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

Introduction

India is on the downward slope of economy, a rash hit due to the fearsome COVID-19 phenomenon has put Indian Economy on reverse. But such trends are not new in M&A. Not every M&A transaction is carried out at equal liberty of the parties; some M&A are hit and run case, or perhaps The Curious case of Distressed M&A, where there is consolidation of authority with the acquirer, an easy target and a profit making deal. The IBC Code, 2016 was brought in with its main purpose of reorganisation and revival, taking care of interest of shareholders which has shackled the boundaries of old regime where it was non-existent. 

Getting to know “distressed” M&A in the face of “traditional” M&A 

To grow or to diversify is the reason why a business exists. “Traditional” M&A happens in various forms of asset sale, slump sale, share purchase agreement, with negotiations, consensus-ad-idem between the parties, fulfilling conditions precedent and subsequent in a no time bound manner, it can be a long term process where a deal can fall apart or come through even after so many years, but such is not the case with distressed M&A, here there is no elaborated negotiations, a time constrained phase, and the company is in Distress where it is facing cash flow crunch, falling margins, poor profits and less time to conduct due diligence.

So, simply put a distressed M&A is done when a company is in phase of “DISTRESS”. This could point out to a possibility that company is facing cash flow issue, improper planning to manage its liabilities, lack of means to raise further finance to satisfy future needs or obtaining or paying down trade credit. 

The twisted tie of Distressed M&A and Insolvency and Bankruptcy Code, 2016

“Insolvency” ordinarily can be characterized as a situation where a corporate or an individual is unable to pay its monetary obligations on time. The phrase ‘inability to pay debts’ is sought to be determined by a simple question, “whether the company is commercially insolvent and unable to meet its liabilities as and when they accrue”, as opined by the High Court of Andhra Pradesh. When such a condition arise IBC, 2016 provides for recovery of outstanding Amount through a Resolution Process.

The progressive Insolvency and Bankruptcy Code, 2016 has overthrown the out-dated regulatory frameworks governing the reconstruction and liquidation of incorporated or unincorporated entities. The earlier regime focused on winding up of corporate body in discharge of debts which did little or no good whereas the IBC, 2016 focuses on continuing business as a going-concern. The code focuses on revival of sick industries to its best efforts, fulfilling the prime objective of the code and if revival is not possible to liquidate the same.

After much debacle and discussions on the Code, Supreme Court upheld the validity of Insolvency and Bankruptcy Code in the case Swiss Ribbons Pvt Ltd. V. Union of India. With this code a new dimension altogether has been opened to distressed M&A space.

By 2018, around 12% of total M&A activity was led by distressed deals enabled through their insolvency process under the code, touching USD 14 billion. 

Insolvency and Bankruptcy as hailed in 2019 Judgement,” Defaulters paradise is lost” was enacted to cover up the loopholes of earlier legislations in place, of which the most significant one was TIME. Earlier legislations were not in a time paced manner which resulted in erosion of value of assets but the new code specifically provided for a 270 days(180 days+90 days) according to S.12(a) and S. 12 (3) of the Code.

This means that the proceedings initiated will be conducted in a time bound manner so as to realise the maximum value of the Assets, price discovery and corporate restructuring during insolvency process are the striking features in M&A market. The information collected during CIRP process and through INFORMATION MEMORANDUM provided by board about the ‘Corporate Debtor’, provides a prospect to Investor interested in M&A.

As per the World Bank ranking in Ease of doing business the effect of IBC is quite effective to be seen in M&A activity, as it helps to identify the distressed Assets in businesses, which means that a profitable deal in form of Assets or a whole business is available at a reduced price, which attract a lot of National and International investment. 

How M&A is taking shape during IBC regime

Distressed asset sale worth Rs. $14.3 Billion was done in India, since the Code become Operative in 2016 till 2018. The Code has worked well even for investors and acquirers who can get their hands on valuable and quality assets at a favourable price.

Some notable distressed M&A deals that were concluded under this regime were, Bhushan steel ($ 7.4 Billion), Reliance communications ($ 3.7 Billion) and Fortis Healthcare ($ 1.2 Billion). Some of the distressed M&A deals that are put on table are directly related to distressed ssset while some are indirect which results from the distress of parent organisation, resulting in sale. IBC regime in Indian has made it legitimately valuable to buy distressed assets which were looked down by promoters prior to the Code.

IBC has been a major step in de clogging the banks balance sheet, and pushed for reallocation of capital for more effective use caused by time bound manner in which proceedings are completed under the provision of the code.

Corporate Insolvency Resolution Process (CIRP)- road to M&A

Corporate Insolvency Resolution Process (CIRP) is the road to settle Distressed M&A.

