OPERATION IN(FRA)SOLVENCY

With over Rs11 lakh crore debt, project investments worth Rs.32.7 lakh crore and cost overrun of Rs14.35 lakh crore is at stake, the current Insolvency and Bankruptcy Code 2016 is a sigh of relief for India’s financial institutions.

 The infrastructure sector is plagued by balance sheet distress that reflects in mounting debt and deteriorating debt-service metrics. It was evident that short-term loans given for long-term projects not only increased the non-performing asset (NPA) levels of banks but also amplified the debt burden of companies that were already stressed. In addition, the credit portfolios of companies were affected by external factors, including aggressive bidding, leveraging and a slowing economy. 
According to ICRA estimates, Rs 30 lakh crore was invested in the infrastructure sector of which about Rs 11 lakh crore came by way of debt. Further, as per the Reserve Bank of India’s recently published data, deployment of gross bank credit to construction and infrastructure sectors is Rs 81,600 crore and Rs 8.88 lakh crore respectively. Major holders of outstanding debts in the infrastructure sector were the power sector with a gross credit of Rs 5.24 lakh crore, roads with Rs 1.71 lakh crore and telecom with Rs 83,000 crore.
It can be said that the banks were at fault for overextending loans to companies that were already debt-laden. But now, with the Insolvency and Bankruptcy Code (IBC) in place, the honeymoon period for both banks and errant companies can be said to be over. 
Ajit Gulabchand, Chairman and Managing Director, Hindustan Construction Company (HCC), observes, ‘If you see, the objective of this Code is first to see if the company can depend on a sustainable debt and find a way to become viable.’He goes on to say, ‘Should that not happen or should it not be agreeable to all creditors concerned, then it is advisable to opt for liquidation.'
 Overambitious projections 
The then Planning Commission, now NITI Aayog, started setting up ambitious targets for the infrastructure sector in all its five-year plans. This is evident from how the overambitious Planning Commission pushed the investment plan for the infrastructure sector from $220 billion for the 10th FYP (five-year plan) to $500 billion in the 11th FYP and $1 trillion in the 12th FYP with the private sector contributing 20 per cent, 30 per cent and 50 per cent of the resources under the public-private partnership, respectively. 
In the absence of large term-lending institutions or an active corporate bond market for raising cheap long-term funds, banks had opportunities to provide large-ticket loans to corporate houses and their special purpose vehicles. Many of the promoters who entered the arena were first-timers with excellent execution capabilities, but equally limited capital. 
Ashwini Mehra, Former Deputy Managing Director, State Bank of India, in her column in a leading daily, point out how the Indian banking sector went bizarre in financing infrastructure. In her column, she explains that while most term funding in banks is done on a debt-to-equity ratio of 67:33, in case of infrastructure projects, the norm was 70:30 in line with ‘international’ practices. Subsequently, this was frequently tweaked to 80:20 based on perceived attractive project viability parameters inter alia – but more proximately, the bargaining skills of the project promoters vis-a-vis the banks. 
Many private equity investors, anticipating the upswing in economic fortunes, jumped on to the infrastructure bandwagon like lemmings by supplementing the marginal requirements of promoters. Given the upbeat, increasingly competitive mood in the country and the entrepreneurs’ desire to grab all possible opportunities, the latter not only started to bid very aggressively but also began to artificially increase the value of projects with exceptional spikes in costs, which was further advanced by certain technical consultants in meeting the lenders’ requirements. For example, while road construction cost was approx Rs 4-5 crore per km in January 2004, it had shot up to Rs 23-29 crore per km by late 2007.
These were the early years for banks in infra-financing. Term lenders like IDFC had highly knowledgeable officials but had little appetite for loans. Hence, banks rapidly grew their loan books, often hitting their sectoral- and group-exposure limits. Banks introduced new concepts, such as cash sweep to reduce the long tenure of the loans and improve asset liability management mismatch when projects achieve better than estimated cash accruals; perpetual part debt in airport financing in recognition of its capital-intensive nature and need for regular replacement capital expenditure; and take-out finance – which never took off even in later years, following a renewed effort by the India Infrastructure Finance Co. Ltd. due to zero or undefined incentive structure for the risk holders. 
