Discussions on insolvency have gathered momentum over the past few months and we see reams of newsprint being spent deliberating on this vital topic. We are starting to see the resolution process coming to a close for the initially admitted cases with a mixed bag of results. A steel firm is acquired by a reputed Indian conglomerate for Rs 35,000 crore; another being acquired by a global conglomerate for Rs 5,000 crore; yet another Indian conglomerate bidding Rs 5,000 crore for a leading textiles firm. There is one concept pivotal to all these situations—the liquidation value. So, what is this liquidation value concept and what is its relevance to the insolvency process? How to determine liquidation value? Are other concepts like fair value of business relevant?
The liquidation value concept is central to most insolvency laws for settling dues of operational creditors and dissenting financial creditors prior to financial creditors who approve the resolution plan. The code defines it as “the estimated realisable value of assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date”.
Assets that can be liquidated in such cases are primarily hard/fixed assets like real estate and plant and machinery. In case of plant and machinery, first the current new cost of the equipment has to be estimated based on parameters like model, capacity, whether imported or indigenous, adjusting for duties or tax structures, providing for installation or commissioning expenses or soft costs. Depreciation effect is then applied on the new cost of the equipment for ageing.
Soft costs like preoperative expenses or interest cost are not included. Adjustments are done for (1) repair costs, (2) dismantling costs, (3) dismantling loss, (4) cost of auctioning and time value of money. In general, the above mentioned adjustments make a dent in the fair value of assets to the tune of 60-70%. For land, various marketability and rush sale discount are applied on the market value.
During the various resolution processes under way in the Insolvency and Bankruptcy Code (IBC), many bids came in at various levels as compared to the liquidation value. Some came in at two times, others were closer to the liquidation value. Market participants looking at bidding for these companies look at various aspects including its status as operating or non-operating, quality of tangible assets, possible synergy with their existing business, and business assets (brand, customer contracts, goodwill, etc).
While bidding process is a way to discover the market value of business that bankers could get, they could possibly do with some help. The idea that a techno-commercial business valuation be done (of the business facing insolvency) in addition to liquidation valuation is worth a debate. While recent amendments to the IBC do refer to a need for fair value, but it still talks of fair value of assets and does not specify the need for an enterprise/business valuation. A business valuation range may come to the assistance of bankers who have to decide on the adequacy of the bids received.
Valuation is an important part of the corporate insolvency resolution process, and a proper understanding of liquidation value is crucial to protect the interest of stakeholders and to formulate a compliant resolution plan. Any errors in determining liquidation value in the corporate insolvency resolution process can have far-reaching consequences, including the effect of undermining of reversing any resolution plan that may be approved based on an incorrect liquidation value. Introduction of other valuation concepts like business value are worth a debate and may be of assistance to bankers in facilitating decision-making.
The IBC 2016 has been one of the far-reaching reforms of the Indian economy, and one must give it due credit for the impact it has made in a brief period of less than two years. These are early days and we are certain that amendments would be made, and new concepts introduced to make it even more effective in the times to come.
The Author is Partner, KPMG in India
(Urvesh Mehta contributed to the article.)