Thursday, March 22, 2018

Public policy in the context of India's bankruptcy code

Public policy implementation is hard. Regulations have to trade-off between being too restrictive and too accommodative. The former stifles genuine activities whereas the latter opens up opportunities for subversion. Given the entrenched, and well-founded, concerns about Indian corporate governance standards, bureaucrats tend to err on the side of caution and choose to be more restrictive than they ought to be.  

The implementation of the Insolvency and Bankruptcy Code (IBC) is a good example. With good intent, the original regulations allowed considerable flexibility on who could participate in the bids for resolved assets. But in the very first case itself it became evident that promoters had exploited the flexibility to game the process and gain control over their firm with the added benefit of having knocked off the debt-holders at negligible cost. 

Stung by allegations of supporting crony capitalism, the government responded by amending the regulations to bar defaulting promoters, loan defaulters, people convicted of offences, barred by regulators etc and their related entities from participating in IBC bids. This is a very wide list of exclusions and given that at least some of these are the norm, most of the country's largest industrial groups get covered. And this is what is happening,
It has become a fertile ground for litigation as bidders come out with reasons to show competitors are ineligible.
Consider this,
The high profile case here is Essar Steel Ltd where lenders are hoping to claw back as much as $6 billion. The eligibility of both its bidders is under a cloud because of their perceived connections with defaulters. NuMetal Ltd has bid in a consortium that includes an entity controlled by a trust that has Rewant Ruia, son of Ravi Ruia, as a beneficiary. VTB, the largest shareholder in NuMetal, has said that is willing to drop the Ruia trust and would go to court if its bid was disqualified. It has also said that cases and judgements in other jurisdictions related to VTB won’t disqualify its bids. Similarly, ArcelorMittal had a 29% stake in Uttam Galva, another defaulter, while its chairman L.N. Mittal held a 33% indirect stake in another defaulter entity KSS Petron. Both these stakes had been sold off before the steel giant bid for Essar, which ArcelorMittal believes is sufficient to ensure its eligibility..In the case of Electrosteel Steels Ltd, Abhishek Dalmia led Renaissance Steel has appealed to the tribunal questioning the eligibility of Tata Steel and Vedanta. Renaissance has alleged that some overseas subsidiaries (or officials) of these firms were convicted.
Could some of these have been anticipated with better framing of regulations?
In its current avatar, the law does not specify whether past associations are relevant for deciding eligibility, but this could very well be grounds for litigation depending on how the committee of creditors, that takes the final call on bids, chooses to view this... the code should clearly specify whether past associations with disqualified entities are relevant and for how long. Another could be to clearly specify what kinds of relationships are relevant instead of an all-encompassing definition of related parties and connected parties.
I'm not inclined to be sympathetic to a Ministry which made regulations without paying attention to such basic details - hard to not have foreseen the problems with not defining the kinds of association with disqualified entities and its duration and leaving them so open-ended. This is just as unprofessional as the original regulation did not anticipate and have some basic safeguards to ensure that promoters do not game the process by capturing the Committee of Creditors. I would classify it a failure of the bureaucracy.

Update 1 (21.04.2018)
Andy Mukherjee makes the good point that the insertion of Section 29A in November 2017 to exclude certain categories of bidders may have been a morality play, which while making a good law appear great, may have actually screwed up the actual implementation effectiveness. Sample this,
The morality was legal overkill; and that’s now evident in the farce that the insolvency of Essar Steel India Ltd. has become. Rather than helping creditors with the best possible recovery for the $8 billion that’s trapped in a 10-million-tons-a-year metals business, the bidding war has disintegrated into a contest to prove rivals ineligible... Rival investor groups led by VTB Capital and ArcelorMittal were the two contestants in the first round. But the creditors’ committee deemed both buyers to be ineligible, and went for a second round of bids. However, in a surprising twist, the National Company Law Tribunal (NCLT) on Thursday held the second round, in which Vedanta Group and JSW Steel Ltd. had also jumped into the fray, to be invalid. Creditors now have to reconsider the VTB and ArcelorMittal proposals...
So what has Section 29A really achieved? Well, for one thing, it’s become an instrument of virtue signalling. Take Indian steel tycoon Sajjan Jindal’s JSW, which stepped in as VTB’s second-round partner, replacing the Ruias, just in case the latter were deemed unfit. Rather than telling creditors what they could do for Essar that the other party couldn’t, Jindal and ArcelorMittal had a public showdown about their relative piety. Whether ArcelorMittal’s sale of shares in another nonperforming asset has cured it of ineligibility to bid for Indian stressed assets, or whether Jindal’s sister’s previous involvement in another bankrupt steel firm makes him less than pure somehow, ought to be irrelevant to resolving Essar’s insolvency.
And as the graphic below shows, it may all well end up in tears for the creditors

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