CIRP IN BRIEF

Once Corporate Insolvency process is initiated under the Code, qualified Resolution Applicant submits Resolution Plan for revival of the company. This Code is relevant for Mergers/ Demergers (Traditional/ Distressed) by sale of Company’s Business to the Investors or Buyers.

A Resolution Applicant in his suggested Resolution Plan can propose a distressed entity to be merged with other organisation, once the plan receives the approval of the Committee of Creditors (COC).

CIRP may include following:

1. Acquiring Substantial shares of the Distressed Entity.
2. Merger of Corporate Debtor with one of more entities after approval of COC.
3. Assets in toto or part can be transferred to one or more entities.

As per Regulation 32, Liquidator may sell:

1. An Asset Separately.
2. All Assets in a Slump Sale.
3. All Assets collectively.
4. Business as a going concern.
5. Corporate Debtor as a going concern.

As per Regulation 29(3) Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provides for a Bona fide title to purchaser of Asset to have a free and Marketable Title of such Assets.

IBC: a preferred choice for M&A and why

The legal sanctity of Merger and Acquisition flowing through the Code help the Acquirers and Investors to acquire Assets or Business as a whole from this process. IBC has increased the quantum of Mergers since its initiation in 2016, benefitting both the Investors as well as Distressed Entities as a whole in following ways:

1. Since IBC was enacted to fill the loophole of extensive time loss in previous legislations. Proceedings under IBC are strictly completed in Time bound manner which help in preventing depletion of Asset value and Investor can Acquire Assets at a fair value and also provide timely capital to distressed organisation.
2. Information Memorandum reported by Interim Resolution Professional helps Investors to gain detailed Knowledge of the Entity, without much stress to the investors.
3. The IBC has accelerated activity in distressed merger and acquisitions (M&A) in India with the transaction involving Indian companies reaching $104.5 billion in 2018.

The post COVID era: changed faces of M&A and IBC, 2016

The startling difference between the pre-covid 19 mergers and post covid will be lingering in for quite some time. Generally on the Global basic share sale is the most regular and common in comparison with Asset or business sale. However there will be a shift in this scenario where there will be an increase in Business or Asset sale.

The on-going Pandemic and Government restraints will see a significant increase with lifting of Regulations. Reconstructing will not be a safe bet in many scenarios which will be an opportunity for shareholders to exit the situation where Financial Investors and Trade Buyers, with inclination to risk will be positioned.

Recent notification dated 22nd December, 2020; Central Government has extended Suspension of Insolvency proceedings for a further period of three months till 25th March 2020, which was set to end on December 25th, 2020.

COVID-19 will create a huge market for distressed Asset in the near future. With the ever slowing of business it has become extremely difficult to pay off debts, perform the contractual obligations and diminishing stock valuation, would create a dearth of Resolution Applicants to save Insolvency Applicants. To address this situation certain measures were necessary to be placed in check, to control the chance of increase in Insolvency and Bankruptcy proceedings:

DEFAULT CAP:

In March, 2020, one of the very first measures announced by Government to keep in check and to reduce the burden of cases under the code was to increase the default cap for purpose of triggering the Insolvency and Bankruptcy Code. Part I of the Insolvency and Bankruptcy Code deals with Insolvency Resolutions and Liquidation of Corporate Persons.

Cap on Triggering of Code prior  to Suspension	Cap on triggering of Code  Post suspension
As per S.4 of the Code, Prior to notification by Central government the code was triggered on a default on account of Corporate Debtor of Rs. 1 Lakh. However, proviso of S.4 provides that Central Government can specify minimum value of default of higher value which shall not exceed Rs. 1 crore.	As per the powers conferred to Central Government Under S.4 of the Code, notification was issued on 24.03.2020 to increase the minimum limit for triggering the Code to 1 crore.

TIMELINE FOR CODE:

The code provide a strict timeline to deal with cases pertaining the code with a maximum timeline of 270 days as per to S.12(a) and S. 12 (3) of the code, however Supreme Court held that lockdown period should not be included while calculating timeline for IB proceedings. Additionally, Guidelines were issued by National Company Law Appellate Tribunal.

SUSPENSION OF APPLICATIONS:

An Ordinance was promulgated, which was replaced by Insolvency and Bankruptcy (Second Amendment) Act 2020 for incorporation of S. 10A to the IBC, to suspend applications filed under S. 7, 9 and 10 for a period of one year to prevent the mounting up of cases under the Act. No applications will be filed in future for initiation of proceedings against a Corporate Debtor, for the default occurring during Suspension Period.

