This article is written by M.S.Bushra Tungekar, from the University of Mumbai Law Academy. The article provides an overview of the legal framework under the Insolvency and Bankruptcy Code for undertaking distressed M&A.

Introduction

The COVID-19 pandemic has had a significant impact on not only the Indian economy but on the world economy. It has caused a groundbreaking reduction in demand and supply. The business all over the world is surely suffering. However, opportunities will arise for those who have the resources to undertake distressed M&A.

The introduction of the Insolvency and Bankruptcy Code in 2016 intensified the distressed merger and acquisitions in India. Prior to Insolvency and Bankruptcy Code, 2016, the companies were a bit hesitant to enter into distressed assets deals.

What are distressed assets? 

The assets’ whose value has decreased tremendously due to factors other than general market conditions. These assets are put out in the market by companies that are going through bankruptcy or will go bankrupt in the near future. Investors purchase these assets at a dirt-cheap rate in anticipation that the said company will survive and emerge through bankruptcy.

Distressed assets after IBC

2 years after the introduction of IBC, India witnessed that around 12% of total M&A activity in India was undertaken by the way of distressed deals. These deals were facilitated by the Insolvency and Bankruptcy Code.

According to the Kroll Spotlight Asia report, the deals were worth approximately USD 14 billion. It comprised 70% of the M&A activity in India. This was caused by the multi-million dollar transaction deals such as Bhushan Steel (USD 7.4 billion), Reliance Communications (USD 3.7 billion), Walmart-Flipkart (USD 16.0 Billion), Idea Cellular-Vodafone India (USD 12.6 Billion), and Fortis Healthcare (USD1.2 billion).

Insolvency and Bankruptcy is a unified code. The code lays down a time-bound recovery process of distressed assets. It lays emphasis on keeping the company “going”. It also tries to avoid the erosion of the value of the assets. The code has established a priority given to creditors.

Information is well collected during the corporate insolvency resolution process which attracts investors toward the distressed asset. The information is deemed to be reliable and trustworthy and is made available effortlessly.

Reasons for the increase in distressed asset M&A activity 

Due diligence exercise in the distressed M&A 

As we all know, due diligence is a key activity under M&A. It has a significant impact on the outcome of the deal with respect to representations and warranties, negotiation leverages and the final decision.

Due diligence is conducted in order to analyze the target company’s capabilities, business, assets, financial position. It is conducted so as to protect itself and be aware of any future commercial or litigation problems that may or may not arise.

The Supreme Court in the case of Nirma Industries and Anr. v. Securities and Exchange Board of India held that it is the duty of the investor company to conduct efficient due diligence before investing in any company. The failure or omission by the investor company to have taken due precaution cannot be excused as ignorance of the investor company.

Due diligence in the case of distressed assets becomes an extremely critical and crucial exercise. Representations and warranties are important clauses under M&A. However, under the distressed assets there is no reliance of the investor company on representations and warranties, unlike the normal M&A transaction.

The resolution applicant acquires the distressed asset on as is where is basis along with the risks. The acquirer has very minimal or no recourse due to the lack of representations and warranties cushion.

According to Section 17 of the Insolvency and Bankruptcy Code, on the appointment of the interim resolution professional (i.e Initiation of corporate resolution insolvency process), the powers of the board of directors or the management or the partners are suspended. The interim resolution professional takes over the management of the corporate debtor.

The interim resolution professional is vested with the powers of the board and has access to various records and documents of the corporate debtor. The resolution professional also manages the affairs of the corporate debtor.

Not only that, the managers and officers are required to report to the interim resolution professional. Section 20 of the code empowers the resolution professional to enter into contracts, to protect and preserve the property of the corporate debtor, to raise interim finances, and to undertake all the activities necessary to keep the concern “going”. Keeping the concern going and revival of the corporate debtor is the main aim of the Insolvency and Bankruptcy Code.

Section 29 of the code requires the resolution professional to prepare and maintain an information memorandum containing the relevant information which is necessary to prepare a resolution plan. This information memorandum is to be made available to the resolution applicant for preparing a resolution plan.

The resolution applicant is therefore dependent on the resolution professional for obtaining all the relevant information required in conducting the exercise of due diligence. The resolution professional who in turn is also dependent on the management for providing the necessary and relevant documents.

