Treatment Of Non-Promoter Public Shareholders Under IBC

Where a listed company is undergoing corporate insolvency resolution process, the resolution plan resolving the insolvency of the corporate debtor may envisage either the continuance of the corporate debtor as a listed company or propose to delist the equity shares of the company from the stock exchanges. The decision on whether to continue the corporate debtor as a listed entity is solely the prerogative of the resolution applicant under the Insolvency and Bankruptcy Code, 2016 ("IBC") and is driven by multiple post-restructuring considerations including inter alia desire of the resolution applicant for: (i) free transferability of or liquidity in dealing with securities; (ii) tight-knit shareholding structure for the exercise of greater control; (iii) further avenues for fundraising; and (iv) easing the compliance burden on the restructured entity.

The decision to delist the corporate debtor or continue it as a listed company also has an impact on the capital restructuring of the corporate debtor pursuant to the resolution plan. For instance, usual practice dictates that where the corporate debtor is proposed to be continued as a listed company, a resolution applicant provides for a selective and partial capital reduction such that the existing promoter shareholding stands completely extinguished whereas the existing public shareholding is proportionately reduced to meet the minimum public shareholding requirements described below. However, where the corporate debtor is proposed to be delisted, the usual practise is to extinguish the entire existing share capital of the corporate debtor.

Current legal framework

The IBC currently provides complete flexibility to the resolution applicant to decide the way the corporate debtor is to be revived under its resolution plan. In this regard, Regulation 37 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 ("CIRP Regulations") specifically recognizes that a resolution plan may provide for any measures necessary for insolvency resolution of the corporate debtor for maximization of value of its assets, including "(ca) cancellation or delisting of any shares of the corporate debtor, if applicable".

Continuing the corporate debtor as a listed company post implementation of resolution plan.

If the corporate debtor is proposed to be continued as a listed entity under the resolution plan, the resolution applicant needs to comply with certain continuous listing requirements prescribed under Regulation 19A of the Securities Contracts (Regulation) Rules, 1957. Ordinarily, a listed company is required to maintain a minimum public shareholding of 25% and if the public shareholding drops below 25%, the listed company is required to restore the minimum public shareholding of 25% within a period of 12 (twelve) months from the fall of such percentage to continue as a listed company.

However, by way of an amendment in 2018 (which was further amended in 2021), Regulation 19A(5) provided a relaxation to listed companies who have undergone the implementation of a resolution plan under IBC. In terms thereof, a listed company which has undergone the implementation of the resolution plan approved under Section 31 of the IBC is required to maintain a minimum public shareholding of 5%, provided that the public shareholding shall be brought up to 25% within a period of 3 (three) years from the date of implementation of resolution plan. Further, during this period of 3 (three) years, if the public shareholding falls below 10%, the same is required to be brought up to 10% within a period of 12 (twelves) months from the date of such fall.

Delisting the corporate debtor pursuant to the resolution plan.

As is clear from Regulation 37 of the CIRP Regulations, the resolution applicant is free to delist a listed corporate debtor pursuant to its resolution plan. The extant framework regarding delisting of a listed company is provided under SEBI (Delisting of Equity Shares) Regulations, 2021 ("Delisting Regulations"). Regulation 3 of the Delisting Regulations, while laying down the scope and applicability of the Delisting Regulations, clarifies that its provisions do not apply to delisting undertaken pursuant to a resolution plan approved under Section 31 of IBC, provided however that (i) the resolution plan provides for an exit opportunity to the existing public shareholders at a specified price, which must not be less than the price at which another shareholder is either directly or indirectly provided an exit opportunity; and (ii) the details of delisting along with the justification for the exit price is disclosed to the stock exchange(s) within one day of approval of the resolution plan under Section 31 of the IBC.

In a usual insolvency situation, the value of assets of the corporate debtor and therefore, the inherent value of the corporate debtor as identified by the resolution applicant in its resolution plan is lesser than the overall liabilities/debt levels of the corporate debtor. In such scenarios, since the resolution amount is insufficient to repay the corporate debtor's debts in full, there is no value in equity, which is entirely written down and extinguished. Since public shareholders are still getting value equivalent to the exit price offered to other shareholders, albeit zero, the condition for delisting under the Delisting Regulations stands satisfied.

SEBI Consultation Paper on 'Framework for protection of interest of public equity shareholders in case of listed companies undergoing CIRP under IBC'

Background

The low/zero pay-outs for the public shareholders in terms of the resolution plans approved under IBC caught the eye of the SEBI. In view of the SEBI's mandate to protect the public shareholders as evident from the Preamble of the SEBI Act, 1992, which defines the legislation as "An Act to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto", SEBI took immediate cognizance of this issue and proposed certain changes in the framework governing listed companies undergoing insolvency under IBC.