 Project derail 
The data from the Centre for Monitoring Indian Economy (CMIE), which tracks the project status of central and state governments and undertakings independently, show that a total of 962 projects at a cost of over Rs 150 crore have been delayed, of which 36 projects are delayed beyond 20 years and 67 projects between 10 and 20 years. A CMIE report suggests that the total investments in these projects were Rs 32.7 lakh crore and the cost overrun stood at Rs 14.35 lakh crore. 
The Ministry of Statistics and Programme Implementation’s (MOSPI) online computerised monitoring system for projects show that of 351 ongoing projects costing above Rs 1,000 crore in the infrastructure sector, 127 projects were delayed, 115 were in cost overruns and 51 showed both time and cost overruns as of February 2017. The major sectors that saw additional delays in projects include road transport and highways, power, petroleum, coal, steel and mines. Of the total 122 highway projects that were in the delayed list, about 90 are being executed by the National Highways Authority of India (NHAI).
Meanwhile, commenting on the stressed assets in the power sector, Hari Sankaran, Vice Chairman and MD, IL&FS, points at some obvious loopholes. According to him, from 2010 to 2017, the total number of long-term key players that were bid out by state electricity boards is under 20,000 MW. ‘There are 75,000 MW of thermal assets ready to supply power, but there is no long-term power purchase agreement in place,’ he cites as an example. (Refer Long-Term PPAs Unlikely – Problem of Plenty on page 53.)
He observes that unless the government backs sectoral reforms with revenue generation schemes, private players are not going to be able to make any headway whatsoever. 
Siva Subramanian, Associate Director-Infrastructure, India Ratings and Research, believes that any spurt in receivable days beyond six months is likely to consume the entire liquidity backup and would force a project company to default. While the Ujwal DISCOM Assurance Yojana (UDAY) scheme is underway, delayed payments by utilities will initially constrain the project ratings and could jeopardise the sector, if not addressed in a timely manner. 
’Although some projects possess a marginal working capital liquidity backstop for two months, state utilities have veered off sharply from an established payable history, leading to developers dipping into debt service reserves,’ he said. 
 Past tensed, future perfect 
As we understand, the first of the debt-laden cases is about to be resolved by Hyderabad bench National Company Law Tribunal (NCLT) and a few more cases may be resolved in the next 270 days. So what is the need of IBC to revive debt-laden companies, especially in the infrastructure sector? The reason is that out of the Rs 70 lakh crore outstanding to the banks, the backlog of NPAs has hit Rs 7.28 lakh crore in end-March this year. 
Recently, Reserve Bank of India (RBI) has come out with 12 accounts responsible for 25 per cent of toxic assets. NCLT has already admitted 11 of the 12 under IBC. There are five steelmakers and an equal number of construction and infrastructure companies -the two sectors hardest hit by coal block cancellations, land delays and environment clearances. Meanwhile, according to RBI sources, another list of 40 has been sent to the banks, totalling the number of toxic assets to 52. Some of the big names include Bhushan Steel, Jaypee Infratech, Essar Steel, Lanco Infratech, Bhushan Power and Steel, Alok Industries, Monnet Ispat, Era Infra Engineering, Amtek Auto, Jyoti Structures and Electrosteel Steel. (Refer Financials of 12 companies that are in the first list of RBI’s big NPA account on page 42.) 
Union Minister Arun Jaitley, Ministry of Finance, Government of India, during the inaugural session of the Insolvency and Bankruptcy Code Conference organised by CII, said, ‘The new legislation should see that the effective functioning of a company does not come to a standstill. Debtors will have to make sure that debts are serviced. For endless years, we have lived in a system that protected debtors and allowed assets to rust.’ The Finance Minister further added that the banking, finance and corporate sectors have given major support for this branch of the law. 
Dr Urjit Patel, Governor, Reserve Bank of India, said that the enactment of the IBC in 2016 is a watershed moment towards improving the credit culture in the country. He elaborated that the IBC, in essence, provides for a single window time-bound process for resolution of an asset with emphasis on promotion of entrepreneurship, maximisation of assets and balancing the interest of all stakeholders. 
