NCLAT gets it totally wrong on Essar Steel

As legal experts have pointed out, Section 30(2)(b) clearly says that as long as the operational creditor gets a minimum of liquidation value, the Committee of Creditors (CoC) can decide on the amount to be distributed.

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Banks will steer most bankruptcies toward liquidation, leading to unnecessary job losses and higher loan-loss provisions in a capital-starved financial system.

The recent ruling by the NCLAT, or the appellate tribunal, in the Essar Steel case—it directed lenders to disburse a bigger share of the recoveries to operational creditors than they are entitled to—puts banks in jeopardy and threatens to erode the sanctity of the Insolvency and Bankruptcy Code (IBC). Indeed, the ruling smacks of socialist thinking, displays little concern for commercial and business ethics, and puts at risk the well-being of the country’s banking system. It is all very well to want to be fair to all creditors—secured and unsecured—but basic business practices must be respected. That secured creditors rank well ahead of unsecured creditors in the repayment hierarchy is acknowledged the world over as it is in the IBC.

The NCLAT bench noted that distributing a larger share of the proceeds only to secured financial creditors and denying operational creditors a bigger share was against the provisions of Sections 30(2) (b) and Regulation 38 (IA). As legal experts have pointed out, Section 30(2)(b) clearly says that as long as the operational creditor gets a minimum of liquidation value, the Committee of Creditors (CoC) can decide on the amount to be distributed. Moreover, Section 31 says that once the resolution plan is approved by the Adjudicating authority, it is binding on the corporate debtor, employees, members, creditors and so on. They also say that Regulation 38, which says the amount due to the operational creditors under a resolution plan shall be given priority in payment over financial creditors, simply means that the former should get their money back earlier.

Unless secured creditors get priority—as is the law—and are given the biggest share of the recoveries, secured credit as a product will be totally undermined. It is because bank loans are secured that banks offer a lower interest rate. Hereafter, banks will have no reason whatsoever to lend against collateral and offer a lower interest rate; instead, they will jack up the interest rate, thereby making loans costlier for every borrower, whether a company or an individual. So, as one lawyer has argued, home loans will cost 15% since banks will build in high-risk premia and not the 8-9% that they cost today. Moreover, even if banks decide to keep collateral, they will, at the first signs of distress in a company, enforce it immediately, depriving the business of its production facilities and preventing any chances of reviving the unit. Else, they will opt for liquidation since they stand to recover more or less the same amount as they would if they opted for the resolution plan route.

The Essar Steel case is now in the Supreme Court with banks having challenged the NCLAT order. The NCLAT has, in its order, cited the SC having said that, when looking into the feasibility of a resolution plan, the tribunal has also considered whether “operational creditors are roughly given the same treatment as financial creditors”. Moreover, it cites the SC as having said that, in instances where the treatment wasn’t the same, the plans were either rejected or modified to ensure that the rights of operational creditors were safeguarded. Legal experts, however, believe the NCLAT’s interpretation of the SC’s observations may not be quite right.

Diluting the status of secured lenders and equating them with homebuyers is dangerous. In another instance, the NCLAT is trying to ensure that Provident Funds are able to recover their dues ahead of the secured lenders on the grounds that it involves savings of people. Such interpretations of the law will not just lead to a loss of faith in the judicial system, they will have deleterious consequences for the financial health of banks.

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First published on: 16-07-2019 at 03:57 IST