Bharat Anand
Under the pressure from the Reserve Bank of India, banks are trying to clean-up their balance sheets. Broadly, where possible, this involves either requiring borrowers to sell assets in order to reduce their levels of stress or, in extreme cases, selling down the loan portfolio to other investors or ARCs. Buyers must be aware of the key risks of acquiring assets from distress sellers, given some of the peculiarities of such transactions in India.
Bharat Anand, Senior Partner at Khaitan & Co.
Firstly, buyers must conduct a proper due diligence in order to get the full picture regarding how the business operates. In addition, the due diligence would be aimed at understanding any exceptional items which may impact the viability of the business. Unfortunately, the buyer may not have the luxury of time. Since lenders are keen to relieve stress, buyers may find themselves under a lot of external pressure to make a binding bid in the shortest possible timeframe. In such cases, buyers will be well advised to make their bids subject to the satisfaction of certain conditions precedent. However, even if the buyer is able to secure appropriate conditions precedent which need to be satisfied prior to consummation of the transaction, buyers would be subject to immense pressure, not to mention the transaction expense, in terms of relying on the conditions and walking out of the bid. To further compress the timeline, lenders will often provide a vendor due diligence report. While in theory these reports should compress the transaction timeline, in practice, they may not be as effective. Since vendors are rarely advised to ensure that the due diligence reports created by their advisors should be assignable to the buyer, an independent diligence for the buyer becomes essential. Here access to data is challenging, especially if data is required from parts of the target operation, which may be unaware of the purpose for which information is being called.
Secondly, in many jurisdictions, distressed companies agree to payment of a “break fees” to the buyer in case a transaction does not materialise other than due to the buyer’s actions. However, in India, market practice does not favour such fees. Rather to the contrary, in case of a distressed asset, lenders are very reluctant to permit such payments outside the ordinary course of business. Such an approach is unhelpful. If reasonable break fee payments that are designed to impact the buyer’s direct costs of exploration of the asset, but not the opportunity cost of capital, are permitted, then buyers would be encouraged to look at a larger universe of assets being auctioned. This would create a healthy competition for the asset, and in some cases, may help all the stakeholders realise the best price. Of course, from a governance perspective, it needs to be ensured that nothing too clever is being planned to use the break fees other than to put the asset into play more effectively.
Thirdly, unlike a normal M&A transaction where adjustments to the final acquisition price are common, in case of a distress sale, lenders suffer from a flight to safety. Accordingly, it is very rare for lenders to accept any form of price adjustments in such circumstances. Therefore, buyers are at risk that if the inter-operating period prior to completion is inordinately lengthy due to delays outside their control, then they may be end up paying a disproportionate premium for the assets. Bringing down the time period to execute such transactions is critical. Regulators, both at the central and state level, must realise that if either the promoters or the banks throw in the towel, employees and consumers will suffer the most. As a general principle, unwarranted or unjustified regulatory delay should result in compensation. Unless some such incentives are introduced, it is hard to see the approach of regulators changing. Courts should also be more pragmatic while permitting third party interventions in distressed sales. Regrettably, our legal system, to ensure that no one gets unjustly deprived of his rights, is open to a high degree of abuse. India’s judiciary must rise to the occasion. Malicious litigation must result in an award of costs so that there is some distinctive to anyone tying his luck to stall a critical exit.
Fourthly, distress assets are often found in industry clusters associated with land acquisition delays, delay in receipt of environmental approvals or other regulatory approvals and consents. By definition, execution and implementation challenges in these projects are extraordinary. Any transfer of such projects to a third party poses an additional challenge in terms of transfer of operating approvals, transfer of contracts, obtaining employee consents etc. In several cases, stakeholders with a vested interest can approach local courts with a view to hold the entire process to ransom. Accordingly, the buyers has no certainty as to whether the transaction will materialise or not. We have seen several instances where buyers cunningly suggest cut-off dates for completion of the transaction that are of a short duration so that they can walk out if the signals for completion of the transaction are not promising. Surely, the better approach is to hold those the make the business environment untenable accountable. In case of distressed deals, transfers of the business should be enabled so that the new owner can concentrate on revival of the business, then a mountain of paperwork for transferring an approval from the name of the legacy owner to the new owner.
Fifthly, in the cases of a distress acquisitions, buyers would be well advised to try and secure payments in escrow or obtain guarantees for a solvent third party to deal with contingent liabilities that are inherent in any M&A process. Where the seller’s equity has been entirely wiped out, and the seller is distressed, it is inadvisable for the buyer to seek recourse solely against the seller. Accordingly, the fundamental substratum of an M&A deal, that the vendor will protect the buyer in case the vendor has not lived up to his end of the bargain, changes. In such cases, negotiating detailed warranties and indemnities may not be meaningful. In fact, payments by the seller to the buyer could be challenged in due course by other unsecured creditors.
Finally, for the reasons set out above, buyers looking at distressed assets would be well advised to enter the market with an experienced internal team and external advisers. Most experienced players understand the need for risk sharing while scouting for such opportunities. Buyers must also ensure that the process is conducted in a manner that they do not reach a point of no return and unknowingly commit themselves to a transaction.
(Bharat Anand is a Senior Partner at Khaitan & Co. Views are personal.)