 Is IRP trustworthy? 
Through this story, INFRASTRUCTURE TODAY tries to understand the role of interim resolution professionals (IRPs). Many questions have been raised on the role of IRPs wherein a company is managed by the new CEO-cum-IRP in such a way that the interest of the creditor and the debtor are managed and a positive resolution is derived finally. 
Here, main agenda of IRPs is not to liquidate, but to run it efficiently and find someone or some process whereby the company turns healthy. The question here is how insolvency professionals around the world and in India have managed this process so far. Have they been able to win over the loyalty of the existing management and work with them? Is the percentage of success very good? Can IRP manage the interest of the creditor and the debtor, balancing both? 
For Nikhil Srivastava, Director, KKR India Advisors Pvt. Ltd., as far as success of the process is concerned, ‘It is still in early days, and has to be a time-bound process. 
 According to Srivastava, the role of IRPs becomes important to deliver the resolution within 180 days and a potential expansion of 90 days. The entire process backs the idea of strengthening the company and not liquidating it, which is not an ideal solution. To some extent, Srivastava is right! 
IT managed to touch base with a few companies who are now under the scanner of NCLT. According to them, the important aspect of the entire process depends on the right talent, to attract which Srivastava suggests ‘incentives’ in place and a ‘safe environment’ to operate in. Ultimately, IRPs need to have the skill set to be able to deal with errant promoters and importantly the management team, which ultimately they need to work with. 
Vinay Bahuguna, CEO and MD, Asset Reconstruction Company (I) Ltd., feels it can be possible but it is a time-bound process because ‘if it gets the right outcomes, it will surely go on to benefit the management and the shareholders.’ 
Speaking on behalf of debtors, Ajit Gulabchand cites an example from Chapter 11 of the United States Board, which gives more power to the management than the IRPs, unless there is a serious default for which the creditors might not get anything. Only in case of liquidation, the management is shunted out leaving the entire operations in the hands of IRPs. Gulabchand is against the idea of letting the IRPs run the show instead of company management until the liquidation process begins. ‘Let the company be managed so that the purpose for which it (IBC) is created is not gone. This is a very important feature. It is also a comfort, based on which the resolution will depend.’ However, he does agree that for large debtors there is a need to appoint IRPs as it involves complex financials and day-to-day operations. In case of small debtors, if necessary, IRP must chip in. Meanwhile, clearing the air about the capability of insolvency professionals, Dr MS Sahoo, Chairman, Insolvency and Bankruptcy Board of India, said, ‘Major decisions are taken by the committee of creditors and IRPs are empowered by being ‘engaged’, which is necessary to run the company.’ 
Sharing his experience Manish Kothari, Managing Partner, BDO India, said ‘it’s fairly balanced.’ Importantly, he said that there is significant support given by entire eco-system that includes suspended management and regulatory authorities as they have a common interest of resolving a deadlock.'
Currently, BDO India’s is appointed as IRP for Jyoti Structure, ABG Shipyard and Bhushan Steel. Jyoti Structures Ltd became the first company to be permitted to the corporate insolvency resolution process (CIRP) by the NCLT has called for an expression of interest (EOI) for potential investors. The conditions identified by the resolution professional for submitting the applications are a minimum turnover of Rs 1,000 crore for FY17 for individual investors, or Rs 1,000 crore of assets under management for investment companies or funds, and a consolidated net worth of Rs 200 crore or more for a group of investors.
He further added, ‘The main agenda, in my view, is to resolve as we are IRPs and then continuing it as a resolution professional. The objective is not to increase the plant efficiency, or production or turnaround the company. In case we unable to find a resolution, liquidation is the last option.’ 
 Bankers talk 
As the financial sector is blamed for rising NPAs, Uday Kotak, Executive Vice Chairman and Managing Director, Kotak Mahindra Bank, enumerates a famous line: ‘Capitalism without financial failure is socialism of the rich’. Kotak points how Indian financial institutions allowed postponement of problems from 2008û2009 to 2017, thus aggravating the situation and making it far more difficult for debtors. ‘If the financial sector had taken some of these calls in 2008û09û10 and had agreed to take cuts, the situation would have been different’. 
