Thankfully, 2020 is behind us. Vaccines are rolling out, and, hopefully we will soon be back on track to the ‘old normal’. Undoubtedly, 2020 will go down in the annals of history as the one of the most gruesome times for the humanity. The current business climate will inevitably lead to businesses being forced to make the difficult choice to seek protection under the bankruptcy code in the U.S. and India. Also, created opportunities for global investors to invest in the distressed asset market both in the U.S. & India.
Distressed Mergers and Acquisitions, acquiring Businesses and Assets under Indian Insolvency and Bankruptcy Code 2016:
The Insolvency and Bankruptcy Code, 2016 (‘IBC’) jump started the distressed asset market in India, and despite there being a moratorium on bringing fresh cases under the IBC until March 31, 2021, the investors in the distressed asset space haven’t shied away but have shown vigour to execute deals in India.
For instance, even in these challenging times, the Singapore-based DBS Group Holdings stepped in to bail out Lakshmi Vilas Bank, which was struggling with a massive bad loan problem. Similarly, several global investors are in the fray to take over the fraud-hit non-banking financial services (‘NBFC’) firm Dewan Housing Finance (‘DHFL’), which has been grappling with insolvency since November 2019. This trend had started picking up even before COVID-19. Notably, in March 2020 the Hong Kong based SSG Capital acquired a defaulting NBFC named Altico Capital.
When the pandemic came into full swing and its ravaging effects became apparent, the Reserve Bank of India acted swiftly to put a moratorium on loan repayment by various borrowers until August 31, 2020. The Hon’ble Supreme Court India further ordered restrictions on declaration of loan accounts as non-performing assets (‘NPA’) until its further orders. As a result, as of January 2021 various borrowers’ accounts are neither under moratorium nor do lenders have recourse for non-payments until the apex court order is stayed. However, both restrictions will end soon. The moratorium on repayment of loans which was extended by the Supreme Court should end soon, as the Supreme Court may deliver its verdict anytime now, and the moratorium on the IBC will expire on March 31, 2021.
As much as the economy is showing some green shoots, there will be some pockets of the economy which will find stressful challenges on their path to full recovery. And, if it pans out in this fashion, then there will be opportunities in the Indian distressed asset market which has matured since the advent of the IBC.
India has its own challenges due to the regulatory regime and government control in many sectors. Tax considerations on overseas acquisition of stressed assets often require highly structured mode of funding and operation. Despite these challenges, the distressed assets segment continues to remain an attractive asset class.
Here is a quick peek at the India’s distressed asset market in 2020 and the way forward in 2021:
Key Sectors Under Stress
A special committee appointed by the central bank of India (K.V. Kamath Committee) identified the sectors under the most stress caused due by the pandemic. These sectors, which are the key pillars for the Indian economy, are infrastructure, power, textile, steel, telecom and real estate.
Substantial Supply Of Distressed Assets
As of October 2020, India’s distressed asset market is comprised of assets worth $115 billion. With Indian lenders facing capital constraints and increased scrutiny by the central bank on asset quality, there is a strong need to shore the capital structure of the lenders.
Nbfcs Under Stress
- With some of the marquee names such as IL&FS, DHFL, and Reliance Home and Commercial Finance having defaulted due to asset-liability mismatch triggered by taking on excessive risk of short-term financing for long-term project loans, which resulted in heavy stress build-up.
During the resolution process of any distressed asset, interim financing is always much needed oxygen that can infuse fresh lease of life in a distressed asset. To this end, amendment to the IBC to provide super ranking for interim financing has paved the way to revive many restructuring objectives, and allow the execution of a successful turnaround plan.
Regulatory Transparency And Pro-active Government Support
With the implementation of the IBC, the Indian government has made the arduous effort to transform India’s distressed assets market and achieve resolution for any distressed asset within a defined timeframe. Along with this, other modes of restructuring such as one-time settlements and out-of-court settlements have also revved up the resolution process for the distressed assets.
