Investment Banking

Investing in distress – A gold mine or land mine?

June 2019

Read Time: 6 minutes

Today most of the discussion revolving around the Insolvency & Bankruptcy (I&BC) law is from lenders perspective – how to maximize recovery for lenders in a timebound manner. But what has been missed out in the conversation is the investors perspective – what are investors seeking from the I&BC? This is important since only by increasing investor interest will competitive intensity in bidding increase - resulting in more recovery to lenders. Our experience in working with some of these investors (both financial & strategic) to acquire these assets has given us a good understanding of investors’ appetite. Some of this may shed light as to why there aren’t many PE firms participating in the I&BC compared to global standards and what can be done to change this.

Blindsided In The Game

It is understandable that any new investor will tread with extra caution while investing in distress situations, since they are throwing good money over bad money. Prior to parting money, what investors seek is maximum clarity regarding the asset. In most process that we have seen, the data provided during the stage of diligence is seen to be severely lacking or outdated. The reasons are many – high employee attrition in distress firm implies that key knowledge pools are lost, non-cooperation of promoter/key managerial personnel, etc. At the same time, the Resolution Professional (RP) too is not aware of many details since they have recently been associated with the company. In such a situation, an investor is at times required to asses a company with little or no information, resulting in low bids. It is here that we see strategic investors being able to take a better call on the risks associated compared to financial investors. 

A key step to mitigate this problem is for lenders to appoint capable Resolution Professionals with a strong team to back them up; who would be able to provide more clarity to investors. This should translate to better bids and more recovery to lenders.

Uncertainty In Rules Of The Game

In some of the cases, we have seen the bidding rules and deadlines change constantly due to several reasons. Bidders who have not ascribed to initial Expressions of Interest (EoI) have been able to enter the process at a later stage and submit a bid. Many times, price discovery was done under IBC, only for a outside/losing bidder to step in and submit a higher bid.  It should be noted that investors spend considerable time, money and effort in evaluating an asset and submitting a bid. If there is no reasonable certainty in acquiring the asset even after submitting the highest bid, it may dissuade them from participating in future bids.

Lenders should ideally reject all bids that deviate from the stated process. By trying to maximize recovery in one or two bids, they will lose out on the longer run. These deviations in the process will also lead to more litigation and delays. This does not augur well for both the investors or lenders.

Fairness In The Game

The law stipulates that only the financial creditors have a say in approving the resolution plan. They are supposed to look after the interest of all stakeholders. However, in our interaction we have seen that the lenders seek to maximize their own recovery at the cost of other creditors (such as operational creditors). Many fail to realize that going forward, the company will have to work with these creditors to run their business. This is detrimental to the lender too, since many a times their repayment is tied to the future performance of the company. We are already observing a key fallout of this - many operational creditors are appealing against approved resolution plan in the NCLT resulting in delays. 

The incoming investor must carefully draft a resolution plan which meets the requirement of all these stakeholders without antagonizing any of them. 

Time-out In The Game

Post approval from lenders, the plan needs to be approved by the NCLT. Due to large backlog of cases in the court, we have seen delays ranging from more than a month or two. The delay in approval increases if there are multiple petitioners (such as dissenting lenders, operational creditors, employees etc.) In many cases delay in resolution, can result in severe impact to ongoing projects of the company. The erosion in value of the distress asset in most cases increases exponentially with time. This is worrisome to the winning bidder who would like to implement the resolution plan as early as possible and prevent any value destruction.

To reduce the delay in the process, the government must actively look at setting up more benches of the NCLT. Since NCLT’s handle variety of cases from IBC to companies act, and are therefore overburdened, the government must consider setting up Bankruptcy courts which focus solely on IBC.

Winning The Game

To most investors the above may seem as a no-go. However sophisticated investors will be aware that the above issues can either be solved or accounted for in the resolution plan. Today, we are witnessing a once in a lifetime fire-sale of assets in India. What makes it exciting is that certain strategic assets can be acquired at a deep discount to its replacement value. Assets that have limited operational issues and are only financial distressed can make for a good acquisition.

The key benefit of the IBC, which outweighs all its current drawbacks, is that all the liabilities of the debtor can be crystallized and solved for in a single process. An investor can acquire an asset in a clean manner with limited or no liabilities. What has been encouraging in the meantime is that the government is actively taking steps to modify and solve the teething issues being faced by this nascent law. No other law in India, has seen this many ordinances & clarifications in such a short period of time. We expect and welcome more of these changes – as long as they simplify the process and remove any uncertainties or delays. Should this happen, we expect more investors to take part in this process – resulting in better recovery for the banks. All in all, we believe this opportunity is a goldmine for investors looking to acquire assets at deep value.

Author: Prateek Jhawar, Director and Head, Infrastructure & Real Assets, Avendus Capital and Adarsh Appaiah, Associate, Infrastructure and Real Assets, Avendus Capital

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