This article is written by Yash Mukadam, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from lawsikho.com.

Introduction

‘Mergers and Acquisitions’ is a term generally associated with expansion and the well being of an economy. It makes sense that when an economy is doing good and businesses are optimistic about the future, they look to expand and grow, while during a recession, companies lay low trying to reduce their costs. This rule of thumb has been challenged since the advent of The Insolvency and Bankruptcy Code, 2016. 

The Insolvency and Bankruptcy Code, 2016 or IBC for short now provides an opportunity not just for distressed companies to resolve their issues but also for other entities to acquire these distressed assets at possibly a cheaper rate. The biggest advantage of the IBC has been the timely procedure for resolving stress.  

Procedure under IBC

Initiation of the CIRP

When any corporate debtor defaults on a minimum amount of INR 1 Crore, a financial creditor, an operational creditor or even the corporate debtor himself can initiate a corporate insolvency resolution process (“CIRP”). 

A financial creditor has to file an application before NCLT for initiating a CIRP. The NCLT then ascertains the existence of a default in and upon satisfaction admits the application (or rejects, as the case maybe) within 14 days. In the case of operational creditors, a demand notice is to be sent by a creditor or the debtor. In the event of failure to make payment or raise a dispute within 10 days of receiving the notice, the creditor can file an application with NCLT, which it may admit if satisfied. A corporate debtor himself can approach NCLT for insolvency, with a resolution passed by 3/4th of the partners (members), if he has committed a default. The CIRP commences from the date of admission. 

Resolution professional

The applicants, along with their applications, propose an individual to be appointed as an interim resolution professional (“IRP”). The IRP is appointed by the NCLT until the committee of creditors (“COC”), once formed, either appoints the IRP as the resolution professional (“RP”) or replaces the IRP by another RP, by a majority vote of not less than 66% of the voting share of the financial creditors, at its first meeting. 

On appointment, the management and powers of the board of the debtor vest in the IRP whose duty is to collect all information relating to, monitor and take control of the assets, finance and operations of the debtor for determining its financial position as well as collating claims by creditor and forming a committee of creditors while running the debtor as a going concern.  Once appointed, the RP is one who conducts the CIRP and manages the operations of the corporate debtor until an order approving the resolution plan or appointment of a liquidator. The RP is responsible for control/preservation/ protection of the assets of the debtor, representation/action on behalf of the debtor, convention of the meetings of the committee of creditors and presentation of resolution plans therein etc. 

Committee of creditors

The IRP, after collusion of all claims received against the debtor and determination of the financial position of the debtor, constitutes a committee of creditors. The COC comprises all financial creditors with voting share proportionate to the share of financial debts owed by the debtor. While the RP manages the debtor during CIRP, he cannot raise interim finance, create any security interest over assets, change the capital structure of the debtor, undertake any related party transactions, among other activities, without prior approval of the COC. Hence, the RP runs the show based on the desires of the COC, who may even replace him by voting for the same and approaching the NCLT.     

Moratorium

Upon admission of an application, NCLT declares a moratorium. This moratorium prohibits institution or continuation of suits against the debtor, transfer/ encumbrance/ alienation/ disposition of any of its assets, foreclosure/ recovery/ enforcement of any security interest created or recovery of any property in possession of the debtor by its owner/lessor. This is to ensure that the debtor’s assets are not appropriated to the disadvantage of the creditors or certain creditors. Even the actions by government agencies against corporate debtors have been held to be ‘illegal’ and ‘inoperative’ during the moratorium period, as was held by NCLT (Kolkata) when the director of mines had ordered a stoppage of mining operations of the insolvent Orissa Manganese & Minerals Ltd. (OMML). 

Resolution plan

Any person (except for the class of persons explicitly disqualified under section 29A of the Act), jointly or individually, can submit a resolution plan to the RP who then examines each of the plans received before presenting the ones that fulfill the conditions laid down to the COC for their approval.  COC then approves a plan by a vote of at least 66% of the voting share of the financial creditors. The RP then submits the approved plan to the NCLT. The NCLT can then either accept or reject the plan depending on whether or not it adheres to all the provisions laid down in the Act. After an order of approval is passed, the moratorium ceases to have effect and the RP is required to obtain the necessary approvals required under any and all laws in force within a period of 1 year from the date of approval.  