Among others, there are 3 (three) popular investment vehicles in India that global investors use to trade in the distressed asset market: (a) Alternative Investment Funds (AIFs), (b) Asset Reconstruction Companies (ARCs), and (c) Non-Banking Finance Companies (NBFCs). The decision for choosing a structure largely depends a wide array considerations including tax, regulatory and commercials.
Distressed Mergers and Acquisitions, acquiring Businesses and Assets under the U.S. Bankruptcy Code Section 363 Sale
The current business climate will inevitably lead to businesses being forced to make the difficult choice to seek protection under the bankruptcy code. Unfortunately most businesses either cannot afford the process or have waited too long to address the underlying problems. The result too often is a filing under Chapter 7 (a liquidation), or a Chapter 11 (reorganization) with the intent to sell the business as a going concern rather than attempt to reorganize.
Potential acquirers of businesses in whole or part can find opportunity in this space. However, the landscape is not without its own unique challenges. Below we have highlighted a quick snap shot of challenges, issues and opportunities, that a potential acquirer needs to consider when contemplating pursuing an acquisition via a bankruptcy proceeding in the US
Challenges – Some of the challenges that arise are attributes of the companies that in this position such as:
- Loss of market share
- Constrained resources
- Diminishing cash reserves
- Litigation leading to potential successor liability concerns
- Adversarial creditors
- Diminished workforce
- Dysfunctional Management
While going through the process of Bankruptcy are issues that arise in the due diligence process, a few to address are:
- Valuation challenges
- Speed is critical
- Challenging Financial records
- Developing a go forward plan
- Assessing reputational damage with key vendors and customers
- Employee retention
- Potential creditor litigation
- Acquire key talent or business processes
- Geographic or Market expansion
- Strategic or synergistic product lines
- Expanded customer base
- Discounted value
U.S. Bankruptcy Code Section 363 Sales
A 363 sale, named after the section of the bankruptcy code, provides for a sale of a business within a bankruptcy proceeding. The process calls for a period of marketing and due diligence followed by an auction process which is overseen by the court. In simple terms, section 363 sale is a cash purchase of assets, whereby a buyer may agree to assume some operational liabilities.
The bad news is that the sale is going to have limited reps and warrantees than would be available in a “normal” acquisition. The sale will also be where is-as is.
Executory contracts and unexpired leases can be assigned as part of the process. There are specific rules regarding the need to cure defaults and continued performance under the contract.
The primary benefit of a 363 sale is that the acquirer will be able to obtain the business free and clear of all liens. This is done via court order approving the sale by the court, which eliminates the potential for subsequent fraudulent transfer litigation.
The Role of Stalking Horse Bidder
Prior to filing for protection or shortly thereafter the debtor will typically engage investment bankers to solicit interest. The goal is to identify a “Stalking Horse bidder”. This bidder will negotiate with the debtor to arrive at the terms of the acquisition. The asset purchase agreement and the resulting bidding procedures will be submitted to the court for approval. The entire process will typically occur very early on in the case with the stalking horse bid serving as an initial bid and floor in the eventual auction to be held.
The benefits to the Stalking Horse are many.
- The ability to conduct extended due diligence,
- Influence on the formation of bid procedures
- the bid is the floor against which all other bids will be measured,
- Certain bid protection in the form of break up fees and due diligence reimbursement
- Negotiated Asset Purchase agreement is the base line for all other bidders
- Minimum threshold for topping bids
- Influence on the formation of the sale order from the court including desired protections
Risks however are always present, such as higher bid being offered, or diminution in value of the assets during the bankruptcy proceedings. There is a possibility that the Court’s may not agree with the bid procedures and protection desired, also potential creditor and/or party in interest may object to the Stalking Horse and or related bankruptcy procedures and protection.
Acquisition of a business in a bankruptcy setting can be challenging, however a successful bidder might just be able to acquire assets and attain opportunities not otherwise within their normal reach.