In today's newsletter we dive deep into Essar Steel's debt saga and why it took 800 days to finally reach a resolution.


The Story

Before we get the meat of this story, we need to talk about the debtor-creditor arrangement.

When large corporates fail to pay up, you would expect banks to immediately take them to task and force a resolution. However, before 2016, the equation was a tad bit different. In the old days, defaulters often pressurized banks to extend repayment periods and take large haircuts i.e. get the banks to settle for only a fraction of the original loan amount while retaining full control of their company. In the event of resistance, corporates often threatened to take the matter to court. And the uncertainty involved in waiting for the courts to rule on the matter often prompted banks to cede ground and settle with the defaulter.

In fact, this emboldened many corporates to willfully default on their payments so long as they were convinced the balance of power remained with them. Outside of hurting banking culture in this country, it created many other distortions. As the Bankruptcy Law Reforms Committee (2015) succinctly put it

“When creditors (lenders) know that they have weak rights resulting in a low recovery rate, they are averse to lend. Hence, lending in India is concentrated in a few large companies that have a low probability of failure."

So you can see why we needed to tip the scales here. And tip the scales we did.

In 2016, lawmakers finally passed the Insolvency and Bankruptcy Code, 2016 (IBC) to provide for a legal framework that banks could use to take defaulting companies to task. This was a watershed moment for two reasons. One, it put a time limit of 180 days (extendable by a further 90 days) within which lenders had to agree to a resolution plan i.e. figuring out repayment terms. Two, in the event that nobody could agree on specific terms, the company was to be dissolved with all the assets put up for sale. The proceeds would then be divided among the lenders in an equitable manner.

In summary, lenders now had every reason to find a resolution plan because they knew they’d have to settle for pennies if they waited for the company to be dissolved. And owners of defaulting companies had every reason to settle because if they didn’t, they would now lose all control of their most prized possessions. A win-win for all parties involved. No more courts, No more endless legal battles. No more bad loans.

At least, that was the plan.

And soon enough, the Reserve Bank of India sprung into action. It identified 12 large borrowers who had failed to pay their dues and Essar Steel figured very prominently in this list. The company owed banks a whopping 43,000 crores and another 11,000 crores to its suppliers and vendors. And in June 2017, SBI and Standard Chartered Bank took Essar to NCLT — a special type of court responsible for dealing with bankruptcy/insolvency proceedings under the IBC. The court admitted their plea and the lenders got together to draft a resolution plan. Their idea was simple. Invite bids for a takeover of Essar Steel and see who’s willing to pay the most. Once the final bid is accepted, they could decide how to split the proceeds.

And this is when things took a very interesting turn. At first two companies expressed interest to buy Essar. ArcelorMittal, the world’s largest steel producer and Numetal, a joint venture between Rewant Ruia — son of Essar co-founder Ravi Ruia — and Russia’s VTB Bank.

Unfortunately, both bids were quashed. The reason — Sec 29A. Under the IBC a special provision barred companies with unpaid dues from participating in the process. ArcelorMittal had some unpaid loans on their books. Rewant Ruia had associations with Essar Steel ( a company with over 50,000 crores of debt). So both companies were disqualified.

Eventually, Revant Ruia left the JV and Numetal bid for Essar without the Ruia connection. ArcelorMittal followed suit, by clearing their dues and tabling a fresh bid. After some back and forth including trips to the Supreme Court Arcelor Mittal won the bidding war with a 42,000 crore offer. Now at this point in time it's important to note that, Essar tried to scuttle the deal by making another offer that included paying off the entire 54,000 crore loan burden.

“Forget the IBC, Forget the NCLT. Let's just settle, eh?”

However, the committee of lenders deliberating the resolution chose to ignore all of this and accepted the ArcelorMittal offer.

Why you ask? Because ArcelorMittal had already offered bank guarantees and put up a lot of the money on the table to signal their intent. They were serious about this thing. Essar, on the other hand, made no real disclosures on how they were planning to raise 50,000 crores. So yeah, ArcelorMittal for the win.

The last problem was distribution. How do you split the proceeds and who gets how much?

The NCLAT (the appeals court above NCLT) issued a rather bizarre order here. It said that all types of lenders had to be treated equally and the proceeds would be distributed on this single premise.

Which means even if you are a lender who offered money against collateral, you are just as good as some chap who loaned out money without asking for any guarantees in return. The banks with the collateral challenged this order and the Supreme Court decided it was imperative that these banks be paid first. The rationale was simple. When banks lend against collateral they offer a lower interest rate on the loan simply because they’ll have the collateral just in case things go wrong. However, according to the NCLAT order, everybody is to be treated equally. So why would banks ever offer a low interest on a loan even if the borrower can back it with collateral? They probably won’t and that would screw up the whole banking equation.

So better sense prevailed and after over 800 days of legal wrangling, the Essar Steel saga comes to a close.


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An earlier version of the article mentioned that NCLT was instituted under the IBC. However NCLT was formed under the Companies Act 2013. We regret the error.