SEBI vs. IBC – A post CIRP anomaly

On November 11, 2022, The Securities and Exchange Board of India (SEBI) released a consultation paper[1] on the modalities of Insolvency and Bankruptcy law, when the process was applied to publicly listed companies. It was an attempt to streamline the interests of a private equity investor or shareholder with that of a financial creditor, associated with an entity undergoing the Corporate Insolvency Resolution Process (CIRP).

The notification was in response to the grievances expressed by the shareholders of delisted entities post-liquidation vis-a-vis the asset distribution process.

The white paper laid stress on the interests of the minority and micro-stakeholders in a sick and liquidating enterprise, where the most common issue addressed in the proposal was the instances of small stakeholders losing their equity stake to the majority holders, once the company flushed out through the exit option provided under the Insolvency and Bankruptcy code.

In order to regulate the cash flow, the SEBI proposal was suggestive of mandatory first offer mechanisms to the non-promoter group shareholders which would enable them to retain a reasonable stake in the post CIRP resultant entity. This comes out as a remarkable move by the Regulatory Body since the resolution process has been seen as a garb for majority stakeholders to divest other shareholders from the entire pool of equity (now converted into equity shares) of the post-CIRP entity.

This would essentially entail a transition of the shareholder group into the ‘new corporate debtor’ (CD) personality, allowing the former to entitle multiple benefits under the Code. In a nutshell, the proposal would allow the buyout by the reserved shareholder class to circumvent the compliances under the SEBI (Delisting of Equity Shares) Regulation,2021, in the event the CD undergoes the liquidation pursuant to the CIRP and the public shareholding does not rise above 5% of the total capital structure of the resulting entity.

Compliances proposed by the Ombudsman

In the vested interest of the public shareholder and the non-promoter group, the same shall be provided with an opportunity to acquire equity in the fully diluted share capital of the new entity, which shall be a minimum of 25%. Furthermore, the resultant entity shall endeavour to acquire at least 5% of the total public shareholding through such an offer made to the non-promoter group.

Point B of the Proposal lists the excluded category of shareholders who cannot be made such an offer, which includes the affiliates of the promoter group and directors of the company. This has been perceived as a bold move since it would require an apparent synergy of both legislations, and in various instances, the jurisdiction of IBC and SEBI have seen not coincided.

In Bhanu Ram vs. HBN Dairies and Allied Limited [2], the NCLAT took an opinion that the IBC cannot cast an overriding effect to vide section 238, over SEBI since the two legislations are actually inconsistent in the sense that the IBC governs the relationship between the debtor and creditor, while SEBI protects the interests of investors in the securities markets. Once the Moratorium is evoked under section 14[3] of the Code, it bars any proceedings under any other legislation, by virtue of Section 238 of the Code.

Further, in Innoventive Industries Limited vs. ICICI Bank Limited [4] , the Apex Court had clarified the position that the non-obstante clause contained in section 238 of the Code prevails over any corresponding enactment applying to the corporate debtor.

The promoter group being offered a mandatory offer in the capital structure would ensure the new entity retains a sizeable amount of liquidity. Additionally, the public shareholding in the new entity should be at least 5% for it to continue its listing on a stock exchange, failure which would lead to the company’s delisting.

Merits of the Proposal

The harmonious construction proposed by the notification is a praiseworthy note, given the fact that the number of listed entities going into liquidation since the 2016 enactment is increasing gradually. Going statistically, the resolution plan of 517 CIRPs has been approved, since 2016, out of which 75 are listed companies, out of which 28 companies ended up in liquidation and 52 were delisted.

The rise in the winding up of investor-driven companies would naturally imply an added layer of complexity to be addressed by the Code, with regard to the distribution of equity of stake in the post-CIRP entity. One of the speculated pros of the proposal focuses on the issue of excessive float suffered by entities post-relisting.

The Minimum Public Shareholding (MPS) requirement of The board had earlier addressed this issue in a white paper published in August 2020[5], wherein it suggested the statutory post-relisting requirement of 5% (MPS), followed by 10% within the year, followed by 25% in the next two years. Another option given the entities was 10% MPS at the time of relisting and 25% in the next 2 years.

This gave entities flexibility in achieving their mandatory MPS requirements based on their public investment pattern and challenges post the CIRP recovery. The Amendment to SEBI (Substantial Acquisition of Shares and Takeover) Regulations,2011 compliments the above proposal, since it allows 75% acquisition in the relevant entity by a buyer in a CIRP, with the remaining 25% being left in the open market to be acquired.

Another merit of the said paper is the lessening of a burden on the New Corporate Debtor /applicant of the resolution plan with respect to the raising of capital for equity in the new entity. The public shareholding mechanism would ensure a smooth flow of capital for the post-CIRP entity, without risking dilution of shareholding, since the promoter/financial creditor would only be complying with the MPS requirement while making an offer to the public non-promoter group.

Auxiliarily, the public – shareholders could now get at par with the promoter-group in since they would not only retain their holding in the resulting entity but also virtually continue to hold the same stake in the resulting entity as well as be able to participate in proportion to their shareholding.

Additionally, the public shareholding group would also be able to acquire the capital in the new entity at the same cost as the acquirer does. Since Shareholders themselves are in the lowest hierarchy when it comes to the distribution of the liquidation proceedings, after secured creditors and unsecured creditors, as per Chapter 7 of the Code, their protection has been crucially considered here.

Possible Drawbacks

The possible dilution of the promoter shareholding is a major issue that this proposal has failed to discuss. As forayed in the article earlier, the IBC and SEBI regulations do not coincide, nor are their provisions subservient to one another on different occasions. Inclining excessively in favour of public shareholders in the event of corporate Insolvency or possible liquidation can damage the established holdings of the Promoter Group.

The 2020 Paper did provide some respite to the new liquidity entity in the sense that the public equity shareholding needed to shoot up to the statutory level immediately, but instead after a certain period of time and in patches. The latest guidelines do a follow-up on the loose-ended question posed by the former and clarified that the SEBI (SAST) Regulations 2011[6], would cease to apply as long as the MPS was below the statutory level.

Conclusion

The link between the insolvency and Bankruptcy Code and SEBI has again been visited this time, albeit leaving the loop open for further discourse over the fact that the two legislations’ sui-generis application has not been properly scrutinized here.

The insolvency of a listed entity poses a complexity in the form of differential shareholdings and their subsequent distribution to creditors/shareholders. In the void of any concrete liquidation process for the listed entities, the Code looms at uncertain bailout for the minority stakeholders, until, of course either of the legislations or the regulatory bodies work out a solution to the conundrum.

References

[1] Priyanaka Gawande,”SEBI floats paper to protect equityshareholders under IBC” (Livemint, Nov11,2022) https://www.livemint.com/market/stock-market-news/sebi-floats-paper-to-protect-equity-shareholders-under-ibc-11668110075157.html

[2] Bhanu Ram vs. HBN Diaries and Allied Limited [C.P. No. IB (547)/2018]

[3] Insolvency and Bankruptcy Code,2016.s,14,238

[4] Innoventive Industries Limited vs. ICICI Bank Limited (Civil Appl. 8837-8838 of 2017)

[5] Sara Jain,”SEBI Consultation Paper on Minimum Public Shareholding” < https://www.arbitrationcorporatelawreview.com/post/sebi-consultation-paper-on-minimum-public-shareholding-in-cirp-cases > (Arbitration Corporate Law Review, Aug 28,2020)

[6] SEBI (Substantial Acquisitions of Shares and Takeovers)Regulation,2011 reg.3(2)

This article has been authored by Akshit Gupta, a student at Bharti Vidyapeeth, New Law College, Pune.