At the outset, the SEBI recognized the overall objectives of the insolvency law and the paramount rights of creditors over equity shareholders in the event of insolvency. It analysed how equity shareholders, being invested in risk capital, occupy the last position in the waterfall mechanisms prescribed in insolvency or liquidation scenarios. Thereafter, it went on to highlight the scale of problem through numbers by stating that around 75 listed companies have undergone approval of resolution plan until June 2022, with only 23 companies continuing to stay listed post CIRP and 52 companies getting delisted pursuant to the approval of the resolution plan under Section 31 of IBC and about 70 companies were currently undergoing CIRP.

Relying upon the numerous references and grievances received by the SEBI, the Consultation Paper goes on to state a brief list of issues highlighted by complainants:

(i) SEBI should ensure that small stakeholders get appropriate value of their shareholding since big players were acquiring shareholding of the corporate debtors at throwaway prices and the retail shareholders received little to no value against their shareholding.

(ii) SEBI should ensure that retail shareholders are allotted some converted shares of the new entity post resolution.

(iii) SEBI should look for a workable solution for retail shareholders since the current process leads to overnight zero value of the equity shares of the corporate debtor that undergo delisting pursuant to resolution plan, without any prior intimation to them.

SEBI's Proposal

In the background and with the objectives highlighted above, the SEBI recommended the following changes to the current framework:

(i) The existing non-promoter public shareholders of the corporate debtor should be provided an opportunity to acquire up to the minimum public shareholding percentage (currently 25%) of the fully diluted equity shareholding of the new entity post-resolution under IBC, at the same pricing terms as the resolution applicant.

(ii) To continue as a listed company, the new entity post-resolution under IBC must mandatorily achieve at least 5% public shareholding through such offer made to non-promoter public shareholders. If the company is unable to muster 5% non-promoter public shareholding after such offer, the company shall have to go for delisting.

(iii) The exemption granted under Regulation 3 of the Delisting Regulations shall be diluted and only apply where: (a) the corporate debtor goes into liquidation; or (b) where the offer of minimum public shareholding to non-promoter public shareholders on the same pricing terms as the resolution applicant fails to achieve 5% non-promoter public shareholding in the new entity on a fully diluted basis.

In the opinion of SEBI, the above proposal would have the merit of: (i) the corporate debtor being able to retain its status as listed company with minimum public float; (ii) burden on the resolution applicant to arrange complete capital under resolution plan would stand reduced and resolution applicants would have additional avenues to raise funds; (iii) existing public shareholders will have the opportunity to participate in the new resolved entity, at the same cost as the resolution applicant.

Critique of the proposal envisaged in the Consultation Paper

SEBI, while noting the objectives sought to be achieved by insolvency law, has taken little regard of its provisions in the ultimate framework proposed by it. While the Consultation Paper clearly lays down the merits of the proposal in the opinion of SEBI, it conveniently fails to consider the larger demerits which plague the framework.

Debt trumps equity

In an insolvency scenario, the corporate debtor may often be required to be shielded from its management. Even in the twilight period prior to initiation of insolvency when the insolvency of the corporate debtor seems imminent, the board of directors is required to be act in a manner that protects the interests of creditors rather than the shareholders. IBC, as a law, was envisaged to legislate this core principle through the creditor-in-control regime as against the already prevailing debtor-in-possession regimes under multitude of recovery laws present in India earlier. This is further elaborated through the following illustration provided in the Report of the Bankruptcy Law Reforms Committee: Volume I: Rationale and Design, November 2015.

"Consider a risky business venture which is financed using Rs.50 of equity and Rs.50 of debt. Once the project is built out, it proves to have a net present value, or NPV, of future cash flows of Rs.40 only. A sound bankruptcy process would work as follows. The equity value of the enterprise would be wiped out and the existing shareholders would lose control. If a new equity investor can be found who is willing to pay Rs.40, this could be paid to the debt investors. At Rs.40, they would face a relatively small loss of Rs.10 and get an 80% recovery rate. The new equity shareholder would get a debt-free enterprise with an NPV of future cash flows worth Rs.40."

