How Debt Impacts Merger And Acquisition Transactions In Stressed Asset Sale

In the past couple of years, India has witnessed quick resolutions for tackling non-performing stressed assets (NPAs) and debts in India, including its restructuring thereof, by providing a powerful tool to the financial and operational creditors in the form of the Insolvency and Bankruptcy Code, 2016 (the “IBC, 2016“).

The effective reforms in the IBC, 2016, since its inception, has enabled the Reserve Bank of India (RBI) to clear its bad debts by the proactive attitude of the financial institutions in their declaration of various non-performing accounts of big corporates and the strict timelines in the Corporate Insolvency Resolution Process (CIRP).

This has compelled non-performing companies to put their assets on stress sale, providing the corporates (both in India and globally) to get access to such influx of quality assets at such lucrative valuations, which has thereby accelerated the forward momentum of mergers and acquisition (M&A) in India.

Investors are keen to dip their hands in the abundance of stressed assets available in the market, ensuing the admittance of several bluechip entities under the IBC, 2016 regime, including IL&FS, and the NCLT proactively approving resolution plans, including the plan for acquisition of Bhushan Steel by Tata Steel – becoming the first successful acquisition under IBC, 2016 – and the plan of ArcelorMittal’s acquisition of Essar Steel (which undoubtedly will be the second biggest steel acquisition in India).

Also, with the recent judgment deciding the liquidation vs. revival of the company in Amar Dye Chem Limited (in liquidation), the promoter shareholder is now allowed to file a Petition seeking revival of the Company through a compromise with creditors, under the provisions of the Companies Act, 2013 (the “Companies Act“) even if the said company is under liquidation.

Therefore, the promoters have been equipped with a weapon against sub-clause (g) of section 29A of IBC, 2016, which disqualified the promoters of the corporate debtor from participating in the restructuring process of the corporate debtor or acquiring its assets under the liquidation process.

Addressing The Legal Liabilities Of The Defaulting Asset

There are various legal liabilities in the acquisition of defaulting assets. When dealing with a distressed company, a potential purchaser must understand the creditor base and the ambit of the indebtedness of such a distressed company.

The sale of stressed assets is usually on an ‘as-is-where-is‘ basis; therefore ‘minimizing the dangers and maximizing the opportunities‘ should be the motto for the acquisition. The prospective buyer must ensure that the asset valuations are done by reputed and registered valuers.

The legal counsels should thoroughly conduct the due diligence exercise and must evaluate even undisclosed or unquantified liabilities, including tax liabilities that come with such distressed assets, which enables the effective structuring of the transaction.

For instance, as in the case of the acquisition of specified assets of Reliance Communications Ltd. and its affiliates by Reliance Jio Infocomm Ltd., wherein Reliance Jio Infocomm Ltd. has extended the term of such acquisition, subject to completion of certain conditions precedent to the acquisition, including disclosure of unquantified tax liabilities and other dues.

Once the legal liabilities are known to the prospective buyer, it is important to formulate provisions to either exclude or limit such liabilities (specially undisclosed or unforeseen), which can be done by including clauses which gives the right to the prospective purchaser to shield itself from any unforeseen claim by third parties, which may hit them after the acquisition. On the other hand, the seller may have exclusion clauses to limit its losses by imposing time limits for claims and restricting remedies in law or in equity.

Importance Of Indemnity Provision

In cases where the prospective purchaser foregoes its right to indemnification, due to the absence of such right in a contractual agreement, the prospective purchaser still has a right to claim damages under the contractual laws in India.

In the Daiichi-Sankyo case, the Delhi High Court shifted from the strict rules of interpretation of agreements and decided that Daiichi is not precluded from filing a claim for fraud, merely because it had forgone the right to indemnification under the agreement.

Alternatively, a fairly new concept of obtaining transactional insurance is in the form of representations and warranties insurance, which protects the buyer from safeguarding its interest and to be compensated in case the seller is unable to do so.

Also, with the influx of availability of attractive stressed assets in the market, a representation and warranty insurance assures comfort and confidence in buyers.

Restructuring Of Acquired Asset Debt

The issue of restructuring of corporate debts has been a focus point for the RBI as well. The RBI has issued various guidelines aimed at specific tools for fast-track debt restructuring and mitigating frauds and losses for the economy as a whole.

One such circular dated February 12, 2018, prescribed strict rules and also recognised an account as non- performing even for one-day defaults and submitted the same to insolvency actions by the lenders. The said circular was quashed and declared ultra-vires by the Hon’ble Supreme Court.

This has not deterred the motivation of RBI in its drive to enhance the momentum of resolution of stressed assets and adherence to credit discipline. The Governor of RBI had made a statement that RBI shall issue a revised circular, as may be necessary, for expeditious and effective resolution of stressed assets.

Case For International Lenders Of An Indian Party

India is fast becoming a global economy since the factors leading to the increased investment in 2018 are continuing. The trend of the Indian Judiciary giving foreign investor favourable judgements has eased foreign investors in entering into commercial transactions with Indian entities (notable cases include favourable judgments for Daiichi and Ericson).

This had led to an increase in international lending, which inevitably gets the international lenders to explore all their options in safeguarding their interests at the time of entering into the transaction, as well at the time of declaration of the asset as non-performing.

Under IBC, even foreign creditors can initiate CIRP against corporate debtors situated in India as a measure to protect themselves from bad debts. This, among other lucrative factors, has facilitated a lot of foreign investment in India.

Once the transaction has been effected, the lender may seek to obtain collateral security as against the debt, thereby acquiring the right to lien and foreclose as a preferential right. It may also secure itself by opting for providing the company with an agreement for an extended payment period, thereby assuring repayment (as seen in the case of IL&FS).

An influx of investment activities is expected in 2019, which will majorly centre on acquisition of stressed assets by corporates. With the foreseen future of the approval of the ArcelorMittal’s acquisition of Essar Steel by NCLT and many corporate debtors admitted by NCLT for liquidation, the Indian market will be a lucrative playing field for investors, both Indian and foreign.

In particular, asset reconstruction companies (ARC’s), alternate investment funds (AIF’s) and consortiums are expected to explore various restructuring in relation to stressed assets.

The article is co-written by Ashish Parwani, Partner, Rajani Associates & Gargi Panwar, Senior Associate, Rajani Associates.