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Judgment of Esar Steel | ET explains: How Esar steel verdict changes game rules for future bankruptcy cases

In a landmark judgment, the Supreme Court accepted the superiority of the Committee of Creditors, which comprises the financial creditors of bankruptcy firms for the distribution of claims.

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

Following this ruling, steel tycoon Lakshmi Mittal can now finally bring its global giant Arcelor Mittal to India to set up shop here.

Deciphering the verdict

The Supreme Court overturned an earlier NCLAT order that brought parity between Esar Steel's financial and operating creditors in terms of revenue distribution.

Thrown out by the NCLAT verdict, creditors have approached Apex Court saying the NCLAT order exceeds the scope of the IBC. They also argued that secured creditors had the first right to the funds, an argument used to deny Standard Chartered the same treatment as other financial creditors. As the Supreme Court finally upheld the FOS distribution championship, there is great concern.

Faster IBC resolution

The delay in resolving bankruptcies comes as a result of litigation – mostly due to operating creditors expressing their dissatisfaction with the allocation of funds. Their view is that they receive a crude bargain from the IBC process and need to take the sharp haircuts.

The Supreme Court's ruling will calm these problems, as it is said that while the Committee of Creditors will have the final say on the allocation of funds, it should also take care of the interests of operating creditors. This judgment is suggested by the fact that no worries can work without 0-creditors.

Deadline of 330 days

The Supreme Court dismissed the 330-day deadline for insolvency and bankruptcy cases after which liquidation would be called.

The 330-day deadline was passed through amendments by the government this year to reduce litigation time. The original 270-day window was broken in many cases for litigation. Courts treated the time spent in litigation outside the 270-day window, causing major delays in the settlement process.

The 330-day deadline includes litigation time. The Supreme Court has empowered the competent authority to decide whether more time is needed to decide a case.

Waterfall mechanism

The IBC follows the waterfall mechanism which essentially defines the order in which winding-up income is distributed among the different categories of creditors.

According to this formula, secured creditors have the first right over the allocation of funds followed by unsecured creditors and operating creditors, in that order.

According to an ET report, the government – which is considering a fixed percentage of operating creditors in order to cut frivolous litigation – will have to participate in the waterfall mechanism, as SOS can favor liquidation if they take a stronger haircut.

The way forward

IBC's biggest USP was timing the resolution of bankrupt firms and allowing them to remain a concern; companies only go into liquidation in extreme cases.

Faster resolution for the IBC is in the interest of all stakeholders as it will relieve the banking sector of the stress it is facing with the NPA. This is important for improving the business climate in India and for the ease of setting up new businesses.

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