Treatment of Public Equity Shareholders under IBC

Introduction

In November last year, the Securities and Exchange Board of India (SEBI) has come up with a proposal to protect the interests of public equity shareholders in the case of listed companies undergoing the Corporate Insolvency Resolution Process (CIRP).^[1] There is currently no distinct division between equity shareholders under Insolvency & Bankruptcy Code (IBC). Since all equity shareholders are regarded as owners of the insolvent business, they are placed last in the “distribution waterfall.” Also, the Committee of Creditors (CoC), which is made up of financial creditors, runs the CIRP with no input from public equity shareholders.

When a publicly listed company implements a resolution plan, there are generally two possible outcomes:

• The company remains listed despite a large capital reduction in accordance with the resolution plan. In such a company public equity shareholders must continue to hold at least 5% of shares as part of the requirements for its continuing listing;
• The company gets delisted pursuant to a resolution plan or undergoes liquidation.

As a result, in most cases, public equity shareholders of a publicly listed company under IBC end up losing the significant or entire value of their shareholdings at the conclusion of the CIRP. The CoC, which is located at the top of the IBC pyramid, does not even provide equity owners—including non-promoter shareholders, who are often regular retail shareholders in the case of listed companies—the opportunity to submit their grievances.

DHFL’s Case^[2]

• A National Company Law Tribunal (NCLT) decision to enable the delisting of DHFL’s shares from exchanges was challenged in the Supreme Court by retail investors. DHFL’s shares ceased trading on the markets following the decision by NCLT, which had authorized the resolution plan of Piramal Capital and Housing Finance Limited (PCHFL) to take over the insolvent shadow bank. According to the resolution plan, the company will buy the equity shares owned by shareholders by reducing paid-up capital to zero.
• Retail investors rushed to purchase DHFL shares in response to the news, anticipating windfall gains once the new management takes control. Once NCLT approved the resolution plan, the stock remained one of the highly traded stocks.
• The excitement around the stock, however, was short-lived as it was revealed that the stock would be delisted in accordance with the resolution plan that had been authorized and that retail investors would receive nothing in exchange for their DHFL shares.
• These shareholders include both those who stayed involved in the business during its heyday as well as those who were duped into thinking DHFL would remain listed under the new management.

The Proposal: SEBI’s attempt at rescuing public equity shareholders

• Numerous complaints and grievances^[3] about companies that were delisted after a resolution plan was approved have been received by SEBI. The complainants’ concerns, among others, included:
  • If the new entity is formed after the bankrupt firm has been acquired by the new management (the resolution applicant) in accordance with an NCLT-approved resolution, SEBI should ensure that the existing shareholders receive shareholding in the company.
  • Since only the major players are currently purchasing the shares of the struggling debtor company at throwaway prices and the retail shareholders receive no consideration against their shareholding in the company, SEBI should decide to give the business of the debtor company the proper value and ensure that all small stakeholders receive the appropriate value for their stakes.
  • It is unacceptable for a resolution process to result in an overnight decrease in the value of equity shares in the case of companies that delist after a resolution plan has been approved, without giving the public shareholders any prior notice or opportunity to even argue their case before the Committee of Creditors (CoC).
• In order to allow the public equity shareholders of an insolvent company a chance to participate in the company’s revival under the new management, SEBI has suggested that the resolution applicant acquiring the insolvent company be required to make an offer of shares to those shareholders.
• According to the consultation paper^[4], the offer must be made at the amount the resolution applicant had paid for the shares. Depending on the equity ownership of the resolution applicant, the amount of equity granted to the public equity shareholders might range from 0% to 25%. Such offers will not be available to the former promoter and his or her family, partner group firms, directors, key management people, or trusts with the previous promoter as beneficiary.
• It has also been suggested that if this offer is accepted by 5% of the public equity shareholders, the new firm will continue to be listed. Public equity shareholders will be reimbursed in line with the rules of the CIRP offer if the resolution applicant fails to obtain a 5% public ownership leading to mandatory delisting.

Why the proposal is a step in right direction?

• Prevents Unjust Enrichment of Successful Resolution Applicant
  • A firm is subjected to the IBC process when a default takes place. The business need not be a balance sheet insolvent.^[5] According to the Insolvency & Bankruptcy Board of India (IBBI), financial creditors (FCs) realised at least 100% of their claims in 56 cases out of the 517 firms resolved through resolution plans until June 30, 2022. Therefore, it is conceivable that some of these businesses may still have equity with value. If the remaining equity value is eliminated by the resolution plan, the purchaser will unfairly get value from the shareholders. From this angle, SEBI’s suggestion is really logical.^[6]
• May lower down Resolution Applicant’s Financial Burden
  • Apart from offering small public equity shareholders a chance to participate in CIRP, SEBI appears to expect that new guidelines will be well-received by acquirers because it will lower their financial burden by raising funds from public equity shareholders. As a result, the company might receive more resolution plans. Additionally, following the reorganization, the firm will be able to maintain its status as a listed corporation with a minimal public float.
• Fair Treatment to Public Equity Shareholders
  • The public equity shareholders who otherwise would have been pushed out will gain the necessary trust as they will be permitted to participate at the same price that is applicable to the resolution applicant.

