Recently, there has been an increased focus on M&A activity in stressed assets. A significant factor in this regard has been a drive by the Reserve Bank of India (RBI) towards greater provisioning for stressed loans and more transparent recognition of non-performing assets.
Last year, the RBI notified guidelines for “strategic debt restructuring” (SDR) by banks. Under the SDR guidelines, a consortium of banks may acquire control over the borrower (by converting a part of their outstanding loan into equity) and then bring about a change in management of the borrower. Once the conversion of loan into equity is completed, banks are permitted to maintain the asset classification of the existing loan for 18 months, irrespective of the status of repayments during this period.
The SDR guidelines require banks to divest their equity holdings in the borrower to a “new promoter” as soon as possible. However, while there has been interest in the underlying assets, significant hurdles are being faced in negotiating the sale of a controlling stake in such entities.
While the SDR process allows banks to restructure or refinance the existing loans to the borrower, the debt levels are frequently unsustainable. Without a partial waiver of the outstanding debt by the banks, the economics underlying a buyout become unviable. Banks have been reluctant to take haircuts on their loans and this often becomes a roadblock in such situations.
Additionally, companies undergoing SDR are often burdened with other liabilities (pending tax claims, claims from suppliers and service providers, regulatory dues, etc.) which new buyers may not be willing to assume. While outstanding liabilities to banks can be restructured or refinanced under the SDR guidelines, there is no formal process to consolidate and restructure the other liabilities of such stressed companies, and the incumbent management and shareholders have no incentive to resolve or settle such liabilities after having lost control of the company.
Indeed, an initial challenge faced by potential bidders in such transactions is that in addition to known and evident liabilities such as the ones mentioned above, the extent of unquantified liabilities is often difficult to determine in the due diligence process on account of lack of cooperation from the incumbent management team and the existing shareholders. Further, given the above, the extent of warranties and the indemnity coverage offered in such transactions becomes all the more important for any buyer. Banks, however, are reluctant to provide any representations or warranties in relation to the past operations and management of the borrower and are unwilling to assume any liabilities in this regard. The erstwhile promoters and the other shareholders have no incentive to provide such warranties or indemnities either.
Another issue which may be faced in such cases is that under existing laws, the conversion price per share for the banks cannot be less than the face value of the underlying shares. The fair value of shares in such stressed assets may be less than the face value and a buyer may not be willing to pay the difference between such fair value and the face value (at which the banks have converted their loan into equity). This issue is particularly evident in cases where the borrower is a listed entity and the traded price of the shares of the borrower is less than the face value of the shares. If banks were more willing to assume existing liabilities, they could set off the difference in the face value vis-à-vis the fair value by assuming other outstanding obligations.
In addition to the above, valuation continues to be a hurdle in most deals in stressed assets.
In view of the above-mentioned issues, parties are increasingly looking towards monetizing the underlying assets of the stressed borrowers as opposed to acquiring the borrower itself. This allows the buyers to be selective in terms of the assets and liabilities that they wish to assume and also results in better valuation of the “clean” assets. Given that the underlying assets are typically charged in favour of the lenders, monetization of such assets was always an option for the lenders through the security enforcement route. However, given the cumbersome enforcement process, a sale of assets of the borrower directly (after having acquired control of the borrower) may be a more streamlined process from a lender’s perspective.
The structures for such asset monetization transactions (which suitably address issues such as efficient and equitable distribution of the sale proceeds, how residual liabilities are dealt with after the sale, approval from taxation and other regulatory authorities for such asset sales in a reasonable time frame, etc.) are still evolving and will need to be fine-tuned further before such deals gain significant traction.
Shuva Mandal is national practice head, general corporate, M&A and private equity, and Sayak Maity is a principal associate-designate at Shardul Amarchand Mangaldas & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.
Express Towers, 23rd Floor,
Mumbai – 400 021
Tel: +91 22 49335555
Fax: +91 22 49335550
Executive Chairman: Shardul Shroff
Email: [email protected]
Managing Partner – Mumbai: Akshay Chudasama
Email: [email protected]