India’s insolvency law has bankers going bald

Genuine reform will mean ending promoter raj, which will, in turn, involve an arduous overhaul of everything from the company law to the securities code. However, even that won’t be enough. The big leap in bankruptcy will require attention to the political economy.

By Andy Mukherjee

If harsh haircuts on bankrupt assets weren’t bad enough, India’s lenders must now be going bald with worry. A recent court order has raised the unpleasant prospect of having to return the money new owners paid them to settle the unpaid loans of insolvent firms — years later.

The nation’s nine-year-old insolvency code has struggled with delays and poor recoveries. A third of the bankruptcies admitted by the tribunals have gone for liquidation, while three-quarters of the cases still open in December had exceeded the prescribed 270-day mark for resolution. Creditors have recouped only 31 per cent of the $133 billion of bad debt they pursued under the law. In many instances, even after finding buyers for troubled assets, banks have had to be satisfied with less than a 10th of their claim.

All these are known problems. However, a recent legal order has introduced a fresh wrinkle. Earlier this month, the Supreme Court in New Delhi said that JSW Steel Ltd.’s acquisition of a debt-burdened rival, Bhushan Power & Steel, didn’t conform to the bankruptcy law. It ordered Bhushan’s liquidation — more than four years after JSW announced its purchase and rehabilitation.

The $2.7 billion (Rs 22,917 crore) that billionaire Sajjan Jindal paid creditors for the asset in March 2021 catapulted him to the top of India’s steelmaking league table. Losing Bhushan now may mean a 13 per cent drop in JSW’s revenue. The steelmaker is preparing to ask for a judicial review of the court order, Business Standard has reported. Government-controlled lenders, including State Bank of India and Punjab National Bank, are likely to do the same, according to Bloomberg News.

Prime Minister Narendra Modi’s government will be watching the case carefully, and not just because it involves state-run banks. The Insolvency and Bankruptcy Code is one of Modi’s signature reforms, introduced in 2016 to unshackle the economy from what eventually became the world’s biggest pile of soured corporate debt.

The code, even when it wasn’t terribly successful in preventing unnecessary liquidation (such as of airlines), or in maximizing recoveries for creditors, at least put a limit on bad behavior. Family owners who mismanaged their firms could lose assets and their social standing. Nearly 14 per cent of all bankruptcy cases have been settled using a pathway that allows controlling shareholders to negotiate with creditors and exit the legal process. But if asset forfeiture or sale is reversed years later, aggrieved lenders’ bargaining position may be weaker against errant debtors.

The judgment will “severely erode investor faith” in participating in the legal process for corporate insolvency and “considerably impair” the bankruptcy code as a resolution strategy, according to Trilegal, a local law firm that recently provided counsel to Chinese creditors in a high-profile case. The court’s decision could “affect the ease of doing business in India and further has the potential to reopen previously implemented resolution plans,” the law firm’s partners cautioned in a note last week.

Now that New Delhi has nearly a decade of experience of operating a modern bankruptcy code, it should reevaluate it. The law needs to provide more certainty to outcomes. But any tweak must also take into account a business landscape that has evolved very differently from the rest of the world. Unlike the US, India has few executive-led corporations. Control of economic assets has passed from “managing agencies,” a 200-year-old British-era colonial invention, to so-called promoters, which are usually business families that do whatever they want with the help of cherrypicked boards, weak regulatory oversight, and other people’s money.

Genuine reform will mean ending this promoter raj, which will, in turn, involve an arduous overhaul of everything from the company law to the securities code. However, even that won’t be enough. The big leap in bankruptcy will require attention to the political economy.

Capital is a highly scarce resource in a fast-growing, labor-surplus nation, and its allocation — to productive businesses, or zombie firms — a busy intersection of economic might and political power. That won’t change overnight, not when such entanglement is happening almost everywhere. It’s perhaps unreasonable to expect that in India, where the world’s most expensive elections are fought with corporate donations, the bankruptcy process can escape being a tool for politicians to greenlight wealth transfers from one business family to another.