian, an executive director at IDBI Bank, which is involved in 11 of the 12 cases. There is a dearth of suitable investors in India and insufficient foreign interest, she said, while banks themselves are unwilling to take direct control of companies by converting debt into equity stakes. 

Instead, she said, they were considering other options, such as the conversion of loans into preference shares, or long-term debentures where controlling shareholders have a convincing long-term business plan. This would dash hopes that the new insolvency regime would wipe out underperforming promoters but could yield more value to the banks than a fire-sale of assets, Ms Balasubramanian said. 

Others argue that some of the 12 companies are in such a poor state that liquidation could be the best option. “These assets have been rotting for so long — four or five years in some cases,” said Mr Mukherjea. “My reckoning is that . . . we’ll end up in a situation where the majority of these assets are a complete write-off for the banks.”

Liquidation would be a powerful warning to other indebted groups, said Saswata Guha, an analyst at Fitch. “We’re already hearing that the movement on these 12 companies has forced some of the promoters not in the list to look up and start coming up with solutions.”

But there would be an unwelcome flip side, he added, with banks forced to provision against the full value of the loans, a fresh blow to already strained balance sheets.

The weaker state-owned banks “could be vulnerable to even moderate levels of stress”, he warned. “Liquidation is not an option for them . . . it could end up with far lower recoveries than what they are trying to secure.”

From worst to first

If it works, India’s new insolvency law would create one of the world’s fastest-acting bankruptcy regimes, from one that is currently among the slowest and least effective.

Last year, the World Bank ranked India’s insolvency system 136th in the world, with cases taking 4.3 years on average, compared with 1.7 years in China and OECD high-income countries. The value of distressed Indian companies typically erodes badly during this protracted process, meaning creditors tend to recover only 26 per cent of the sum owed, against 73 per cent in the OECD.

India’s new bankruptcy law is intended to revolutionise this process. It can be invoked by creditors over a default on sums as small as Rs100,000 ($1,544). If the newly formed National Companies Law Tribunal agrees to hear the case — a decision it must make within two weeks — it will appoint an insolvency professional to take control of the company, assuming the responsibilities of the board. 

If a resolution plan is not agreed by the creditors after six months, with a possible three-month extension, the tribunal is required to order liquidation. 

The sheer ambition of the law has prompted doubts about whether nascent supporting infrastructure, such as insolvency professionals and the NCLT, will be a match for the huge volume of corporate distress in India.

“I wonder whether there is capacity to deal with so much,” said Cyril Shroff, managing partner of law firm Cyril Amarchand Mangaldas. “The timeframes are very aggressive.”

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