[By Devansh Dixit & Abhimanyu Pathania]
The authors are students of Gujarat National Law University.
Introduction
The insolvency regime prioritizes the interests of creditors and hence, the interest of minority shareholders of an entity undergoing CIRP remains largely ignored. They occupy the lowest position in the ‘distribution waterfall’. They don’t have any representation in the CoC. The minority shareholders of DHFL and Sintex Industries suffered huge losses when the resolution plans suggesting for the delisting of the entities were approved by the NCLT and they were left with no recourse.
SEBI recently issued a consultation paper on safeguarding the interests of public equity shareholders in listed companies undergoing CIRP under the IBC. This article aims to critically analyse the consultation paper and its potential impact on the protection of public equity shareholders if the suggested framework is implemented.
The current legal framework
As highlighted above, the IBC hardly has any provision for protecting the minority shareholders. Through precedents like Jaypee Kensington Boulevard Apartments Welfare Association v. NBCC and Keshav Agrawal v. Abhijit Guhathakurta, it has been laid down that minority shareholders cannot raise objections against a Resolution Plan (RP) approved by the CoC.
The IBC coupled with several regulations further adds to the distress of the public shareholders. Regulation 3(2) of the SEBI Delisting Regulations provides exemption delisting carried out in accordance with a resolution plan approved under IBC if such plan provides for “exit opportunity to the existing public shareholders at a specified price”. Hence, the public shareholders are denied a fair bargain by providing an exit opportunity at a market-determined price and are instead left at the mercy of the Resolution Applicant (RA). The provision that existing public shareholders be given exit opportunity at a price which equal to or more than what is offered to the promoters is of little help considering that promoter’s equity is often written off, making it highly unlikely that public shareholders will receive any value. Further, in insolvent liquidations, there is no liquidation value attributable to equity-holders.
Another amendment in the Securities Contracts (Regulation) Rules, 1957 (SCRR) in 2021 mandated a minimum of 5% public shareholding for an entity to remain listed post-CIRP. Such a mandate disincentivises the new entity post-CIRP to be listed and hence, they go for delisting which again is against the interest of minority shareholders.
Therefore, once a RP is approved for a listed company, the possible scenarios are:
Liquidation of the company in which case they get virtually nothing;
Continuation of the company with or without listing, based on the resolution plan which largely results in dissolution of shares again squeezing out the shareholders.
In both the scenarios, the existing public equity shareholders get squeezed out and usually end up with almost nothing.
Need for protection of minority shareholders
One could argue that the treatment of such shareholders is justified if they chose to remain interested in the company even when the company had reached at that stage. While this reasoning is not misplaced, it is also important to consider that the shareholders are often misled hoping that they might end up getting a better deal.
The minority shareholders argue that they don’t have much say when equity owners run down the company. Further, most of such minority shareholders are retail or small shareholders who don’t possess the awareness and the level of information to make a timely decision.
Another concern is that the CIRP can be triggered on a mere default and the company need not be balance sheet insolvent. Data shows that as of June 30, 2022, 517 companies were resolved by resolution plans and in 56 cases, FCs realized at least 10% of their claims. Hence, there is a realistic possibility that some of these companies may have residual value in its equity yet in many cases it is wiped out in the resolution plan.
The SEBI consultation Paper
Addressing the concern of the minority shareholders, SEBI came out with a framework for protection of interest of public equity shareholders in case of listed companies undergoing CIRP. The key recommendations are as follows:
Opportunity for Public Equity Shareholders: Public shareholders will have the opportunity to acquire equity in the new entity that is formed post CIRP. Promoter and promoter group, KMPs etc. would be excluded while identifying such public equity shareholders.
Minimum and Maximum limit: The acquisition of equity by public shareholders will be minimum 5% and a maximum of 25% of the capital structure. The pricing terms for this acquisition will be the same as those agreed upon by the resolution applicant.
Mandatory Delisting on failure to achieve minimum Shareholding: For the company to continue as a listed entity, at least 5% of the fully diluted capital structure must be held by public shareholders. If the resolution applicant fails to achieve the 5% public shareholding, the company will be delisted, and the consideration received from public equity shareholders will be refunded.
