MUMBAI—Hundreds of companies are headed for bankruptcy proceedings in India, and that’s a good thing.
A new bankruptcy code sets a tight timetable for a defaulting company to deal with its debt: If it doesn’t come up with a solution in nine months, the company is liquidated. In May, Bhushan Steel Ltd. EQBHUSANSTL -3.26% became the first of a group of large defaulters pushed into the bankruptcy court by the central bank to be resolved under the new rules. It was sold for $5.2 billion, and creditors recovered almost two-thirds of what they were owed.
“This has never happened in India before,” said Vikram S. Gandhi, founder of VSG Capital Advisors, which helps manage the Canada Pension Plan Investment Board’s investments in India. “New investors have come in, taken out the old investors and the banks can get on with business.”
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The code is an ambitious part of Prime Minister Narendra Modi’s anticorruption drive. Banks have historically been loath to push companies into bankruptcy out of fear they would face legal action or political backlash. Moribund companies stalled for years, giving controlling shareholders the opportunity to siphon off assets.
The result is that the share of nonperforming loans to total loans in the Indian banking system ballooned to 11.6% in the latest fiscal year, according to the central bank. In both the U.S. and China, that figure is less than 2%. All told, Indian banks sit on some $150 billion of bad debt that has all but halted new corporate lending.
Last year, India’s central bank made it easier for lenders by forcing them to put about 40 of the largest corporate defaulters into bankruptcy proceedings under the new code, changing their management and starting the clock for a nine-month deadline to deal with their debt or face liquidation.
“This brings a lot of transparency and clarity to a lot of stakeholders,” said Kaizad Bharucha, executive director at HDFC Bank, India’s largest private-sector bank.
Under the code, as soon as a large bad-loan case enters the bankruptcy court, the controlling shareholders are replaced by resolution professionals, and the clock starts.
“It’s a law which was, I think, much needed and much sought after” by lenders, said B. Sriram, former managing director of State Bank of India, the country’s largest bank, who is now managing director of IDBI Bank. “It has come as a sort of support to the banking system.”
In the World Bank’s ease-of-doing-business survey, India’s ranking for resolving insolvencies jumped more than 30 places thanks to the new law.
Removing the owners and founders of chronic defaulters is expected to shake out those who have been abusing the system, allegedly using political connections and bribes at times to acquire giant loans.
Bhushan Steel—the first company to be sold under the new process—like many steel companies, began having problems paying its debts in 2012, as prices of the metal fell. In 2014, its managing director, Neeraj Singal, was arrested on charges the company had bribed a bank official. Mr. Singal has been released on bail and denies wrongdoing.
Steel prices continued to fall, and when the central bank at last forced Bhushan into bankruptcy court, its debt had jumped to more than $8 billion from $2.9 billion when its problems began. Tata Steel Ltd. has acquired almost 73% of its shares and Mr. Singal and his family members have lost control.
In another big deal that is poised to come out of the new code, resources company Vedanta Ltd. earlier this month moved to take control of bankrupt Electrosteel Steels Ltd. , which owes banks $2 billion.
Among those next in line to complete some debt deals are textile firm Alok Industries Ltd. , cement maker Binani Cement Ltd., steelmaker Essar Steel Ltd. and edible-oil maker Ruchi Soya Industries Ltd. Lenders will likely recover close to $15 billion in debt this year that they had largely written off, analysts say.
An insolvency industry—which has been waiting years for distressed assets to come on the market—is at last emerging in India, and the law has prompted more distressed debt funds to come to the country.
‘This brings a lot of transparency and clarity to a lot of stakeholders’
The new code is already facing legal challenges. Some cases are expected to drag well beyond the 270-day deadline as controlling shareholders and bidders contest points in court.
Others say the rule that founding shareholders lose control of a company as soon as it enters the bankruptcy court is unfair. Mismanagement isn’t always the cause of the bankruptcies and the founding shareholders are often the most qualified to find a way for their companies to bounce back, say critics of the new law. “For people who are in genuine difficulty and the causes of default are beyond their control, I think it is a little unfair,” said Vivek Sibal, a lawyer who is helping companies navigate the new bankruptcy code.
Write to Corinne Abrams at corinne.abrams@wsj.com and Debiprasad Nayak at debi.nayak@wsj.com
Appeared in the July 2, 2018, print edition as 'India Finds Answer to Bad-Debt Problem.'