Peace Out

Indian Bankruptcies Go Karmic, Uncle Sam Style

Willful defaulters are out, but folks who innocently ran highly leveraged businesses into the ground? They're fine.
Photographer: Thomas Brown/Getty Images

India's fledgling bankruptcy regime is turning both karmic and American. Eat, pray, love; applaud the shift.

The government tweaked the 2016 insolvency law on Wednesday to disallow managements that have been "willful defaulters" from bidding for their own assets.

That weird term has been defined by the central bank as instances where borrower firms didn't repay while having the capacity to do so, or their controlling shareholders siphoned off money or assets. None of the 12 largest ongoing corporate bankruptcy cases, representing almost a quarter of the soured debt for the country's banking system, involves willful defaulters.

Their businesses got into trouble, as the likes of Essar Steel Ltd. have claimed, because of extraneous circumstances: How do you make sponge iron if the government cuts off the pledged supply of domestically produced gas? How does the government deliver on its promise if the billionaire producing the gas gets into a messy legal battle with his estranged brother over the price of the commodity? That's in the past, but lingering shadows are what karma is all about.

The Big Bailout

A $32 billion recapitalization plan for India's state-run lenders has made investors optimistic of an end to their asset-quality woes

So while willful defaulters are out, the karmic variety -- folks who innocently ran highly leveraged businesses into the ground -- will be able to submit restructuring proposals like any other bidder. Forensic audits to get their names cleared of malfeasance will make the process a tad longer, but if insiders can offer lenders a recovery of 40 cents on the dollar when the next-best proposal is 30 cents, then bankers can go with them without any fear of jail time.

This latter point is vital. As much as $182 billion of the $207 billion in Indian impaired loans is with state-run banks. Taxpayers have only just been told of a planned $32 billion bailout. A poll in Prime Minister Narendra Modi's home state of Gujarat is due next month, and opposition parties are ready to pounce on any perceived benefit to crony capitalists. The government has to make some concession to public anger over socialization of private losses, while ensuring the debris gets flushed out of the clogged credit pipes.

Fragile Five

Indian banks with the worst bad-loan ratios are all state-run

Source: Corporate reports

Going American is the right strategy. The Indian insolvency code is modeled on the British system, which makes it more focused on liquidation with a maximum 270 days allowed before a mandatory coup de grace. Chapter 11, whose debtor-in-possession approach allowed for the disposal of $1.8 trillion in corporate distress during the 2008-09 financial crisis, is better suited to India, where a majority of businesses are family-run. 

Buyout firms will also welcome insiders into the fray, provided they come through the front door. Nobody wants a repeat of Synergies-Dooray Automotive. That was the very first case to be decided by India's national company law tribunal. The debtor group won back control of the assets, while creditors took a 94 percent haircut. One lender has appealed against the resolution, alleging it was fraudulent.

India's bankruptcy law is new, and there's plenty of tweaking still to come. Acquirers of assets, for instance, can't be sure if haircuts they force on creditors will be considered as income for the companies that are being restructured. If so, there might be hefty tax bills.

Eventually, wrinkles will be ironed out. If Bain Capital Credit says opportunities in India are "near the top of our list," and domestic investors like banker Uday Kotak say it's a "once-in-a-lifetime" chance, then India has already moved tantalizingly close to a closure of its bad-debt problem.

Kotak, though, has a word of caution. While he's reasonably confident, it's important to "always be aware of something being different," he said. Asia's richest banker, it seems, knows a thing or two about karma.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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