Wednesday, July 14, 2021

Question mark over IBC process

I return to my blog after a long lay-off caused by various discloations. Somme recent resolutions under the IBC process have triggered a huge controversy, thanks to poor recoveries on bank loans. 

 It does appear that trying to mimic America's Ch 11 bankruptcy process in India has its shortcomings. Many decisions of the NCLT are challenged in courts. The process of resolution stretches out, causing an erosion in the value of assets. Also, we need deep pools of debt capital that can finance biddders so that the auction process is competitive enough Finally, bench strength at the NCLT needs to be increased to expedite hearings. 

Lacking these elements, banks cannnot hope to recover much. Banks must first try to resolve defaults through negotiation and restructuring. Only then should they approach the NCLT. Given the fear of investigative agencies, the IBC has become the default option.


 Bankruptcy process needs a re-look 

A mechanism is needed to ensure bank-led resolution— not the NCLT— is the first resort for lenders Bankers are finding out that the National Company Law Tribunal (NCLT) is an expensive saloon to visit. 

The hair-cut on the sale of Videocon to the Vedanta group is 95.85 per cent, that is, banks will recover only 4.15 per cent of their total admitted claims of Rs64,838 crore. Videocon companies will be sold for a price of Rs 2,962 crore. The fair value was assessed at Rs 4,069 crore. Talk of a terrific bargain. 

The Videocon, offer, the NCLT bench noted, is close to the estimated liquidation value of Rs 2,568 crore. The liquidation value is to be kept confidential and disclosed to the banks’ committee of creditors only at the time of finalisation of bids. The bench seems to be hinting at a possible leak of the liquidation value. 

The danger in such a leak should be obvious. If a bidder believes there will not be any serious bidder in the fray, he can take his chances by quoting a price close to the liquidation value. Further, if a bidder acquires a company at the liquidation value, he may not have any great incentive to run it. He may choose to liquidate if he judges that he can realise, say, 15 per cent more than the estimated liquidation value. The point about selling a company to a bidder is to keep the concern going, to preserve jobs and incomes. Where it is sold at close to the liquidation value, this objective may be defeated. There is nothing in the statutes that prevents a bidder from liquidating a company after having submitted a resolution plan.

In another case, Siva Industries, the banks sought approval from the NCLT for a settlement with the promoter at a hair-cut of 93 per cent on outstanding debt of Rs 4,863 crore. The NCLT bench has sought an explanation and reserved its order. This is the sort of hair-cut that banks would find it difficult to take on their own. They must reckon that doing so under the auspices of NCLT gives them cover—“We followed due process.” 

One of the primary motivations for creating the IBC route was to improve recovery for banks. They weren’t recovering enough through restructuring, one-time settlements and sale to Asset Reconstruction Companies (ARCs). With ARCs, very little reconstruction was happening. They were just a means for banks to hand over the liquidation process to a third party. Recoveries were poor as a result. The hope with the newly constituted National Asset Reconstruction Company Limited is that we will see serious asset reconstruction. 

Is recovery any better at NCLT? According to Macquarie Securities, recovery under NCLT has averaged 24 per cent if we leave out the top nine accounts referred to the NCLT by the Reserve Bank of India. We should not be surprised. Only 8 per cent of cases have been resolved. Thirty per cent of cases have undergone liquidation. Banks need to see if recoveries in bank-led resolution in the recent years are better. 

Bank-led resolution, not the NCLT, should be the first resort for banks. They should be able to keep enterprises going through restructuring wherever possible. This doesn’t happen as much as it should because, in the public sector, bankers fear the law enforcement agencies may come after them—even years down the road. They need a mechanism that gives them protection for hair-cuts they take. It is the absence of such a mechanism that has made the NCLT the first resort ever since it came into being. 

