By Purav Bhandare (University of Queensland) and Priyal Maheswari (New York University)
India’s steel sector experienced rapid growth in the 2000s, but after FY2012, oversupply and depressed steel prices pushed many of the top companies into financial distress. Bank credit growth to steel companies was growing at a healthy pace before FY2012, so the financial distress increased the number of non-performing assets. The Insolvency and Bankruptcy Code was introduced in 2016, which was a time-bound corporate insolvency resolution process, which aimed to tackle India’s non-performing assets problem. The Code enabled the steel industry (along with many others) to transform, with many sectors emerging stronger and with much more sustainable debt levels.
Section 1: India Before IBC
During 2008-2014, banks gave loans indiscriminately, many of which defaulted and resulted in a rise of non-performing assets.
The largest contributor to the rise of NPA for banks turned out to be the steel industry. The debt from five major steel companies accumulated to approx. INR 1482.89b (US$20.2b). Previous acts fell short to address the needs of all the creditors and therefore a new improved act took place.
Section 2: IBC Process
The Insolvency and Bankruptcy Code (2016) is an encompassing law that deals with bankruptcy for corporations or individuals, initiated by a default of INR 100,000 (~US$1,362).
Once the Corporate Insolvency Resolution Process (CIRP) begins, within 330 days, a resolution plan is agreed upon by 75% of the creditors (in terms of debt value) and enacted upon, or, the company heads for liquidation.
Section 3: RBI-12 IBC Cases
The Reserve Bank of India (RBI) claimed that 12 companies held 25% of the country’s gross non-performing assets, and referred these 12 companies for a CIRP through IBC.
As of Sep 2020, 11 out of the 12 cases have been resolved; 3 of the largest ones were steel manufacturers, which resulted in distressed acquisitions and had the best recoveries.
Section 4: Steel Sector Before and After IBC
India’s steel sector experienced rapid growth in the 2000s, but after FY2012, oversupply and depressed steel prices pushed many of the top companies into financial distress.
IBC enabled the steel industry (along with many others) to transform, with many sectors emerging stronger and with much more sustainable debt levels - consolidation between large players being a key theme within the steel industry.
Section 5: IBC Rule Changes Following COVID-19
Heavy losses faced by the companies as the result of the on-going pandemic and lockdown, the central government made few changes to IBC in order to protect businesses.
Mainly three changes were made, one of them extending the time period of “default” for the debtors. However it is unclear how these changes will affect the cases of bankruptcy and insolvency filed before the pandemic.
India before IBC
The Indian Banking System consists of Scheduled and Non-scheduled banks, which were included under the Second Schedule of Reserve Bank of India (RBI) Act, 1934. These banks have two types of facilities: (1) they are eligible for debts/loans at the bank rate from the RBI, and, (2) they automatically acquire the membership of clearinghouses. During the mid-2000s (2008 - 2014) banks started giving loans indiscriminately, which led to a rise in Non-Performing Assets (NPAs). Due to this increase in NPAs, banks suffered heavy losses, which took a toll on the economy as well.
The steel industry is the largest contributor to the rise in NPAs for banks, with Essar Steel, Bhushan Steel, Monnet Ispat, JSPL, and Electrosteel Steels' debts adding up to a whopping INR 1482.89b (US$20.2b). However, steel played a vital role in India and contributed ~2% to the GDP as per the National Steel Policy, 2017. The framework before IBC was not time-bound and took years to complete one case of insolvency/bankruptcy, and hence were subjected to foul play by the company owners (Chandani, Divekar, Salam, Mehta; 2019).
Acts such as the Securitization and Reconstruction of Financial Assets and enforcement of the Security Interest (SARFAESI) Act (2002), have tried to solve the complex problem in banking. SARFAESI was a well-thought act in which if a company defaulted, and secured creditors can give 60-days prior notice and sell the defaulters liabilities. However, a significant drawback of SARFAESI was there was no right available to unsecured creditors. Therefore, IBC is the most significant Act that brought a time-bound framework for both secured and unsecured creditors for insolvency and bankruptcy (Pleders, 2019).
