Essar Steel Insolvency: NCLAT On Sharing Profit, Discrimination And Ruia’s Contention

The National Company Law Appellate Tribunal upheld ArcelorMittal SA’s bid for Essar Steel Ltd. but tweaked the way how claims will be settled, stripping lenders of a key power.

The 118-page judgment by Retd. Justice SJ Mukhopadhyay ruled on distribution of profits between the creditors, status of profit earned by the company during the insolvency process, and the role of the Committee of Creditors in distributing claims.

Essar Steel Promoter’s Contention

Prashant Ruia, Essar Steel’s promoter, had approached the NCLAT arguing that ArcelorMittal is ineligible to bid as the steelmaker was barred under Section 29A of the Insolvency and Bankruptcy Code.

The provision bars promoters of a defaulting company from bidding. ArcelorMittal was the controlling shareholder of Uttam Galva Steels Ltd. and KSS Petron Pvt. Ltd., which were struggling to repay lenders. The Supreme Court last year allowed ArcelorMittal’s bid after asking the company to settle dues of its other two companies.

Ruia, however, approached the NCLAT again citing “new grounds” which he argued disqualified ArcelorMittal as an eligible bidder.

The NCLAT, however, said the issue has already been settled by the Supreme Court. The tribunal refused to go into it citing the principle of res judicata, which bars relitigating an already-decided dispute.

Role Of Committee Of Creditors

The NCLAT held that the Committee of Creditors has no role in distribution of claims from the resolution plan, and it can only decide on the viability and feasibility of the bid. The CoC comprises financial creditors who are claimants and allowing them to decide on distribution will be conflict of interest, the appellate tribunal said.

Rejecting the argument by the CoC that it is empowered to deal with all commercial aspects of the plan, the NCLAT held that it is only the resolution applicant, in this case ArcelorMittal, which can decide on the distribution of claims. The appellate tribunal said the distribution of claims must be reflected in the resolution plan and if found discriminatory, the powers lie with the adjudicating authority, in this case the NCLT.

It’s not a fundamental change as the CoC still has the right to vote on it, Piyush Mishra, partner at AZB Partners, said. “Now the first proposal has to emanate from the resolution applicant. The CoC has to review that allocation and bring up a cogent argument on why that allocation to its mind is not fair and reasonable and whether it should be reallocated or not,” he said.

Once they are able to arrive at a consensus, there still could be dissenting creditors and they will challenge it on grounds of being discriminatory, Mishra said. “This is where the next set of questions on what is the correct method of allocation becomes important.”

In the Essar Steel case, the CoC had empowered a sub-committee to negotiate with ArcelorMittal. The steelmaker submitted a revised resolution plan, empowering the sub-committee to decide on distribution of claims.

The appellate tribunal held there is no provision allowing such a committee and ArcelorMittal cannot delegate the distribution of claims to the CoC or the sub-committee.

Discrimination Between Creditors

The NCLAT pointed to “huge discrimination” between the operational creditors and the financial creditors. There was discrimination even among the financial creditors, it said, adding that plan to distribute payments was made in an arbitrary manner.

The appellate tribunal referred to the Supreme Court judgment in the Swiss Ribbon case, which held that the rights of the operational creditors must be protected.

The operational creditors should not be paid less than what they could have received in the event of a liquidation, the NCLAT said. But that doesn’t mean they should not be paid more than the amount they could have received through liquidation as it would “amount to discrimination”, the NCLAT ruled.

“A large number of cases where plans have already been approved would probably have some kind of distinction between creditors, and perhaps we can see challenges to those plans from the side of the creditors,” Pooja Mahajan, managing partner at Chandiok and Mahajan, said. “A resolution applicant may simply propose a flat percentage which is equal for everyone. I do expect a lot of litigation.”

Mishra of AZB Partners said it is correct to say that after the NCLAT order the difference between creditors has collapsed, something which has been acknowledged by Section 53 of the insolvency code that lays down the hierarchy of the creditors. “The NCLAT judgement makes it clear that it will only apply at the liquidation stage.”

“Financial creditors may seek to go for liquidation instead of the resolution plan if they have a very good security. The judgment puts good and bad creditors in the same category,” he said. While lending, lenders keep the priority of charges in mind as it’s the ultimate touchstone is insolvency, according to Mishra. “If I am treating everyone on the same footing irrespective of the charge, then ultimately what is the value of security remains a major challenge to creditors today.’’

Mahajan said it’s a matter of concern for banks which lend on the basis of security. “There is a risk they take and that is determined by the security they take. The minute you say in an insolvency all of that does not amount to anything and all are equal, then that puts the entire basis of credit on its head,” she said. “If I were a bank today, I would be very worried. When you have security, you have certainty that if the company goes in insolvency, I will be able to recover the value of its security. That certainty has gone away with the NCLAT judgment,” she said.

The NCLAT has ordered that all operational creditors with claims above Rs 1 crore will get around 60 percent of what they claimed and employees will get 100 percent payment irrespective of the amount claimed.

Standard Chartered, one of the lenders, had argued that it was deliberately kept out of the sub-committee by the CoC, and that while other financial creditors would receive more than 95 percent of their claim, it would get only 1.7 percent.

“We hold that the ‘Financial Creditors’ cannot be discriminated on the ground of ‘Secured’ or ‘Unsecured Financial Creditors’ for the purpose of distribution of proposed amount amongst stakeholders in the ‘Resolution Plan’ by the ‘Resolution Applicant,” the NCLAT ruled. It held that all financial creditors seeking more than Rs 1 crore will get 60 percent of their claim.

Profit During Insolvency Period

Operational creditors, financial creditors and ArcelorMittal staked claim to profit generated by Essar Steel during the insolvency period. According to an affidavit by the resolution professional, that stood at Rs 3,495 crore.

The Committee of Creditors argued that the amount must be kept by financial creditors. But the operational creditors said they should be entitled to the profit for keeping the company as a going concern.

ArcelorMittal argued that the profit can be shared among creditors but only after adjusting Rs 2,500 crore provided as working capital.

The NCLAT held that the profit cannot be given to the successful resolution applicant as it didn’t invest any money during the resolution process. The financial creditors can claim interest on the profit if they invested any money during the insolvency process. Moreover, if the resolution plan does not settle the full claims of creditors, then the profit should be shared by all creditors.

The profits generated by Essar Steel during the insolvency process will be distributed among all financial and operational creditors on a pro-rata basis of their claims, provided what they get doesn’t exceed the admitted amount, the NCLAT ruled.