Auction of assets will not automatically lead to the discovery and realisation of the best price. The auction has to be efficient. And the conditions for an efficient auction, such as multiplicity of bidders, correct reserve price, etc are so onerous that these are rarely met even in advanced economies. Besides, resolution under NCLT has been plagued by delays caused by litigation and the sheer volume of cases. Macquarie estimates that cases take more than 400 days, whether for liquidation or resolution, against the stipulated time limit of 270 days. Bidders will know that acquiring an asset would stretch out in time and assets will shed value in consequence. They will tailor their bids accordingly. 

It’s not clear how well assets for sale are advertised in NCLT cases. In some cases at least, investment bankers should be entrusted with a mandate to find suitors on a global basis. Private equity funds must be sought out. Banks are, perhaps, better equipped to do this. 

There is also a case for revisiting the exclusion of promoters from bidding where promoters are not wilful defaulters. An NCLT bench had recently suggested that the promoters be given a chance to bid in the DHFL case. Banks were outraged at the suggestion and have taken the case to NCLAT. Bankers are right in thinking that allowing promoters to bid for assets after they have defaulted creates moral hazard. But there are many cases where default occurs for reasons beyond the control of the promoter. By all means, penalise wilful defaulters. But don’t treat every default as a moral issue and rob banks of decent recovery on their loans. 

Here’s a thought. Let promoters, who are not wilful defaulters, be allowed to bid at NCLT. Where bankers feel that a promoter’s track record does not inspire confidence, they should have the right to reject promoters who have won the bid and opt for the next bid after placing their reasons on record. Some will say that giving discretion to bankers will result in abuse. But the absence of such discretion results in a bigger abuse, namely, poor recovery on loans. The bankruptcy process needs a re-look if Videocon and Siva Industries are not to become the norm. 

Air of optimism on banking 

 The dog did not bark. Non-performing assets (NPAs) did not rise as much as feared. That’s the interesting thing about Indian banking in the time of the pandemic. There’s no mistaking the optimism in the RBI’s latest Financial Stability Report (FSR). The FSR of January 2021 had said that NPAs in the baseline case— which is the best case— would be 13.5 per cent of advances by September 2021. Now it estimates the baseline NPA at 9.80 per cent in March 2022, just a tad higher than the figure of 9.5 per cent in March 2021. “RBI sees NPAs at 14.8 per cent,” some headlines had screamed last January. That was the estimate for the worst case scenario in September 2021. Now, the RBI says that, in the worst case, NPAs would be 11.22 per cent in March 2022. What do the RBI’s revised numbers mean? First, that the second wave of the pandemic has left the Indian banking sector largely unscathed. This would be a truly astonishing outcome if the RBI’s estimates for the coming year are proved right. It would show how much stronger the banking system is today after the crisis years of the past decade. It would also be proof that the macroeconomic impact of the second wave is nowhere as bad as the doomsayers had predicted. Your columnist stands vindicated.

Sunday, April 18, 2021

Re-visiting the Economic Survey on India's handling of the pandemic

The first chapter of the Economic Survey of 2020-21 is devoted to India's handling of the pandemic. The note of exuberance is unmistakable. The Survey claims that the early and stringent lockdown reduced the loss of lives and, at the same time, paved the way for a V-shaped economic recovery:

India’s policy response to the pandemic stemmed fundamentally from the humane principle advocated eloquently in the Mahabharata that “Saving a life that is in jeopardy is the origin of dharma.” Therefore, the “price” paid for temporary economic restrictions in the form of temporary GDP decline is dwarfed by the “value” placed on human life. As the Survey demonstrates clearly, using a plethora of evidence, India’s policy response valuing human life, even while paying the price of temporary GDP decline, has initiated the process of transformation where the short-term trade-off between lives and livelihoods is converted into a win-win in the medium to long-term that saves both lives and livelihoods.

One stringent lockdown and we were done with the problem- so the Survey suggests. India's experience was unlike that of many other countries that did not impose as stringent lockdowns and had to face second and third waves:

The analysis in the chapter makes it evident that India was successful in flattening the pandemic curve, pushing the peak to September. India managed to save millions of ‘lives’ and outperform pessimistic expectations in terms of cases and deaths. It is the only country other than Argentina that has not experienced a second wave. It has among the lowest fatality rates despite having the second largest number of confirmed cases. The recovery rate has been almost 96 per cent. India, therefore, seems to have managed the health aspect of COVID-19 well.

