India did not have an effective legislation for revival of an insolvent company until the Insolvency and Bankruptcy Code, 2016 (“Code”).

The Code presents an exciting new opportunity for acquisition of stressed companies in India. The acquisition process is similar to a bidding process and the bid (referred in the Code as the ‘resolution plan’) is finally approved by a special tribunal called the National Company Law Tribunal (“NCLT”). A judicial approval (by the NCLT) ensures that the acquirer is able to efficiently clean up past defaults and dues.

However, not everyone can participate in the bidding process and acquire an India company pursuant to the Code.

The Code requires in section 29A that, an acquirer (referred in the Code as the ‘resolution applicant’) must not be disqualified, and lists eight categories of disqualifications. Section 29A disqualifications are far reaching and although drafted from the perspective of Indian laws, they also apply if there is a corresponding disability in any foreign jurisdiction. These disqualification apply in addition to other requirements under Indian laws, specifically with respect to foreign investment.

THE NEED FOR DISQUALIFICATIONS

Until November 23, 2017 (when Section 29A introduced) there was no disqualification from becoming a resolution applicant. However, the peculiar circumstances at that time forced the Government to introduce Section 29A in haste, through an Ordinance while the parliament was not in session.

In June 2016, India’s central bank – the Reserve Bank of India (“RBI”) issued a direction to Indian banks to trigger insolvency proceedings under the Code, for 12 companies, whose defaulting loans aggregated to about 25 per cent. of the gross non-performing assets in India’s banking system.

The Government feared that the Code will be used by the owners to settle the outstanding loans at a significant discount, and in the process, banks (including several Government banks) will lose money. This prompted the Government to introduce Section 29A, with the idea that if banks have to lose money, the defaulting company should have a new ownership and management.

Section 29A is very widely worded and the disqualifications apply in broad sweep. For example, a resolution applicant may be disqualified if, the brother of a director of the resolution applicant controls a company (even if unrelated to the target company) that has defaulted on its loans, and its lenders have classified the loan as a non-performing asset for a period of more than one year!

THE DISQUALIFICATIONS

A resolution applicant is disqualified if: (a) the resolution applicant; (b) any person acting jointly or in concert with the resolution applicant; or (c) a connected person (explained below) to the resolution applicant is, one of the following, in India or correspondingly in a foreign jurisdiction:

• An undischarged insolvent.
• A wilful defaulter in accordance with the guidelines issued by the RBI.
• Defaulter on its loans; or in the management or control, or a promoter of a company that has defaulted on its loans, in each case where such loans have been classified by as a non-performing assets by the respective lenders for a period of more than one year, subject to the following:
• this disqualification can be cured if the overdue amount (with interest) is repaid before the resolution plan is submitted; and
• this disqualification does not apply to a resolution applicant that is a “financial entity” that is not a “related party” to the company in insolvency. As an exception, a financial entity that has become a related party by conversion of debt into equity in the past is exempt from this disqualification in certain situations. In the context of Section 29A, “financial entity” has a specific meaning and it includes regulated entities such a banks, entity regulated by a foreign central bank or a securities market regulator, alternative investment funds etc.
• Convicted for any offence punishable with imprisonment for specified periods. This disqualification does not apply to a connected person.
• Disqualified to act as a director under the Companies Act, 2013. This disqualification does not apply to a connected person.
• Prohibited by the Securities and Exchange Board of India from trading in securities or accessing the securities markets.
• A promoter or in the management or control of a company in which a preferential, undervalued, extortionate credit or fraudulent transaction has taken place and NCLT has issued an order to this effect.
• A guarantor for a company against which an application for insolvency has been admitted under the Code, where the guarantee has been invoked but not paid.

CONNECTED PERSONS: WIDE MEANING

The Section 29A disqualifications listed above, by themselves are not onerous. However, the wide definition of a “connected person” is what makes them onerous. 

Connected person includes following three categories:

• any person who is the promoter or in the management or control of the resolution applicant; or
• any person who shall be the promoter or in management or control of the business of the insolvent company during the implementation of the resolution plan; and
• the holding company, subsidiary company, associate company or related party of a person referred to in clauses (a) and (b), with the exception of a ‘financial entity’ that is not a related party to the insolvent company- in which case this category (c) does not apply, subject to certain conditions.

A related party has been widely defined, and it applies to a long list or persons, and illustrative, in case of a company, the following are related parties: (i) a director or his relative; (ii) a key managerial personnel or his relative; (iii) a firm, in which a director, manager or his relative is a partner; (iv) a private company in which a director or manager or his relative is a member or director; (v) a public company in which a director and manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital; (vi) a body corporate whose management is accustomed to act upon the guidance of a director or manager; (vii) any person on whose guidance a director or manager is accustomed to act; (viii) specified group companies; and (ix) a director (other than an independent director) or key managerial personnel of the holding company or his relative.

This wide meaning of “connected person” results in following two outcomes:

• a potential acquirer must conduct a detailed review of itself and all its connected persons before evaluating an Indian target company for an acquisition through a resolution plan; and
• the acquisition itself should be carefully structured to avoid disqualification under Section 29A, for example through use of a financial entity.

THE ACQUISITION PROCESS

Once the Section 29A hurdle is cleared, the rest of the acquisition process is very similar to a bidding process guided by the Code.

A company can be dragged to insolvency upon a default of as low as INR 100,000 (~USD 1400). Once a company is admitted to insolvency, its board of directors is suspended and it is managed by a “resolution professional” appointed by the NCLT, who constitutes a committee of creditors (“CoC”) comprising of financial creditors (and not operational creditors). The CoC issues eligibility criteria for resolution applicants and evaluation criteria for resolution plans. The resolution plans submitted by eligible resolution applicants are evaluated select the resolution plan with highest score, which is then presented to the NCLT for final approval. This entire process is statutorily required to be completed within a score, which is then presented to the NCLT for final approval. This entire process is statutorily required to be completed within a  maximum of 180 days (extendable just one by up to 90 days) from the insolvency commencement date. Despite the Code prescribing strict timelines, on account of litigation these timelines have been extended in some cases.

In a resolution plan, a resolution applicant must ensure certain mandatory minimum payments, and is free to provide any other terms, including a write-off of financial or operational debts.

BRIGHT PROSPECTS FOR ACQUISITION THROUGH INSOLVENCY

The first 12 cases referred to insolvency by RBI are nearing completion, and those have witnessed immense interests with resolution applicants offering billions of dollars as pay-outs in their resolution plans. In times to come, this new way to acquire an Indian company is bound to emerge as an attractive investment method, but one that requires careful review and structuring.