Right intent, wrong definition

Sanjay Singal, promoter of the distressed Bhushan Power & Steel, is an angry man. In his petition before the Supreme Court, Mr Singal has questioned Section 29A of the Insolvency & Bankruptcy Code (IBC) as it is 'ultra vires' of some of the rights guaranteed by the Constitution. The section bars promoters of defaulting companies from bidding for distressed assets and was implemented with retrospective effect. But the simple question Mr Singal has forgotten to answer is this: Why is he so keen now to pay “fair value” for a company whose debt ballooned to Rs 450 billion under his watch? Worse, he did not pay up his dues to banks in time. 

In that context, the government’s decision to bar certain promoters from bidding for their own assets under the IBC was just what the doctor ordered. But in its over-enthusiasm to be seen as a warrior against crony capitalism, the government seems to have prescribed too strong a medicine. 

Let’s look at the positives first. It would have been pure bad optics if promoters, who defaulted on their loans, were effectively rewarded with the control of their company, leaving creditors to write off a substantial part of their debts. The decision was important to minimise moral hazard; otherwise, firms would have an incentive to default on their loans and then offer to repay them at a discount. After all, if a promoter knows that he can afford not to repay bank loans and buy back his company at a discount with a reduced debt burden, he has a strong incentive to run his company into the ground, perhaps by siphoning off funds from it. 

To teach promoters the right lesson, several amendments have been made to the IBC, first by way of an ordinance in 2017, and then by further amendments this year which, among other things, brought in Section 29A. This section specifies persons not eligible to apply for taking over a company, and has 10 clauses. The 10th clause is further divided into three sub-parts. 

The problem begins here. Section 29A is a restrictive provision, as any person falling in the negative list is not eligible to submit a resolution plan. It imposes four layers of ineligibility, two of which are “connected person” and “related party” of connected persons. However, the ambiguity in the definition of these two layers has created a huge confusion, leading to outrageous claims and counterclaims. 

Consider this. After losing the bid for Ruchi Soya, Baba Ramdev’s Patanjali Ayurved is reported to have argued that the Adani Wilmar promoters were ineligible to bid as per Section 29A on the ground that Pranav Adani, managing director of Adani Wilmar, is married into the Kothari family, the erstwhile promoter of Rotomac group, which allegedly defaulted on nearly Rs 37 billion in bank loans. Though Patanjali’s argument was dismissed, it did showcase the vaguely wide ambit of ineligibility that could be used by other bidders to challenge the eligibility of the resolution applicants. 

There are more such examples. Speaking at the Business Standard Annual Banking Forum, State Bank of India Chairman Rajnish Kumar said amendments to the Section is a must because of “definition challenges”. “There is a case where two brothers have split their businesses 20 years ago, but as one brother is now a defaulter, the other brother cannot bid for the assets under the IBC,” he said. 

Though Mr Kumar did not name anybody, he was clearly referring to the Mittal brothers. In October, the resolution professional of GPI Textiles, a Pramod Mittal group company, informed the Committee of Creditors of Essar Steel and filed a caveat that ArcelorMittal should repay the dues of the company to the public sector banks under Section 29A of the IBC, as Pramod Mittal is the younger brother of L N Mittal. The resolution professional also filed a caveat that it should be heard before clearing any transaction. ArcelorMittal had said it is not liable for Pramod Mittal’s loan defaults. 

The SBI chairman has a point: After all, the Mittal brothers had split years ago, and there is no reason why any default by the younger brother should be used to declare the older brother ineligible to bid for Essar Steel. 

The lack of clarity on “connected persons” or “related parties” has already led to delays in many cases. A case in point is MBL Infrastructure. During the discussions, the Committee of Creditors was unanimous in its decision that even the non-defaulting promoters of the company were barred under Section 29A from submitting a resolution plan. On the other hand, the resolution professional was of the opinion that they did not fall under the criteria of ineligibility specified under the Section as they were not defaulters. Though the matter was sorted out later, there was an entirely avoidable confusion which delayed the insolvency process. Section 29A of the IBC needs a hard look, indeed.