IL&FS Crisis: Creditor Hierarchy Under Insolvency Law Cannot Be Followed, NCLAT Says
IL&FS resolution: NCLAT reduces the share of pie for secured creditors in ‘public interest’.
Creditor hierarchy laid down under the insolvency law cannot be applied to the resolution of Infrastructure Leasing & Financial Services Ltd., and distribution to creditors and shareholders must be made on a pro-rata basis, the National Company Law Appellate Tribunal has held.
This will significantly reduce the recovery by financial creditors, especially since the appellate tribunal has allowed allocation to IL&FS’ shareholders from resolution plans of group entities, experts told BloombergQuint.
The NCLAT has approved the resolution plan, proposed by the government, for IL&FS and its 169 group companies. In October 2018, the NCLAT had granted a moratorium to IL&FS and its group entities so that they are not called upon to meet any financial obligation arising from a term loan, commercial paper, fixed deposit and guarantees.
Since then, 133 offshore group entities have been excluded from the moratorium and their resolution has to approved by IL&FS’ government-appointed board and supervised by retired Justice DK Jain. The 169 domestic entities were divided under Green, Amber and Red categories based on their ability to meet financial obligations, and their resolution is underway.
But a question arose before the NCLAT that under resolution plans of group entities, who should get how much?
Secured and financial lenders like L&T Infrastructure Finance Company, Induslnd Bank Ltd., Bajaj Finance Ltd., Aditya Birla Finance Ltd., etc. argued that distribution should be made under section 53 of the Insolvency and Bankruptcy Code. This section lays down the order of priority of creditors at the liquidation stage—insolvency process costs, dues of workmen, secured creditors, unsecured creditors, statutory dues and then operational creditors.
Initially, the government too had advocated allocation based on section 53 hierarchy last year. But it changed its stance in January this year to recommend a pro-rata distribution.
The NCLAT has now approved this plan, which spelled out the rationale for the approach:
- Holding companies IL&FS Transportation Networks Ltd., IL&FS Financial Services Ltd., IL&FS Energy Development Company Ltd., etc. had raised debt from public fund creditors – pension, provident, gratuity and super annuation funds, including Army Group Insurance Funds.
- These holding companies have in turn granted debt to various other group entities.
- For these public fund institutions to recover their dues from the holding companies, it is critical that they receive some payments from the sale proceeds from the asset level resolution currently underway.
- Loans by holding companies to operating level entities were used to fund cost overruns and working capital funding. This enabled the operating level entities to complete the project, thereby generating cash and resulted in creation of assets, including those which are currently being monetised. The loans also enabled the relevant operating level entity to service its secured financial debt.
“Accordingly, it is ‘just and equitable’ that the interest of the lenders at the holding company levels are also considered in the resolution framework…” —NCLAT Order
The NCLAT cited “public interest” to say it can’t be that shareholders of IL&FS should not be paid anything by following section 53 procedure. A large number of banks and different funds have invested in the group companies by purchasing their shares, it said.
“This would be against the public interest as the money invested by purchasing shares by Life Insurance Corporation of India, IL&FS Employees Welfare Trust, Central Bank of India, State Bank of India are public money, who are the shareholders.” —NCLAT Order
IL&FS’ shareholders also include foreign entities like ORIX Corporation -Japan and Abu Dhabi Investment.
It’s confusing as to how the public interest argument applies to these entities—that’s not Indian public money, Pratibha Jain, regulatory head at Nishith Desai Associates, said. “Shareholders—foreign or domestic— make equity investments fully knowing the risk this instrument carries. To now say that in public interest, all contractual rights and the well-understood credit hierarchy will be overridden is unfortunate.”
Illustratively, the pro-rata distribution would workout like this:
Let’s say, there are 15 road projects housed in different special purpose vehicles under IL&FS Transportation Networks. Each of these SPVs will have its set of creditors. Assume the debt at ‘X’ is Rs 100 and the bid value is Rs 70. First, the value of the security with the secured creditors, who are owed Rs 70, will be calculated. Assume it’s Rs 20.
As per the pro-rata distribution, the secured creditors will get Rs 20. The remaining amount—Rs 50 [bid value minus security value] will then be divided among all creditors—secured creditors, unsecured financial creditors, operational creditors, etc.—on a pro-rata basis of their residual claim.
If the priority under section 53 was followed, in the above illustration, the remaining amount of Rs 50 would’ve gone only to secured creditors. And as an unsecured financial creditor, ITNL or any other IL&FS group companies that lent to the SPV wouldn’t have got anything.
The provisions of company law—sections 241-242—under which IL&FS was brought to court relate to shareholder dispute. But this is a debt-restructuring or resolution, which has to be a creditor-led process, Ajay Shaw, partner at DSK Legal, said. Only if there is residual value should the shareholders get anything, Shaw said.
He said it’s likely that once this pro-rata distribution is operationalised via resolution plans at individual company level, the aggrieved creditors may approach NCLTs saying they have been prejudiced.