Distressed M&A Under The Insolvency And Bankruptcy Code, 2016: Navigating Challenges And Opportunities
The introduction of the Insolvency and Bankruptcy Code, 2016 (I&B Code) has marked a pivotal moment in India's approach to corporate insolvency and restructuring of distress companies undergoing financial crisis and turmoil. In 2019, an amendment to the I&B Code was introduced, amending Section 5 to clarify that the resolution plan may incorporate provisions for restructuring the corporate debtor, including through merger, amalgamation, and demerger. Regulation 37(1) of the Insolvency and Bankruptcy Board of India (Insolvency Regulation Process for Corporate Persons) Regulations, 2016 permits restructuring of a corporate debtor by way of merger/consolidation or sale/transfer of assets of the CD pursuant to the resolution plan.
The I&B Code, 2016 is a comprehensive framework aimed to consolidate and streamline the processes of insolvency, restructuring, and bankruptcy, thereby providing a clear pathway for distressed mergers and acquisitions (M&A). The I&B Code, 2016 has not only redefined the mechanics of distressed assets but has also reshaped the strategies employed by investors, lenders, and corporate entities in navigating financial distress and overcoming the situation of instability and volatility.
Understanding Distressed M&A
Distressed M&A refers to the acquisition of corporate debtors facing financial difficulties, often characterized by insolvency or severe operational challenges and reviving the business by strategizing and using the resources and the assets of the distressed corporate entity as a synergizing tool. In such scenarios, potential buyers/investors can acquire the corporate debtor along with its assets and business at discounted prices, allowing them to capitalize on turnaround opportunities. However, these transactions are fraught with complexities, particularly in the context of the I&B Code.
The Framework of the I&B Code conducive for distressed M&A
The I&B Code represents a comprehensive legal structure for addressing insolvency and bankruptcy issues of the corporate entities including individuals in India. Its framework is designed to facilitate maximization of the value of corporate assets, time-bound resolution of the corporate debtor, protecting the interest of all stakeholders and reducing the burden on the judicial system. Some key components include:
1. Corporate Insolvency Resolution Process (CIRP): The I&B Code stipulates a structured process where insolvency can be triggered by a default of ₹1 Crore. Once initiated, the CIRP involves the appointment of a resolution professional (RP) who takes over the management and supervises the corporate debtor’s affairs, facilitating negotiations among committee of creditors, formulating resolution plans and evaluating the best plan in the interest of the stakeholders and the corporate debtor.
2. Role of the Committee of Creditors (CoC): A significant aspect of the I&B Code is the formation of the CoC, comprising financial creditors who hold the power to take all the decisions for the Corporate Debtor including approval or rejection of the resolution plans for the revival of the Corporate Debtor. This collective decision-making by CoC ensures that the interests of creditors are prioritized while providing a structured approach to M&A.
3. Resolution Plans: Resolution plans can include various strategies, including asset sales, operational restructuring, or M&A. These plans must adhere to specific guidelines set forth by the I&B Code and must be approved by at least 66% of the voting share of the CoC, ensuring alignment with creditors' interests after considering its feasibility and viability and this includes the resolution plan containing sale of business of the entity or its merging into other entity.
4. Fast-Track Process for Small Companies: The I&B Code also provides a fast-track resolution process for smaller firms, allowing for quicker resolution processes and fast track M&A transactions, which can help preserve value of the assets of the corporate debtor and jobs of employees of the corporate debtor.
5. Quick Decision-Making: The I&B Code mandates a time-bound process, with the resolution period capped at 330 days. This urgency can create a conducive environment for M&A as buyers/investors seek to finalize deals swiftly to avoid the liquidation of assets.
6. Protection from Pre-existing Claims: Once a resolution plan is approved, the corporate debtor and the successful resolution applicant (investor/buyer) is protected from any previous claims, which makes distressed M&A more attractive to potential buyers who seek to start fresh without the baggage of past liabilities of the corporate debtor. Section 32(A), insertion in the I&B Code in 2019 has been made with the intention of saving a corporate debtor as a going concern for the benefit of its stakeholders and employees. Section 32(A) releases the investor of liability for claims or proceedings brought against the corporate debtor prior to the date of the acquisition.
Opportunities in Distressed M&A
1. Attractive Valuations: One of the primary attractions of distressed M&A is the potential for acquiring assets at significantly reduced prices as the creditors are flexible to take the haircut, identifying the distress situation and getting some return out of the Non-Performing Asset. Corporate Debtor under CIRP is often undervalued due to their financial problems, providing savvy investors with opportunities for value creation at a bargain.
