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The author is Arka Biswas, a fourth year student at Guru Gobind Singh Indraprastha University.
Introduction
As per the report of the International Monetary Fund (IMF), the aims of ‘orderly & effective insolvency procedures’ are - the allocation of risks among the participants in an equitable & transparent manner; and maximising the value to benefit the interested parties.
The Insolvency and Bankruptcy Code (IBC) was implemented to provide a framework for the Corporate Insolvency Resolution Process (CIRP) of distressed companies and ensure that creditors receive a fair distribution of the assets of such companies, and finally facilitate the revival of the company.
However, it is irrefutable that the CIRP mechanism under IBC is primarily meant for the creditors and the rights available to them (at the time of liquidation) are far superior to those available to equity shareholders; because equity shareholders are placed at the last position of the ‘waterfall mechanism’. This causes a lot of grievances, especially in respect of the liquidation of listed companies; and moreover, if we consider the IMF report, it is essential to recognise & protect the interest of both equity and debt instrument holders.
Hence, the Securities and Exchange Board of India (SEBI) published a consultation paper in November 2022 proposing a framework to safeguard the interest of public equity shareholders during the CIRP of a listed company.
SEBI’s strategy to shield the stakeholders
When the creditors take control of the corporate debtor under a resolution plan, the existing shareholders are forcefully ousted from the company because the current CIRP causes substantial stock dilution or even delisting.
To address the issue and protect the interest of the shareholders, SEBI proposed that the non-promoter public shareholders of the corporate debtor shall be given an opportunity to purchase the equity of the new entity up to the MPS (minimum public shareholding) i.e 25% on the same pricing terms as that of the resolution applicant. ‘Public Equity Shareholders’ exclude promoters and promoter group and their family members, trusts managed by promoters, directors and their relatives, key managerial persons, associate and subsidiary companies and a public shareholder nominating a member in the board.
If the new entity formed out of the CIRP process, fails to maintain even at least 5% public & promoters’ combined shareholding, it shall proceed for delisting.
Illustration - In Company A (corporate debtor), the promoters and the public have shareholding of 60% and 40% respectively; and according to the resolution plan, B (resolution applicant) is going to acquire 97% of company A. Now, the old capital has been reduced to 3% and the promoter and public will remain as minority shareholders holding only 1.8% & 1.2% respectively.
To protect the interest of such minority stakeholders, as per SEBI’s proposal B has to offer only to the non-promoter public shareholders a minimum of 22% (because the remaining 3% is already held by minority shareholders - promoters & public combined) share in the newly formed entity after the CIRP of company A. And, at least 2% of it must be accepted by such non-promoter public shareholders to keep the company listed.
This process helps to keep the interested minority shareholders involved in the company post-restructuring and also maintains the status of the company as LISTED even when the public shareholding declines below the MPS.
By providing an opportunity for these shareholders to acquire shares of the company after the CIRP, it ensures that the shareholders are not forced out of the company's future growth and profitability under the new management. Moreover, these existing public shareholders are being offered to purchase shares of the newly formed entity at the same pricing terms at which the acquirer/creditor/resolution applicant (B in the above example) is acquiring.
So, this proposal fulfils its primary objectives pretty well. In addition to the minority stakeholders, it also provides some relief to the acquirer/resolution applicant to some extent. Because he can raise capital from the offerings to existing non-promoter public shareholders; and if the new entity post-CIRP remains a listed company, he can issue further public offerings (FPO).
Gauging the gravity of myopia
Though SEBI undertook a very bold approach through this proposal, it raises some concerns as well.
First of all, it has ignored the heavy dilution of the promoter shareholding. After CIRP, according to the approved resolution plan, an acquirer takes control over the corporate debtor and the old capital gets reduced to dewdrops. Years of hard work, sweat and toil of the promoters vanish in a flash. It may be argued that had the promoters run the company effectively, no question of CIRP would have arisen. But, the situation is not always under their control. Since we are focusing on the interest of non-promoter public shareholders; we shouldn't ignore the promoters’ shareholding. They also deserve a fair and equitable exit. If SEBI is concerned with the interest of public shareholders, it is expected that it may bring similar measures for protecting the interests of promoters as well.
Secondly, during CIRP often the corporate debtor goes through restructuring including mergers, demergers or acquisitions. And according to this proposal, the acquiring company has to ensure public participation even if it doesn't want to do so. There is no clarification about the scenario where the resolution applicant is not willing to keep the corporate debtor listed.
Thirdly, the proposal states that SEBI intends to address the interest of the stakeholders ‘without compromising the speed and efficiency of the CIRP process’. However, it doesn't specify any timeline within which the offering, acceptance and raising of money need to be completed. The Committee of Creditors (COC) cannot wait for an indefinite period of time to comply with this proposed mechanism, and it can adversely affect the speed & efficiency of the CIRP process.
Fourthly, SEBI indicated that such an offer to public shareholders would help the resolution applicant to reduce its financial burden because it has the opportunity to raise funds from the public shareholders. However, it would be too optimistic to assume that public shareholders would be willing to invest further in a stressed company going through CIRP; where even financially stronger companies are often seen struggling to fulfil the MPS criteria. There is a high chance that the applicant/ acquirer would not get the desired acceptance from public shareholders even after making the offer. Thus, it would neither be easy for the acquirer to determine the capital requirements nor to specify a certain percentage of equity allotting to public shareholders in the resolution plan.
And finally, the proposal remains silent on the question of whether such an offer to the public for equity participation will be considered a new issuance of securities or an offer for sale.
Surmounting the setbacks
To overcome the probable setbacks, it must clarify whether such an offer will be considered a new issuance or an offer for sale. It is also vital to understand whether it is to be recognised as a public issue or a preferential allotment in order to determine the relevant compliance requirements and to avoid any interpretational conflicts.
Delisting Regulations may have to be followed when the applicant is not willing to keep the corporate debtor listed. Also, it has to provide a clear timeline to comply with all the requirements in order to maintain the speed and efficiency of the CIRP process.
Overall, instead of such an opportunity to acquire shares after CIRP by further investment; an opportunity to recoup the already invested capital and provide a fair exit option - is likely to be more beneficial and aligned with the interest of public equity shareholders.
Conclusion
It cannot be denied that SEBI has attempted to formulate a framework for the protection of public shareholders of listed companies undergoing CIRP, which is indeed a much-needed and commendable approach. However, practically it would be challenging for the resolution applicant to obtain the desired level of acceptance from the public and to raise funds through such offerings made to public equity shareholders. Rather it would cause unnecessary delay in the CIRP process which can eventually harm all the stakeholders.
Hence it would be more appropriate for the regulating bodies of IBC like IBBI, instead of SEBI, to come forward with an ideal solution. Public equity shareholders can probably be exempted from clause (h) of Section 53(1) of IBC. And a new well-structured mechanism is required regarding the CIRP process of listed companies to properly tackle the issue and protect the interest of public equity shareholders.