The government of India has taken several steps in the past few years to attract foreign investment in the infrastructure sector and to solve the issues that have plagued the sector for decades. These include reforms in the contract enforcement regime and debarring courts from granting injunctions in suits involving infrastructure projects that delay the completion of the projects.
The government also took sector-specific reforms such as the introduction of the toll-operate-and-transfer model to enable monetization of road assets as well as granted permission to the National Highways Authority of India (NHAI) to divest 100% equity in build-own-operate road projects two years from completion. However, inordinate delays in implementation, strained finances and aggressive bidding, especially in the power sector, led to infrastructure companies becoming prime candidates for bankruptcy referrals.
Indian banks, stretched at both ends, have rushed to offload stressed infrastructure assets from their balance sheets under the Insolvency and Bankruptcy Code, 2016 (IBC). This made a large pool of distressed infrastructure assets with substantial turnaround potential available at bargain prices, which attracted both domestic and foreign investors. A survey by PwC and the Confederation of Indian Industry (Decoding the code: Survey on twenty-one months of IBC in India) reveals that more than half the investors surveyed by them have evaluated distressed asset deals in the infrastructure and power sectors.
While the investors have focused on tapping the turnaround potential, they have come up against practical challenges, primarily relating to turnaround value determination, maintenance of business value and the risk of future regulatory claims.
Risky inheritance: In a corporate insolvency resolution process under the IBC, it becomes crucial for investors to determine the turnaround potential and undertake a risk analysis before submitting their bids. Investors, typically, conduct in-depth legal and technical due diligence on their targets. The success and accuracy of such due diligence processes, in turn, depend upon the access provided to investors (and their advisors) to the records of target companies and the accuracy of the data received.
Under the tribunal-driven insolvency resolution process, the management of the target company is run by an insolvency resolution professional (IRP). The IRP has the obligation to provide the potential bidders only basic information on the target company. For example, the details of the assets and liabilities; the latest financial statements; particulars of outstanding debt etc.
Additional information, including forensic reports and transaction testing reports, is seldom shared with the potential bidders. Further, with no direct access to the promoters or the previous management of the target company, it becomes more difficult for an investor to determine the authenticity of the data provided by the IRP.
Promoters as comrades: It is a common practice for promoters to hive-off infrastructure assets into special purpose vehicles, either as a regulatory or contractual requirement or for maintaining independent operation. The special purpose vehicles, in turn, sub-contract the construction or operation to promoter entities or affiliates.
However, once the insolvency resolution process starts, the involvement of the promoter and the previous management in the distressed company is minimal. This lack of promoter involvement makes it difficult for the interested investor, especially in the case of construction projects, to get operational clarity and to ensure the continuity of business.
Post-acquisition housekeeping: Another area of concern for investors is housekeeping after the acquisition. The turnaround process becomes a herculean task due to delays in procuring or renewing regulatory approvals, rectification of latent defects identified through technical due diligence, regularizing of past regulatory and contractual non-compliances. In addition to housekeeping woes, the investors may also be exposed to the risk of imposition of statutory and regulatory fines or penalties on the target company, which were unknown during the insolvency process.
In a nutshell, while the reforms in the regulatory regime have helped attract the attention of different types of investors, the practical challenges point to the need for policy measures to give distressed infrastructure assets a second life.
Rupinder Malik and Sidharrth Shankar are partners and Srishti Moitra is an associate with J. Sagar Associates. Their views are personal.
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