Mergers and acquisitions under Bankruptcy Code: some concerns
By encouraging a transparent and time-bound sale of assets and businesses of defaulting corporate debtors, the Insolvency and Bankruptcy Code, 2016 (Bankruptcy Code) promises a fillip in merger and acquisition (M&A) trades. This has been furthered by recent policy changes e.g., Securities and Exchange Board of India or Sebi’s announcement exempting issuance of shares by distressed listed companies from complying with minimum pricing guidelines. That said, sale of such assets via creditor-controlled processes requires consideration of several practical issues.
The problem of hostile promoters/management cannot be wished away
The admission of the corporate insolvency resolution process by the National Company Law Tribunal (NCLT) signals the commencement of the asset sale process under the Bankruptcy Code. At this point, the insolvency resolution professional (IRP) is appointed and essentially takes over the reins of the corporate borrower, superseding existing management. The IRP is a nominee of the creditors, so this process of putting the creditor in control may result in management losing interest in the sale process or turning “hostile”, leading to severe inconsistencies in the flow of information on the corporate debtor and the true extent of its assets and liabilities. This may impede the price discovery process as well as potentially discourage bidders from offering acquisition proposals.
There is ambiguity on whether a sale under the Bankruptcy Code will trump the requirements under the Companies Act. For instance, where the acquisition involves several corporate actions/shareholder approvals e.g., issuance of new shares to an acquirer, so that it can inject new funds into the defaulting company to revive it and get majority ownership—there are question marks whether the NCLT’s approval for such action suffices, or whether the requirement of a special resolution of shareholders under the Companies Act still applies. The special resolution may not be forthcoming in situations where existing promoters are not sufficiently incentivized, and will require acquirers to explore other means of taking control of defaulting corporate entities.
Freeze on M&A during the moratorium period
In the period after the NCLT admits and kick-starts the insolvency resolution process, the corporate debtor will be precluded from selling its businesses/related assets until the expiry of a moratorium period of 180 days (extendable by a further period of 90 days), or until a sale process is approved by the NCLT. Such a forced time gap could result in deterioration in the value of the assets of the borrower and in some cases, business of the corporate debtor. One way of avoiding such a “melting ice-cube” situation would have been to permit “pre-pack” arrangements, which allow the sale of at least a part of a company’s business or assets to an identified purchaser at a price negotiated prior to (or simultaneously with) the commencement of the bankruptcy process by the NCLT. Such “pre-pack” arrangements have been popular in international jurisdictions, but are not allowed under the Bankruptcy Code.
The absence of “pre-pack” arrangements may also deter serious acquirers who have a genuine turnaround plan for the insolvent company, but do not wish to get embroiled in an auction process under the Bankruptcy Code–as the resolution professional will be statutorily required to seek out other bidders.
No stamp duty relaxation
There is no exception for payment of stamp duty and other statutory costs in relation to acquisition of assets under the Bankruptcy Code. Acquirers will, therefore, need to appropriately factor this cost into their financial model, and where possible, modify their transaction structure for efficiency.
Questions over continuity of business
Any acquisition of assets by a buyer under the Bankruptcy Code—even though sanctioned by the NCLT—may not result in automatic transfer of government consents, licenses, customer and third-party contracts. Accordingly, a steel plant acquired via this process will not follow suit with the iron ore mining lease attached to it (or for that matter, a captive coal mine attached to a power plant, or the spectrum associated with a telecom asset); with the buyer needing to separately negotiate the transfer of the relevant government concession/license to itself. This is bound to create deal uncertainty in situations where highly regulated businesses are subjected to insolvency proceedings e.g., likelihood of the government approval coming through, increase in fees/premium payable to the government; and buyers would be well advised to plan for regulatory intervention well in advance of submitting any acquisition offer.
Creditor decision making, problem of plenty
For a sale of a business under the Bankruptcy Code, 75% of the creditors’ committee must approve such a plan. This is a high threshold, especially compared to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, which requires approval only of 60% of secured creditors; and the Bankruptcy Code does not distinguish between a secured creditor and an unsecured creditor on voting rights in the committee. Such parity of status could result in delay/multiple voices on the table, and incentivise the secured creditors to only seek the best possible deal for themselves—outside of the Bankruptcy Code process, and to the exclusion of the unsecured creditors. As such, unless buyers are confident of coordination and consensus among creditors, they may be wary of investing time and effort in such situations.
Kartick Maheshwari is partner, and Aashutosh Sampat is Principal Associate at Khaitan & Co.