Unsecured Secure?

Published on Sat, Sep 14,2013 | 18:51, Updated at Sat, Sep 14 at 18:51Source : Moneycontrol.com | Watch Video :

This month, The Firm deviated from law to talk about the consequences of a depreciating rupee and a deteriorating economy. With over 200 billion dollars in foreign borrowings, many Indian companies could face a serious risk of default. Fortunately 2013 is not a big year for FCCB redemptions. Because if it were, defaulting companies could face a losing battle in court. I say this because after the 2011 victory against Wockhardt, foreign bondholders have been on a winning spree. Zenith, KSL, Shiv Vani, Moser Baer- all these companies have been successfully litigated against by their bondholders. And there are more in the pipeline! Payaswini Upadhyay finds out what this new credit hierarchy means for companies, their secured and unsecured lenders.

In 2011, the Wockhardt case marked nothing less than a revolution for the Indian financial world, as unsecured creditors successfully asserted their rights for the first time. The financially beleaguered pharmaceutical company was in the throes of a corporate debt restructuring process initiated by its secured lenders. Excluded from the CDR, a few unsecured FCCB holders filed a winding- up petition against Wockhardt in the Bombay High Court. Their intent was to block the sale of Wockhardt's nutrition business to Danone, until their dues were recovered. The court agreed – forcing Wockhardt to repay bondholders or face liquidation proceedings. For the first time unsecured creditors jumped the queue.

Sitesh Mukherjee
Partner, Trilegal
"Before the Wockhardt judgment was pronounced by the Bombay High Court, these bondholders were not being entertained in the CDR process and they were not happy with the way CDR process was going on and they basically felt that the CDR process would only extend the rights of the existing secured lenders and leave them further behind in the queue in case the company became insolvent."

H Jayesh
Founder Partner, Juris Corp
"What is the right we are talking about? It was not right of recovery. It's a right that if the company claims it is unable to pay me as a creditor, why should the company be allowed to survive. That is the right we are talking about and that's what Wockhardt is really about. People see Wockhardt as Oh, the unsecured creditors got paid out. That's not the point. Point is if a promoter or some of the creditors claim that it's ok not to pay the unsecured creditors but pay us and continue to exist, that is where Wockhardt comes up."

The corporate debt restructuring process is an informal process devised by the RBI and run mostly by Indian bank lenders. It often envisages the sale of a company's assets in order to repay secured creditors. The CDR format does not include unsecured creditors. Which is why unsecured creditors such as bondholders have often gone to court to file a winding up petition against the company and thereby block a CDR unless their demands are also met. It's worked in Wockhardt and it's worked in the case of Shiv-Vani and Moser Baer as well.

Oil and gas company Shiv-vani defaulted on its FCCB obligation - prompting the bond trustee Citicorp to file a winding up petition in the Delhi High Court. Last week, the court restrained Shi-vani from implementing any Corporate Debt Restructuring or CDR scheme. 4 days later, the court relaxed its order to allow Shiv-vani to undergo CDR but on the condition that any fresh rights created in the company's assets will need court permission.

A similar battle played out between Moser Baer and its bond trustee Citibank. With unpaid dues of Rs 688 crores, Citibank, filed a winding up petition against Moser Baer in the Delhi High Court last year. In December, the court restrained the company from alienating any of its assets. But the company's secured lenders argued against a winding up and in favor of a CDR and committed to a debt haircut. The court subsequently allowed Moser Baer to continue with the CDR process but on the condition that any sale of assets will require court approval.

Sitesh Mukherjee
Partner, Trilegal
"We have to understand that the purpose of the unsecured creditors or bondholders is not to prevent the CDR process - that's not what they want. The courts are also not looking to stop the CDR process. What they would however like is that if there is a CDR process and the secured creditors want to confine it to themselves and not look after the interests of the unsecured creditors, then the unsecured creditors have certain remedies in law."

Shishir Mehta
Partner, Khaitan & Co.
"It ultimately depends upon the negotiation power of the unsecured creditors and there have been instances where the borrower has managed to come to some sort of a deal with the unsecured creditors - one was in the matter of GTL infra - 35% of the debt was compulsory converted. And for the remaining 65%, a different pricing was agreed to. So it could be that if the unsecured creditors are aggressive and which is what the strategy has been in the last couple of years and which is working because they are well within their rights to enforce a winding up."

