India’s crackdown on companies that have defaulted on loan repayments is reshaping the country’s economy in fundamental ways. As the first three articles in this series detailed, competitive advantage is being tilted towards larger firms because only a handful of buyers is picking up most of the insolvent firms on sale. Between the resulting consolidation and the fact that most of these firms are changing hands at low rates, existing companies will struggle to compete. In addition, regional companies are being pushed into businesses beyond their core strengths.

These processes have been in motion since January 2016, when India’s banks, prompted by the Bharatiya Janata Party-led government and the Reserve Bank of India, started taking defaulting firms to the National Company Law Tribunal in an attempt to recover outstanding loans.

These structural transformations have been caused by the curious inflexibility that characterises India’s insolvency proceedings, which place the blame for bankruptcy entirely on the firm’s promoters, experts said. “The government is not making any concessions,” complained the chief financial officer of a steel plant in Chhattisgarh which has slipped into insolvency proceedings. “It is just putting the project up for sale.”

Inflexibility also shows in how these distressed projects are being rehabilitated. This is obvious from the way the proceedings have unfolded for a thermal power plant set up some 10 years ago by a well-regarded business group in North India. The group’s chief financial officer, who is in his mid-50s, said in his 35-year career, he has never seen anything similar to India’s bankruptcy proceedings that his unit is now facing.

The firm’s financial troubles were not caused by a fuel supply problem or dwindling demand for power – the plant had access to coal as well as buyers for its power. “The EBITDA margins were on a par with industry averages,” said the official, referring to the earnings before deducting interest, tax, depreciation and amortisation.

The problem lay elsewhere. “Between delays in government permissions and the delivery of plant machinery, the project’s cost went up by 20%,” he explained. After making all its payments (loans, taxes, running costs), the project was not left with enough working capital.

Attempts to recast the loan went nowhere. The group asked banks to take equity in lieu of some of the debt but it had multiple lenders and they could not reach a consensus, the executive said. The group also tried to get an investor from outside who would inject Rs 600 crore to Rs 700 crore, paying the banks a part of their dues immediately and the rest gradually. But the lenders again failed to agree. Then, on February 12, the Reserve Bank of India issued a circular instructing banks to start insolvency proceedings if a company missed its payments by even a day. Promptly, the bankers began seeking a buyer for the power plant.

Over a dozen companies evinced interest in the project but, eventually, only three made bids. The top bid – a little less than half the plant’s outstanding loans – came from a little-known company new to the power sector. The other two bids were half this company’s bid.

Clearly, these dynamics will neither help rehabilitate the power plant nor limit its creditor banks’ losses. Instead of restructuring the group’s loan – which would have enabled the banks to recover 70% of their outstanding dues – the banks pushed the project into a process through which it will either go to a company with no power sector experience for half the outstanding loan amount or be auctioned for an even lesser sum.

One reason for the inflexibility in India's insolvency proceedings is the BJP government’s fear that it would be seen as being soft on corruption, a former Union finance secretary said. Photo credit: PTI

Time of great inflexibility

One reason for the inflexibility in the insolvency proceedings, said a former Union finance secretary who did not want to be identified, is the government’s fear that it would be seen as being soft on corruption. “It sees even bad loans as fraud,” he said. This is why the government is taking measures such as “extinguishing shareholdings” – that is, getting rid of the promoters of all defaulting companies.

This attitude, observers said, refuses to acknowledge the fact that companies can become nonviable for multiple reasons. In recent years, these have included promoters’ malfeasance, abrupt government decisions such as demonetisation in November 2016 which cut off the flows of vital capital and Supreme Court rulings such as the one in 2014 cancelling the allotment of captive coal blocks, pushing many steel and power companies into a crisis when they suddenly had to buy fuel at higher rates but sell their electricity at the same prices as before.

Other firms were pushed into distress by global factors such as China’s slowing appetite for steel after the 2008 Beijing Olympics. “There are ups and downs in business,” said the chief financial officer of the stranded power plant. “There are business cycles. All delays in loan repayment are not due to the promoter. In our case, bankers did not support us when needed.”

If one reason for this inflexibility is the government’s suspicion that all bad loans indicate corruption, another is its hurry to get banks lending again. “Lending is down and there is no money to invest,” said the former finance secretary. “So, the government thinks insolvency proceedings will bring money back to the banks and things will get back to normal.”