Hence, it is imperative that an effective and fair insolvency process provide for the rights of creditors to trump over the rights of shareholders (whether public or otherwise) where the capital risk is allocated from the creditors to the equity shareholders. In fact, this is also recognized by SEBI in its Consultation Paper while referring to equity as 'risk capital'. This also factors in the fundamental principle that the shareholders responsible for running the enterprise and utilizing creditors' monies to generate revenue should be held accountable and not be unjustly enriched at the cost of such creditors when the enterprise turns non-profitable and goes into insolvency situation. Thus, unless the debt obligations of the corporate debtor are fully repaid and satisfied, it is fundamental to the economics of risk allocation under insolvency law that the equity value be allowed to be entirely written down, unless otherwise proposed by the resolution applicant. The UNCITRAL Legislative Guide on Insolvency Law, 2005 categorically recognizes this paramount status of debt claims over equity and ownership interests in insolvency scenario:

"Owners and equity holders may have claims arising from loans extended to the debtor and claims arising from their equity or ownership interest in the debtor. Many insolvency laws distinguish between these different claims. With respect to claims arising from equity interests, many insolvency laws adopt the general rule that the owners and equity holders of the business are not entitled to a distribution of the proceeds of assets until all other claims that are senior in priority have been fully repaid (including claims of interest accruing after commencement). As such, these parties will rarely receive any distribution in respect of their interest in the debtor."

Resolution Applicants must have complete flexibility on commercial aspects of resolution plan

The IBC provides complete flexibility to the resolution applicant and the committee of creditors to negotiate on a feasible and viable resolution plan, which ensure the revival of the corporate debtor and puts it back on to its feet. This mandate of the IBC is explicitly recognized in the definition of resolution plan under Section 5(26) of IBC and Regulation 37 of the CIRP Regulations, which allow a resolution applicant to propose any such measures in its resolution plan as may be necessary for insolvency resolution of the corporate debtor. In fact, the purpose behind introduction of exemption from the rigors of Delisting Regulations and continuous listing requirements of mandatory minimum public shareholding for entities undergoing insolvency resolution was to ensure that the resolution applicant can freely propose the best-suited of the two options under its resolution plan from the perspective of post-resolution business and turnaround strategy.

By disallowing delisting of a corporate debtor without consideration of an option to continue as a listed entity post-resolution through an opportunity to public shareholders to acquire equity of the new entity post-resolution, the Consultation Paper indirectly allows the public shareholders the right to decide whether a company would be delisted or continue to stay listed post-resolution under IBC. This effectively creates an obstacle for a resolution applicant proposing a turnaround strategy for a corporate debtor, against the fundamental principle of the IBC, which allows complete flexibility to the resolution applicant to resolve the insolvency of the corporate debtor.

Impracticality of public shareholders acquiring the equity at same cost as resolution applicant

Upon initiation of insolvency of the corporate debtor, the equity value of the corporate debtor is most often equivalent to nil. As a commercial bargain, the resolution applicant proposing the revival and turnaround strategy of the corporate debtor, or any other financial investor coming along with the resolution applicant, takes an immense risk by infusing capital in a failed business with the expectation of proportionate reward in terms of gains from increase in the value of the equity of the corporate debtor post implementation of its turnaround strategy. The Consultation Paper effectively seeks provision of a huge percentage of equity (25%) to public shareholders at a price equivalent to the price at which the resolution applicant acquires the equity of the corporate debtor. While the value at which the resolution applicant acquires the equity shareholding may be nominal, however, the commitment for the resolution of the debt of corporate debtor and subsequent capital infusion for improving the business operations are huge. To equate the nominal value for acquiring equity with the actual value committed by the resolution applicant is erroneous. Therefore, mandating the issuance of equity to the existing public shareholders at the same price as resolution applicant is devoid of merit and not only undermines the statutory ranking enshrined under Section 53 of IBC but also allows disproportionate benefits to the public shareholders. It disincentivizes the resolution applicants, causing a major problem to the framework for insolvency resolution under IBC.

Conclusion

SEBI has proposed the Consultation Paper keeping in mind its regulatory objectives and functions under the SEBI Act, 1992 including inter alia the protection of public/retail shareholders. However, since the framework proposed under the Consultation Paper effects insolvency resolution under IBC, any suggestions to legislate such framework must consider appropriate feedback and suggestions of stakeholders not only involved in the insolvency process (investors, creditors, etc) but those involved in the institutional development of insolvency law in the country, especially the IBBI being the regulator for insolvency in India. The solution of multi-faceted problems cannot be achieved by unilateral changes proposed without adequate consultation at all levels - thus, the SEBI must reconsider the proposal laid down under the Consultation Paper and ensure that it also takes into the account the key principles of insolvency law and the objectives sought to be achieved through them.

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