Investing through insolvency code

By Sanjay Asher and Nikhil Kaul, Crawford Bayley & Co.
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IBC has created opportunities for equity and debt investors alike, write Sanjay Asher and Nikhil Kaul

The Insolvency and Bankruptcy Code, 2016 (code), notified by the government of India in May 2016, was in response to piling bad debt and the increasing quantum of non-performing assets plaguing the credit exposure of banks and financial institutions. The preamble of the code states that its fundamental objective is to consolidate and amend the “laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximization of value of assets of such persons”.

insolvency
Sanjay Asher

The code is a significant departure from the earlier regimes governing insolvency and liquidation in India. The insolvency resolution process under the code (resolution process) introduces 1) a creditor-in-control model – providing significant control to financial creditors over critical decisions in the resolution process; 2) appointment of a resolution professional to conduct the resolution process; 3) a time-bound systematic approach.

The resolution process sets out the implementation of a resolution plan for corporate and debt restructuring, in a way that ensures the corporate debtor continues to function as a going concern, which is in the interest of all stakeholders (including the creditors). The code provides the committee of creditors (CoC) with powers to take decisions on the manner in which the resolution process has to be conducted, including the right to approve or reject a resolution plan. A failure to implement a resolution plan within the timelines provided under the code would render a corporate debtor fit for liquidation, which is a process also governed under the provisions of the code.

Investment in equity

Insolvency
Nikhil Kaul

The code has attracted the attention of investors (resolution applicants), resident and non-resident, eager to participate in the race to pick up stressed assets at reasonable prices. The enthusiasm of resolution applicants is often fueled by the notion that the resolution process will wipe the slate clean with respect to past transgressions, non-compliances and defaults of corporate debtors with the blessings of the adjudicating authority, the National Company Law Tribunal (NCLT). The approval of a resolution plan by the NCLT makes it binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.

The enactment of the code has, in a short span of time, led to the evolution of India’s investment landscape. As far as prospective equity investors are concerned, distressed Indian assets seem to be the flavour of the season. Corporate debtors with assets and businesses considered attractive are receiving expressions of interest and resolution plans from numerous prospective resolution applicants. The competitive bidding process may require prospective Resolution Applicants to offer competitive prices (and at times, revise it upwards).

In cases where there is a dearth of interest from prospective resolution applicants, due to lack of competition, they may be able to command a better price through the restructuring of corporate debtors, provided they can obtain approval from the CoC.

In the event that a resolution plan is not approved by the CoC within 180 days (extendable up to 270 days) from the date of commencement of the resolution process, a corporate debtor is required to be liquidated. Potential investors continue to explore the commercial feasibility of either acquiring such corporate debtor as a going concern in the liquidation process or acquiring the assets of the corporate debtor piecemeal during the liquidation process.

The code prevents and disqualifies certain persons from submitting a resolution plan owing to their antecedents, including promoters in management and control of corporate debtors whose accounts have been classified as non-performing assets for more than a year. As a consequence, former promoters of a corporate debtor may cause or attempt to cause roadblocks or hurdles to derail the resolution process, substantially delaying resolution. Animosities between former promoters and prospective resolution applicants have given rise to an era of adversarial acquisitions in India. In this regard, it is important for prospective resolution applicants to safeguard their interests and prevent the possibility of former promoters affecting the viability of reviving the corporate debtor.

In accordance with the code, resolution professionals or liquidators have to file applications before the NCLT for avoidance and clawback of transactions, which are preferential, undervalued, extortionate, fraudulent or wrongful in nature during a look-back period of one year (or two years in the case of related-party transactions) before the date of commencement of the resolution process (avoidance transactions).

The resolution professionals ordinarily appoint independent forensic auditors for analysing and investigating possible avoidance transactions. In cases where a resolution professional can establish that avoidance transactions have been undertaken, prospective resolution applicants should analyse and ascertain the impact such avoidance transactions may have on the business and financial position of the corporate debtor and further re-examine whether the financial statements of the corporate debtor continue to provide a true and fair view of the state of their affairs. Therefore, it becomes imperative for a prospective resolution applicant to safeguard its interest and exercise due caution.

In line with the notion that the resolution process under the code will provide a clean slate to resolution applicants. Various resolution applicants are seeking reliefs, concessions and waivers from the NCLT under their resolution plans (including in relation to taxation, stamp duty payments, other statutory and regulatory dues). However, the NCLT has ordinarily not granted such reliefs, concessions or waivers and requested them to approach appropriate forums. In this regard, it is important for resolution applicants to be aware of the jurisprudence available at the time and whether specific reliefs, waivers or concessions may be granted by the NCLT under a resolution plan. Considering that it does not seem to be the intention of the legislation to overburden a company facing stress with levies of tax, stamp duty or other statutory and regulatory dues and further considering that the provisions of the code are intended to override other laws in the case of any inconsistency, one may expect further clarifications or relaxations in this regard going forward.

Investment in debt

In a short span of time, the code appears to have built confidence among creditors of the viability of making recoveries from their distressed debt exposures, thanks to the structured and time-bound approach of the code.

The code has increased appetite among asset managers, asset reconstruction companies and distressed debt investors for taking over distressed debt exposures of existing financial creditors at deep discounts and, in turn, stepping into the shoes of the existing financial creditors. Accordingly, the incoming financial creditors would be entitled to representation and voting rights on the CoC of such corporate debtors.

In order to ascertain the commercial and legal viability of acquiring debt from existing financial creditors during the resolution process, an incoming financial creditor has to take into consideration, among other things: 1) the enforceability of the existing lending documents, 2) the nature, status, tenability and estimated realizable value of the charged assets, 3) the estimated liquidation value of the corporate debtor, 4) the quantum of voting rights such an acquisition of debt would provide the CoC of the corporate debtor, 5) the prospects and viability of receiving resolution plans seeking to revive the corporate debtor, and 6) the proposed terms of settlement or restructuring of the exposures of the financial creditors in the case of resolutions plans that have already been received during the resolution process.

In order to enable a resolution professional to effectively conduct the resolution process and bear the operational costs involved, debt that is raised by a resolution professional during the resolution process (interim finance) been given priority over (equal to the priority given to the costs involved in the resolution process) payment to all other creditors of the corporate debtor. Consequently, interim finance raised during the resolution process may provide financial creditors in India with an attractive opportunity of deploying funds at high rates of return while balancing risks.

The efforts of the Indian judiciary have been key in maintaining the momentum of the code and providing clarity on key conceptual issues that have emerged from time to time. In the case of equity and debt investments alike, given the evolving nature of the code, it would be wise for investors to be aware of developments, put in place appropriate safeguards, exercise due care and keep their commercial risk appetites in check.

insolvencySanjay Asher is a senior partner and Nikhil Kaul is a senior associate at Crawford Bayley & Co.