M&A in the time of Bankruptcy Code

Carefully considered and implemented, these could be value-accretive

The Indian Insolvency and Bankruptcy Code, 2016 (Code) is here and rules governing the resolution professionals and the corporate insolvency resolution process (CIRP) have been brought into force with effect from December 1, 2016. With the high levels of distress in the industry, there are various opportunities on the buy-side in India today. What does Mergers & Acquisitions (M&A) look like in the time of the Bankruptcy Code?

M&A in the twilight period, i.e., the period immediately prior to a potential corporate insolvency, is perhaps the period with the most light-touch regulations but where most prudent advice is required.

The twilight period is likely to yield attractive valuations but those valuations need to be carefully ring-fenced to ensure that the buyer is not inadvertently assuming more liabilities than bargained for. This is a function of careful consideration as to which liabilities are most likely to attach to the asset being acquired (for e.g, tax liabilities or environmental liabilities). This is established only after careful due diligence and transaction structuring.

A careful exercise

The new Code arms the resolution professional (appointed when the seller goes into insolvency) with a full suite of anti-avoidance powers. For e.g., Section 45 of the Code empowers the resolution professional to apply to the National Company Law Tribunal (NCLT) to challenge any transfer of assets undertaken within a period of one year prior to the commencement of CIRP, where the transaction was significantly undervalued. In case the NCLT agrees, it may reverse the transfer or ask the buyer to pay the fair market value. In addition, Section 47 contains a whistle-blower provision, allowing creditors and shareholders to make such a request of the NCLT. Therefore, the valuation of assets in the twilight period is a careful exercise.

The challenge, of course, is to conduct this exercise in a careful manner, with the right people at the helm and in the least amount of time since, quite typically, “time to market” for M&A in the twilight period is very short.

In recent times, it has not been all smooth sailing as we can see from the auctions in the Vijay Mallya case and the decision of the Bombay High Court in Blue Coast Hotels. These are all topics for another day; importantly, once a corporate debtor is in CIRP, all lender enforcement actions (including actions under SARFAESI) are stayed. This, effectively, puts a “full stop” to any M&A, at least until liquidation proceeds are allowed to resume as per the Code.

Buying assets under the Code

The Indian Code has not adopted the “UK pre-pack” or the “US section 363” asset sale models. The “pre-pack” and “363” sales are fast track sales where the administrator/court finds that the company cannot be revived as a going concern — not without selling some assets. We have not adopted these models. Hearteningly, the joint parliamentary committee which reviewed the Code hinted at its adoption at some time in future.

For the moment, under the Code, once the NCLT admits a CIRP against a corporate debtor and orders the moratorium on actions, no assets sales are permitted without approval. Once the committee of creditors is formed no asset sales are permitted without consent of 75 per cent of the committee by value.

The Code does provide a “small sale exemption” for sale of small-value, unencumbered assets in the ordinary course of business, but that will not help with a large strategic sale. Furthermore, no transfer of shares of the corporate debtor is permitted except with the consent of 75 per cent of the committee by value.

Therefore, it would appear that, for the moment, the buyer has two options: (i) execute the sale with the consent of the committee of creditors or (ii) execute the sale under a resolution plan approved by the committee of creditors by 75 per cent value and blessed by the NCLT as being in compliance with the Code. While the first option will likely be quicker, the second option will likely provide more certainty to the transaction with less likelihood of challenge and easier transfer of customers and business licences.

Thus, with rising levels of debts and the enactment of the Bankruptcy Code, there will be opportunities aplenty.

The writer is Partner, Khaitan & Co

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