Essar Steel Case: The ‘Upside-down’ of the Insolvency & Bankruptcy Code

By: Hansaja Pandya


After almost a year of tussles with every eligible adjudicating authority, ArcelorMittal, the world’s largest steel producers whose production capacity is said to be as mammoth as “India Itself”, has got its bid of 42,000 crores for Essar Steel approved by the National Company Law Appellate Tribunal (hereinafter ‘NCLAT’). The NCLAT order, approving the resolution plan of the world’s leading steel and mining company, prompts a reflection on what is at stake for the three-year-old Insolvency & Bankruptcy Code (hereinafter ‘the Code’), and India. It has come to be known as the ‘most dangerous’ decision for the Indian debt market. 

The saga began when the operational creditors of the debt-laden Essar Steel and Standard Chartered Bank complained to the tribunal about the unfair treatment meted out to them. While all the other financial creditors had a recovery rate of 90%, Standard Chartered Bank would have only been able to recover around 2% of its debt lent to a subsidiary of Essar Steel. Apart from mentioned creditors, tax authorities, operational creditors like energy companies and power utilities, had almost negligible recovery under the resolution plan approved by the Committee of Creditors (hereinafter ‘CoC’). 

THE RULING

The NCLAT postulated that the waterfall of creditors given under Section 53 of the Code applies only in cases of liquidation; bankruptcy proceedings do not prescribe any hierarchy of creditors. Therefore, for the Tribunal, every creditor was at par with the secured financial creditors. The Tribunal stripped the CoC of its power to decide the distribution of the amount of debt which was recovered, which disregarded the hierarchy of creditors that was maintained by the Code, i.e., secured creditors occupying the top slot and the operational creditors saddled at the bottom of the pyramid, the latter being forced to take the biggest haircut. Tribunal boldly stated in its order that:

“…we hold that the ‘Committee of Creditors’ has no role to play in the matter of distribution of amount amongst the Creditors including the ‘Financial Creditors’ or the ‘Operational Creditors’…”

This order indicated that the Tribunal now had the power to decide how the amount of debt which is recovered is to be distributed among creditors; and if it ‘wished’ it could bring the operational creditors on the same pedestal as that of the financial creditors. 

ANALYSIS: WHERE THE NCLAT WENT WRONG

Overstepping its Jurisdiction

The NCLAT has religiously followed the current sentiment of the economy to give equal treatment to both financial and operational creditors, which seems to be a bright development for the deprived class of creditors. But in doing so, it has overstepped its power and gone beyond its jurisdiction, by exercising the power to amend Resolution Plans — a power which it was never envisaged to have. The only power the Tribunal is granted under Section 31(1) of the Code, vis-à-vis a Resolution Plan, is to determine whether the Plan conforms to the requirements of Section 30(2) of the Code, and if it does, the Tribunal must then approve the Plan. Section 30(2) provides that the operational creditors are entitled to recover an amount which is not less than the amount they would have received in the event of a liquidation. The ArcelorMittal Resolution Plan perfectly complied with this requirement, and hence the Tribunal overstepped its jurisdiction by amending the Resolution Plan that was approved by the CoC. The ruling violates the fundamental principle of law that the secured creditors are entitled to preferential treatment over the unsecured ones, as they have been cautious in supporting their debts with collateral.

Equal Treatment of Financial/Operational/Secured/Unsecured Creditors 

As highlighted above, the courts and tribunals are increasingly promoting equal treatment of all classes of creditors, especially when operational creditors are more in number, but such equal treatment may go against the very framework of the Code. For instance, Section 30(2) has imported Section 53, which contains the waterfall of the creditors in cases of bankruptcy, to cover insolvency proceedings as well. Sub-clause (b) reads:

(2) The resolution professional shall examine each resolution plan received by him to confirm that each resolution plan—

(b) provides for the repayment of the debts of operational creditors in such manner as may be specified by the Board which shall not be less than the amount to be paid to the operational creditors in the event of a liquidation of the corporate debtor under section 53;

