[By Damini Chouhan & Vinisha Jain]
The authors are students at the Institute of law, Nirma University.
Background
The Covid-19 pandemic was no less than a catastrophe for economies around the world. In India, insolvency resolution process among other economic activities has suffered a huge setback. The funds invested by the creditors have remained blocked for an entire year and the delay has worsened the stress on ailing companies as they had no recourse to stress resolution during this period. To house these challenges, the government believed that it is the opportune time to introduce the pre-pack regime in India. Pre-packs are a semi-formal agreements that are designed to facilitate the restructuring of a company in a more expeditious way. The Ministry of Corporate Affairs formed the Insolvency Law Committee in May 2020 to prepare the structure of pre-packs suitable for the Indian markets. While discussing the key features of pre-packs the sub-committee of Insolvency Law Committee noted that in most countries under this regime, the promoters and management have ‘the first and exclusive right’ to buy the business of Corporate Debtor (“CD”). The Graham Review[i] was also cited by it which expressed the probability that during economic depressions, the management of the company would be the only willing candidate to buy the CD due to the lack of Resolution Applicants. Hence pre-packs inclines towards the possibility of bringing Management Buyouts (MBOs) in India.
Introduction
Pre Packs can bring a breakthrough change in India’s financial market by paving the way for the much awaited (“MBOs”) transactions. MBOs are the type of acquisitions steered by the current management to acquire the ownership of the company. MBOs have the potential to streamline and revitalize the companies’ competence by unclogging the plethora of opportunities a management can avail of, in the interest of the company. Since, buyouts confer more freedom and control in the hands of management, the decision making process becomes easier. However, the journey of MBOs in India will be full of roadblocks owing to two reasons; First: the negative mind-sets and presumptions, present not only in India, but world-wide that insolvency of a CD takes place due to the failure of its management. Second: the stringent regulatory framework in India makes MBOs a rare event.
Mind-sets and Presumptions
The apprehensions with respect to the management of the CD can be seen in the insolvency regimes of Canada, Australia and Britain. They are structured on the belief that the management of a defaulting company should not be given the responsibility to administer the insolvency process. In their view, the management having driven the CD insolvent obviously lacks the adeptness possessed by the experts and administrators and ‘leaving them in the charge of distressed company would be like leaving the fox in charge of the henhouse”[ii] . Such reservation raises concerns regarding the credibility of the management and rears doubts with respect to its intention in bringing round the distressed company. Despite these fears, America’s insolvency regime is built on the faith that chances of the revitalizing the ailing company are higher when the same management carries out the formal process. Being based on the risk model, their insolvency regime propounds that the current management is more interested in the wealth maximization of the company’s business as they already know the business in and out. An insolvency practitioner on the other hand may be an expert, but his or her interest would be limited to paying out the creditors and keep the company going, even if as an empty shell.
Legal Framework in India
The management ensuing MBOs will have to go through the obstacle laid path floored by the RBI and Companies Act, 2013. Understanding the sensitivity of Indian financial market and status quo of the debt market in India, RBI has placed restrictions on banks, to give funds to the firms against the assets of the target company as it fears that investments in buyouts of ailing companies can put unnecessary strain on overall economy. In addition to the RBI regulations, SEBI (Alternative Investment Funds) Regulations 2012 are also present that regulate evolving sources such as venture capital funds, private equity funds, to keep an eye on them. Furthermore, Section 67 of Companies Act, 2013 bars the public companies to provide any financial assistance to any person for the purpose of buying any shares in the company or its holding company which pushes the management to opt for delisting of the company. Moreover, delisting process is also not hassle-free making the MBOs even more extensive procedure.
Conclusion
The possibility of MBOs through the Pre Packs can be a game changer. Even though, MBOs will not have a red carpet in India but the possibilities cannot be narrowed down to zero. In the current setting where there is a lack of resolution applicants it is prudent to introduce a feasible model of MBOs in India. Thus, the regulatory framework surrounding MBO transactions needs to be eased out if MBOs have to be made a viable option. The scepticism associated with MBOs is not irrational rather it is overly cautious. Since, the insolvency laws in India are continuously evolving and are being considered mature enough to introduce pre-packs it is time to introduce MBOs as well. Further, adding them as a subset of the Pre-Pack regime will also provide MBOs the necessary checks and balances under to prevent any misuse apprehended hitherto. With the advent of MBOs, the developing debt market will get a chance to grow and the distressed companies will be able to revive better in the hands of current management.
[i] Ministry of Corporate Affairs, Report of the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process (October 2020), (January 08, 2021), https://ibbi.gov.in/webfront/notice_alongwith_subcommittee_report_for_public_comments.pdf.
[ii] Gerard Mc Cormack, Control and Corporate Rescue: An Anglo American Evolution, 56, Intnl. & Comp. L. Q. 515, 524 (2007).