Exemptions from Delisting Regulations: The recommendation also states that exemptions from Delisting Regulations will be applicable only in cases of liquidation or if the public equity shareholding remains below 5% of the new entity after the offer.
SEBI’s Proposal: A measure for protection or an instance of myopia?
- Should IBC protect the minority shareholders?
The IBC was designed to promote entrepreneurship, improve credit access, and strike a balance between the interests of all stakeholders while maximising the value of a company under insolvency. It identifies two main sets of stakeholders: shareholders and the creditors and hence, endeavours to balance their rights.
The Bankruptcy Law Reforms Committee in its first report, observed,
“The limited liability company is a contract between equity and debt. As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run. When default takes place, control is supposed to transfer to the creditors; equity owners have no say.”
The problem with the suggested framework is that it assumes that the minority shareholders must be given any protection in such cases. Shareholders’ interest can’t be prioritized over the creditors as it is against the very scheme of the IBC. The IBC aims maximum efficient recovery and is not the appropriate mechanism for investor protection, which will indirectly dilute the core statutory intent. Even if it is agreed that IBC shall safeguard the interest of the shareholders, the responsibility of developing a framework lies with the IBBI rather than SEBI.
- Interest of a Resolution Applicant
The framework proposed by the SEBI proposes shareholder protection but that protection again, comes with a cost. Looking at the proposed process from a RA’s perspective, the proposal is not at all fair. Since the RA takes incredible risk by acquiring such an entity, they would want operational autonomy with least amount of non-promoter stakeholder influence and friction. Further, they would want some breather from the stringent SEBI (LODR) Regulations, at least for a few years. However, as per the proposed framework an RA now has to offer shares to public shareholders at the same cost, while assuming all the risk. Furthermore, from what the framework proposes, it can also be concluded that in case the RA meets the 5% public shareholding threshold post the public offer (which is mandatory), and if it wants to delist the new entity, the SEBI Delisting Regulations need to be complied with practically forcing them to remain listed. All this will discourage potential RAs to participate in the bidding. When comparing the position of the existing shareholders and an RA in a post-CIRP scenario, RA is the one assuming debt in the new entity and hence, it will be unfair to provide protection to shareholders at the cost of the interest of RA.
- Will this provide any actual protection?
SEBI has proposed this framework for providing “protection to the existing public equity shareholders” of a company undergoing insolvency resolution process. However, this mechanism hardly provides any protection to such shareholders. The framework only gives an opportunity to the existing shareholders to remain invested in the entity. Just holding equity does not guarantee any return on their earlier investment. Further, the new equity to be offered will be against the new value. In such a scenario, it is too ambitious to think that such a public shareholder would want to invest additional money in the firm at this stage because by this time, all they are looking for, is a better exit option.
- Increasing inefficiency
As a result of a scenario stipulated above, there are chances that bidder may not receive the necessary public shares from the offer. It is very realistic because even financially stable companies sometimes find it difficult to satisfy Minimum Public Shareholdings criteria. Hence, a RA might not receive the expected/ necessary public shares from the process. This will create difficulty for the RA in calculating the exact amount of capital needed because it will depend upon the proportionate acceptance of the public offer. Usually, the CoC requires that the amount shall be available as soon as possible but the proposed mandatory public offer, will stall the process. This will affect the overall efficiency of the insolvency resolution process.
Conclusion
As highlighted, the proposed framework suffers from major flaws and won’t solve the problem in the long-term.
The CoC can be mandated to consider the appointment of a representative on behalf of minority equity shareholders to present their case. The CoC would then have the discretion to accept or reject this proposition. While this proposal may not be the ultimate solution, it addresses a significant concern of minority equity shareholders and serves as a starting point for further discussion and potential resolution. Further, rather than mandating the public listing of every company leading to a deadlock, the framework proposed should be made obligatory only for those companies, in which the resolution applicant in consonance with the plan wishes to keep the entity listed.
Finally, it is important to recognize that while both equity and debt play a major role in business, they deal with completely different transactions and hence, shall operate independently in their respective fields. Regulator’s interference in these processes might create conflicting situations and overcomplicate the established practices. The regulators should not intervene where the intervention is not required. A better step to protect the interests of the minority shareholders would be to evolve a parallel structure for developing a more transparent disclosure regime while focusing on investor education.