The Art of Restructuring

In the vast array of financial services, ‘special situations’ conjures up something vaguely mysterious. Yet this is a fast-growing investor class whose mandate is potentially transformational: gain control of distressed or insolvent companies, typically by acquiring their non-performing loans, restructure with fresh capital and smarter management, bring out inherent value and finally exit via a sale.

India’s IBC was designed to do much the same: an attempt to consolidate and accelerate the paths to debt resolution, backed by law. But the IBC has now been suspended for new referrals for one year, recognition of the devastating impact of the Covid-19 pandemic on business activity.

Until the IBC resumes, stressed and distressed companies will either continue to limp along, knowing their fate but impotent to change course; or they may revert to the pre-IBC status – compromises and arrangements under the Companies Act with the bias on lenders to determine debt restructuring. One consequence of this hiatus is that the burden of negotiating and implementing a restructuring has essentially shifted from the courts to the creditors.

This is the ‘special situation’ that financiers relish because they get to demonstrate their ‘art of
restructuring’.

There are five critical factors that tend to differentiate a successful restructuring from a failed one:

1. Pick the industry or sector carefully before engaging with an existing lender. Make sure the selection plays to your expertise and experience and is ripe for disruption (energy, shipping and aviation).

2. Conduct deep diligence to understand the business. Differentiate between the need to fix the business as opposed to fixing the balance sheet. The latter is always easier.

3. Determine the efficacy of the existing management, change if necessary and agree a path to fill gaps.

4. Negotiate an acquisition price that creates a sustainable capital structure for the underlying business while ensuring alignment of interest between various stakeholders.

5. Create buffers in the business plan for contingencies while recognising that things will not operate like clockwork. It invariably takes longer for things to fall into place.

The temporary halt on referrals to the IBC is a timely moment to reflect on its efficacy and ask how the process can be sharpened for a more impactful resumption. Most assessments of the IBC are based on the number of companies that have gone through its doors and emerged with a buyer at a reasonable price. We believe that there are two more important longer-term benchmarks for judging its success:

• First, has IBC changed credit culture: have underwriting standards, of judging commercial and governance risks, improved and is credit flowing to more deserving borrowers?

• Second, does IBC encourage more out-of-court settlements between all stakeholders? On the first point, based on SSG’s observations of the lending community, the answer is a resounding yes. On the second point, we believe much more needs to be done and the next 12 months will be a critical opportunity to test resolve. We think the post Covid-19 era should see more resolutions outside of IBC, a development that would suggest IBC is not viewed as an effective and efficient process. That perception had formed quickly after IBC’s launch, two years ago, when it hit stumbling blocks over interpretation that reflected its ambiguous drafting. The same caution persists, though today because of IBC’s huge backlog.

The tilt to stay outside of IBC was apparent before Covid-19, as evidenced by Altico Capital, an NBFC whose lenders ran a resolution process that arguably was swifter than the log-jammed IBC, eventually selecting SSG as the preferred bidder. Banks will always favour a restructuring or exit at a good, even right price instead of risking delay, loss of value and the uncertain outcome of IBC jurisdiction. We believe two critical factors can help position India for the next wave of NPLs: one, early recognition of NPAs and proactive restructuring, and two, making it easier for companies to raise equity capital quickly.

• On the first factor, the RBI has done a commendable job with its review of asset quality in the banking segment and we hope that a similar exercise is done with the non-bank financial sector.

• On the second factor, raising equity capital is still inhibited by regulatory restrictions or because managements simply miss opportunities due to promotor bias against dilution. SEBI has been proactively removing regulatory impediments; recent amendments on change of control at large companies should encourage promoters to be more receptive to dilution. Foreign funds view these developments positively and they can play a critical role not only in the capital raising and sharing of expertise and experience; but also in enforcing contingent
disciplines of governance.

In sum, timely and proactive restructuring of stressed assets will also provide much-needed breathing room to the IBC to clear its large backlog - before a potential second wave from the impact of Covid19.

Shyam Maheshwari

Guest Author The author is Founder - Nextinfinity. He also co-founded SSG Capital Management, one of the largest special situations and credit-focused investment houses in Asia-Pacific and has been active IBC-related cases.