Fixed deposits in a company/NBFC are unsecured borrowings
Shivram, an FD investor in Dewan Housing Finance Limited (DHFL) talks to his chartered accountant cousin Janaki to understand the waterfall mechanism.
Shivram: Sorry to bore you with this when you’ve come for a fun visit Janu. I had DHFL fixed deposits when it went bust in 2019. I was happy to read somewhere that the Piramal group is going to take it over under IBC. I saw a resolution plan where FD holders will get back their money. But now I see the whole thing is going to drag on more, because creditors aren’t happy.
Janaki: Many of my clients hold not just FDs but also secured NCDs in DHFL.
Shivram: See, what irritates me is that these big lenders like banks and insurance companies are blocking FD holders from getting more money. They just voted out a proposal to give FD holders an additional ₹966 crore, over the ₹1241 crore proposed in the original plan. That would have meant my getting back over 40 per cent of the money, instead of 23 per cent. I’m already taking a 60 per cent ‘haircut’. Why can’t small investors get entire money back? Only big guys can afford costly haircuts!
Janaki: I see that you aren’t aware of the waterfall mechanism. When a company goes broke and has less assets than liabilities, this mechanism decides which lenders get priority over others.
Shivram: The only waterfall I know is in Kutralam! So Janu, tell me, why is this waterfall giving me a haircut?
Janaki: Haha, you see, haircuts and waterfalls come into play in the DHFL case because the Piramal group which is acquiring it is willing to pay only ₹37,250 crore for it. But DHFL has outstanding dues totalling to over ₹90,000 crore. So, lenders have to take haircuts.
Shivram: But how do they decide that pensioners like me take an 80 per cent haircut?
Janaki: That’s what the waterfall mechanism does. Imagine a mini-waterfall, not Kutralam, where the water pours down from a height and there are buckets placed below it at different levels. Water flows into the second bucket only when the first one overflows. The third bucket gets filled after the second. If there isn’t enough, the bottom buckets get only a trickle. Similarly, waterfall mechanism in debt resolution decides which creditors of a company are the top buckets when there isn’t enough money.
Shivram: Why does this waterfall mean FD holders get only 23 per cent of their money?
Janaki: Because FDs in a company/NBFC are unsecured borrowings. The IBC’s waterfall mechanism gives clear priority. With any money that comes in, the resolution costs are met first and any accumulated dues to workmen are paid off. Secured creditors get top priority. Salary dues to employees come after them and unsecured financial creditors like depositors only after that.
Shivram: You’re telling me people who invested in DHFL NCDs will not take haircuts?
Janaki: They too will but probably less than FD holders.
Shivram: So is nobody going to take a bigger haircut than me?
Janaki: Equity investors are, Shiv. They come last in the waterfall mechanism.