Possible Implications of the Proposal

• May Impact Successful Resolution Applicant’s Operational Autonomy
  • The effects of starting the company again with non-promoter, public equity shareholders (who can own up to 25% of the shares) may need to be considered by resolution applicants. Despite the good intentions behind SEBI’s suggestion, an applicant might not want to give public equity shareholders a say in how the firm is reorganized post-CIRP. Additionally, existing shareholders might not want to invest money in buying shares of a business where they have already lost money.
• Goes Against the Contract Between Equity and Debt
  • A 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.^[7]
• Compliance Burden for Listed Company Might Drive Away Prospective Applicants
  • Successful Resolution Applicant might prefer to operate, at least temporarily, free from the stringent compliance requirements under SEBI’s LODR Regulations which are applicable to all listed companies. It would be a turn-off if this factor drives away potential resolution applicants who wanted to submit a resolution plan.
• Shareholder Enrichment at the Cost of Haircuts for Creditors
  • If public equity shareholders receive consideration for their shareholding when various creditors are taking “haircuts,” it would lead to “shareholder enrichment” at the expense of creditors. Therefore, the basic premise of the insolvency law shall stand violated.
• Resolution Plan vis-a-vis Section 230 Scheme
  • The way the IBC is formulated makes the resolution plan different from a mutually agreeable settlement (say, under section 230 of the Companies Act, 2013). Resolution plans are forced, unlike Section 230 schemes which may also offer protection to members and creditors.^[8]

Way Forward

• For some, the continued listing may be a welcome proposition while others may consider it burdensome. There could be ways to lighten the burden. For example, a longer time frame could be considered to raise public float to 25%. Utmost caution should be taken to ensure that entitlements for public equity shareholders do not complicate the legal framework.^[9]
• Also, the current legal framework provides certain options for minority shareholders. One, minority shareholders, non-promoters, and non-controlling shareholders are not covered by Section 29A. That is to say, either individually or collectively, the minority shareholder may submit a resolution proposal (provided they are not otherwise disqualified under other clauses of section 29A). However, a situation like that would be slightly uncommon. Two, there is no restriction on public equity shareholders submitting a section 230 scheme under the Companies Act, 2013 after the commencement of CIRP. Therefore, the minority shareholders may offer a plan to the NCLT if it is better than an insolvency resolution. An issue that has to be overcome is the concurrent functioning of a section 230 scheme and the CIRP.
• It has been observed that it is difficult and complex to successfully resolve the insolvency of listed corporations. Adding more complexities may prove to be a deterrent.

Reference:

^[1] Framework for Protection of Interest of Public Equity Shareholders in case of Listed Companies Undergoing CIRP under IBC, Available at https://www.sebi.gov.in/reports-and-statistics/reports/nov-2022/framework-for-protection-of-interest-of-public-equity-shareholders-in-case-of-listed-companies-undergoing-corporate-insolvency-resolution-process-cirp-under-the-insolvency-and-bankruptcy-code-ibc-_64850.html (Accessed on 22th January, 2023)

^[2] Economic Times, 6th December, 2022, https://economictimes.indiatimes.com/prime/corporate-governance/minority-investors-often-get-a-raw-deal-during-insolvencies-can-sebis-new-proposal-change-things/primearticleshow/96015757.cms

^[3] Supra

^[4] Supra

^[5] According to Section 4 of the Insolvency & Bankruptcy Code, 2016 CIRP is triggered when default amount is more than INR 1 crore.

^[6] CKG Nair & MS Sahoo, ‘Ensure Equity in IBC Resolution’, Hindu Business Line, 4th December 2023, https://www.thehindubusinessline.com/opinion/ensure-equity-in-ibc-resolution/article66223450.ece

^[7] Report of Bankruptcy Law Reforms Committee, Pg. No. 10

^[8] Sikha Bansal, ‘Minority Shareholders under IBC’, Vinod Kothari Consultants, 25th August, 2021, https://vinodkothari.com/2021/08/minority-shareholders-under-ibc/ 

^[9] Supra note 6

 

 

 

 

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Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.

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