Why the power sector deserves exemption to IBC

Projects Energy & Infrastructure

Why the power sector deserves exemption to IBC

By Hemant Sahai on 02 Apr 2020

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Author by Hemant Sahai

It is an established fact that a robust power sector provides one of the fundamental underpinnings for modern socio-economic development. While a series of legislative reforms by the government – beginning with the plan in 1990s to galvanise private sector investment in this sector and resulting in the Electricity Act, 2003 as a comprehensive legislation governing this sector – have sought to modernise different aspects of this sector, one of the peculiarities of the current architecture is that the private investor or producer inevitably deals with a state-owned monopoly for distribution.

It is indeed true that some segments of the sector have been opened up to private investment, and with reasonable success so far, however, the state and its instrumentalities have assiduously resisted the opening up of the most inefficient segment of this sector, i.e. the distribution and retail sale of electricity, to private investment and competition.

Therefore, unlike other infrastructure sectors such as highways, airports, metro railways etc., where the revenue collection risk is dispersed amongst a multitude of users, in the power generation sector, the entire offtake and revenue risk is concentrated on single buyers that are state-owned monopolies.

The only thing worse than a private monopoly is a state-owned monopoly since it brings not only its might as a monopolist but also its might as an instrument of the State, with its own peculiar and subjective assessments of what constitutes ‘public interest’.

These assessments are inconsistently applied and, consequently, the economic and financial principles that apply to the distribution sector, which is essentially a business, get sullied and distorted by political, ideological and non-commercial considerations.

The starkest example of this is the current impasse in Andhra Pradesh where the new government tried to reduce the solar and wind tariffs of already executed and operative power-purchase agreements ostensibly in “public interest”. Fortunately, the attempt was ultimately quashed by the Andhra Pradesh High Court by holding such unilateral action effectively to be “arbitrary”. The said case is presently being appealed on certain limited issues of jurisdiction.

Systemic inefficiencies that are directly traceable to government control of distribution companies or discoms continue to distort the commercial dynamics of this sector.

It is noteworthy that as of Jan 2020, discoms owe Rs 88,782 crore to the generators, and the situation gets further aggravated when we consider that it is the state governments that have the lion’s share of the outstanding amount due to discoms, which stands at a staggering Rs 82,073 crore as of January 2020. Such inefficiencies have been instrumental in the marked rise of stressed assets in the power generation sector. There are currently close to 60,000 MW of thermal power generating assets (constituting nearly a fifth of the aggregate installed generation capacity in India) that are undergoing insolvency proceedings under the Insolvency and Bankruptcy Code.

Is IBC a solution or…

Any consideration of stressed assets invites discourse on the applicability of Insolvency and Bankruptcy Code, 2016, to ostensibly alleviate and resolve the distress faced by private sector producers. Numerous companies in the power sector have been declared to be insolvent by the respective National Company Law Tribunals and are undergoing corporate insolvency resolution process.

IBC, however, is prescriptive in nature and mandates a certain course of action without making any distinction between sectors or indeed the causes leading to the financial situation. If corporate insolvency resolution process under Chapter II of Part II of the IBC is initiated against a company or the company initiates voluntary liquidation proceedings under the IBC, the most desirable outcome is that the debts of the creditors are satisfied and there is a change in the management of the company so that after resolution, the company does not go back into the hands of the promoters or directors who have led to its downfall in the first place.

IBC lays down an expeditious process wherein upon admission of the application for initiation of insolvency proceedings by the concerned National Company Law Tribunal, the existing management is ousted and the interim resolution professional steps in within 14 days of said admission.

Given the sectoral inefficiencies that can directly be attributed to the state, and are responsible for the sectoral stress in private power production, there is an urgent need for creating a special dispensation for power sector within the IBC framework.

Firstly, the non-payment of dues by discoms is a major contributory factor to the sectoral stress. In various instances, discoms are citing the pendency of appeals, or non-receipt from other third parties, as reasons for such non-payment. However, such appeals take years to get finally decided. In the meantime, generation companies suffer undue financial distress.

Secondly, power sector is also plagued by several issues that are essentially beyond the investors’ control. One such issue is the non-availability of fuel despite the assurance of supply of 100 percent coal to power projects vide the New Coal Distribution Policy dated October 18, 2007 which was later reduced and thereafter, vide a remedial measure i.e. the Shakti Scheme which came in 2017, brought down to 75 percent of the coal requirement. Though the Supreme Court in the matter of Energy Watchdog vs CERC recognized the reduction of assurance of 100 percent coal as a change-in-law event, however, the approval from the respective regulatory commissions for pass through of this cost is a time-consuming process and, in the interregnum, the generators have been made to bear the additional cost, which is a major reason for the financial stress. Compensation for time value of money by way of interest is usually too little and too late and in any case is frustrated once again by the monopolistic buyers through diverse stratagem.

Thirdly, unlike most other sectors, the power sector is highly regulated – from the applicable tariff and claims for compensations, including increase in taxes and duties that can be recovered as part of the tariff, to allocation of inputs required for generation solely by the government of India, and restriction on purchase of generated power only by distribution or trading licensees – all aspects are regulated by the regulatory commissions.

In light of this, it would seem that applying a purely commercial framework for resolving stress in the power sector seems inequitable at the very least and, in fact, presents a compelling argument as to why there should be reconsideration on the blanket applicability of the IBC on the power sector.

These aspects, along with various other power sector specific issues such as discrimination between private and public sector generation companies, lack of power purchase agreements etc. were raised before the Supreme Court in the matter of Dharani Sugars and Chemicals Limited vs Union of India & Ors. wherein the court, while passing the judgment on April 02, 2019, failed to discuss and deal with the said issues crippling the power sector.

These issues and arguments have, till date, been overlooked by the Parliament and by the courts. The Supreme Court, in the challenge to the RBI circular of February 2018, did recognise these factors, but eventually did not rule on this inequitable power sector architecture. It is high time to rethink our approach to avoid adverse consequences accruing to the power sector as a whole and to India’s economy at large.

The Alternative?

The provisions of the IBC should be relaxed in terms of their applicability to the power sector by way of introducing additional pre-requisites for initiating insolvency proceedings, higher default limits, introduction of the ground of ‘pre-existing’ disputes in case of entities pertaining to the power sector etc.

Another approach can be to make a distinction regarding the extent that the IBC should apply to assets or segments that are financed by private sector i.e. generation and transmission, unlike in the case of distribution companies which are mostly government owned.

Further, the IBC should not apply to commissioned and operating transmission and generation assets where there is a sole procurer that has defaulted on payments for an extended period such as three month, (considering that most of the regulations for tariff determination usually account for two-three months of working capital costs.

In this context, it also relevant to note that, in addition to IBC, there are other pieces of legislation that are perhaps more suited to this sector such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 which enables lenders to enforce the security interest put forward by the borrowers in order to recover their loan amounts, without necessarily derailing the management and essentially bringing the entire company to the ground. This also provides a chance to the company to revive itself basis the remaining assets and continue its business operations as a going concern, which, in context of the power sector, would be in the best interest of the economy of the consumers.

In light of the above, Parliament needs to seriously consider the specific existential realities of the power sector and address these challenges faced by private sector investors in the generation and (to a lesser extent) the transmission business objectively. In this case, what’s gravy for the goose is not necessarily gravy for the gander.

Source: BloombergQuint