Almost a third of the banking sector's non-performing assets (NPAs) of ~Rs 10.3 trillion (as of March 2018) have been referred to the National Company Law Tribunal (NCLT) under the IBC process.
That number is expected to rise after the Reserve Bank of India voided all restructuring plans preceding the IBC in February 2018. Therefore, the suitable amendments in the Code will increase the efficacy of the process and help avoid the issues that have cropped up in resolution of existing cases.
A recent CRISIL report reveals that the amendments will reduce timelines, enhance transparency and improve realisations from their resolution. Krishnan Sitaraman, Senior Director, CRISIL Ratings, adds, 'The amendments will help safeguard the interest of lenders by maintaining the residual value of assets and spur the pace of resolutions under the IBC.
The fine-tuning of Section 29(A) of the IBC opens up opportunities for resolution applicants to bid once their eligibility is proven, and exempts financial entities from being disqualified from bidding.
That would significantly increase the number of eligible bidders.'
Vydianathan Ramaswamy, Associate Director, CRISIL Ratings, says, 'Treating homebuyers on a par with financial creditors will give a say to homeowners in the resolution process. A clear framework outlining the manner in which they participate in the IBC resolution process is needed to avoid logistical complexities in decision-making.'
Other amendments including allowing corporate debtors to trigger insolvency resolutions under the IBC and resolution process and putting the onus on the applicant to prove eligibility will strengthen the process and help achieve better outcomes.
The developers' perspective
While the amendment attempts to cater to the interests of homebuyers, prima facie it appears to be worrisome for real-estate developers, believes Manoj K Singh, Founding Partner, Singh & Associates.
'By giving homebuyers the status of a financial creditor, it has empowered them to take the developer (corporate debtor) to insolvency court on a mere default in excess of Rs 0.1 million. Hence, the amendment may prove to be quite draconian in the sense that the management and control (and eventually even shareholding) will be lost on a mere delay in delivery or refund to a single flat buyer.' Having said that, Singh believes the ordinance provides a silver lining for builders looking to acquire other distressed builders facing insolvency. 'Also, with homebuyers getting a seat at the decision table being part of the Committee of Creditors (CoC), there are more chances of a resolution plan being approved if it caters to their interest as against the pure recovery mindset of lenders.'
Indian Accounting Standard 115
Further, on March 28, 2018, the Ministry of Corporate Affairs had notified the Indian Accounting Standard 115 (IndAS 115) - its implementation will have a significant impact on the financial reporting of real-estate companies. More important, IndAS 115 complements the recent amendments to the IBC, wherein customers were accorded financial creditor status.
Analysing the impact, Shubham Jain, Vice President and Sector Head, ICRA, says, 'With the applicability of IndAS 115 for real-estate developers from April 1, 2018, change of accounting from the 'percentage completion method' to 'transfer of full control' will not only have a significant one-time impact on the balance sheet of these players but a lasting impact on the profit and loss account. However, IndAS 115 is only deferring the recognition of revenues and profits until the control of the goods is transferred and is not expected to have any material impact on the cash flows of companies. It will also improve disclosure with regard to contract balance and performance obligations, among others, which will enable the users of financial statements to appreciate them better. Nevertheless, it will also increase compliance requirements for developers, especially from the taxation perspective.'
Thus, the traditional percentage of completion method, based on the principle of 'transfer of risk and reward', will now be superseded. Companies will now recognise revenues based on the principal of transfer of control of goods and services by them to customers, at an amount that is in accordance with the transaction price determined at the time of entering into the contract, and commensurate to the transfer of control of goods and services.
Given the applicability of the new standard to all ongoing projects with a retrospective effect, companies will have to carry out adjustments to revenues and profits recognised on these projects. This would result in a one-time notable impact on net worth along with the other balance sheet items like inventory and debtors (including unbilled revenues), according to ICRA.
'In addition, ICRA believes disclosing receipts from customers as advances and current liability until the conclusion of the project complements the recent amendment to the IBC, wherein customers were accorded financial creditor status,' adds Jain. 'The disclosure of customer advances until completion of their respective projects will facilitate assessment of potential liability towards customers of ongoing projects.'
Considering the regulatory and structural changes witnessed by the real-estate sector over the past 18 months, the applicability of IndAS 115 comes as a complementary step that typically defers the recognition of revenues and profits till the complete transfer of control of the goods and services to the customer. Further, it is expected to improve disclosure while increasing compliance work for real-estate entities.
Impact of IBC Amendment
Here are the key amendments to the Insolvency and Bankruptcy Code (IBC) and CRISIL's view on their impact:
1. Amendment: Reduce the minimum voting threshold for the CoC to 66 per cent from 75 per cent for key decisions, and to 51 per cent from 75 per cent for routine decisions.
CRISIL's view: Significantly improves decision-making powers.
2. Amendment: Allow promoters of micro, small and medium enterprises (MSMEs) who are not categorised as wilful defaulters to bid for their assets.
CRISIL's view: MSME promoters under genuine distress or hardship can participate in the bidding process. This will reduce liquidation proceedings and improve the loan recovery rate of banks.
3. Amendment: Pegs the rights of homebuyers on a par with financial creditors.
CRISIL's view: Provides much-needed clarity, especially with respect to cases undergoing resolution under the IBC, where homebuyers are de facto creditors.
4. Amendment: Section 29(A) of IBC tweaked to exempt pure-play financial entities from being disqualified to bid for assets; three-year window for applicant that had acquired an NPA in the past under the IBC process.
CRISIL's view: Expands the eligible pool of bidders and will enable better price discovery and, therefore, lesser haircuts for banks.
5. Amendment: Streamlines the bidding process by discouraging exits and late offers.
CRISIL's view: Aids in bringing faster closure to the resolution process.
6. Amendment: Liberalisation of terms for interim finance during the insolvency process.
CRISIL's view: Will help the resolution professional keep the asset on a going concern basis and preserve its value.
- SERAPHINA D'SOUZA
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