Effect of suspension on recent M&A trends

Due to suspension of IBC for the current year, it will result in standstill in proceedings under the Code; however this provides a relief to the borrowers but jeopardizes the interest of lenders. Due to suspension there will be erosion of value of Assets of distressed entities, so this will increase out-of-court settlement deals for M&A, pushing promoters to opt for one time settlement and negotiate with banks to raise debts at affordable rates. Due to suspension of IBC companies having good future prospects will be acquired on an inexpensive price by smart investors and other will have to opt for Reconstructing internally or even sale of their non-core business. This halt in IBC will have long term effect in M&A sector, as it will reduce the burden of cases for current year but will lead to accumulation of liabilities and erosion in value of Assets, defeating the purpose of enacting Code.

Learning from the past : financial crisis v/s health crisis

It is important to understand how the Economic Failure due to COVID-19 crisis has some similarities and differences from the Financial Crisis, or Global Financial Crisis of 2007-2009, and how both impacted the M&A activity in the Economy in their own ways:

FINANCIAL CRISIS

HEALTH CRISIS

The 2008 Global Financial Crisis (GFC) caused a sharp decline in M&A activity, GFC mainly impacted Real estate sector and banks, for which Government has to devise strategies to get them out of clutches of overextending credits to business. In the economy due to difficulty in financing the deal, for a large transaction deal to be carried out there was not enough financing and availability of funds in the economy, moreover there was uncertainty with the future of Economy and with grim corporate earnings expectations forced Acquired to delay hold or delay their Acquisition prospects.  The 2008 Global Financial Crisis (GFC), Recession and Crash of Economy were a Financial Crisis in Nature. It was due to lack of Investors’ confidence, with a steep increase in number of Borrowers unable to pay debts, which broke the bone of Financial Institutions in the Economy. With a sinking Real Estate Business, and excessive risk taking of Financial Institutions, with Bankruptcy of Lehman Brothers the world entered the International Banking Crisis. Loss of Investors interest in Financial Institutions and decline of credit availability in the system led to tumbling stocks and commodity prices. The world economies also slowed down due to decline in International trade. In GFC, due to Financial machinery breaking down there was a loss in investors’ confidence which resulted a plunge in Demand, and supply was hit later. DEMAND SUPPLY

Since COVID-19 is a health crisis, it has affected entire Service sector and unemployment is on an all-time high, with a negative Economic Growth rate.   As companies are entering the phase of uplifted regulations by Government, there will be more and more Acquisitions which were long sought because, simply because company having an indicatively poor balance sheet which was earlier reluctant to sell their Assets will now be pressured to sell, to cope with their cut-backs and mounting debts. With more and more Distressed M&A in place and Suspension of IBC there has been a significant rise in out-of-court M&A and the quantum.  Though the M&A market are shrinking, but Companies opting to make M&A moves are outperforming those who had not.  A lot of significant Acquisitions have taken place in the Economy. Indian telecom as well as digital space, having more than half a billion active users has become now favourite for International Investors. Tech Giants like Facebook and Google have invested heavily in Reliance Jio with a total investment of $5.7 Billion and $ 4.5 Billion respectively. Think and Learn, platform which operates the leading education giant Byjus has acquired Whitehat Jr for whooping $300 million all cash transaction. Reliance Acquisition in online Pharmacy non-tech front Netmeds. Increased use of digital payment gateways has strengthened the Fintech Sector. Contrary to GFC there will be a decline in supply chain, which will later impact Demand. SUPPLY DEMAND

Clearly both the Global Financial crisis and COVID-19 has lots of similarities as well as differences. This can be looked as to see how M&A in an economy is affected in a downturn. Similar to GFC, there will be shrinking of M&A and a rise in Distressed Asset, but due to it being a health crisis, there can be a lot of Distressed M&A in the near future.

Conclusion

Distressed M&A are not new to Economy of India, Improper planning, policy issues, bureaucratic and political differences could be few of the reasons as to why businesses fail. In a distressed M&A, both the Investors and sellers have a lot to analysis, process and due diligence to do in a lot less time. Distressed M&A is nothing short of an art, it requires remarkable skills and an equally remarkable appetite. Insolvency and Bankruptcy Code was brought in to prevent the plague of non-performing Assets in Market and providing effective and efficient Resolution process to deal with it. IBC regime has facilitated the growth of M&A sector, by giving swift Corporate Insolvency Resolution Process and since the timelines for the proceedings which are already under CIRP, have been relaxed by Central Government Notification, this would lead to a more effective Examination resulting in more valuable Mergers. COVID-19 has severely impacted both Human resources as well as Business resources in economy which will indubitably increase the load of Distressed M&A, but at the same time this is looked down as an opportunity for both domestic and International Investors. Safe to say, this will be like flipping a coin, and only future will tell what it holds.

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