The following details of the corporate debtor are mentioned in the information memorandum according to Regulation 36 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016:

• Assets and liabilities of the corporate debtor with depreciation.
• The latest year financial statements of the corporate debtor.
• Audited financial statement of the corporate debtor of the 2 preceding financial years.
• Updated provisional audited financial statement of the current financial year.
• A list of claims containing the name of the creditors, the amount claimed, and the security interest if any.
• Particulars of a debt due to and from the corporate debtor.
• Particulars of any guarantees given by any other party in relation to the debts. Whether a guarantor is a related party and details thereof.
• Details of the members or the partners holding at least 1 percent of the stake.
• Details of all pending litigation, ongoing investigations, ongoing proceedings whether initiated by any authority or state government. 

The information related to the distressed assets provided by the CIRP is in-depth and it facilitates the ease of conducting business. It can be seen from the above regulation that the CIRP provides for a near-identical due diligence process similar to the normal due diligence conducted under M&A transactions. It covers the financial, legal, and technical aspects of due diligence efficiently.

The time-bound process 

Insolvency and Bankruptcy Code establishes a time-bound process for dealing with distressed assets. The code aims at protecting the interest of the stakeholders and to revive the corporate debtors in a timely manner.

Section 12 of the Code mandates that the corporate insolvency process must be completed within 180 days of the initiation of the proceedings. Section 56 of the Code mandates that a fast track corporate insolvency resolution process is to be completed within 90 days of the initiation of the proceedings.

These sections further provide for the extension of time which is granted by the adjudicating authority after a resolution is passed for the same at the committee of the creditors meeting. For the resolution to be passed by a vote of 66% and 75 % of the share for corporate insolvency process and fast track corporate insolvency resolution process respectively.

The extension cannot exceed 90 days for the standard resolution process and 45 days for the fast track resolution process. Further, the process however must be completed within 330 days.

The time taken to conduct the transaction related to distressed assets is faster and efficient. Personal due diligence otherwise costumes a lot of time. The time-bound process helps in the value maximization of the assets.

Value maximization of assets 

On admission of application for commencement of corporate insolvency resolution process, the adjudicating authority passes a moratorium order. The moratorium order is passed under Section 14 of the Insolvency and Bankruptcy Code. The moratorium order prohibits the following activities: 

• Institution of suits.
• Keeping up with pending suits or proceedings. This includes execution of judgments or decree or order passed by the court of law, or tribunal or authority or arbitration panel.
• Getting rid of the assets or beneficial interest of the corporate debtor by the way of transfer, disposal, alienate, encumberment.
• Recovery of any property that is occupied by or is in possession of the corporate debtor.

This is done so as to protect, maintain and preserve the value of the distressed assets of the corporate debtor. This step ensures that the management does not interfere with the distressed assets and the process of corporate insolvency. The sale of distressed assets at a compromised price is protected by the moratorium order.

How is distressed M&A different from general M&A?

General M&A

• Both parties have equal or near-equal leverage.
• Under the general M&A, the parties are free to conduct detailed due diligence. 
• There is no restriction of time to complete the entire process.
• The parties determine the nature of transactions. 
• Negotiation of the deal and drafting of the required documents concerning the M&A.
• One of the most important clauses in any M&A is the Representation, warranties, and indemnity clauses. They are applicable in the case of a general M&A.
• The standstill clause also plays an important role especially in preventing hostile takeover when the parties are unable to negotiate efficiently and come to a mutual decision.
• A party may have the right to walk away from the deal in case of any emergence of material adverse change.

Distressed M&A

• Sellers are forced into selling due to financial crises.
• The corporate insolvency resolution process has established a timeline for conducting due diligence.
• Interim insolvency resolution professionals are required to guard and maintain the value of the property of the corporate debtor. It is also required to manage the entity as a “going concern”. 
• Insolvency and Bankruptcy Code mandates the submission of a resolution plan. The details of the same have been defined and specified under the code.
• The resolution plan is required to be approved by the adjudicating authority, which is the National Company Law Tribunal.
• The Moratorium takes effect from the date of such an order and is in existence till the completion of the corporate insolvency resolution process. 
• A resolution applicant cannot withdraw its resolution plan once the resolution plan has been approved. Therefore the resolution applicant does not have a recourse to back out after the approval of the resolution plan.