The Insolvency and Bankruptcy Code (IBC) was passed in 2016 in India. IBC helped banks recover bad debts by creating a single law for insolvency and bankruptcy proceedings. Banks and creditors were losing a significant portion of their bad debts, and insolvency procedures took many years before the introduction of IBC. For example, in 2015, the average time for an insolvency process in India took 4.3 years, compared to 1 year in the UK and 1.5 years in the US (Gayam, 2016); hence, a change was required. IBC turned this around, stating a strict 270-day period for insolvency and bankruptcy proceedings (this was later amended to 330 days).
Figure 1: Time to Resolve Insolvency (years) (Gayam, 2016)
The Insolvency and Bankruptcy Code (2016) is an encompassing law that deals with bankruptcy for corporations or individuals, initiated by a default of INR 100,000 (~US$1,362) (Parker, 2020). An operational or financial creditor files for an IBC initiation before the National Company Law Tribunal (NCLT), and two things are considered: (1) existence of debt and (2) notice of default. Financial creditors involve a creditor-debtor relationship that is purely financial (e.g., loan). Financial creditors are given the same priority as workmen and employee dues by higher than operational creditors. Operational creditors, on the other hand, are those to whom a debt is owed for provision of goods or services. They must also prove that there is no dispute between the creditor and debtor regarding the amounts due.
Once a creditor files for an application to initiation the Corporate Insolvency Resolution Process (CIRP), the outcome of the application is provided within 14 days. The process begins with management suspension, and an interim Insolvency Resolution Professional (IRP) takes over management to investigate the default claims within 30 days of NCLT admitting the application for CIRP, and constitutes a committee of creditors. Following this, an IRP is appointed for the rest of the CIRP. Within 180 days of CIRP initiation, the IRP is required to create a resolution plan for corporate debt revival, which needs to be approved by creditors holding at least 75% of the debt. If CIRP fails, financial creditors have the option to liquidate the corporation’s assets.
RBI-12 IBC Cases
Seven months after IBC was introduced, the Reserve Bank of India (RBI) claimed that 12 companies held 25% of the country’s gross non-performing assets. RBI referred these cases for insolvency proceedings. As of Sep 2020, 11 out of the 12 cases reached some form of resolution:
Table 1: RBI-12 Cases and their Recoveries (Bloomberg Quint, 2020)
The three steel sector cases boosted overall recoveries - Essar Steel (86% recovery), Bhushan Steel (65%) and Bhushan Power & Steel (42%). Overall, lenders have recovered INR 116,000 Cr (US$15.79b) out of the INR 296,000 Cr (US$40.30b) in claims admitted by the financial creditors - average recovery rate of 39.2%. Seven out of the 12 cases resulted in distressed M&A acquisitions, especially in the steel sector, which had the highest recovery rates. Four of the remaining 5 cases ended up finding no buyers and hence ended up in liquidation. As for Era Infra & Engineering, the committee of creditors is yet to approve either of the two resolution plans, with no end in sight three years after NCLT admitted the case.
Figure 2: RBI-12 Distressed M&A Cases (Bloomberg Quint, 2020)
Steel Sector Before and After IBC
The construction of social and economic infrastructure, automobiles, and defence require steel, making the steel industry essential for developing countries such as India. The steel sector had a tremendous growth phase in India between FY2004 and FY2008 and faced steady growth until FY2012. However, things went downhill after FY2012, as world and Indian steel prices declined due to falling iron ore prices and additional pressure from falling Chinese demand. In 2013, India exported ~US$9.2b worth of iron and steel. In 2016, India exported iron and steel amounting to only ~US$830m, a 91% decline (Trading Economics, 2020).
