.jpg)
10 August, 2017
The new Indian Insolvency and Bankruptcy Code, 2016 (Code) has now been in force for just over six months, having been introduced with a swiftness and commitment that took many observers by surprise.
Introduction
The Code itself was notified in December 2016, and the necessary rules and regulations required to implement it fully in relation to corporate insolvencies came soon after, so that the new regime has really taken off and is now being used by financial and operational creditors and by corporate debtors themselves.
We have continued our interest and involvement in this exciting and transformational area. We have met and discussed the latest developments with a wide range of market participants in recent weeks, both in India and abroad. Our previous bulletins on the subject cover an early overview and foreign perspective followed by an in-depth analysis of the Code, and we are now offering our thoughts on what has been going on and how the market seems to be developing, based on the wide ranging discussions we have engaged in.
As before we speak from the point of view of a foreign creditor or investor, and do not attempt to advise on Indian law.
We cannot be definitive or cover everything but we would be delighted to enter into dialogue and discussion on any of the issues we touch upon or more generally.
We recognise that in such a fluid and fast changing landscape we can only offer thoughts and opinions rather than definitive guidance, and we gladly continue our commitment to assist and support the constructive and speedy evolution of an effective and efficient modern restructuring and insolvency regime in India which is in line with the approach of other developed legal regimes.
There is a strong appetite for information and learnings from the international experience of restructuring and insolvency (particularly in relation to the UK model on which the Code was in large measure based), and so we hope that these thoughts will be of interest and value.
Cases
At the time of writing over 1,000 applications have been filed before various benches of the National Company Law Tribunal (NCLT) (which is the tribunal to which applications in respect of corporate insolvencies are made) for the
institution of resolution processes against corporate debtors, of which roughly 25% have been admitted and the number is growing steadily. It seems that the time lines set out in the Code are broadly being kept to by the NCLT and that it is taking a procedural role rather than delving into the substantive rights and wrongs of particular cases. We welcome that and anticipate the international creditor community will regard that as a positive sign.
The applications filed to date suggest that the new Code is being utilised more by operational creditors as a tool for debt recovery rather than by financial creditors for the restructuring of non-performing assets, and this is driven in part by the lack of other remedies available to operational creditors following the introduction of the new system. It seems that many corporate debtors have often swiftly paid the defaulted payments in question, resulting in a significant number of applications not proceeding.
In some cases different benches of the NCLT have considered how to tackle the references in the Code to disputed debts; while there have been some conflicting decisions, a majority have taken a narrow view of what the Code means and therefore are interpreting it strictly in favour of operational creditors. Whilst this is encouraging, there seems to us potential for an increase in court proceedings in the event of disputed claims at the instance of corporate debtors in difficulty (ie, to pre-empt the use of the Code by creating a formal dispute) since that would make it harder for operational creditors to take proceedings under the Code in the event of non-payment.
It has become clear that if payment of undisputed amounts is not made swiftly (ie, within days) before admission of the application, the moratorium and the full corporate insolvency resolution process (CIRP) must begin; all stakeholders could be caught unawares by this. It is not yet commonly understood in the market that this is the case. Similarly, it is not generally understood that once a CIRP has begun (ie, once an application has been admitted by the NCLT) there are only two possible outcomes; either a liquidation of the corporate debtor or (provided 75% of the financial creditors approve it) a resolution plan.
Many foreign creditors look to promoter support in some form – be it a formal guarantee or a letter of support. In a recent case the Mumbai Bench of the NCLT held that notwithstanding the commencement of a CIRP against the corporate debtor, enforcement action could be taken against the personal property of the promoters given as security to the financial creditors, making it clear that promoters cannot benefit from a moratorium granted in favour of a corporate debtor. This is very helpful from the international perspective.
The need for financial creditors to cooperate and plan ahead
Banks and financial institutions must become more vigilant; the risk that an unpaid operational creditor could trigger the CIRP and catch them unawares and unprepared is too great to be ignored. It will be harder for foreign creditors to monitor the situation and a closer eye must be kept on the day to day affairs of Indian corporate debtors. A more rigorous approach to drafting and monitoring compliance with information covenants in debt documents may be advisable.
There are, we understand, encouraging signs that the Indian financial community is recognising this consequence and beginning to react in a number of very positive ways. For example financial creditors are apparently beginning to cooperate more and are focusing less on their individual positions and their own provisioning. There is a recognition that the 180 day window allowed under the Code for a resolution process is challenging and therefore that pre planning and early recognition of distress are essential.
The international model emphasises that insolvency processes and proceedings are a means of implementing, rather than negotiating and agreeing, solutions. It is recognised that insolvency proceedings by their very existence decrease value at the cost of all stakeholders. For example in the UK, administration and schemes of arrangement are commonly used to achieve what has already been pre agreed, often as a result of lengthy negotiation between key stakeholders taking account of financial viability studies and the wider interests of the whole creditor universe.
Different terms are used in the USA, but the same approach is taken for similar reasons.