Distressed M&A opportunities under IBC 

Initiation of the corporate insolvency resolution process 

A corporate insolvency resolution process can be instituted against a corporate debtor when a corporate debtor defaults in payment of a minimum of INR 1 crore according to Section 4 read along with Section 6 of the Code.

A financial creditor or operational creditor can initiate the CIRP even the corporate debtor himself can initiate the process. The corporate insolvency resolution process commences on the admission of application for the process.

The application for admission of the corporate insolvency resolution process must be filed under Sections 7, or Section 9, or Section 10 of the Insolvency and Bankruptcy Code.

Issuance of moratorium order 

The adjudicating authority of admission of the application issues a moratorium order prohibiting certain actions and activities to be initiated against the corporate debtor. This is done so as to maintain and preserve the value of the distressed assets of the corporate debtor. And the distressed assets are sold at a compromised rate.

The moratorium order lasts till the completion of the corporate insolvency resolution process or until NCLT passes an order for liquidation.

Resolution applicant 

Once the process has initiated any eligible applicant can submit a resolution plan for the purpose of revival of the corporate debtor. A resolution applicant has been defined under Subsection 25 of Section 2 of the Code as a person who either alone or jointly submits a resolution plan which is in accordance with the invitation to submit.

Furthermore, only those resolution applicants can be invited to submit a resolution plan who fulfill the criteria laid down by the committee of creditors as stated under Section 25(2) clause (h) of the code.

Resolution plan 

The resolution plan is defined under Subsection (26) of Section 2 of the Code. The section states that a plan offered by a resolution applicant for the purpose of revival of the corporate debtor means a resolution plan. Further, the section clarifies that the said resolution plan may include provisions for the restructuring of the corporate debtor by the way of merger, demerger, and amalgamations.

Therefore a resolution applicant put forward a resolution plan suggesting merger, demerger, or amalgamation of distressed assets. Regulation 37 of CIRP Regulations 2016 provides for measures to be undertaken for maximization of the value of assets. It could include the following ( with respect to distressed assets under M&A): 

• Restructuring of the corporate debtor, by way of demerger or merger, or amalgamation.
• The substantial acquisition of shares of the corporate debtor, or the merger or consolidation of the corporate debtor with one or more persons.
• Depending on applicability delisting of shares of the corporate debtor.
• Transfer of all the assets or parts of the assets of the corporate debtor to one or more persons.
• Sale of all the assets or parts of the assets of the corporate debtor whether subject to any security or not.

Acquisition opportunity under regulation 29 

Regulation 29 of the CIRP regulation provides that if the resolution professional is of the opinion that the sale of encumbered assets of the corporate debtor is necessary for better accomplishment of the value of the asset then he may do so. The sale here is a sale other than the one conducted in the ordinary course of business.

However, the book value of the assets in the aggregate which is sold during the corporate insolvency resolution process period under regulation 29 must not exceed 10% of the total claims.

In order to sell the assets under regulation 29, the sale must be approved by the committee. The approval is to be obtained by a vote of  66% of the voting share of the members.

A bona fide purchaser who has purchased the assets under this regulation shall have a free and marketable title to such assets regardless of the terms of the shareholders’ agreement, joint venture agreement, or constitutional documents of the corporate debtor.

The entire insolvency resolution process makes it attractive for M&A of distressed assets. The information collected during the corporate insolvency resolution process provides a detailed insight into the distressed assets. 

Major distress transaction under M&A

Bhushan steel acquisition through Insolvency and Bankruptcy Code:

• Tata Steel acquired Bhushan steel through its wholly-owned subsidiary in 2018. The acquisition took place through a resolution under the IBC.
• Bhushan steel’s financial health was deteriorating. The main cause of which was said to be the promoters siphoning off funds.
• Tata steel acquired 72.65 per cent of shares through Bamnipal Steel Limited.
• Bamnipal Steel Limited subscribed to equity shares for Rs 158.89 crore (an aggregate amount). The additional funds of Rs 35,073.69 crore (aggregate) were given by way of debt/convertible debt. 

References

• https://blog.ksandk.com/misc/undertaking-due-diligence-and-its-challenges-a-perspective-of-the-ibc-regime/ 
• https://ibbi.gov.in/uploads/legalframwork/2020-08-17-234040-pjor6-59a1b2699bbf87423a8afb5f5c2a0a85.pdf 
• https://mnacritique.mergersindia.com/tata-steel-acquires-bhushan-through-ibc-route/ 

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