Restructuring and insolvency experts predict that India’s banks and bondholders will receive less money from insolvency resolutions under a planned law reform that would give more money to junior creditors, like unpaid vendors and the government.
The government aims for a “equitable structure of distribution of proceeds,” according to a discussion paper released in January that recommends other significant revisions to the Insolvency and Bankruptcy Code. However, secured creditors, who are normally paid out earlier those with unsecured claims, may be less sympathetic to the IBC if those modifications are eventually implemented, according to bankruptcy practitioners.
Secured creditors, mainly banks and bondholders, would continue to have first claim on the proceeds of an insolvency resolution plan, but only up to the corporate debtor’s liquidation value. According to the paper, which was out for public comment earlier this month, any recovery above liquidation value would be split ratably among all creditors, including unsecured financial creditors, delinquent vendors, and statutory dues owed to the government.
According to Abizer Diwanji, financial services and restructuring head at EY India, the plan appears to be unjust to secured creditors and would have a substantial impact on credit markets and security considerations.
Overall recovery under the IBC, which has already been plagued by delays and litigation, have been around one-third or less of claims. Under these conditions, the government’s proposal may turn off even more lenders, ranging from Indian banks to overseas private credit funds.
What Will Be Different?
The proposed insolvency cascade prioritises secured claims similarly to the existing liquidation waterfall, which determines the order in which creditors are repaid, but only up to the value of the security. The residual proceeds in a liquidation are divided first to unpaid salaries, next to unsecured creditors, and last to shareholders. In the event of insolvency, the proposal treats all unsecured creditors fairly.
Using an example of an insolvent corporation with secured creditor claims of 100 rupees, unsecured claims of 150 rupees, a liquidation value of 75 rupees, and a recovery of 125 rupees, Diwanji explained the issue. He said that under the current system, secured claims would receive full payment, and the remaining $25 would be distributed to unsecured claims in a hierarchy. However, he said that under the new method under consideration, secured creditors would only be given 75 rupees, with the remaining 50 rupees being allocated equally among all unsecured claimants.
According to MS Sahoo, the under-secured creditors who have lent more than the value of the underlying security or who have witnessed a sharp decrease in the value of the security will be the ones who will be most affected.
In a time when India has had non-performing assets across banks, it will professionalise lending, according to Sahoo. He noted that the amendments will compel lenders to monitor security value and give sufficient protection to unsecured creditors.
Resolution plans frequently include funds for operational creditors that are essential to maintaining corporate operations. According to Diwanji, this is better handled on a case-by-case basis rather than affecting secured creditors’ rights, which have broader ramifications.
There have been conflicting reactions to the government’s proposal to separate the court approval procedures for resolution plans and distribution funds.
ALSO READ: ICOMM signs first ever ‘Transfer of Technology’ agreement with UAE-based CARACAL