Provided that operational creditors do not precipitate a crisis by application for a CIRP, the new Indian resolution process should accommodate a very similar approach, but this has not happened yet, for understandable reasons.
In the UK, we benefit from many years of restructuring experience and practice and this stability enables different stakeholders to identify their likely outcome on insolvency and use that to try and negotiate a better outcome. It is recognised that in some restructurings, value will be maximised for stakeholders if a sale is executed as soon as the administrator is appointed. Such a "pre-packaged" sale is possible under English law as the proposed administrator can oversee the marketing of the relevant assets and negotiate with bidders prior to appointment and sign the agreed sale documentation upon being appointed. The interests of creditors are protected by the administrator, who owes duties to all creditors and must comply with regulatory guidance (Statement of Insolvency Practice 16) designed to ensure there has been a proper marketing process and that a "pre-packaged" sale is appropriate in the circumstances. This combination of law and regulatory guidance enables "pre-packaged" sales that minimise the value lost in an insolvency process.
It is this piece of the jigsaw that is currently missing in India. For want of this piece, not only is the Indian insolvency professional currently reluctant to implement a "pre-packaged sale" without starting again from scratch post appointment, but also potential participants (eg, a potential purchaser of a business) are reluctant to commit the necessary time and resources to a pre-packed arrangement if it may subsequently fail when the CIRP begins.
There is a good framework for financial creditors to work together in the Reserve Bank of India’s (RBI) Corporate Debt Restructuring (CDR) derived approach of the Joint Lenders' Forum (JLR) and related schemes. If mandated for Indian lenders, the approach could readily provide a framework for other financial creditors that are not regulated by the RBI to informally achieve the necessary consensus as to how to tackle a financially distressed corporate debtor before commencing the formal CIRP. There is a mechanism for the viability of a corporate debtor to be assessed, the level of sustainable debt to be judged and corrective action to be taken, so much of what is needed for a pre-packaged deal to work is in place. If the Indian insolvency professional is involved throughout and is protected in implementation, provided it can be demonstrated that the pre-packaged proposal is not a dishonest or unfair arrangement, we see no reason why it couldn't work in the same way in India as it does internationally.
The foreign creditor has generally stood back from these CDR derived processes (not being bound to become involved they have rather preferred not to, monitoring the situation but choosing to join in formally in rare cases where it is manifestly in their interests to do so), and it is felt by many overseas lenders that the decision making processes of many Indian lenders have not been swift or effective enough for this framework to have fulfilled its potential. Foreign parties would be much more willing to participate if they had confidence that they could participate on equal terms with the Indian lenders (especially as to information) and in a robust, speedy and effective process.
An ordinance was issued proposing amendments to the Banking Regulation Act, 1949 in May of this year which granted the authority to the RBI to issue directions to banks and financial institutions requiring them to resolve specified stressed accounts under the Code. The RBI constituted an Internal Advisory Committee following the issue of this ordinance and the committee (among other things) identified 12 of the biggest loan defaulters in India who account for about 25 per cent of the gross NPAs in the banking system. RBI issued directions to the relevant banks to immediately institute insolvency proceedings against these 12 defaulters under the Code. In a recent ruling the High Court of Gujarat rejected the writ petition filed by one of the 12 debtors challenging the RBI's authority to issue these directions.
Proceedings have since been commenced against each of these companies and it would seem to us that it is in the best interests of the lending banks to cooperate and align their strategy in advance of the commencement of the relevant CIRPs and formation of the relevant Creditors' Committees.
Interim finance before and during the resolution process
Early recognition of distress, and consequential planning for an effective and speedy resolution of it – whether using the CIRP or not – will of course require the financial creditor stakeholders to consider interim (and potentially pre resolution process) financial support that will enable the operational creditors to be paid on a timely basis, to prevent any aggressive or disruptive action by them.
We point again to the relevance of international experience; because resolution of distress (whether it is through a formal insolvency proceeding or otherwise) generally necessitates the business (or a significant element of it) of the corporate debtor continuing to be viable, the operational creditors de facto have considerable leverage if they must be paid in order to maintain a going concern. We anticipate that the financial creditor community in India would aim to quickly adapt to cooperate in order to drip feed funding to a distressed debtor so as to keep the operational creditors at bay for long enough to agree a plan that can swiftly be implemented through a CIRP under the Code. Priority for such drip feeding (and for any funding through a CIRP) is key to the success of such an approach.
There are clear reasons for financial creditors to doubt the security of (and security for) any emergency funding pre-process given what the Code and relevant regulations say about re writing the pre-process status quo in a resolution plan. However it seems to us (though of course we defer to Indian advice on the point) that there must be a way of developing pragmatic approaches to address this problem. In other jurisdictions it is entirely possible for creditors to bind themselves contractually as to how they will vote in a scheme or equivalent court process. The provider of emergency finance during the period of pre-process planning by the creditor community ought to be able to achieve sufficient contractual comfort from other parties before taking on such exposure from at least a blocking vote of the financial creditors.
