Anecdotal evidence of malfeasance apart, the root cause of distress in most assets is a combination of very high leverage coupled with foundational shortcomings in their underlying business models, technical and management capability, and their operating practices.
The continuing bankruptcy filings with the NCLT for some of the largest NPAs and the recent bank recapitalisation announcements are welcome steps towards resolving the distressed asset situation in India. Anecdotal evidence of malfeasance apart, the root cause of distress in most assets is a combination of very high leverage coupled with foundational shortcomings in their underlying business models, technical and management capability, and their operating practices. Certainly, the global commodity cycle bust, overcapacities, mine deallocations and infrastructural woes also had a big role to play in price deflation and the ensuing losses, leading to defaults. Most underlying physical assets of these distressed firms, however, are productive high-quality assets and have substantial opportunity to create value if organised and operated in the right way. With appropriate interim turnaround management and capital support, they can be restructured, reorganised and eventually managed by rightful stewards.
Unfortunately, our approach to resolving these distressed assets through the fledgling bankruptcy system appears to be heading towards liquidation and fire sale rather than reorganisation and resolution. Liquidation is the least desirable option because the price that distressed assets fetch in a liquidation sale is much below the values they would command when put to best use. This results in large haircuts to lenders as well as avoidable social costs. The problem is two-fold. First, a creditor-in-possession-driven reorganisation plan which vests the management rights of the bankruptcy estate to an interim resolution professional (IRP) is fraught with risks of a disorderly transition that may eventually lead to an undesirable and avoidable liquidation. It is not only unlikely but also unreasonable to expect that an IRP would have the breadth and depth of experience, competency and industry knowledge required for planning an orderly transition and turnaround for such complex multi-billion dollar bankruptcies. This is evident from the fact that assessment of the liquidation asset value of some of these distressed firms is being set as the floor for disposition, rather than a realistic assessment of the intrinsic value based on its cash-flow generation ability or its best use value. In the absence of deeper and more meaningful information and knowledge about the distressed firm’s operations and possibilities, creditors and IRPs are unlikely to come up with any meaningful resolution plan apart from liquidation in the stipulated time-frame of 180-270 days. A creditor-in-possession-only-based reorganisation orchestrated through an IRP reinforces the likelihood of liquidation due to information imperfections and lack of multidimensional expertise that is required for such resolutions.
Second, any auction or bid-based approach in ‘thin’ markets will likely lead to adverse outcomes for banks as the winning bid will not likely be anywhere close to intrinsic value of the asset. The tepid industry situation in the core sector and lack of enthusiasm in the private sector for investments limits the number of buyers, which deepens the discount on the asset if attempts are made for a hasty sale. Thin markets with few participants promote lack of competition, as options are few, which drives down the price of these assets. Given the scale of financing required by buyers for acquiring assets in large bankruptcies, lack of adequate financing will also discount the price further. Discounting towards liquidation value is exacerbated by the fact that bidders are required to propose the resolution plan. In a market with few buyers, the incentive for participation and bidding with any meaningful plan with a going-concern value of the distressed asset is limited. This could be further aggravated by potential collusions or withdrawals in anticipation of fierce competition. Eventually, this may result in just one bidder to enter and grab the distressed asset at a fire sale price.
A mechanism during resolution phase that thickens markets, reduces information asymmetries and encourages cooperative bargaining between creditors, debtors and potential buyers can result in a value-creating plan that can be used as a basis to rationally distribute value amongst the claimants through cash and non-cash instruments. Allowing participation of bankrupt promoters without onerous preconditions—as long as they are not wilful defaulters—will help thicken participation and aid in driving up the value in cooperative bargaining process. A competent, trusted team for intermediation and interim management for turnaround planning and resolution guidance can enable successful resolution through cooperative bargaining. This can result in an agreed-upon business plan and valuation after reorganisation; arrangement of interim financing; de-listing and asset reorganisation; negotiated debt write-downs; payout agreements across claimants; new investments; and a go-forward management plan. The credible threat of liquidation should be used to move the resolution process forward, not as a primary premise for asset liquidation through bankruptcy. Yes, if all else fails, liquidation would be inevitable. Successful resolution of stressed assets should attempt to preserve maximum economic value through restructuring and orderly change of control, and should not degenerate into a mechanism for value-destructive liquidations.
At the same time, myths, populism and sensationalism needs to be separated from the successful resolution of these important bankruptcies. Mental models of the larger public, media and the polity, which might be enamoured by malfeasance and throwing the robber barons in jail part of the NPA story, will put pressure on the bankruptcy resolution process to lean towards self-fulfilling prophecies leading to liquidations. Rhetoric and emotions apart, the first priority is to successfully resolve the large and present danger of bad loans, which, if resolved through a fire sale approach, will likely lead to large-scale destruction of productive assets. We must learn to develop a workable resolution framework along with competent interim resolution boards with deep industry, business, finance, technical, legal, operational and organisational expertise applied towards resolving these large and complex bankruptcy cases. In our zeal to throw out defaulting promoters, we should not land up liquidating recoverable companies, destroying employment and exhausting recapitalisations through inefficient allocation to debt write-downs. Liquidations should always be the last option.
President, MN Dastur & Co.
Views are personal