.....India, in fact, has been an outlier in its experience with COVID-19. It reached its first peak in mid-September, after which rising mobility has been accompanied with lower daily new cases .. Globally, many European countries and US have been facing deadly second and third waves around this time with easing of lockdowns and increasing mobility. Most countries had to re-impose intermittent lockdowns while India has been increasingly unlocking. These trends reinforce that India has been effective in combating the COVID-19 pandemic.

The message is clear: India had won the war on covid. The Survey went on to almost rule out any further wave of covid:

 Also, most countries experienced their subsequent waves within a period of 2-3 months of crossing their first peak. These second waves have been more lethal in terms of number of cases. (Figure 23). The fatalities in US were 2.9 times higher during second wave. The prospect of India facing a strong second wave is receding with the start of the vaccination this year.

 The authors of the Survey must be regretting those words!

Clearly, the severe lockdown last March was not the last word in the war. Did the analysis above lead policy-makers on to relax restrictions a trifle too hastily? It may appear so. 

But that raises another question: if lockdowns cannot be relaxed quickly enough, what does that bode for economic recovery? What is the correct severity of a lockdown at any given point in time? 

Alas, a year into the pandemic we are left with more questions than answers.


Citibank exit from Indian consumer business

Citibank's decision to exit the consumer business in India (except for wealth management) is no surprise. There have been several exits of foreign banks from the consumer business in India- HSBC, Bank of America, RBS, to name a few. 

Foreign banks lack the branch presence needed for retail business. Many of them have no more than a couple of dozen branches. This limits access to low cost funds and it limits access to retail borrowers. There is no way they can match either the public sector banks, with their large branch network inherited from the past, or the private banks that have rapidly expanded their branch network in recent years and continue to do so.

Foreign banks were restricted for long in expanding their branch network by reciprocity agreements under the WTO. In November 2017, the RBI announced 'national treatment' for foreign banks, that is, they would be treated on par with domestic banks for the purpose of branch licensing and in other respects, subject to their setting up a wholly-owned subsidiary in India.

But foreign bank subsidiaries are subject to onerous requirements. The governance requirements include such as having a board of directors with at least 50 per cent locals, one-third independent directors, etc. This is undoubtedly a deterrent for foreign banks that would like complete control over their local boards. Besides, a retail presence in India would entail a large commitment of capital. Ever since the global financial crisis of 2007, foreign banks have found it difficult to access capital or have developed a preference for conserving capital for their home markets. 

We are thus in a curious position today. After putting enormous pressure on the Indian government to open up to foreign banks, these banks have suddenly lost appetite for the Indian market. The RBI's policy of allowing domestic private banks to enlarge their presence before letting in foreign banks- a policy authored by Y V Reddy when he was RBI governor- has worked.

Saturday, April 10, 2021

Covid and conspiracy theories

It's fair to say that we- and this includes the scientific community- know little about Covid-19. We don't quite know how it arose, we are not sure if masking and social distancing are effective and we don't how well vaccines work and what their long-term effects are. The scientific community appears divided on the subject. The particular course that nations have adopted is driven by scientists and doctors in the establishment.

Conspiracy theories abound. There is one school that believes that masks are part of the effort to simply whip up a crisis atmosphere so that the state has an excuse to curb civil liberties. Frankly, I don't know what to make of these theories. But when a respected journalist, such as Neil Clark of the UK, says that the requirement of masking is part of a conspiracy, it does make one wonder.

Clark says that those who argued thus last year were dismissed as crackpots. But masking remains very much in place:

Masks would be temporary – restricted to shops – and as soon as the Covid threat had passed they would be dispensed with, like social distancing. Anyone who said these measures were designed to be permanent – and were part of the global elite’s plan to keep the plebs muzzled up forever – was dismissed as a ‘crank’ and ‘a conspiracy theorist’.