The spate of bondholder victories has forced some companies to deploy new tactics. Last year, after Zenith Infotech failed to make a Rs 586 cr FCCB redemption, its bond trustees filed a winding up petition in the Bombay High Court. After several months of twists and turns, while the matter was pending decision, Zenith filed a reference with the Board For Industrial and Financial Reconstruction or BIFR asking to be declared a sick company. Bombay High Court's Judge Kathwala frowned on the tactic saying- 'the principal object of the SICA is to rehabilitate genuinely sick companies where due to factors beyond their control, the companies have become sick, and that the Act is really not mean to help those companies where the company has become sick due to dishonesty, siphoning off funds and misappropriation of funds by its promoters and management.'

H Jayesh
Founder Partner, Juris Corp
"In the past what has upset the courts that adjournments are taken on various basis. And in the meantime a reference is filed and admitted. Some of the High Courts in the country have become sensitive to this and are more conscious when they are granting adjournments - at times they just ensure that an overall undertaking is given that this doesn't mean you will go and make a reference to SICA and defeat the whole purpose. Or at times, they are expediting the hearing when they realize that the process of the court is being abused to make a reference to SICA and to defeat the whole process."

Justice Kathawala ultimately decided not to interfere with the BIFR process but not without saying – I am also conscious of the fact that such dishonest promoters of the company take advantage of a beneficent legislation like SICA

A more recent member of the club of successful unsecured creditors is Bank Of New York Mellon - a trustee for KLG Systel's bondholders. After failing to recover dues worth 130 cr rupees, the American bank filed a winding up petition against KLG Systel in the Punjab and Haryana High Court. In May this year it emerged victorious.

Shishir Mehta
Partner, Khaitan & Co.
"Courts would use winding up as a matter of last resort. Having said that if the company is delinquent in its finances, the unsecured creditors frankly have no option but to pursue a winding up of the company primarily as a pressure tactic. For secured creditors- it doesn't make any sense to co-operate with the unsecured creditors - their interests are completely different. To that extent, there won't be any synergy between those two groups. But the courts will be increasingly more and more forceful on the borrower to address the issues of debt on both the secured as well as the unsecured side."

Wockhardt, Zenith, KLG Systel, Moser Baer and Shiv-Vani- these are the cases that have reached some fruition in favor of unsecured creditors. The pipeline looks equally robust in terms of numbers. Tulip Telecom is facing winding up proceedings in the Delhi HC filed by Axis Trustee Services that holds 84 crores worth Non-Convertibles debentures on behalf of the bondholders. Winding up proceedings against Sterling Biotech are ongoing in the Bombay High Court after it failed to pay its bondholders last year. Bondholders are fighting a similar battle against ICSA in the Hyderabad High Court. Geodesic has defaulted on dues of $113 million and currently has winding up petitions filed against it by Standard Chartered, Citibank London Branch, Barclays and HDFC. Suzlon, Sakthi Sugars and S Kumar have been served legal notices by their respective bondholders asking them to pay up or face winding up proceedings.

H Jayesh
Founder Partner, Juris Corp
"Why is it that the CDR doesn't deal with the promoters; why is it that CDR doesn't make promoters do meaningful sacrifices including write down of shareholding or change of management. And that has been the biggest objection of unsecured creditors, especially bondholders, has been that you are asking us to take a huge haircut and wait for 10 years before we get paid and you are allowing the very people who have created the problem - see its one thing to say economic conditions are such world over- but some of the instances that have happened in the last few years will show clearly, its the promoters who have siphoned off funds, who have been reckless in the way they managed the company etc. But the secured creditors keep giving them a further chance at the cost of the unsecured creditors. I think that will change. At least some of the secured creditors we have been talking to are conscious of this fact that the days of taking the unsecured creditors for granted, the days of giving promoters priority over unsecured creditors are coming to an end."

Add to that the promise made by the Companies Act 2013 that envisages the formation of the National Company Law Tribunal or NCLT. Once set up, the NCLT will exercise the powers of BIFR under SICA and the winding up power of High Courts. Since all the proceedings of a defaulting company will take place under NCLT's roof, the hope is it will reduce the abuse of court process that Jayesh spoke off. But since that will happen in due course, for now, the unsecured creditors are asserting their rights like never before.