» Business » Why banks are uncomfortable with bankruptcy code

Why banks are uncomfortable with bankruptcy code

By Anup Roy
October 04, 2017 08:48 IST
Get Rediff News in your Inbox:

Recent tribunal rulings open prospects of large haircuts and barriers to auctioning of personal guarantees, among other issues

Are banks getting boxed in after the introduction of the Bankruptcy Code? Some signals seem to be pointing that way.

Not only are they looking at prospects of steep haircuts (write-offs) on their loans, the Code would also mean banks losing their business to the bond market.


The Code is also upsetting the traditional rules of the games, where banks sold the personal guarantor's assets if a company was in default.

Recently, a ruling of the Chennai bench of the National Company Law Tribunal (NCLT) stopped State Bank of India (SBI) from trying to do so.

The case in question was between Veesons Energy Systems and SBI, in which the bench ruled in favour of the former's promoter and managing director, V Ramakrishnan, who gave personal guarantees to banks.

SBI notified Veesons and Ramakrishnan on November 12 last year that the personal assets would be sold off.

The company challenged it, stating it had applied to the Board for Industrial and Financial Reconstruction (BIFR) and till its application was decided, dues could not be recovered.

The Bankruptcy Code became operational from December 2016.

The company's debt is about Rs 100 crore (Rs 1 billion), of which SBI's share is nearly 70 per cent.

NCLT ruled that in case a guarantor's personal property is sold to realise a portion of debt dues against a company in default, it would create a charge on assets of the company, "which shall amount to 'encumbering' the properties of the corporate debtor".

Meaning, if the bank tried to sell off the assets, the promoter would be deemed a creditor to the company, since his assets had been sold to pay off debt.

The Code says when a company is going through insolvency proceedings, "transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein" is prohibited.

Bankers say this introduces a grey area in the asset resolution process, as recovery through personal guarantee should be separate from other loans of the companies in which a whole host of banks and operational creditors have a share.

Lawyers say personal guarantees would lose their flavour if banks fail to invoke those, as it increasingly looks like all distressed companies will be going through the insolvency proceedings.

"Whether the guarantor gets charge of the properties of the company or not, it should be an independent right from the already established mortgage right.

The guarantor is always treated as a principal debtor and he cannot stall the right of the banks but surely his rights on the company can be debated," said a senior corporate lawyer, who did not wish to be named.

The Synergies Dooray case has clearly spooked bankers after the NCLT ruled in favour of a 95 per cent haircut.

This is also a case where lenders witnessed backdoor entry of the promoters. Edelweiss ARC has challenged the ruling and banks say if the order is not overturned, it would clearly set a precedent that can be explored by unscrupulous borrowers.

Even if Synergies Dooray doesn't become a standard format, bankers say haircuts could be as large as 75 per cent in many cases; the average will have to be 50-60 per cent of loans.

This entails a heavy cost to the lender. And, steep Reserve Bank of India-mandated provisioning norms means banks are left with very little capital to support healthy credit demand.


Increasingly, it was looking like top rated companies are moving away from bank loans to the bond market route.

With the Bankruptcy Code now giving an umbrella protection to bond holders, lower rated companies could also find enough investors for their bonds and raise money at a much cheaper rate than what they pay for bank loans.

"From an investor's standpoint, an effective and robust bankruptcy regime is important for developing the corporate bond market. Investors have been shying away from low-rated corporate bonds even if the rating is of investment grade, given the high rate of defaults," Ajay Tyagi, chairman of the Securities and Exchange Board of India (Sebi), said at a recent event.

Some bankers agree. "The way things are headed, I don't think there will be any top rated borrowers left on any bank balance sheet. It is a serious issue," said Hitendra Dave, HSBC India's head of global banking, in an interview to Business Standard.

Some do believe there would be enough of a market for all.

"It is unlikely that the bond market will fund all your capital expenditure growth. Besides, right now, investors don't want to invest in companies below 'AA' rating.

That is unlikely to change immediately and it would be always difficult for lower rated firms to tap the bond market in the same way they have access to bank loans," says Venkat Nageswar, deputy managing director for global markets at SBI.

What banks fear
  • Insolvency Code could force high haircuts
  • Bond market may gain at the expense of bank loans
  • Guarantees cannot be invoked during insolvency proceedings
  • NCLT rules in favour of Veesons Energy against SBI
  • Invoking personal guarantee means introducing new creditor
  • New creditors not allowed during insolvency course

Photograph: Ajay Verma/Reuters

Get Rediff News in your Inbox:
Anup Roy
Source: source

Moneywiz Live!