Well, nine months on, and where are we?

The UK government has issued a ‘road map’ for taking us – with the speed of a 150-year-old Galapagos Island tortoise on sleeping tablets – out of lockdown. But there’s no mention of when masks and social distancing will be dispensed with.

Well, that could be because Covid hasn't gone away. When people said masking was temporary, they didn't know that Covid would last as long as it did.

Clark is on firmer ground when he says there were no masking requirements in the UK last March and April and masking was introduced even as deaths fell:

We shouldn’t forget that in the week that masks were first introduced last summer, deaths with Covid literally reached zero.

The BBC’s Health Correspondent Deborah Cohen asked the World Health Organisation if their change of advice on masks had been due to political lobbying, and they did not deny.

Why, if masks were so important in preventing transmission, weren’t we told to wear them last March and April? In fact, government scientists advised us not to wear them.

And why is masking becoming semi-permanent? To create a general state of fear:

If cases and deaths with Covid have plummeted to zero, but we want to make people live as if there is a permanent pandemic, to keep control over them, and to introduce ‘Covid-certification’ to restrict where they can and cannot go, how else can we keep Project Fear going without masks? It’s the only way we’d know that these were not ‘normal’ times. Which is, of course, precisely why they were introduced when deaths had dwindled to very low numbers. 

Phew! I thought that the pandemic was stressful enough without such theories.

If you want more such theories, you only need to visit the blog of Paul Craig Roberts, former Asst Treasury Secretary in the US and former Deputy Editor of Wall Street Journal. Here is a sample of websites that Roberts points to.

Friday, April 09, 2021

Tata-Mistry spat: Supreme Court verdict is a boost for 'promoters'

The Supreme Court handed down its judgement on the Tata-Mistry spat last month. The Tatas are clear winners. 

The judgement makes clear that, on every point of law, the Tatas are in the right and Cyrus Mistry in the wrong. My analysis of the verdict appeared in BS today. It is reproduced in full below.

One of the striking features of the judgement is the excoriation of Mistry's conduct consequent to his removal. I given below a few extracts from the judgement so that you get a flavour of how clearly the SC comes down on the side of the Tatas.

Many of the observations in the judgement pertain to Tata Sons as a private company and a holding company that does not have any business activity of its own. But my apprehension, as I indicate in my analysis in BS, is that this judgement will be construed as favouring promoters in general. The temptation to use holding companies with their nominee directors to control group companies while being exempt from the strictest standards of governance is bound to strong.

 Excerpts from the judgement:

 i. On Mistry's allegations of questionable business decisions and transactions of the past:

An appeal from the Order of the NCLAT to this Court under Section423 is only on a question of law. Considering the nature of the jurisdiction conferred upon NCLAT, it is clear that the findings of the NCLT, not specifically modified or set aside by NCLAT should be taken to have reached finality, unless the parties aggrieved by such non-interference by NCLAT have approached this Court, raising this as an issue. Though SP group has also filed an appeal in C.A. No.1802 of 2020, the grievance aired therein, as seen from para 3 of the memorandum of appeal, is limited to the failure of NCLAT to grant certain reliefs. The failure of NCLAT to specifically overturn the findings of fact recorded by NCLT, is not assailed in the SP group’s appeal. Therefore, we have no hesitation in holding that the allegations relating to

(i) transactions with Siva and Sterling Group of Companies;

(ii) Air Asia;

(iii) Transactions with Mehli Mistry;

(iv) the losses suffered by Tata Motors in Nano car project;


(v) the acquisition of Corus

reached finality.

ii. On Mistry's conduct consequent to his removal 

The subsequent conduct on the part of CPM in leaking his mail dated 25102016 to the Press and sending replies to the Income Tax Authorities enclosing 4 box files, even while continuing as a Director, justified his removal even from the Directorship of Tata Sons and other group companies. A person who tries to set his own house on fire for not getting what he perceives as legitimately due to him, does not deserve to continue as part of any decisionmaking body (not just the Board of a company). 

