Decoding the Myths of Asset Value Maximisation in Insolvency

[Mudit Jain is a penultimate year B.A. LL.B. (Hons.) student at the National University of Advanced Legal Studies, Kochi]

The Insolvency and Bankruptcy Code, 2016 (“IBC”) envisages ‘asset value maximisation’ under the long title of the statute. This has been amply litigated before being settled that the role of the committee of creditors (“CoC”) in a corporate insolvency resolution process (“CIRP”) is to maximise the asset value and balance the interest of all stakeholders while keeping the concern going. The principle that the decision of CoC is to be accorded finality in terms of their commercial wisdom and its application was ingrained by the Supreme Court in K. Sashidhar v. Indian Overseas Bank, AIR 2019 SC 1329. The Supreme Court decision earlier this year in Maharashtra Seamless Ltd. v. Padmanabhan Venkatesh, 2020 SCC OnLine SC 67, ignited many minds with the question whether the decision is numbing all the checks and balances by bestowing onto the CoC discretion beyond any bounds.

The post will briefly explore the decision highlighting the precise concern. It would then move on to analyse the meaning of ‘value’ and ‘value maximisation’, as is inherent in the basic aim and objective of the IBC and then delve into the practical aspect of how a CoC applies its commercial wisdom to ensure value maximisation of assets. It would finally conclude by maintaining that the decision in Maharashtra Seamless correctly maps the commercial wisdom and its scope.

The ‘What’ of Maharashtra Seamless Limited

In Maharashtra Seamless, the CoC approved a resolution plan wherein the upfront amount being paid by the resolution applicant was ₹477 Cr. as against the average liquidation value (“LV”) of ₹597.54 crores. The registered valuers had valued the corporate debtor at ₹681 crores, ₹513 crores and ₹352 crores, based on which the average of the two closest estimates was considered the LV or the fair value (“FV”) in accordance with regulation 35 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (the “CIRP Regulations”).

However, the total exposure of the resolution applicant was much more, as it included an additional ₹180.50 crores being directly infused in the corporate debtor and ₹57 crores being infused towards 25% margin money of the working capital expenditure. In fact, the total working capital expenditure was estimated at around ₹224 crores, the balance of which was to be procured by way of bank loan.

The CoC-approved resolution plan received the approval from the adjudicating authority (“AA”) as well. Subsequently, the National Company Law Appellate Tribunal (“NCLAT”) rejected the resolution plan on the ground that accepting a resolution plan with resolution value (“RV”) falling short of the LV would militate against value maximisation object of the IBC. The Supreme Court reinstated the AA’s order holding the supremacy of the CoC’s commercial wisdom and directing that NCLAT lacks the jurisdiction to dictate matching of LV in a resolution plan.

What does value maximisation entail?

To answer this question, we need to delve into a more fundamental question of what comprises ‘value’ in the given context. Although not expressly defined, it can be inferred that the asset ‘value’ in the IBC is not merely the ‘price’ receivable on sale of the corporate debtor (as a whole or any assets thereof). This is because the IBC does not envisage an auction of the corporate debtor (which would enable maximum monetary inflow by the bidding process) but rather its reorganisation and insolvency resolution as a going concern.

Against this backdrop, we shall now move further to analyse RV. The chairperson of the Insolvency and Bankruptcy Board of India (“IBBI”), Dr. M. S. Sahoo, notes that in common language RV is the money that a resolution applicant is willing to bring to the table for insolvency resolution of the corporate debtor as a going concern. The meaning of RV, thus, cannot be restricted to enterprise value (“EV”), which is the ‘highest and best use’ value of assets.

EV, in simple words, is the earnings that the corporate debtor is anticipated to generate in the future if it remains a going concern and operates at its best efficiency. In the ideal scenario, RV should indeed be equal to EV. However, from a more practical outlook, the RV proposed by the resolution applicants is, most often, less than EV. It can also be more than EV, if the resolution plan provides for an additional infusion of money, for instance, towards working capital expenditure or escalating the business. The EV typically includes the ‘going concern surplus’ of RV over LV.

LV is defined under regulation 2(1)(k) of the CIRP Regulations as the estimated realisable value if the corporate debtor were to be liquidated on the insolvency commencement date (“ICD”). Notably, the concept of EV is foreign and can be equated with the Indian concept of FV. Regulation 2(1)(hb) of the CIRP Regulations defines FV as the estimated realisable value in an exchange of corporate debtor’s assets on ICD in an arm’s length transaction carried out prudently and without compulsion.

At this point, I submit that value maximisation does not merely mean maximising the RV. If it were so, a resolution plan having RV less than the FV or LV would always be rejected even if it provides for the entirety of the creditors’ claims while, in the same case, a plan where RV is greater than the FV or LV would be accepted even if the contribution towards creditors’ claims is lesser than the former plan.

Thus, while these numerical parameters, namely RV, FV and LV, form an integral part of the assessment of feasibility and viability of a resolution plan, it is to be understood that these are not the only determining factors. In order to facilitate the process, the regulation 39(3) of the CIRP Regulations mandates strict use of an evaluation matrix (“EM”) by the CoC in the evaluation of the resolution plans. An EM has been defined under regulation 2(ha) as a set of parameters approved by the CoC to be applied for consideration of a resolution plan, and includes the manner of their application as well.

IBBI issued the Draft Specimen of Evaluation Matrix, which lists several quantitative as well as qualitative parameters with 70:30 weightage assigned respectively. Factors such as term of resolution plan, upfront payment, debt-to-equity swap, fresh infusion of equity for operational efficiency, arrangements with creditors such as regarding reduction of interest rates, corporate restructuring by way of schemes of merger or acquisition, etc. form part of the quantitative parameters. On the other hand, qualitative parameters include, inter alia, the eventuality of honouring proposed commitments and reasonableness of financial projections, managerial competence, technical abilities and track record of implementing turnaround of distressed assets, credit rating and revenue standing of a resolution applicant.

The definition of EM indicates that it is for the CoC to determine the parameters that are to be included in the EM, the individual score they should hold, and the weight-bifurcation between the quantitative and qualitative parameters. This suggests that the answer to “what does value maximisation entail?” varies from case to case.

Concluding Remarks

In Maharashtra Seamless, the CoC approved the resolution plan after thorough evaluation and application of its commercial wisdom. The NCLAT not only mistakenly equated the upfront payment (which is only one of the quantitative perimeters in the evaluation matrix) with RV, but it also subsumed excessive jurisdiction by directing the resolution applicant to modify the resolution plan to make the upfront payment equal to LV. It is noteworthy that the object of the IBC calls for asset value maximisation to balance the interests of all stakeholders, not for maximisation of RV and the interests of the operational creditors.

Further, ‘value maximisation’ is not a mere blend of black and white arithmetical calculations; it is a multifaceted enquiry. In fact, the subjective nature of enquiry involved in the process is the very reason why ‘value maximisation’ is not a criterion to be determined by AA (under section 31 of the IBC) before approving a resolution plan. The IBC instead bestows this responsibility onto the CoC’s business ingenuity and commercial wisdom. Thus, the Supreme Court decision in Maharashtra Seamless sets right the position of law by setting aside the NCLAT order and restoring the predominance of CoC’s commercial wisdom.

Mudit Jain

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