In a way, the Indian commercial banks were not meant to lend large sums of corpus to corporate entities at all. Although India has development financial institutions (DFIs), they were forced to merge with the nationalised banks leaving a gap to fund long-term debts. This situation is similar to handing over the plates, but failing to serve food. Resolution cannot happen without involvement of all participants in the system, including the existing ones, opines Sunil Mehta, Managing Director and CEO, Punjab National Bank. 
Mehta supports the idea of IRPs and suggests that the professionals need assistance from the existing management to manage the suppliers and vendors, and to protect the system. ‘Insolvency professional can keep a watch on financial movement, so from that point creditors interest is protected,’ he said. 
 Applicability of the code 
For banks that are still struggling to get their dues back, IBC is definitely a paradigm shift in both the Indian legal system and the financial system. The country has gone through several avatars of trying to quickly resolve the bad loan problem or ordinary debtor problem. The first one was in 1993, when India had the Debt Recovery Tribunals (DRTs) or Debt Recovery Appellate Tribunals (DRATs) with the same time line of 180 days that the IBCs have at present. But then, the system fell back and the reason was attributed to the non-appointment of DRTs or DRATs at the right time. 
Then, exactly 10 years later in 2003, India thought the ‘Nirvana’ had arrived with the introduction of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SERFAESI) Act, where the debtor-creditor problems could be solved quickly. But again, the country failed. However, with the IBC in place, India sees hope. It appears now the cases under the IBC Act will get resolved in six months or 270 days as the code decrees. 
The case of IDBI Bank vs. Jaypee Infratech Ltd. reflects the ordeal of the homebuyers, who have now filed a PIL seeking stay on the NCLT order initiating insolvency proceedings against Jaypee Infratech to which the Supreme Court has agreed to hear the parties. The company has defaulted on outstanding loans of Rs 526.11 crore to IDBI Bank, for which the appointed IRP had notified homebuyers to submit their claims latest by August 24th, 2017. To this, the buyers have contended that such an order was forcing them to submit to the jurisdiction of IBC without their interests being taken into consideration. The request made to the Apex Court in this regard is to seek direction under Section 14 of the Code that it will not curtail the legal and statutory rights of the homebuyers as consumers, as defined in Section 2(d) of the Consumer Protection Act, 1986.
 Further, in the recent case of Standard Chartered Bank & Ors. vs. Essar Steel India Ltd., Gujarat High Court dismissed the petition of Essar Steel challenging the initiation of its bankruptcy proceedings. This allows its creditors such as State Bank of India (SBI) and Standard Chartered Bank to proceed against Essar Steel in NCLT under the Code. However, the company filed before NCLT requesting that it should be given the opportunity to restructure within six months, which has also been provided to 488 other companies in resolving their bad loans. The company claims that there has been substantial improvement in the operating parameters, which would enable debt restructuring. The HC had left the decision of all substantial issues to the NCLT in this case, since nothing was found erroneous on part of the creditors for approaching the NCLT. 
The judgement by National Company Law Appellate Tribunal (NCLAT) in Neelkanth Township & Construction Pvt. Ltd. vs. Urban Infrastructure Trustees Ltd. has effectuated a paradigm shift in the interpretation of the Code, which held that the Limitation Act of 1963 would no longer be made applicable to the IBC, which means that the debts that were otherwise not recoverable for being time barred can now be the basis for initiating insolvency proceedings. The Tribunal dismissed an appeal by the builder, Neelkanth Township, thereby allowing even operational and small-ticket lenders to recover their dues. The ruling holds that debenture comes within the meaning of financial debt, irrespective of applicable interest rate, and is useful for the industry. This decision is likely to encourage the investors in debt securities to approach the NCLT for their unpaid dues.