This denotes that, even in cases of bankruptcy, only the lower limit of the amount to which the operational creditors are entitled is prescribed; and this minimum amount is calculated after subtracting the dues of the financial creditors and other persons ranked above them. Such distinction between the two classes of creditors seems to be a clear intention of the legislators, as the CoC is comprised of only the secured financial creditors. They are eligible to be a part of the committee only if their debts amount to or are more than 10% of the aggregate of the debt owed. This intention is also reflected in Section 8, which requires the operational creditors to send a demand notice as a pre-requisite to initiate Corporate Insolvency Resolution Process, while financial creditors are under no such obligations. 

The case of Essar Steel is not the only one. In the case of Binani Industries Ltd v. Bank of Baroda, which can be aptly treated to be the ground for the genesis of the idea of equal treatment of all creditors, the same mistake was made. Such decisions carry the potential danger of opening a floodgate of proceedings by operational and unsecured creditors seeking equal treatment. 

In the same context, it is important to cite the case of Swiss Ribbons Pvt Ltd v. Union of India, wherein the court gave the intelligible differentia between the two kinds of debt, and justified the difference in treatment in the following words:

We have already seen that repayment of financial debts infuses capital into the economy in as much as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses. This rationale creates an intelligible differentia between financial debts and operational debts, which are unsecured, which is directly related to the object sought to be achieved by the Code. In any case, workmen’s dues, which are also unsecured debts, have traditionally been placed above most other debts. Thus, it can be seen that unsecured debts are of various kinds, and so long as there is some legitimate interest sought to be protected, having relation to the object sought to be achieved by the statute in question, Article 14 does not get infracted. For these reasons, the challenge to Section 53 of the Code must also fail.

Thus, there seems to be no constitutional backing to the present NCLAT order in the Essar Steel Case. In fact, in the spirit of the Code, the secured creditors must be put on the top of the ladder. In light of this landmark decision, the future of the NCLAT order seems dim and is likely to be struck down by the Apex Court. Owing to the fact that they generate credit for the economy, financial creditors are given a position at the top of the rung. When banks (which constitute a significant amount of financial creditors) lend, the multiplier system comes into play and every loan that they give earns interest and creates credit. In order to create more credit and liquidity in the economy, the banks must be encouraged to lend, but the order in Essar Steel case is contrary. Therefore, the argument for favouring financial creditors is more economical then legal.

EFFECT ON INDIAN DEBT MARKET

The Essar Bankruptcy Case will thus, for economic reasons, alter the momentum of the debt market in India. It will slow down the current trend of increasing Foreign Debt Specialists investing in India to help clean-up huge heaps of bad loans, which is estimated to be at a staggering value of $200 Billion. This is mainly because treating Foreign Financial Debt at par with Operational Debt will force foreign lenders to take higher haircuts and demotivate the investment sentiment, thus reducing the capital flow in the country. This ruling will also lead secured financial creditors to steer the insolvency proceedings more towards liquidations, in view of the fact that they will have only very little recovery if unsecured and operational creditors are treated at par with them. As bankruptcies turn into liquidations, it will lead to excessive unemployment and higher loan-loss provisions in a capital-starved financial system.

CONCLUSION

While there is a need to recognise the rights of the secured creditors over that of the unsecured ones as the former has been more cautious, there is also a need to ensure that no creditor is side-lined to the extent that the operation of the Code becomes unfair and unjust for that class of creditors. In the present case, the Standard Chartered Bank was saved from the unjust discrimination meted out towards it in spite of being a financial creditor. But on the other hand, the unsecured creditors, who have been so negligent so as to not even secure their debt, should not be allowed to get the same privileges as those of the secured creditors who have performed their due diligence and made every effort to ensure that the debt does not become a non-performing asset, and in its extension, a burden on the economy. The Hon’ble Supreme Court is expected to arrive at a balanced formula that does not discriminate against any creditor but also does not unduly favour any creditor.


(Hansaja is currently an undergraduate at Gujarat National Law University.)

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