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Sunday, March 25, 2018

Concerns about the Indian bankruptcy reform

by Ajay Shah.

The key idea of the IBC


The centrepiece of the bankruptcy process is the Insolvency Resolution Process (IRP). Because a firm after default is like a melting ice-cube, every day of delay destroys value. So the IBC provides for a limited time of 180 days for the IRP to work out. It is within this time limit that multiple external persons come up with proposals on resolution plans for the defaulted firm. These are evaluated by the Committee of Creditors and the best one is chosen. The chosen one takes control of the company and walks away into the sunset, and all others forever hold their peace.

This machinery must be understood and trusted by all. When there is certainty that this process will work as defined, all parties -- bidders, committee of creditors -- are incentivised to invest resources, and work within the defined procedures.

We need to be nuanced about the phrase "the best bid". The decision before the Committee of Creditors is more subtle than a simple auction of a commodity. There are many factors in the picture. Do we trust the promises of the bidder? If cash will come out to the creditors at a future date, then the creditors need to weigh the possibility of the new person becoming their borrower. In complex cases, each bidder may show a different restructuring strategy as his preferred one; the comparison between different bids is then not apples to apples. There is a great deal of judgment about the thought process of the Committee of Creditors. Sometimes, it's a simple question of the person who offers the highest number, but in most complex transactions, it's more complicated than that.

Recent events


The bankruptcy process for Binani Cements has raised concerns about these concepts being disrupted. On February 27, the Committee of Creditors chose one bid (Dalmia) at Rs.6,700 crore. This was a near-100% recovery rate as the total liabilities were Rs.7,000 crore. A binding agreement was signed and sent to NCLT for ratification. In any reasonable bankrutpcy process, this should be a done deal that cannot be reopened.

A month later, Ultratech announced a deal with Binani's holding company to purchase the firm for Rs 7,300 crore, and petitioned the NCLT that it should not approve the Dalmia deal because Ultratech is really the highest bidder.

In a previous case of a similar nature, Liberty House failed to get a bid in time into the IRP for Bhushan Power. In the IRP, the Committee of Creditors chose Tata Steel. After the terms offered by Tata Steel were revealed, Liberty House has tried to go to the NCLT, saying that they had a better offer.

Implications


Consider an auction for some listed shares. The market price is Rs.100 and the auction outcome is near Rs.100. Now half the time, the price of the shares on the public market goes up. Suppose we have a situation where a month later, they are worth Rs.110. Can a person now ask to reopen the auction because she is bidding Rs.105? This would be a ridiculous position to take, one that completely undermines the sanctity of the auction process. The auction is your opportunity to make a bid, and once it's over, you must forever hold your peace.

Agreeing with Ultratech or Liberty House would undermine the IBC-defined machinery of the Committee of Creditors. There is a trivial sense in which they are now claiming they have a superior bid. But going with their claims would disrupt the resolution timelines of 180/270 days. It would undermine all future IBC outcomes, setting a precedent of someone coming along, late, and reopening the matter. The lack of finality would, in turn, disrupt the trust of bidders in the process. Bidders who mistrust the IBC would tend to put in less resources in thinking about each case, and they would tend to put in lower bids because the outcome is not certain.

In the case of Binani, Ultratech was one of the participants in the IRP. They were not chosen there. This offers a natural response: Why did you not make a more attractive offer while the IRP was in process?. If they were not part of the IRP, a natural response would be: The forum where bids are analysed by the Commmittee of Creditors is the IRP; it is transparent and widely announced to enable a fair playing ground for everyone who is interested in resolving the firm. Why was your proposal not presented there?



I thank Josh Felman and Susan Thomas for useful discussions.

1 comment:

  1. Sir, in the interest of keeping the bidding process transparent, why not have an open auction with the serious buyers only. Seriousness can be enumerated with a earnest money deposited (EMD) in an escrow account, where the float factor is minimum. Deposit money on Monday, for open auction on Tuesday or Wednesday. And the unsuccessful bidders be returned their EMD in minimum times, post auction.

    Only interested parties be allowed to progress up to the EMD and auction stage. Agreed that every passing day costs the stakeholders dearly, but why just restrict the process. A small amount of bidding outdoing can help save the haircut for the lenders, even it is a small fraction.

    Also, the prospective bidders come to the tender stage when they see economic merit and buying rationale. Instead of wasting time later on litigation, there is quite some sense in asking the prospective buyers to fight it out in the auction hall.

    And, while the lenders have the floor price fixed, the buyers will fix the upper cap. Whoever finds merits in outbidding the other will do that, and stop at the point where the economic merit becomes neutral or likely turn negative.

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