With the order on operational creditors in the Essar Steel matter, NCLAT has veered into legislative territory, sans electoral accountability
Prof UR Rai, one of India’s foremost constitutional law professors, began his lectures by declaring that ‘judicial activism, for lack of a better word, is a pejorative term’. His words could not ring truer in the context of the NCLAT’s decision in the ongoing bankruptcy proceeding of Essar Steel. Put loosely, judicial activism refers to the practice of judges going beyond interpreting statutory law in its textual form and using subjective notions of justice and equity to render judgements transgressing legislative intent. Judicial activism is problematic on many levels. It militates against the fundamental principle of separation of the legislature and the judiciary, compromises policy initiatives of Parliament that is accountable to the electorate, and causes subjectivity and unpredictability in judgements. There is some merit for activism where laws strike at core constitutional values such as fundamental rights and individual liberties. However, activism in the area of technical and commercial laws dealing with rights of private parties is unwarranted and portends a dangerous trend of tribunals acting like lawmakers sans electoral accountability.
The IBC was passed in the face of mounting NPAs gnawing at fiscal reserves of the banking sector. The government constituted an expert committee comprising economists, bankers and public policy experts to draft the framework for a new insolvency regime. The committee’s recommendations can be summarised into a few ground rules. First, the IBC must be made as ‘judge proof’ as possible—by vesting all commercial and operational decisions with the committee of creditors and the insolvency professional to reduce time lost in litigation—and the NCLT acts as a guardian of due process. Second, classifying all government dues, employees and trade counterparties as operational creditors who, in any restructuring proposal, are entitled to receive the value they would have recovered in the event of liquidation. In most distressed companies, the liquidation value of such dues would be close to nil, since secured banks, being higher in the pecking order, are already suffering huge haircuts. Third, defaulting promoters would not only lose their companies but also would be liable to pay creditors under their personal guarantees to the full extent of the haircut.These rules led to the unprecedented success of the IBC. However, the NCLAT decision in the Essar Steel matter is an example of egregious judicial activism threatening to derail the government’s reform agenda.
The NCLAT appears to re-examine the superiority of financial creditors compared to operational creditors by opining that according ‘liquidation value’ to operational creditors can harm the Indian economy. This is deeply distressing since our constitutional scheme does not confer tribunals with the task of evaluating what is desirable for the Indian economy. Rather, Parliament, being an elected body, must give policy direction to the economy. In any event, the policy of subordinating operational creditors under the IBC was upheld by the Supreme Court (SC) in Swiss Ribbons. Regardless, the NCLAT felt that the proposed payout under any bid must be shared proportionately between operational and financial creditors, since that would be ‘fair and equitable’. Arcelor Mittal was roughly proposing a 90% recovery to financial creditors, which the NCLAT hasdrastically reduced to 60%, leading to heavy losses to banks. Foreign investors had trusted in the IBC process and bought large pools of Essar loans from PSBs with the hope of achieving profitable IRRs. Not only has frivolous litigation entertained by NCLAT inordinately delayed recoveries and suppressed IRRs, but this order has also shrunk their principal recovery.
This leads to an anomalous situation where financial creditors would rather enforce security at the first sign of financial distress in a firm, thereby depriving it of its essential productive facilities, or choose to vote for liquidation of the company, since, in both cases, they stand to make higher recoveries as opposed to under a resolution plan under NCLAT’s formulation. This will cause more companies to be wound-up, even if they are economically viable. This surely could not have been the intention of Parliament. Further, the NCLAT ruled that all lenders deserve the same payout under a resolution plan, regardless of the level and nature of their security. This goes against the grain of core banking practices the world over, defeats the purpose of credit appraisal and eliminates the commercial basis for pricing credit risk.
The SC, in K Sashidhar, emphatically held that the NCLTs should not interfere in the commercial decisions of lenders. However, after the bid was approved by the Essar lenders, the NCLAT fundamentally altered its commercial terms thereby frustrating their financial objective. The NCLAT makes a valiant effort to paint the distribution of proceeds under a bid to be a non-commercial matter and consequently not immune from judicial review. If proposed recovery to lenders is not a commercial matter, then one wonders what is. After imposing an additional 30% haircut on lenders, the NCLAT notes that since the plan clears the debt of the company, the personal guarantees of promoters also abate. Banks not only lose an additional 30%, but also lose their rights to sue promoters for the entire 40% haircut!
The Centre and regulators have left no stone unturned to tackle NPAs. But, by treating banks as mercenary Shylocks bent on sacrificing operational creditors, the NCLAT is eroding a well thought out legal policy. Being custodians of public deposits and predominantly public-owned, the policy of prioritising the banking sector was a conscious choice. By negating that, the NCLAT has trespassed on legislative territory. It remains to be seen if the desecration of creditor rights is undone by the SC or by way of amendments of the IBC. Either way, the patience of foreign investors is running thin and, unfortunately, they are fleet-footed when searching for their elusive IRR.
The author is a Partner, AZB & Partners (Views are personal)