iii. On Mistry's allegations of oppressive conduct on the part of Tatas

 The subsequent conduct on the part of CPM (Cyrus P Mistry) in leaking his mail dated 25102016 to the Press and sending replies to the Income Tax Authorities enclosing 4 box files, even while continuing as a Director, justified his removal even from the Directorship of Tata Sons and other group companies. A person who tries to set his own house on fire for not getting what he perceives as legitimately due to him, does not deserve to continue as part of any decision making body (not just the Board of a company). It is perhaps this realisation that made the complainant companies give up their original prayer for restraining the company from removing CPM and singing a different tune seeking proportionate representation on the Board.

iii. On governance at Tata Sons

The requirement under Section 149(4) to have at least

One-third of the total number of Directors as independent Directors applies only to every listed public company. Insofar as Tata Sons is concerned, the Articles of Association of the Company continue to contain the prescribed restrictions which make it a private company within the definition of the expression under Section 2(68). Therefore, the provisions discussed above do not apply to Tata Sons.

Yet Tata Sons has a Board packed with many people who are ranked outsiders. If the idea was to run Tata Sons purely as a family business, RNT need not have stepped down from the Chairmanship. Today nobody wants to step down from any office, except if afflicted by brain stroke or sun stroke.

iii. On the relationship between Tata Trusts and Tata Sons

Affirmative voting rights for the nominees of institutions  which hold majority of shares in companies have always been accepted as a global norm. As a matter of fact the affirmative voting rights conferred by Article 121 of the Articles of Association, confers only a limited right upon the Directors appointed by the Trusts under Article 104B. Article 121 speaks only about the manner in which matters before any meeting of the Board shall be decided.If it is a General Meeting of Tata Sons, the representatives of the two Trusts will actually have a greater say as the Trusts have 66% of
shares in Tata Sons.

.....Therefore, if we apply Section 152(2) strictly, the Trusts which own 66% of the paid up capital of Tata Sons will be entitled to pack the Board with their own men as Directors. But  under Article 104B, only a minimum guarantee is provided to the two Trusts, by ensuring that the Trusts will have at least 1/3rd of the Directors, as nominated by them so long as they hold 40% in the aggregate of the paid up share capital.


I will stop there and urge you to read the judgement in full.

My analysis in BS:



A comprehensive win for Tatas

They stand vindicated in the Mistry saga, but what is legally sound may not conform to the best standards of governance

In October 2016, Cyrus Mistry was removed as executive chairman of Tata Sons, the holding company of the Tata group. A huge controversy erupted thereafter.

Mr Mistry claimed that he was removed because he was trying to set right many things that were wrong with the Tata group, including questionable business decisions and transactions of the past. He said his removal as executive chairman without any notice and without any explanation was illegal.  

Mr Mistry moved the National Company Law Tribunal (NCLT) in the matter. In July 2018, the NCLT dismissed Mr Mistry’s petition. He then moved the NCLT Appellate Tribunal (NCLAT) against the NCLT order. In December 2019, the NCLAT granted Mr Mistry’s appeal and ordered that he be restored as executive chairman of Tata Sons.

Last month, the Supreme Court (SC) ruled in the matter. It set aside the orders of the NCLAT and  rejected all the substantive contentions of Mr Mistry/the Shapoorji Palonji  (SP) group. The Tata group could not have asked for a more comprehensive win. However, the implications of the verdict for important questions of corporate governance are somewhat unclear.

The SC’s verdict may baffle many who have watched the long drawn-out battle between Ratan Tata and Mr Mistry. Common sense suggested that some of Mr Mistry’s complaints, especially the one about his summary removal as executive chairman, had substance. Alas, common sense is no guide to the law. The SC’s 282-page, rigorously argued order is worth reading. It makes clear that the law is emphatically in favour of the Tatas. Students of company law will especially find the references to the evolution of company law and judicial precedents compelling.

