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ET Explains: How Essar Steel verdict changes the rules of the game for future bankruptcy cases

It was one of India's original Dirty Dozen referred by the RBI to NCLT for resolution under IBC.

ET Online|
Updated: Nov 15, 2019, 06.53 PM IST
NCLAT's Essar Steel ruling set aside: Everything you need to know
NCLAT's Essar Steel ruling set aside: Everything you need to know
In a landmark judgment, the Supreme Court has upheld the supremacy of the Committee of Creditors comprising the financial creditors of the bankrupt firms over the distribution of claims.

The order will finally pave the way for resolution of Essar Steel, one of the oldest cases in the IBC process. It was one of the original Dirty Dozen referred by the RBI to NCLT for Corporate Insolvency Resolution Process under the IBC Code.

Following this verdict, steel tycoon Lakshmi Mittal can now finally bring his global giant ArcelorMittal to India to set up shop here.

Deciphering the verdict
The Supreme Court quashed the earlier NCLAT order which brought parity between financial and operational creditors of Essar Steel in matters of distribution of proceeds.

Peeved with the NCLAT ruling, the financial creditors had approached the apex court saying that the NCLAT order exceeds the scope of the IBC. They also argued that secured creditors have the first right over funds, an argument that had been used to deny Standard Chartered the same treatment as other financial creditors. With the Supreme Court finally upholding CoC's primacy over distribution of funds, a major area of concern has been addressed.

A faster IBC resolution
The delay in the resolution of bankrupt firms occurs due to litigation — mostly on account of operational creditors expressing their unhappiness over the distribution of funds. Their stance is that they get a raw deal from the IBC process and have to take steep haircuts.

The Supreme Court's verdict will put those concerns to rest as it said that even though the Committee of Creditors will have a final say on apportioning the funds received, it has to take care of the interests of the operational creditors as well. This ruling is premised on the fact that no concern can function without 0perational creditors.

The 330-day deadline
The Supreme Court has done away with the 330-day mandatory deadline for the resolution of insolvency and bankruptcy cases after which liquidation will be invoked.

The 330-day deadline was brought in through amendments by the government this year with the purpose of bringing down litigation time. The original window of 270 days had been breached in many cases on account of litigation. Courts treated the time spent in litigation as outside of the 270-day window, thereby causing major delays to the resolution process.

The 330-day deadline included time spent on litigation. The Supreme Court has given the adjudicating authority the powers to decide if it needs more time to decide on a specific case.

The Waterfall Mechanism
IBC follows a waterfall mechanism which essentially delineates the order in which the liquidation proceeds will be distributed among the different categories of creditors.

According to this formula, secured financial creditors hold the first right over the distribution of funds followed by unsecured financial creditors and operational creditors, in that order.

According to an ET report, the government — which is considering a fixed proportion for operational creditors in order to cut down on frivolous litigations — will have to factor in the waterfall mechanism because CoCs may favour liquidation in the event of them taking a more steeper haircut.

The Road Forward
The IBC's biggest USP was its time-bound resolution of bankrupt firms and allowing them to remain as going concerns; companies are referred for liquidation only in extreme cases.

A faster IBC resolution is in the interest of all stakeholders as it will relieve the banking sector of the stress it is currently facing in terms of NPAs. This is important for improving India's business climate and ease of setting up new businesses.

Also Read

Bankruptcy law comes of age

Finance firms’ bankruptcy: Fail, and pass the test

NBFC/HFC bankruptcy provisions positive for banks: Moody's

View: Common sense wins in India's bankruptcy case

RCom subsidiary files for bankruptcy in US

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