Time frame

The IBC is so revolutionary because it provides for a timely resolution of stress. The resolution process is to be completed within a period of 180 days from the date of admission of the application which may be extended once by 90 days. In total the resolution process is to be mandatorily completed within 330 days. Where the debtor fails to resolve its insolvency in accordance with the Act, within the time frame, the NCLT passes an order for the liquidation of the debtor governed by Chapter III of the Act.

Impact of IBC on mergers and acquisitions environment

To put it simply, IBC is nothing but a mode of merger/acquisition of distressed assets. Until the advent of the IBC, companies were reluctant to pick up distressed assets due to the extremely high risks associated with them. Now, however, more and more companies are showing interest. Due to the time bound nature, all stakeholders have a sense of urgency when trying to resolve the stress leading to these assets being available at a throw away price. These assets provide a much cheaper alternative to companies who otherwise would have had to pay hefty sums for their purchase or invest a lot of time and money in establishing assets from scratch.  Distress M&As accounted for 12% of the total M&A value in 2018. This might sound like a small number in isolation but consider the fact that distressed assets often sell for a fraction of the value of the assets as opposed to at a premium in good times. Some of the notable distress M&A deals were Bhushan Steel, Reliance Communications and Fortis Healthcare. Other financial players such as private equity firms and pension funds are also showing interest in putting money in distressed assets. IBC has given a legal face to buying distressed assets. 

To put things into perspective, let’s study the case of Bhushan Steel. The company was pushed into IBC after it defaulted on its loan of around INR 57,160 crores. Though the company was reporting net losses due to a high interest burden, it was profitable at the operational level as is evident from the profit of about ₹4,000 per tonne of output recorded in FY18. Sensing an opportunity, Tata Steel successfully submitted a resolution plan of INR 35,132 crores with remaining debt to be converted to equity.  Tata Steel acquired Bhushan Steel on May 18, 2018 through its wholly owned subsidiary – Bamnipal Steel. Aided by recovery in the domestic steel market, Bhushan Steel delivered an operating profit per tonne of INR 9,650 in the first quarter itself which was more than many peers in the industry. Operating profits of the company have only continued to increase since then, accounting for around 15 percent of Tata Steel’s revenue. Bhushan Steel’s liquidation value was estimated to be INR 14,541 crore. Clearly IBC in this case turned out to be a win – win scenario for the debtor, creditors as well as the acquirer. 

Challenges

Even though it might look like risks are much higher when dealing with distressed assets, things may not be much different from an M&A. At times, an asset may not be bad, but due to some unforeseen circumstances, it may have turned bad. In such cases, as with a regular M&A, a proper due diligence and having an effective strategy in place can help not only mitigate risks but also turn out to be extremely beneficial for acquirers. However, there remain certain challenges in the way of IBC’s success. Domestic financial institutions are generally reluctant to finance acquisition of distressed assets while raising finance from abroad continues to be challenging. Risk generally stems from the fact that the resolution applicants bid for acquisition on the only basis of whatever information is available and whatever information they can verify through due diligence without having the cushion of representations and warranties from the debtor, as is the case in regular M&As. In other words, acquirers acquire the assets on an as is where is basis with risks being passed on to the applicant with very little fall-back option. Since CIRP is a time bound process and that the RP himself depends on the existing management, the information available to the acquirers may not be as reliable or enough. 

Concluding remarks

IBC has surely stirred up the M&A scenario in the country. Given the high number of stressed assets, it provides a unique opportunity for companies to expand at minimal costs. However, in the present environment, this option is only for the ones with a high-risk appetite. IBC is yet at a nascent stage and one can only hope that it develops into a revolutionary legislation. 

References

• Notification No. S.O. 1205(E)
• “IBC Triggers M&A Deals for Distressed Assets.” M&A Critique, 10 Apr. 2019, mnacritique.mergersindia.com/insolvency-bankruptcy-code-drives-mergers-acquisitions/.
• Sontanam, Satya. “A Look at Two Successful IBC Cases in the Steel Industry.” BLoC, Bloc, 15 Feb. 2019, bloncampus.thehindubusinessline.com/b-learn/insight/a-look-at-two-successful-ibc-cases-in-the-steel-industry/article26281699.ece.
• PTI. “Tata Steel to Pay ₹ 35,200 Cr Cash for Bhushan Steel.” @Businessline, The Hindu BusinessLine, 2 Apr. 2018, www.thehindubusinessline.com/companies/tata-steel-to-pay-35200-cr-cash-for-bhushan-steel/article23415064.ece.   

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