Bankruptcy: Salvage what you can from your holdings in insolvent companies

Shareholders will get very little value for their holdings as bankruptcy laws don't favour equity investors

Many retail shareholders of companies that are undergoing bankruptcy proceedings are watching developments closely. They are hoping that the bidder who gets the National Company Law Tribunal's (NCLT) approval may revive the ailing company and their fortunes may change for the better. However, with lenders taking a massive haircut, shareholders may not be able to realise much value from their investments in these companies. 

Piyush Pandey, who has invested in Monnet Ispat & Energy, is ruing the fact that he didn't exit the stock when the price was higher. “I should have exited the company in November or December when there was still investor interest in the stock. The stock was trading at Rs 32-35 then,” says Pandey. The stock closed at Rs 14.14 on Friday. Monnet has outstanding loans of Rs 110 billion. The lenders are expected to take a haircut of around 72 per cent, according to the resolution plan that has been submitted.

Shareholders don’t get any preference under bankruptcy proceedings. “When a company goes into insolvency, by definition it means that existing shareholders have been wiped out. Many investors don’t realise it and, therefore, we see shares of these companies trading at such high prices,” says Sandeep Parekh, founder, Finsec Law Advisors.

Shareholders come last: The whole objective of the Insolvency and Bankruptcy Code (IBC) is to enable lenders to recover their dues. Whatever money the bidder invests goes first to secured and unsecured creditors, bondholders and then the government's dues are paid. Only after all these parties have been repaid in full does the turn of the shareholders come to get some value.

But in the current cases, the secured and unsecured creditors are receiving only a part of what the company owes them. Equity investors should, therefore, not expect any value out of the resolutions. "The IBC does not provide for any special treatment for shareholders generally or even a class of shareholders such as the minority shareholders, bidders are free to submit plans without any special consideration towards equity investors. It is the bidder’s call to decide the benefit he wants to give to various stakeholders,” says Amar Gupta, a partner at J Sagar Associates. 

They could lose their entire investment: There’s a lesson for shareholders in the resolutions that NCLT has approved and those that are in an advanced stage. According to Vedanta’s resolution, it will acquire 90 per cent stake in Electrosteel Steels. It means that the company will write-down existing equity by 90 per cent. The remaining will be held by public, promoters and banks who have the pledged shares.

It’s even possible for the bidder to submit a resolution where it wants to write down 100 per cent equity, which means that the holdings of existing investors amount to zero. While such a resolution has not come up in NCLT yet, lawyers say that the markets regulator, Securities and Exchange Board of India (Sebi), may not allow such proposals. But investors can expect a significant write-down of equity.

New regulations could be unfavourable:  Sebi is considering bringing in new regulations pertaining to companies that are under bankruptcy proceedings. Depending on the position Sebi takes, there are chances that the regulations may hamper shareholders' chances to exit a company.

“Representations have been made to Sebi to halt trading of stocks that are under insolvency proceedings,” says Kumar Saurabh Singh, partner, Khaitan & Co. Following this, Sebi had come up with a discussion paper in which it discussed halting trade as one of the options. If the regulator decides to halt trading or restrict it, existing shareholders will have even fewer opportunities to exit their holdings.

Many investors have been hoping that their investment in the defaulting company could grow, as Sebi regulations state that a listed company should have minimum 25 per cent public shareholding. They believe that the winning bidder cannot write-down maximum 75 per cent equity. At present, companies such as Vedanta will need to approach Sebi seeking an exception to its rules, and hold 90 per cent stake. But there’s always the possibility that Sebi may bring in regulation to relax the minimum public shareholding norms for companies that are in NCLT.

There’s also ambiguity on whether 100 per cent equity write-down will trigger delisting provisions, in which case shareholders have to be compensated adequately. Bidders, lawyers and other stakeholders are awaiting the regulator's clarification on this.

Don’t put fresh money: Stocks of insolvent companies have witnessed a fall when resolution proceedings have reached an advanced stage. Investors realise that they are not getting any value. Electrosteel Steels closed at Rs 1.04 on Friday. A month back it was at Rs 2.85, or 170 per cent higher. In January, it had even touched Rs 7.06. The stock of Bhushan Steel has seen similar volatility and at present trades at Rs 27.65.

Experts say that these were speculative trades. “Once the company is in NCLT, there are hardly any disclosures of proceedings. Those trading in the shares, therefore, speculate based on news about the proceedings,” says Ashesh Shah, MD, Trans Continental Capital Advisors Even after approval, the resolutions from the winning bidders can face hindrances, and the entire process could be delayed or reworked. There are a lot of uncertainties surrounding NCLT proceedings. Investors should, therefore, avoid putting fresh money until the restructuring exercise is completed.