The Insolvency and Bankruptcy Code, 2016, is a landmark legislation that shifted the balance of power in favour of creditors in India and, as envisaged, kick-started the process of making NPAs productive again. An area where the IBC is expected to deliver better results (and help drive better Ease of Doing Business ranking) is the ‘recovery rate’ criteria. The average recovery for financial creditors for 52 successfully resolved cases (as per IBBI’s quarterly publication ended September 2018) is around 45%. However, the recovery rate drops to 28% if two large steel assets are excluded. Barring a few sought-after assets, recovery is expected to be low for the current lot of NPAs primarily due to vintage, quality and complexity. There are, however, several changes that can be adopted by all resolution stakeholders to improve the resolution value even in a time-bound process like the IBC.
First, it is important to cast a wide net of potential buyers, not only from corporate debtors’ ecosystem, but also HNIs and experienced industry professionals, who can be backed by financial investors. Mere newspaper ads, unsolicited emails and cold calls do not serve the purpose. Marketing pitch has to be customised for each buyer and addressed at senior management/owners. An example of a recent marketing pitch for an agri-commodity business targeted at a strategic investor included the impact on its market share, reduced cost to serve and profitability. A large number of Expressions of Interest in a distressed situation is a confidence booster for stakeholders, including potential buyers.
Second, a big dampener of value in a distressed situation is ‘uncertainty discount’. Creating transparency about the business and good information flow goes a long way in giving comfort to buyers. Having a clean opening balance sheet, monthly financials, periodic operating metrics, and access to manufacturing/warehousing sites and key management help develop confidence about the business and its potential.
Third, at the heart of the process is the business and its operating capability. Most distressed business performance drops significantly leading to lower capacity utilisation, loss of customers, departure of key employees and loss of market share. Buyers try to leverage upon this poor performance to offer low value. In a recent example, the resolution professionals’ (RP) team was able to quickly ramp up production and sales by engaging and building confidence with existing and new customers. This new growth was financed by sale of scrap material (found during an initial physical inventory check), greater focus on recoveries of loans and advances, and further stretching payables. Production costs were lowered through shift rationalisation and improved procurement process. These steps contributed meaningfully to improve recoveries for financial creditors from the originally estimated 30% to over 45%.
The next step is to increase competitive intensity in final stages through sophisticated negotiating tactics. Maintaining an air of confidence that the asset is sought after by multiple serious bidders and controlled sharing of information at this stage can keep all bidders on the edge. There are many approaches to running the sales process (identifying and negotiating with H1 bidder, Swiss auction and outbidding). A combination of the latter two may be considered, where after following few rounds of Swiss auction, a day can be reserved for outbidding to extract last ounce of value. Drafting the process note in a way that gives adequate flexibility to Committee of Creditors and having time on hand helps.
For this to happen, lenders must see the big picture when appointing the RP—whose role is not just about legal compliance with the code, but more about creating value from operations and running a sophisticated sale process. Recently, a bank chose to appoint RPs by running a reverse auction for their services, which is value-destructive.
Lastly, regulators must resolve judicial pronouncements regarding no waiver for past statutory dues, role of operations’ creditors in the resolution process, penalties levied on the corporate debtor for pre-IBC period mistakes, etc. These uncertainties need to be resolved to minimise the discount to potential value recovery for all stakeholders.
Source: Financial Express, December 25, 2018