 Key financial trends 
Debt-laden sponsors have gradually embraced the investment trust model launched a few years ago by cherry-picking projects with reasonable operational performance to refinance and trim the debt loads. Sponsors with sizeable operating projects in roads and power are the likely beneficiaries of this model. Infrastructure investment trusts (InvITs) not only free up the locked equity capital (with some premium) for sponsors, but also embellish project sustainability. However, with the addition of 10 per cent under construction assets to the InvIT portfolio and the acquisition window always being active, elevated leverage can be expected. Such jeopardising additions expose the cash flows of better performing assets to the perils of new weak entities. (Refer Likely InvITs in FY18 on page 50)
 Stressed assets and book value 
Sankaran from IL&FS raises some concerns over the book value of assets that would come under the hammer. He cites the example of Union Budget document, wherein two modules related to the Income Tax Act insist that the valuation of equity of a predetermined asset be called as book value. However, in the fair market value, it will be known as discounted value. Under the rules of Income Tax, this difference is taxable income and includes both the purchaser and the seller. 
Sankaran opines that ‘It is important for banks to have clarity on the difference in taxable income in restructuring stressed assets.’ Uday Kotak clarifies the confusion by saying, ‘Book value is a ‘booked value’ as determined by the accountants. So before the sale of an asset, if audited accounts are being used to mark down the book value as fair value then it could solve the issue.’ Sankaran counters, ‘It could, but then, in case of concessionaire, how would a concessionaire get fair value in the last seven years of repayment? Book value will be much more of the stressed asset.'
In a normal situation, if a company has a debt of Rs 40,000 crore and the new buyer buys it for Rs 10,000 crore – Rs 30,000 crore will have to be recorded as writeback in the company’s P&L, eventually increasing the company’s book profit. And MAT of 20 per cent will be applicable on that – Rs 6,000 crore in this case.
 The beginning 
The IBC emphasises the concept of ‘Creditors in Control.’ Both operational and financial creditors can initiate insolvency proceedings. Operational creditors such as workmen, employees and suppliers have been recognised as the important stakeholders in the resolution process. It is, therefore, imperative to understand the nuances on how the interests of each class of creditor are addressed in the collective decision making in drawing up the resolution plan. Alternatively, a corporate debtor can also initiate the insolvency resolution process by making an application to the NCL.
A debtor may be a small-scale enterprise or a well-established entity. However, the Code takes away control from such corporate debtors during the insolvency process. Hence, harmony needs to be achieved between the creditors and debtors in each case to attain the desired benefits of the Code. But, in the entire exercise, resolution success rate has been questionable, both abroad and in India. It will be interesting to watch NCLT, which has already started accepting cases with the help of IRPs in resolving the conundrum between banks and NPAs.
 HAM attraction continues 
With fewer buildûoperate-transfer (BOT) projects, the current breed of contractors now focuses on hybrid annuity projects. What is more, not only roads but also railways prefer the HAM model over the public participative policy (PPP). Till now, the NHAI has awarded 30 highway projects of total length 1821.54 km and cost Rs 28,162.13 crore. The Ministry of Water Resources, River Development and Ganga Rejuvenation has also adopted HAM for its Namami Gange programme. Under this programme, tenders for three sewage treatment plants have been invited. As far as the railways is concerned, one contract for the third railway line has been planned under annuity model for which the response has been good and finalisation of contract is under process.
 Deflation erodes toll roads: Sluggish traffic likely in FY18 
Ind-Ra foresees revenue growth ranging between 6 and 8 per cent across its portfolios in FY18. The hurdle that came in the form of toll rate contraction, halted traffic gains in 2016. However, Ind-Ra expects modest inflation to aid in upward toll rates revision in FY18. While in mature toll roads, 6 per cent year-over-year traffic growth commensurate with economic growth, built-up liquidity would comfortably meet debt service, project companies rated in the sub-investment grade categories will be required to grow at 9 to 10 per cent consistently to meet debt service.
 Additionally, toll suspension that lasted for a month due to demonetisation has significantly wiped out debt service reserve to meet debt obligations, and even sponsors backing several sub-investment grade projects are absent. Irrespective of timely compensation, this reserve is unlikely to be replenished in FY18, given the muted traffic in many projects.

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