The emerging insolvency profession
When the Code was implemented there was no one who could be appointed as a resolution professional because none had been recognised.
It was clear very soon after the Code was introduced that there was a real concern in the creditor community over who would or could be an effective insolvency professional. A host of people applied and were granted that status under the initial transitional provisions and it was clear that relatively few were experienced or, indeed, intended to take appointments.
An initial concern was as to the liability of the individual or organisation (in the case of insolvency professional entities, ie, firms or companies where a majority of the partners or directors are registered as insolvency professionals under the Code) taking the appointment. There was, and (we understand) is still no professional indemnity insurance generally available, although we understand steps are being taken to address this.
It is noticeable that almost all of the interim resolution professionals appointed in respect of the 12 defaulting companies notified by the RBI are the Indian counterparts of experienced international insolvency practitioner firms who are applying the experience of their international colleagues to the cases in question.
This issue reflects the uncertainty as to what responsibility the resolution professional owes, and to whom. In contrast to the position in the UK, where the administrator is an agent of the company in respect of which he or she is appointed, and where indemnities are given by the company, the Indian picture is more nuanced. An interim resolution professional is appointed initially by the financial creditors (if the application is by the financial creditors) or the NCLT (if it is by an operational creditor) and the appointment is confirmed, or the interim resolution professional is replaced, by the Creditors' Committee once that is constituted. The interim or confirmed resolution professional runs the company in respect of which he or she is appointed but bears no explicit statutory liability to it or to its stakeholders (creditors or equity) under the Code. The resolution professional is more in the nature of an officer of the court.
Given the lack of explicit wording in the statute, interested insolvency practitioners have anticipated potential liability to creditors, equity and other stakeholders in the likely event of a loss of value during the resolution period and held back from accepting appointments. This is clearly changing fast, but we feel the market would welcome greater clarity on the liability issues so that a trusted profession can swiftly develop.
Will foreign financial creditors participate in the Creditors’ Committee?
A further point has arisen in relation to the Creditors' Committee. Participation appears to be mandatory although there are provisions in the regulations defining what makes a meeting quorate, which is an apparent contradiction.
We anticipate that although (in contrast to the previous regime under RBI mandated resolution procedures such as the CDR, JLF etc.) it seems more likely that all financial creditors will be participants in the Creditors' Committee, the unusual position that certain business decisions are to be taken by the resolution professional only with reference to and approval of the Creditors' Committee might give some creditors a concern that by participating in the Creditors' Committee, liability could accrue to them. This might suggest a reluctance on the part of some creditors (particularly from abroad, where Creditors’ Committees routinely and explicitly avoid such a risk) to participate in the relevant decisions, although not necessarily from voting on the resolution plan itself.
A further issue we anticipate will need to be addressed is in relation to financial creditors who have recourse to overseas assets or group members as well as to a parent company in India.
A number of overseas acquisitions by Indian corporates have taken place using acquisition finance made available to overseas subsidiaries with an element of parent company support (such as a parent company guarantee or share security). In these cases the overseas creditor may prefer to access the overseas assets and covenants through recourse to the overseas obligors – under the law of the relevant jurisdiction – rather than potentially being estopped or prevented from doing so by that very law because they participate in the Indian process.
We would encourage the NCLT to be pragmatic if, for any such reason, foreign creditors choose not to participate in a Creditors’ Committee; to take the approach that participation is optional rather than mandatory and to confirm the competence and validity of the Creditors' Committee and its decisions notwithstanding non participation by certain creditors where there is good reason for them to stand back.
Dissenting creditors and valuation issues
As noted above, a resolution plan proceeds if approved by 75% by nominal value of the financial creditors of a corporate debtor subject to the CIRP. We have commented elsewhere on the lack of secured and unsecured classes of creditors, and the equal voting given to those who stand to lose less in a liquidation than those who through security or recourse to other group members have an expectation of better recovery; this is at odds with the position under other established international systems and we believe it is an issue that should be considered further by the authorities.
Another unusual feature of the new Indian system is that dissenting creditors (ie, up to 25%) stand to receive the liquidation value of their claims under the resolution plan before the 75% receive anything under the resolution plan. Payment of these amounts must be funded by the resolution plan – either out of the company’s cashflow, sale of assets or new debt provided by the 75% creditors.
Questions of valuation have given rise to significant litigation in other jurisdictions, and we anticipate this could prove to be the case in India. Values are to be arrived at by reference to international standards, according to the Code, which may mean by reference to the book value of a company’s assets suitably discounted for a fire sale.
There will have to be a distinction between the liquidation value of a secured claim compared to that of an unsecured claim, and it is not going to be clear until cases are run through the system exactly how these questions and distinctions are resolved.
Conclusion
In conclusion, these points are but a few that have struck us; market participants will all have their own concerns and questions and we would be delighted to participate in and contribute to the discussion of them.
For further information, please contact:
Clive Barnard, Partner, Herbert Smith Freehills
Clive.Barnard@hsf.com
