Open offer pain

New norms may lead to fewer players in bankruptcy resolution

The Securities and Exchange Board of India (Sebi) has tightened the norms for open offer exemptions in cases of debt restructuring. Only lenders such as banks and financial institutions will receive exemptions from open offers when taking over a company under the Insolvency and Bankruptcy Code (IBC). This is aimed at giving minority shareholders a fair deal in takeovers. But it could also cause some impediment to the process of disposing of bankruptcy cases since it raises costs for asset reconstruction companies (ARCs), or “white knights”. Under normal circumstances, the Sebi Takeover Code demands that when an entity acquires 25 per cent of the equity of a listed company, it makes an open offer for a further 26 per cent of equity. This provision allows minority shareholders to exit if they so choose, and, in practice, an open offer usually leads to a rise in the share price, which is beneficial for minority shareholders. An open offer may raise the cost of debt recovery considerably for lenders in bankruptcy cases and, therefore, Sebi has offered an exemption in such cases. In bankruptcy situations, it is a common strategy for lenders to convert some portion of the debt into equity. If the equity holding exceeds the 25 per cent threshold, it could trigger the open offer mechanism without the exemption.

The earlier norms allowed for wide-ranging exemptions from the obligations of making open offers in bankruptcy cases. The new norms will allow lenders to convert unpaid debts into equity in the hope of recovering their dues if the company turns around. But this exemption will no longer apply to non-lenders and it will apply only in IBC cases that have come to court and not in cases of corporate debt restructuring, where lenders have worked out a deal. It is also common for existing shareholders other than the promoter to act as white knights by investing in a stressed business in return for higher equity stakes. In a case like the proposed Jet Airways bailout, lenders such as the State Bank of India-led consortium may receive exemptions if Jet Airways comes to the IBC. But white knights like Etihad will not receive exemptions. This could scuttle the bailout.

An enforced open offer could raise the cost of debt reconstructing considerably in many cases. It could, therefore, make the entire business of asset reconstruction unviable. ARCs can play major roles in resolving bankruptcies. ARCs may buy debt from the lenders at a deep discount and look to convert that into equity. Or, they may seek to buy equity directly. Any ARC must now reckon on the cost of a potential open offer and this could mean the exit of many ARC players.

As such, while the tightening of the open offer code may, in theory, be beneficial to minority shareholders, it could, in practice, mean fewer players in the bankruptcy resolution space. That would imply fewer resolutions and slower movements for IBC cases. It also casts a cloud over the concept of debt restructuring outside the ambit of the IBC since those bailouts would trigger the open offer provisions.