In its petition to the NCLT, the SP group had made serious allegations about various transactions and business decisions of the Tata group, such as those related to the Sterling group of companies, the acquisition of Corus in the UK and the Nano car project.  The NCLT rejected these allegations. The NCLAT did not overturn the findings of the NCLT on these points. Nor did the SP group, in its appeal to the SC, question the failure of NCLAT to do so. The SC takes the position, therefore, that the NCLT findings in respect of the allegations made by the SP group are final.  

One of the key issues in the tussle between Mr Mistry and Mr Tata was the suddenness of Mr Mistry’s ouster as executive chairman in October 2016. There had been no indication of any dissatisfaction with Mr Mistry’s leadership until then. The Tata group had performed well under his stewardship. The Nominations and Remuneration Committee of the board of Tata Sons had endorsed his performance and recommended a pay hike. Mr Mistry contended that the manner of his removal was oppressive and unfairly prejudicial to minority shareholders.

The SC’s response to this point is interesting. It suggests that if there had been oppressive conduct on the part of the Tatas, the group could not have done well under Mr Mistry’s stewardship. Nor could the board members and Mr Mistry have formed themselves into a “mutual admiration society” until his ouster.

The lay person may well ask: How did the “mutual admiration society” dissolve all of a sudden in October 2016? What exactly were the grounds for Mr Mistry’s abrupt removal? The Tatas told the SC they had lost trust and confidence in Mr Mistry. At what point did this happen and why? We do not have an answer.  

The SP group contended that no advance notice was given to Mr Mistry regarding his removal nor did the item figure on the agenda of the meeting in which he was removed. The SC takes the view that, according to the Articles of Association of Tata Sons, advance notice is required only where a director wants to raise a particular matter at a board meeting. There is no such requirement for the board taking up an agenda. A sense of unease remains. The abrupt removal  may have been in conformity with the law. But can we say that it conforms to the best standards of governance?  

The relationship between Tata Trusts and Tata Sons has been very much in the limelight. Two Trusts of the Tatas have the right to nominate one third of the directors on the board of Tata Sons. At Tata Sons, matters that required the approval of the majority of board members required the affirmative votes of the directors nominated by the Tata Trusts. In effect, the two Tata Trusts exercise veto powers on the board of Tata Sons. The SP group argued that such a situation was against the norms of good governance. But the norms of good governance under the Companies Act 2013, the SC points out, apply to public and listed companies. A private company such as Tata Sons is not subject to these norms.    

The SP group had argued that the nominees of Tata Trusts on the board of Tata Sons were conflicted between their obligations to the Trusts and those towards Tata Sons. The SC thinks that the conflicting obligations of Tata Trusts’ nominee directors are inevitable and not inconsistent with the statutes.

The SC notes that Tata Trusts are charitable trusts. Tata Sons is a holding company and is not engaged in any business activity. The nominee directors of Tata Trusts on the board of Tata Sons are thus not on the same footing as a company’s directors appointed at a general meeting of the company. The SC goes so far as to suggest that it may not be practical to expect all directors on a board to exercise independent judgement. If they did so, there would be no need for a category called “independent directors”! 

These observations raise interesting questions. Can promoters operate through trusts, holding companies and nominee directors and render themselves exempt from conflicts of interest? Can directors other than independent directors in non-holding companies allow their obligations to promoters to override those towards other shareholders? Can the government’s nominee directors on public sector companies claim a similar exemption?

Mr Mistry had asked for proportional representation on the board for his group. The SC makes it clear that there is no such provision under law for a company, whether public or private. At the most,  small shareholders in a listed company can be enabled to elect one director.

 The Tatas stand vindicated in the matter.  They will find most gratifying the SC’s point that Tata Sons has been well ahead of the legal curve in respect of the functioning of its board. But what is legally sound does not always conform to the best standards of governance. Many will wish the Tata group to stay ahead of the governance curve as well. One way to do so may be to unilaterally subject Tata Sons to even higher standards of governance by making Tata Sons a public, listed company.