Mergers and acquisitions in distressed assets during pandemic

I. INTRODUCTION

The COVID-19 pandemic has drastically altered the economic situation of the entire world. The companies have found the problem difficult to tackle. However, some companies saw this as an opportunity to merge and acquisitions with distressed companies. Distressed mergers and acquisitions are legally covered under the Insolvency and Bankruptcy Code, 2016. However, the government of India had suspended the Insolvency and Bankruptcy Code, 2016, from March 25, 2020, to March 31, 2021. The authors have tried to analyse the impact of the suspension of the Insolvency and Bankruptcy Code, 2016, on distressed mergers and acquisitions. Furthermore, the authors have pointed out three major problems present in implementing the Insolvency and Bankruptcy Code, 2016, in the current situation and the solution to these problems. The COVID-19 pandemic has impacted all the economies of the world. The world GDP growth rate for 2020 plummeted to -3.6% due to the pandemic. The extreme economic challenge faced by the companies because of this pandemic is difficult to tackle. Many companies would not be able to survive this situation. However, some companies have taken advantage of this situation by entering into mergers and acquisitions (“M&A”) with distressed companies. These deals of M&A are unique from the general sales of M&A considering the pandemic. The most challenging part of distressed mergers and acquisitions is confirming the rules while transacting with an insolvent company.

The world had faced an economic crisis in 2008 as well. Even though the financial problems in 2008 were caused by different agents than the agents which caused the 2020 economic crisis, economists predict that the condition of distressed M&A would be similar. The authors believe that the buyers should prepare themselves for a transformation in the mergers and acquisitions domain and grab the opportunity to acquire distressed assets. For this, the buyers must understand the risks and benefits associated with the M&A of a distressed asset.

II. COVID 19 AND DISTRESSED M&A

The risks involved in the M&A of a distressed company is unique from the M&A of a non-distressed company. The buyers, in this case, do not use standard contract clauses like the indemnification clause. Furthermore, the buyers involved in M&A of a distressed asset are better protected under the bankruptcy code regarding unwanted liability.

When the pandemic hit the world, each business responded to the crisis differently, and the M&A was different in the pandemic. No company was prepared to face this crisis. While this remained an issue in the early 2020s, companies no longer need to be afraid of it. The companies can identify suitable opportunities and grab them to grow. They have learnt to deal with the pandemic crisis.

The COVID-19 pandemic has reversed the growth of the Indian economy. As per a report, “The Indian economy contracted by 7.3% in the April-June quarter of this fiscal year”. But such contraction isn’t new in M&A. Not every party is at an equal footing in an M&A. In many cases like that of a distressed M&A, the acquirer has greater authority and autonomy than the other party. The acquirer also has the discretion to get a higher share of profit out of this deal. Distressed transactions in India have been reduced due to an interim ban on “insolvency filings” and “moratorium on interest payments”. Even though these support measures have helped decrease the rate of distressed transactions, they pose a problem since the increased time of support measures would impact the economic recovery of India. Once these measures are removed, the rate of distressed transactions is expected to increase.

III. WHY IBC IS THE PREFERRED CHOICE FOR M&A

The Insolvency and Bankruptcy Code (“IBC”) became operative in India in 2016. Since then, distressed transactions worth $14.3 billion have taken place in India. Investors and acquirers favour this code since they get quality and valuable assets. Many famous distressed deals were made during the operation of this code (2016-2018), which include Fortis Healthcare ($ 1.2 Billion), Bhushan steel ($ 7.4 Billion) etc. These deals have been both direct deals and indirect deals wherein the parent company has become distressed leading to the M&A of that company.

The IBC regime had incentivised buying distressed assets for the buyers. The legitimacy provided by this code to M&A has allowed the investors and acquirers to buy the companies and investments. This regime had also increased the number of mergers, thereby profiting the investors and distressed assets. IBC was brought into force to remove delays in the M&A process. Proceedings under this code have benefitted the distressed company by providing capital to them promptly. Additionally, the Information Memorandum prepared by the Interim Resolution Professional includes information about the asset to make an informed decision.

The IBC was suspended till 25 December 2020; however, the government 22 December 2020 extended the period of suspension by three months. The pandemic has created a massive market of distressed assets, and the rest of IBC at this time poses a problem. With the economic slowdown in the country, it has become difficult for businesses to perform contractual obligations and pay off their debts. Therefore, it is necessary to have a code of procedure like IBC to address the issue at hand.

