The Insolvency and Bankruptcy Code, 2016 (the Code) has caused a paradigm shift in the manner in which cases of sick companies have been handled in India. The Code, which repeals the erstwhile Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) attempts to make the entire process of insolvency a time bound one. i.e., within a period of 180 days, which can be extended to a maximum of 270 days. The much talked about Code seems to be an effective mechanism for dealing with the problem of mounting non-performing assets (NPAs) clogging up our banking system today.
However, the success of any new legislation depends on the effective and seamless implementation of the same. A seemingly well-drafted legislation may face various unforeseen bottlenecks during its implementation. On the first anniversary of the Code, we have endeavored to perform a reality check of how effective the Code has been.
While the Code is a bold step to solve the issue of stressed assets in our country, it is not a complete code in itself. This is because the Resolution Plan, as submitted under the Code, does not grant a blanket approval under all regulations governing the company under insolvency. Hence, apart from seeking the approval of the National Company Law Tribunal (NCLT) during the process of insolvency, one has to seek approval from various other regulatory authorities, if applicable, such as the Competition Commission of India, State Governments, SEBI or specific sectoral regulators. Consequently, the Resolution Plan is mired in a legal tangle of sorts. The government has realized that the competence of the Code depends on the support of other legislations. The willingness of the government to enable hassle-free implementation of the Code is seen from the plethora of amendments introduced in other legislations in support of the Code.
The SEBI (Substantial Acquisition of Shares and Takeovers) Code, 2011 has been amended to exempt acquisition of shares of a listed company made under the Resolution Plan approved under the Code. This amendment now enables any acquirer to buy shares in a listed entity under insolvency without making an open offer. The whole footing of the Code is to enable the resolution of financial problems faced by companies by giving the control of the company to third party investors who may infuse funds and revive it. In such a scenario, exempting the investors from open offer requirements upon change in control is a wise decision of the government.
The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI ICDR) was also amended recently. It deals with the preferential allotment of equity shares in a listed entity. The SEBI ICDR exempted companies under insolvency proceedings from complying with some of the requirements of preferential allotment, such as pricing guidelines. This amendment permitted any third party investors or acquirers to acquire equity shares in listed entities under insolvency at a price that is less than the price proposed by SEBI ICDR. Generally, the pricing of the shares of companies under insolvency does not consider the actual fair value of the company. Therefore, the price of the shares determined in accordance with SEBI ICDR (which is approximately the market price of the shares in most cases) may not be indicative of the actual fair value of such companies. The exemption allows the investors/ acquirers to acquire shares in the companies at any commercially agreed price, rather than a legally enforced price. However, purchasing shares is at a price lower than the fair market value may lead to adverse tax implications. Furthermore, it is important to note that SEBI ICDR only exempts the acquirers from acquiring equity shares and the pricing requirements of such preferential allotment. The shares so allotted continue to have lock-in restrictions as prescribed in the SEBI ICDR. Further, while issue of equity shares is exempted from certain compliances under SEBI ICDR, there is no such exemption available to the issue of any convertible instruments, i.e., preference shares, debentures, etc.
While the government kept up the pace of reforms by amending the above SEBI regulations, one area awaiting similar amendment is the SEBI (Delisting of Equity Shares) Regulations, 2009 (SEBI Delisting Regulations). The delisting regulations, as they stand today, provide exemption to companies registered under the SICA from following the procedure of delisting their equity shares. However, similar exemption is not extended to companies under the Code.
An investor looking to invest in a financially strained listed company with an objective to revive it may prefer delisting it to facilitate quick decision making without much public interference. In addition, as there is substantial value erosion in such a company, there may be no value left to pay off the public shareholders. Although, as the SICA has now been repealed and the Code covers similar situations, the exemption to the companies under SICA may be construed as an exemption under the Code; this position is not conclusive and the SEBI may take a different view. Currently, the Resolution Applicants are desirous of acquiring Target Companies, which are either unlisted or are delisted pursuant to insolvency proceedings. However, in the absence of a specific exemption, they are considering seeking separate approval from the SEBI for the same, which is slowing the process.
However, apart from such generic regulations, an entity needs to follow a series of sector specific regulations. Generally, any change in control of these entities or transfer of assets requires the approval of these sectoral bodies. The large accounts of stressed assets currently belong to sectors such as infrastructure, power, cement and steel. For all these entities, there are many regulatory restrictions around change in their control. Some of these necessitate taking separate sanction of sectoral regulations, such as mining regulators, etc. There are already reports that resolution professionals are seeking extension of timelines for resolution of the 12 major NPA accounts identified due to various commercial holdups. In such a scenario, the lack of a regulatory environment that is conducive to insolvency proceedings, will mean that the completion of such cases within 180 days remain only on paper.
While the government has sown the seeds of reform – it requires constant legislative nurturing in the form of amendments to existing laws, to bear fruit.
*Authors – Falguni Shah, M&A Tax Partner, PwC India and Nidhi Mehta, Associate Director – M&A Tax, PwC India