Barely hours after the Bankruptcy Code resolution process finally closed its first major case – Essar Steel – the code and its adjudicators have been saddled with an even more difficult task – of resolving stressed financial service providers (FSPs). This is a tall task: In most countries, the process of resolving stressed finance companies is far different from the process used to resolve bankrupt manufacturing companies.
That’s because FSPs – like NBFCs, mutual funds, insurance companies and banks - bring with them contagion risk and if the process takes 800 days as it took in Essar Steel , the finance company would have imploded by then. Secondly, financial entities like banks and insurance companies have thousands of creditors - like policyholders or depositors. It’s impossible to coordinate with all of them in the manner the IBC process requires. Thirdly, these small creditors – ie. depositors and policyholders - are more consumers, who need protection and it is tough to protect them in an IBC process which is meant for financial maximisation of a small bunch of creditors.
The IBC process is modified
To be fair, the govt has modified the IBC process for finance companies. It is the regulator who will send a company to the NCLT. The regulators shall also vet the appointment of an administrator who will run the company during the resolution process. The regulator has a chance to depose before the tribunal as also approve the resolution plan. The new buyer must pass the fit and proper test of the regulator.
Now let us see what are DHFL’s chances of being resolved if indeed it is the first case. For starters, DHFL has been under the charge of bankers for at least six months now, and some fear its collection mechanism is already breaking down. Many borrowers may have stopped paying even now counting on the inability of the company to proceed against them and enforce security.
Assuming the RBI does send DHFL to the NCLT, it is likely it may even find a good administrator from the bunch of former bankers and central bankers available in the country. The tough task begins when the administrator takes over. Understanding the web of related parties to whom and through whom DHFL is alleged to have lent can be really tough, even if much of the work of tracing relationships must have already been done by the forensic auditors. Next the administrator may have to undertake some smart restructuring. For instance: divide the company into a good bank and a bad bank or maybe into retail book and non-retail book. If done speedily, when the company’s collection system is still in place, the good/retail book may find a buyer. It may be far more difficult for the administrator to find a buyer for the bad book, since it will require judging how much haircuts lenders will have to take.
An uphill task
And this takes us to the most challenging part of the process: convincing the tribunals of accepted cannons of finance. These canons will require that every lender be paid according to the weight of his security. This could well mean that bankers will get more because they may have lent against security, while mutual and pension funds and retail bondholders may turn out to be unsecured lenders. Any effort to give a lower haircut to the unsecured creditors – because they are weak retail investors or vulnerable pensioners – can be suicidal, for DHFL, for future resolutions and indeed for even future loan giving in the economy.
This is a tall ask from the NCLTs. Every tribunal requires a learning time. By instinct, most of the tribunals, who may be former judges, will be moved towards the ‘small’ investor. But this may be misplaced sympathy as it contravenes the principle of primacy of secured loans. Conversely, if the company law tribunals do get the logic of financial creditors and lean in favour of secured creditors, any of the so-called ‘vulnerable’ investors may drag the RBI, or the administrator, or the bankers of DHFL to court. Indeed the sheer fear of such litigation may keep buyers away from bidding for the company's assets.
RBI in a tight spot
The courts can pose more genuine questions. The rules (made under section 227 of the IBC) are subordinate legislation, that should be in keeping with the main IBC law. But the rules announced last week are hugely different from the main tenets of the IBC. For instance the new rules say moratorium begins on the day of filing of the application. Under IBC it is date of admission of the plea. Under the new rules, only regulators can approach the NCLT with an FSP. Under IBC, any creditor can take a debtor to NCLT. Many lawyers wonder if subordinate legislation can be so different from the mother law. Will the courts strike it down?
All this puts regulator RBI in a tough spot. If they take DHFL to the NCLT under the bankruptcy code and some such court intervention stalls the case, the mess can get bigger and the distrust deeper. The RBI needs to tread with caution but that in itself is not enough. The entire legal ecosystem has to tread with caution, restraint, maturity and above all speed. And yet taking DHFL to the IBC may be still better than the current drift.
