Muddling regulations

Insolvency resolution should not be weakened

A new Securities and Exchange Board of India (Sebi) discussion paper proposes minority shareholders be given the chance to reinvest in companies undergoing corporate insolvency resolution. While this may offer minority shareholders a second chance at wealth creation, it may also interfere with the resolution process by making takeovers less attractive and adding to the already formidable complexity of restructuring. In bankruptcies, minority shareholders suffer losses. There are discounts to the share price and often huge equity dilutions involved in taking over bankrupt firms. The acquirer often ends up with 100 per cent (or near 100 per cent stake) and the value of minority stakes evaporates. The paper states that the regulator believes that a Corporate Insolvency Resolution Plan (CIRP) which leads to “overnight zero value of equity shares” is “not an acceptable process”.

 
Of a total of 5,636 CIRPs, 3,637 have been closed. Of the closed cases, 1,703 have ended in liquidation while 517 have resulted in the approval of the resolution plans. Seventy-five of these were listed companies. The rest of the closed cases have either been disposed of, or settled, or withdrawn. So far, 28 listed companies have ended in liquidation while 52 have been delisted following CIRP approval, and 23 continue to be listed. Another 70 listed companies are at some stage of the CIRP. In cases where the company remains listed, even if there is a significant capital reduction, it must maintain at least 5 per cent public shareholding. The regulator has received many representations from minority shareholders with variations of the following suggestions. The minority shareholders ask Sebi to intervene and allot converted shares, or to find some other means of assigning an appropriate value to minority investors.

 
Hence, the paper proposes minority equity shareholders will be provided an opportunity to acquire equity in the fully diluted capital structure of the resolved entity up to the minimum public shareholding percentage (currently 25 per cent) at the same pricing and on the same terms agreed upon by the entity that is taking over the firm. At the minimum, at least 5 per cent public shareholding should be ensured through an offer to minority shareholders in an equitable manner. The former promoter and family, associate group companies, directors, key management personnel, trusts with the former promoter as beneficiary, and so on will not be allowed to participate in such offers. The offer process to the minority shareholders of the new entity would be tech-enabled to ensure that the speed of resolution is not impacted or compromised. If all this is not possible and delisting has to occur, minority shareholders will be compensated in accordance with the terms of the CIRP offer.

 
This “parachute” does in theory offer a safe landing for minority shareholders and if there’s a recovery in market value after the takeover, they get a second chance at wealth creation. However, this process would also add complexity and additional costs to the CIRP, and this, in itself, may be an impediment to resolution. It is axiomatic that equity investments are high-risk and equity investors should be prepared for losses. In practical terms, implementing this measure may compromise the speed and efficiency of the CIRP, making “zombie bankruptcies” more common. In that case, potentially useful assets would cease to generate returns and that might be a broader concern. The idea of speedy resolution should not be compromised.