[Saurabh Agnihotri is a 4th year BA. LLB student and Ayushi Mehta a 4th year BBA. LLB student at Gujarat National Law University]
Under the Insolvency and Bankruptcy Code, 2016 (“IBC”), valuation of assets is one of the core features dealt with in a corporate insolvency resolution process (“CIRP”). The process of valuation conducted by registered “valuers” or valuation professionals helps determine the current value of the assets which are to be liquidated. The requirement of valuation under the IBC is an important concern for registered valuers in all three asset classes: plant and machinery (“P&M”), land and building (“L&B”), as well as securities or financial assets.
As laid down under regulation 27 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”), within seven days of appointment, but no later than the forty-seventh day from the insolvency commencement date, the resolution professional shall appoint two registered valuers to assess the fair value and liquidation value of the corporate debtor in accordance with regulation 35, which further assists in the CIRP.
Clarification needed on the term “liquidation value”
The terminology “liquidation value” in accordance with regulation 35(1) of the CIRP Regulations is defined as ‘the estimated realizable value of assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date’. The procedure for estimating liquidation value is specified in regulation 35(2) of the CIRP Regulations. The said definition in its bare reading indicates that liquidation value is the notional realizable valuation of the corporate debtor’s assets if the corporate debtor’s assets were liquidated on the insolvency commencement date (and not the value that may be actually realized under a resolution plan). Uncertainty emerges, however, when assessing “estimated realizable value” in the context of the insolvency resolution process as opposed to valuation in an out-and-out asset liquidation. Characteristically, an asset often has more than one sale value based on valuation under different scenarios.
For example, an asset may be valued at fair market value, realizable value or the distressed sale value in the valuation report. The already demanding task of the registered valuers and insolvency professionals functioning as interim resolution professionals (“IRPs”) and resolution professionals (“RP”) to determine the character of an asset value to be considered as liquidation value under regulation 35 with regulations 36 and 38 of the CIRP Regulations becomes even more difficult with the extensive use of technical jargon and terminologies used in the IBC. Hence, given the practical implications on resolution plans, as well as the claims of creditors and potential investors, understanding and determining the “liquidation value” of assets becomes extremely pertinent.
The term “liquidation value” refers to a valuation of an asset that is obtained in a hypothetical liquidation scenario, when the seller is under pressure to sell. This is similar to the concept of “vertical comparison” as defined under Chapter 11 of the United States Bankruptcy Code, which is an accepted definition for determining liquidation value under insolvency laws.
Fair Value
Earlier, the IBC read with the CIRP Regulations, 2016 made stipulations only regarding the determination of “liquidation value”. However, the amended Regulations now provide for determination of “fair value” in addition to liquidation value.
“Fair value” has been defined as follows —
(hb) “fair value” means the estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion.
Fair Value vs. Liquidation Value
While both liquidation value and fair value deal with the realizable value of the assets estimated on the commencement date of insolvency, the fundamental assumption in determining the two values are exactly opposite. While in “liquidation value” the basic assumption is that the company is to be liquidated as on the insolvency commencement date and hence the values of assets are therefore estimated on this assumption, in “fair value” the basic assumption is that the company will continue as a going concern. It is the estimated realizable value of the assets were to be exchanged between a willing buyer and seller.
Consequences of Incorrect Valuation
Valuation is one of the most essential parts of a CIRP, as it determines the amount that may be retrieved if all the assets of the debtor were to be liquidated. The holistic understanding of liquidation value is critical to safeguard the interests of stakeholders, as this value leads to the successful formulation of a resolution plan. The consequences of errors or incorrect methods of valuation are far-reaching and may result in reversing approved resolution plans. Therefore, the onus on insolvency professionals and registered valuers likewise is quite high for error-free valuation of the assets. It is colloquially accepted that the liquidation values ascertained by the valuation professionals are more or less accurate. However, there is no particular method or procedure prescribed in the Code or by the Insolvency and Bankruptcy Board of India (“IBBI”) to determine a standard valuation method. This absence has left a gaping hole in the scheme of the IBC, leading to complacency within the valuation professionals, which has resulted in incorrect valuations of assets. In addition to lapse of diligence and breach of care, there can be intentional lapses and misevaluation of assets to cater to mala fide interests, which defeats the provisions of the IBC.
Recently, the Mumbai bench of National Company Law Tribunal (“NCLT”) raised certain doubts over “confidentiality” of the liquidation valuation of the assets of Videocon Industries and its 12 group companies during the insolvency process. According to the CIRP Regulations, the liquidation value is ascertained through two registered valuers and is kept as confidential along with fair market value. The members of the committee of creditors are informed about these values only during the finalization of the bids. The values determined by the two valuers in this case were almost similar to the bid made by the resolution applicant, which is a rare occurrence. This raised certain doubts over the valuation professionals and their integrity, along with a potential breach of the confidentiality clause. The NCLT requested the IBBI “to examine this issue in depth to ensure that the confidentiality clause is followed without any compromise by the parties involved”.
In another isolated event, a criminal complaint was filed against officers of a private securitization firm and the resolution professional for allegedly determining improper liquidation value under the CIRP of Hotel Gaudavan Private Limited.
The Way Forward
The incidents mentioned above showcase the necessity of not only a standard valuation regime but a holistic overhaul in the valuation industry. In the past, an attempt was made to regulate valuation by the draft Valuation Professionals Bill, 2008. Notwithstanding Companies (Registered Valuers and Valuation) Rules, 2017 and other regulations, a regularized institutional framework seems to be the need of the hour for the proper regulation of valuation, which is not only exclusive to the ambit of the IBC or the Companies Act, but also any other law where valuation is required.
It is pertinent to that the committee of experts of the IBBI in their annual report stated that after extensive consultation with the stakeholders, it was deemed that an institutional framework was the need of the hour. In our opinion, such a framework could lay down the foundations of standardized methods for valuation from the grassroots level as it could provide educational courses to the valuation professionals. This can be achieved through way of an exclusive statute which establishes the National Institute of Valuers, which regulates and develops the profession of valuers and protects clients who use the services of valuation professionals. The IBBI report suggested that the framework must have zero gestation period and must be malleable to evolving environment, bringing the profession of valuation to be full-time, making it a more sincere field of practice similar to doctors, chartered accountants, and the like.
The report further went on to suggest that a statute must be enacted to establish the basic structure of the institutional framework, which would comprise of the National Institute of Valuers (statutory body), valuation professional organizations (frontline regulators), valuation institutes (educational bodies) and the valuers. The statutory body could regulate and register valuation institutes under it, whereby the latter would conduct examinations and various other forms of screening to grant required qualification to an aspiring professional.
The institutes must be tasked with ensuring that expertise is maintained for valuation of various types of assets. This will help in sectoring the profession and will reap more efficient valuation as the individuals would have specialization in the specific asset classes. To enable this, the institutes can provide courses for different asset classes, namely L&B, P&M and financial assets.
The Draft Valuers Bill, 2020 proposed by the IBBI report suggested that a valuation standards committee must be established which comprises of all relevant stakeholders. This committee must recommend guidelines and procedures to formulate a standardized valuation regime, on whose basis the statutory body would issue the formal procedure. The procedure must be adhered to by every valuer, irrespective of the law under which they are appointed.
Even though India is still at a nascent stage with its insolvency laws and valuation methods, the Draft Valuers Bill, 2020 builds a roadmap to standardized and well-regulated valuation methods and terminologies, which is imperative given the state of the economy in India.
– Saurabh Agnihotri & Ayushi Mehta