IV. IMPACT OF THE SUSPENSION OF IBC

After the pandemic, the government of India had postponed fresh proceedings under IBC to curb the infections. New NCLT proceedings were also suspended, and the mode of the hearing was switched to a virtual one. This proved a significant hindrance to the creditor’s realisation and stressed assets. Various experts and scholars have raised their apprehension towards the slow-down of the resolution process due to virtual hearings by NCLAT and NCLT. According to ICRA, there will be a 40% reduction in the amount realised by the investors compared to the fiscal year 2019-2020.

A need for technical members was likewise realised for the virtual proceedings to occur. This has led to companies not recovering due amounts on time without a proper mechanism. This has furthermore reduced the growth rate of IBC. However, this has benefited those businesses and companies who find themselves in a liquidity crisis by supporting them. Therefore, the suspension of IBC has relieved the borrowers, but it has forgotten to take the grievances of the lenders into account amid the pandemic.

A new trend will emerge wherein alternative methods will be used for M&A deals. Companies would be acquired at a lower price irrespective of their prospects, and some businesses would have to sell off their non-core businesses. In the long term, it would lead to a backlog of cases, thereby defeating the very purpose of IBC. The government of India has inserted sections 10(A) and 66(3) by an amendment “Insolvency and Bankruptcy Code, Ordinance, 2020”. Section 66(3) is inserted to protect the director of a “corporate debtor” from any liability arising when the Corporate Insolvency Resolution Process (“CIRP”) gets suspended under section 10(A) of the IBC.

Regulation 40(C) was introduced in Insolvency and Bankruptcy Board of India’s (“IBBI”) rules to provide exemption during the lockdown period. This left many open areas for interpretation regarding the diverse issues at hand. For example – the “out of court” regime applies to only RBI-regulated creditors through contractual agreements. In this case, the court will have a role in making this regime successful, especially when a party refuses to comply with the contract after signing it. The debt recovery tribunal system needs to be strengthened since they have a backlog of cases. Likewise, the ordinance does not give any space to personal guarantors to file for bankruptcy or insolvency.

If a need to liquidate the company arises, the company can choose voluntary liquidation under IBC or the winding-up process under the Companies Act. However, the creditors are excluded from opting for the winding-up process under the Companies Act for the company. Therefore, there is an apprehension that the debtor would mismanage the company, and the creditor would have to incur losses as a result. It would be necessary for the creditors to monitor the debtor’s actions in this case closely.

V. OVERCOMING DIFFICULTIES

There are three difficulties in implementing IBC in the present times. Firstly, during an economic crisis such as these, IBC may be helpful for large firms, but they do not benefit small firms in any manner. The government of India has increased the limit to become bankrupt from Rs 1 lakh to Rs 1 crore. This initiative by the government can reduce the number of small firms coming under the ambit of the code. However, many businesses in India are unincorporated partnership firms and sole proprietorships. These can fall under the purview of this code.

Secondly, there is a difficulty in interim financing and recapitalisation of the firm. Under the IBC, temporary funding has been prioritised in the liquidation waterfall. If a firm gets liquidated, then interim finance is provided by the government on a super-priority basis. If a firm receives restructured, then the government will give a loan which could be repaid at a later point in time. It is also to be noted that if a promoter can restructure its business, it should be ensured that the law does not prove an obstacle.

Thirdly, the judicial incapacity poses a great difficulty in implementing the IBC properly. The judicial inability to handle the cases efficiently is a significant concern. This problem can be addressed in two ways. Firstly, the government must conduct a study to understand which delays the overall process. The government should then redress this problem as quickly as possible. Secondly, the government could lower the chances of litigation by developing a framework, especially in those situations wherein there are pre-negotiated agreements between the debtor and the creditor.

VI. CONCLUSION

Distressed M&As are not a new phenomenon in the Indian economy. COVID-19 has reduced human and business resources, leading to a world economic crisis. This has increased the workload of distressed M&A, which is an excellent opportunity for domestic and international investors. Keeping the circumstances into account, there is a need to enact laws and regulations specifically for a smooth switch to a post-covid era. The government needs to consider the present abruptions and determine the feasibility of the current rules and regulations governing distressed M&A transactions.

The IBC has existed for four years now, and we are facing a “Health Crises vs Financial Crises and Livelihood vs Life” situation. We need to understand the importance of enterprises. Furthermore, given the economic situation we are facing, distressed M&A deals have become an essential consideration for the country. The amendment by the government of India is the right step to attain the goal of resolution by removing ambiguities in reigning the M&A deals.

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