2. Revitalization Potential: Distressed assets often come with untapped potential and underutilized full resources and capacities. Strategic buyers with expertise in turnaround management find these deals lucrative as they could implement operational efficiencies, revamp business models, and restore profitability using business expertise.
3. Access to New Markets and Technologies: Acquiring a distressed entity can provide access to established market positions, synergy in respect to customer bases, brand name, asset base of the corporate debtor and proprietary technologies, which might be difficult to obtain through traditional M&A channels.
4. Favorable Regulatory Environment: The structured framework of the I&B Code, along with the participation of the NCLT/NCLAT, can boost investor confidence by clarifying the resolution process, establishing timelines, and ensuring legal protections. The acquisition of the corporate debtor through I&B code enshrines various relaxations to the investor (few examples being relaxation from mandatory shareholder approval, time period of 1 year for obtaining necessary approvals, exemptions from preferential allotment rules, SEBI Takeover Code, Delisting Regulations, LODR Regulations, etc. This, in turn, facilitates smoother transactions and the transition of distressed entities.
Challenges in Distressed M&A under the I&B Code
Despite the opportunities, distressed M&A under the I&B Code is not without the challenges:
1. Complex Due Diligence: The financial and operational state of distressed companies often complicates due diligence. Investor/Buyers are required to thoroughly assess the corporate debtor’s assets, liabilities, contingent claims, and the overall financial health of the target Corporate Debtor to avoid post-acquisition surprises.
2. Valuation Difficulties: Accurately valuing distressed assets can be complex due to uncertain future cash flows, claims of the creditors and the deteriorated state of the business of the corporate debtor. Investors/Buyers are required to thoroughly assess the viability of the acquisition and determine the accurate value of the corporate debtor while submitting the resolution plan.
3. Regulatory Hurdles: The I&B Code continues to evolve with time and inconsistencies in its interpretation can create uncertainties for potential investors. Understanding the regulatory landscape, including compliance with other allied laws including security market laws and competition laws and sector-specific regulations, is critical.
4. Stakeholder Dynamics: Balancing the interests of multiple stakeholders including operational creditors, employees, govt. dues etc. may resist the sale of distressed assets, complicating negotiations. Addressing these concerns while ensuring stakeholder alignment is essential for a successful transaction
5. Post-Acquisition Integration: Acquiring a distressed entity often involves integrating a struggling operation into a healthier business model. Merging a distressed entity into a healthy organization poses unique challenges. Investors /Buyers are required to carefully plan the integration process, addressing cultural differences, operational inefficiencies, and potential disruptions.
The Future of Distressed M&A in India
The I&B Code has laid the groundwork for a more structured and transparent process for distressed M&A, and several trends are likely to shape its future:
1. Emergence of Specialized Funds: The increasing awareness of distressed assets has led to the rise of specialized private equity and hedge funds focusing on these opportunities. These funds often have the expertise and resources needed to navigate the complexities of distressed M&A.
2. Growth in Cross-Border Transactions: As global investors become more familiar with the I&B Code, there are possibilities of an uptick in cross-border distressed M&A transactions. The potential for Indian companies to access international markets can enhance recovery prospects for distressed assets.
3. Sector-Specific Strategies: Different industries may require tailored approaches to distressed M&A. For example, established businesses in the technology sector may focus on acquisition of the distress corporate entities having intellectual property, while businesses in the manufacturing sector might find entities having operational setup lucrative considering integration and synergy to their overall business model.
4. Increased Collaboration: Collaborations between strategic and financial investors can lead to more effective turnaround strategies. By combining financial resources with operational expertise, stakeholders can enhance the chances of successful outcomes.
5. Legal Developments: The current wave of deal-making could drive M&A activity to record levels in the coming years. While Indian corporate houses have predominantly led M&A transactions through the I&B Code mechanism, landmark deals like ArcelorMittal's acquisition of Essar Steel are likely to boost confidence among foreign investors, as these assets are available at a discount rather than a premium. To facilitate this growth, the government must ensure that the M&A process under the I&B Code is transparent. Clarifications on gray areas and necessary amendments should be made promptly to align the I&B Code with other laws, thereby streamlining the M&A process through the I&B Code route.
Conclusion
Distressed M&A under the Insolvency and Bankruptcy Code, 2016, presents a unique blend of challenges and opportunities for stakeholders in the corporate ecosystem. As the framework continues to evolve, it offers a promising avenue for revitalizing distressed businesses and maximizing asset values. With careful navigation of the complexities involved, investors/acquirers can harness the potential of distressed M&A to foster growth and stability in an increasingly competitive market.
Disclaimer: This article was first published in the S&A Law Offices - 'Indian Legal Impetus' newsletter in October 2024.