14 May 2018

Bankrupt firms need enabling regulation

I have a piece in today's Economic Times on how companies facing resolution and bankruptcy need a lighter touch regulation from SEBI and the exchanges with respect to listing regulations:

The law applicable to listed companies needs to be relooked at when such companies are going through the near death experience of resolution and insolvency. SEBI has come out with a paper to solicit views on how to deal with various extant regulations in respect to such companies. The companies deserve a light regulation approach. As the poet William Blake said, the same law for the lion and the ox is oppression.

The seven ages of resolution
For a company going through severe distress, it experiences financial haemorrhaging, departure of senior management and lack of compliance with multiple regulations. Clearly, little information about the true condition of the company is available in public domain before and after it enters resolution. A company in such process undergoes several stages, from filing of an application before the company law tribunal for resolution, appointment of a resolution professional (RP) to replace the board of directors, consideration of revival plans by the creditors in consultation with the RP, receiving bids from suitors, choosing the best bidder, restructuring capital based on the bids and injection of capital by the bidder, conversion of some or all debt into new equity and a route back to a smaller but healthier company with new management, or liquidation if revival is impossible.

The RPs are expected to collect information about the company in a matter of weeks and also take it through the resolution/insolvency process within a very aggressive timelines. While the RPs are entitled to appoint financial and legal professionals, their main objective is to revive the company. In many if not most cases top management has departed, the board of directors have by law been superseded by the RPs and much of the information that is relevant to investors does not really exist in a well documented form because of the stress in the company and departure of key people.

Best effort disclosure of past events
A materiality threshold should be applicable on the disclosures which may be lower than regular listed companies. Being price sensitive information, events such as filing of application for initiation of resolution, admission of such application by NCLT, terms of the bids once the winning bid is announced should be mandatorily disclosed by the listed corporate debtor under the listing regulations. Other routine disclosures may be relaxed, for instance quarterly financials. In addition, some level of protection must be provided to RPs for disclosures made in good faith and diligently, as they may not be able to disclose routine information as mandated. They should disclose all relevant information after they have taken over though.

Trading in stock exchanges.
Trading should be allowed to be continued subject to enhanced restrictions, such as intra day circuit filters of 5%, restriction on trading in Futures and Options segment, etc. Trading permits those who wish to exit, to transfer the risk of success  or failure of the company to those who can better bear the risk return mix. There is a risk that trades occur at, above or below fair valuation, but that is a price worth paying. Freezing trading may appear optically sound but will in fact completely block the exit doors when the building is on fire. Other mechanisms could also be used like a ‘call auction’ or batch mode trading, say once a week to focus liquidity. In any case, there should be no inter-day circuit limit as that would also be akin to locking the doors. If the consensus price is say Rs. 50 (based on new information about resolution chances) and the last traded price the previous day was Rs. 30, trade will not edge up slowly within a 5% circuit limit per day, but would completely clot the arteries of stock orders. This is because no seller would sell at Rs. 30, that which they think is worth Rs. 50. Conversely, trading should be stopped for the few days when the bids are received till one has been accepted, as the information asymmetry becomes huge between a handful of RPs with creditors and the rest of the investor community.

Re-classification of Promoters
The existing promoters whose shareholding in the listed corporate debtor undergoing resolution has reduced significantly may be automatically re-classified as public shareholders. Post resolution, there would be various stakeholders including creditors converting their debt into equity, sometimes acting as a group or consortium of investors, who may acquire substantial shareholding of the listed corporate debtor, replacing the erstwhile promoters. It is suggested that SEBI may prescribe a test for determination of ‘promoters’ which is flexible. Typically, there would be mix of new acquirers getting shares and the creditors whose loans would stand converted into shares partially or fully. Ideally, the two should not be clubbed together as they are not acting in concert except for the purpose of taking the corporate debtor out of its near-death existence.

Compliance with Minimum Public Shareholding
Infusion of outside capital during resolution may reduce the public shareholding below the statutory minimum of 25%. The immediate obligation to fulfil the prescribed MPS norms may not be in the interest of a newly revived company. Thus, the period of 1 year for compliance with the required MPS norms should be extended for such companies to 5 years or 10 years. For a company which has gone through the resolution process, the important agenda is to revive the company and for which it would require several years of nurturing. Divestment while the company is still struggling would not be an ideal outcome and for a company in such position to revive and be partially divested would take a minimum of 5 years.

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