Vinayak Chatterjee, head of the infrastructure consultancy Feedback Infra added, “NCLT is essentially a banker’s solution to what is a larger problem.”

In this hurry, neither the government nor the commentariat has adequately considered vital questions like who will buy the distressed companies. “While we were all excited about teaching promoters a lesson, we did not think of a Plan B,” said a person familiar with the Company Law Tribunal’s proceedings in Mumbai who did not want to be identified. “Were there enough buyers? What will we do if a few companies do most of the buying?”

“NCLT is essentially a banker’s solution to what is a larger problem.”

There were other questions, such as the legal capacity of the Company Law Tribunal courts to rule on such high-stake business battles, not to mention the sheer number of cases. The country has 12 benches of the tribunal and 26 judges. Considering the workload, this report estimated, at least 80 benches are required.

As with most new pieces of legislation, India’s bankruptcy code comes with several ambiguities and contradictions. Compounding the problem, the National Company Law Appellate Tribunals, which hear complaints pertaining to the Company Law Tribunal’s rulings, have come up with some contradictory judgements – one admitted a company into the proceedings even though arbitration (talks between banks and lenders) were underway; another said such companies cannot be admitted into the proceedings.

“It will take four or five years for the new bankruptcy code to settle down,” said a resolution professional, who is tasked by banks to find buyers for firms that have defaulted. But “even before such bugs could be ironed out”, the official added, the Reserve Bank added to the problem by starting insolvency proceedings against the country’s largest defaulters.”

The resulting costs are heavy.

Great economic cost visited a steel plant in Chhattisgarh that has slipped into insolvency. To begin with, its suppliers and business partners like transporters have stopped working with it. “They want cash upfront,” said the company’s chief financial officer. Long-standing clients for whom the company developed special components pulled away as well. “They were unsure about the company’s prospects and wary of jeopardising their product lines,” said the executive. “We have somehow kept our production from falling – by paying for supplies upfront – but at great cost to margins.”

As more and more companies enter insolvency proceedings, operational creditors to these companies – suppliers, logistics providers, and so on – will be badly hurt. “The worst hit in all this are the operational creditors,” said the resolution professional. “As many as 50%-60% of them will perish in the next five or six years.” That is because the money generated from the sale of a bankrupt company goes first to its creditor banks and then employees. The operational creditors are left out. “I get calls from companies saying they were owed Rs 10 lakh and if they only get back Rs 50,000, they will be wiped out,” said the resolution professional.

As companies get sold at a fraction of their outstanding loans, or slip into financial distress due to the insolvency proceedings, India will see an erosion in the value of these assets. Further, as a few companies buy most of the distressed firms, the country will also see a concentration of wealth. It will also see a slackening of investments, several executives told

With the government removing the managements of all companies that fail to make their loan repayments without factoring in reasons for the default and handing over the reins to bankers and resolution professionals, businesspeople feel insecure. “We are telling promoters their shareholding means nothing,” said the chief financial officer of the North Indian business group. “This is not a good sign for welcoming further investment. Even Indian companies will now go and invest overseas. Do you see any reports in the financial dailies announcing fresh capacity expansions?”

A better way 

Given that businesses can run aground for many reasons, one view is that every project should have received a “bespoke solution”, said Feedback Infra’s Vinayak Chatterjee. “The country should have created a category of national assets and treated them according to their problems – not just as a banking problem,” he said. “Only in cases where the promoter was a wilful defaulter should the company have been taken away.”

Alternatively, the government could have asked public sector giants such as the Steel Authority of India or the National Thermal Power Corporation to take over these projects. “SAIL could have rehabilitated these projects,” said a Mumbai-based steel analyst. “That would have given India better control over steel prices than the private players [buying most of these assets]. They should have done something similar with NTPC.”

Worrying track record

India’s insolvency proceedings were started with a complex set of objectives. They had to minimise losses to banks. They had to rehabilitate the distressed companies. They had to do all these swiftly and transparently.

The record so far is worrying. Only a few firms are doing most of the buying. Besides, banks are recovering only a fraction of their loans. Beyond the top 50 defaulters, said the steel analyst who did not want to be identified, most companies will be bought at even lower valuations – mostly by asset reconstruction companies that are likely to sell them piecemeal. The outcome is one where the buyers will make money not by running these companies but by trading in them.

This is the last article in a four-part series on India’s attempts to tackle its bad loan crisis. You can read the other parts here.