India’s steel industry is a fragmented market, with the top 3 to 4 players holding 30-40% of the industry market share. Between FY2013 and FY2017, most of the steel companies faced losses. In FY2013, Essar Steel posted a loss of INR 2,785 Cr (US$380m) and a subsequent loss of INR 1,597 Cr (US$217m) in FY2014. In FY2015, Essar Steel managed to make a small profit of INR 648 Cr (US$88m) (Business Standard, 2015); however, most of its competitors posted losses - Bhushan Steel made a loss of INR 1,255 Cr (US$171m), Bhushan Power and Steel made a loss of INR 1,361 Cr (US$186m), Tata Steel made a loss of INR 3,930 Cr (US$535m), Jindal Steel & Power made a loss of INR 1,280 Cr (US$174m). This underperformance across the steel sector led to an overall rise in the debt burden, with many of the players unable to service debt repayments, having to undertake corporate debt restructuring measures.
Between 2010 and 2011, bank credit to iron and steel companies grew at 30% to 165,700 Cr (US$22.6b). Between 2016 and 2017, bank credit to the sector grew at a mere 2.5% (all-time low) (Bhatia, 2017). Over the years, the steel sector’s contribution to the overall banking non-performing assets (NPAs) increased significantly, growing from a 2.2% ratio in FY2008 to 11.2% in FY2018. The Insolvency and Bankruptcy Code was introduced in 2016 to address this NPA issue, where the steel sector was a large culprit, being the largest contributor to the national banking system’s non-performing assets. After the introduction of IBC, Essar Steel, Bhushan Steel and Bhushan Power & Steel were three of the RBI-12 cases that were resolved through distressed acquisitions. Eleven other iron and steel companies could not reach a resolution process and ended up heading for liquidation. By Jan 2018, there were 525 active IBC cases with a total of INR 128,810 Cr (US$17.53b) in defaults, with the steel sector being the largest defaulter at 45 claims totalling INR 57,001 Cr (US$7.76b) defaults (44% of total) (The Hindu Business Line, 2018).
Figure 3: Bank Credit to Iron and Steel Industry (INR billions) (Bhatia, 2017)
Many of the large industrial companies in India have promoter-shareholder families, and the IBC has taught these promoters to be extremely mindful and careful with debt. The critical risk to them is that if a company defaults, through the IBC, the promoters risk losing their assets, either through a distressed acquisition or liquidation. Overall, IBC is enabling the metals industry, especially steel, to emerge much stronger with sustainable debt levels. It is also driving consolidation across the sector (given the IBC-led distressed M&A transactions) and is helping global players enter the Indian market, which is still ripe for growth (The Economic Times, 2018). The introduction of IBC has allowed India’s banking system to become much healthier; there is still a long way to go, given the impact of COVID-19; but overall, a healthier banking system improves the flow of capital. This capital will be able to fund investments which will be required in the future to enhance capacity to meet steel and other metals’ demand. To meet the expected demand for steel in the future, the Indian government has a target to produce 300m tonnes of steel by FY2031 (Business Standard, 2018), and IBC has undoubtedly been a critical tailwind driving the industry towards its goal.
IBC Rule Changes Following COVID-19
The novel spread of the coronavirus, business have suffered huge losses, and therefore, changes were made in order not to cause further distress to businesses. The changes within IBC were the following:
Increment of the threshold value from INR 100,000 (US$1,362) to INR 10,000,000 (US$136,200). This was implemented mainly to save micro, small, and medium enterprises (MSME’s) from insolvency, as they might have defaulted due to the pandemic. However, it is unclear what actions will be taken to the defaults between the range of INR 100,000 to INR 10,000,000 has happened before the pandemic hit.
A one-year suspension of the Corporate Insolvency Resolution Process (CIRP). This suspension can be counterproductive for various reasons, lenders (due to suspension of Section 7) will be left with very few options if a default does take place. Secondly, the suspension of Section 9, as well as the rise in threshold value, will lead to operational creditors left with going to civil courts in case of a default. Lastly, business owners wanting to dissolve their business will be left with no option due to the suspension of Section 10, and therefore might face huge debts.
The period of lockdown is not considered as a “default” time period, saving companies who suffered huge losses from the initial lockdown of almost three months.
Nevertheless, actions have been taken to protect companies, even if there is some uncertainty in how these new rules would proceed (The Economic Times, 2020).