The Essar insolvency saga

The National Company Law Appellate Tribunal, in a recent ruling has removed the historical separation between secured and unsecured creditors. The ruling stated that all creditors of Essar Steel India Ltd would be treated equally in the $6 billion sale of the company's plant to Arcelor Mittal.

Background

Essar Steel Ltd. runs a 10-million tonne per annum steel mill in Gujarat. In August 2017, it became insolvent with dues of more than ₹54,000 crore.  ArcelorMittal was the highest bidder for this asset and offered a resolution plan with a cash payout of ₹42,000 crore to be apportioned to financial and operational creditors.

Essar Steel owes ₹49,000 crores to banks led by the State Bank of India. The case has gone on for over 600 days when the legal limit for such cases is 270 days. 

Analysis

Lenders led by the State Bank of India have filed a petition in the Supreme Court against the National Company Law Appellate Tribunal (NCLAT) ruling in the bankruptcy case of Essar Steel. The tribunal has ordered that at the time of settling claims, operational creditors have to be treated on a par with financial creditors. 

Essar Steel's financial creditors are mainly state-run banks, while its operational creditors are vendors and suppliers. ArcelorMittal has offered to pay ₹30,030 crores to financial creditors and ₹11,969 crores to operational creditors. The judgment will qualify vendors such as Associated Road Carriers Ltd. to get 60 per cent of the 11.2 million rupees ($163,000) which they lent while State Bank of India will qualify to receive 60.7 per cent of the 132 billion rupees against collateral which was lent. 

The rights of financial creditors are always held superior to those of operational ones. This is because they lend at lower rates in return for a claim on the debtor's assets as collateral. The current ruling will have a long lasting impact on the status of operational creditors, as this class has now been placed at the same level as those who form the committee of creditors (CoC). Operational creditors are not part of CoCs.

The consortium argued that "By virtue of the impugned judgement the entire CIR (Corporate Insolvency Resolution) process with respect to the corporate debtor being one of the largest non-performing assets of the country, has been put under jeopardy and the shocking unsettling of otherwise settled principles of law recognising and protecting the rights of the secured creditors on account of complete misreading of the code (Insolvency and Bankruptcy Code) has endangered the national economic interest of the country overall."

NCLAT has asked the committee of creditors to use a reputed chartered accountant firm or legal firm to determine the exact amount to be apportioned to each operational creditor.

The judgement had two parts. In the first part, the court dismissed the appeal by Prashant Ruia, managing director, group chief executive officer and director, Essar Global Holdings Limited, stating Section 29A of the IBC code which says bidders cannot be connected to other defaulting entities. He challenged ArcelorMittal's eligibility to bid for Essar Steel. The appellate tribunal noted that the matter was settled on 4 October 2018 and ruled that ArcelorMittal's entitlement as resolution applicant "cannot be re-agitated again and again".

In the second part, the appellate tribunal covered the apportionment of resources among all creditors. NCLAT notes that "In the resolution plan, 0% of their (operational creditor) debt has been proposed to be paid, whereas the financial creditors have been proposed to be paid 92.5% of their dues and claims of some of the operational creditors have been notionally assessed at Re1 by the resolution professional without any basis." Justice S.J Mukhopadhaya, Chairperson NCLAT stated that "Instead of rejecting the resolution plan submitted by ArcelorMittal India Pvt. Ltd, we modify the plan to safeguard the rights of the operational creditors and other financial creditors".

The NCLAT held Section 53 of the Code, in order to protect the interests of the operational creditors (where unsecured and operational creditors come after secured creditors) irrelevant under the insolvency process.  The court ruled that the distribution of debts to the financial and operational creditors during the Corporate Insolvency Resolution Process cannot be equated with the distribution of proceeds to all stakeholders after the liquidation, therefore, the resolution applicant cannot take advantage of Section 53 for the purpose of distribution to be made in favour of certain creditors. 

The lenders protested that the tribunal's ruling is likely to result in higher borrowing rates with increased risk of capital, leading to further unavailability and inaccessibility of credit in the market. "This will result in serious damage to the Indian economy as a whole and dilapidate the entire banking system," lenders said in the petition. In addition, further distress in banking may force the government to make contributions to maintain the required capital adequacy.

Assessment

  • NCLAT was set up to settle disputes relating to IBC and attract foreign investment. We feel that by removing the distinction between secured and unsecured creditors, the ruling went against the principles of commercial law that prioritises secured creditors.
  • The redistribution of funds ordered by the tribunal has taken away the lenders' ability to make a commercial decision about bids during the insolvency resolution process. We feel that denying repayment priority to banks will lead to them to raise premiums on doing business in India, in order to bear the cost of lending. We feel that this will thwart the concept of collateral.
  • Banks may hesitate to pursue debt recovery under Bankruptcy code.

 

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Image Source - Fungus Guy [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0)] 

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