With the Securities and Exchange Board of India expected to consider the implementation of a ‘safety net’ for Initial Public Offerings in its next board meeting, retail investors can look forward to some safety in stock market investments for at least the short term of six months.
However, there are a number of other instruments where retail investors do not have much redressal if things go wrong. For example, in the past couple of months, defaults and restructuring of short-term debt has risen. The commercial paper of Glodyne Technoserve was recently downgraded due to the company’s weakening financial and liquidity profile. In July, Deccan Chronicle defaulted on short-term non-convertible debentures of Rs 200 crore. As a result, CARE Ratings slashed its debt rating from A1+ to D. These defaults and downgrades have raised concerns over companies’ liquidity in the current economic environment.
While the defaults discussed above are only on certain instruments, there could be cases where companies go belly-up. And, if you are one of these, what can you do?
Mumbai-based lawyer Ajay Sethi says there is hardly anything individual investors can do, as secured creditors get preference over others when the time comes to pay back. Typically, if secured creditors, such as banks, feel the company does not have money to pay up, they take it into liquidation for their dues. The company's assets such as land and other immovable properties are auctioned to raise funds. Any creditor can opt for this but there is a preference order in which each one will be paid. And, the process is frustratingly slow and takes years before it gets solved.
Here's what you can do if you hold of the instruments listed below.
Equity shareholders: If a company goes bankrupt, government creditors such as the income tax department get first preference. Then come secured creditors such as banks and debenture holders, followed by unsecured ones like term deposit holders, preferential shareholders and equity shareholders, explains Anil Harish of Mumbai-based law firm, DM Harish & Company.
Some believe that equity investors should not even expect any returns in case a company goes bust. They are the last of the lot to receive their money, as they take the ownership risk, being stakeholders. As a result, each time a company goes bust, thousands are left unpaid.
Preferential shareholders: Unlike the name, these are debt instruments and carry a fixed coupon rate. These may be convertible, to normal equity shares on a fixed date or unconvertible ones. If the company is taken into liquidation, preference shareholders will be considered to be paid before equity shareholder, but only in case of non-convertible ones, say lawyers.
Term deposit holders: These are unsecured credits you have paid to the company. Says Amit Agarwal, partner at SN Gupta & Co, “Such investors can file a recovery suit. But, this is only if the company is cash-rich and is not paying the investors.” Again, the process will take its own time to conclude. Many times, the company may not bother with the recovery suit.
However, if the company is cash-strapped, then any of the investors/ creditors can initiate the winding-up process. Firms such as wine maker Indage, says Harish, paid up at this initiation. Otherwise, the court may hear your process and if it gives a decree in your favour, you can use it to auction the firm’s assets. Remember, you will be paid on a pro rata basis, as and when the assets are sold and only in line with the preference order.
Debenture holders: These can be secured or unsecured. Recently, issues of Shriram Transport Finance and Muthoot Finance were secured issues. Many of the secured debt instruments are marked to a trust that pools money for security reasons. Therefore, a secured debenture holder has the right to enforce security against the issuer. That is, they have the right to be paid without taking the company into liquidation. The unsecured debentures are called equity-linked instruments. These may be fully convertible debentures that are not redeemable but converted into equity shares such as preferential shares. Partially convertible ones have some debt component and are not fully convertible. But, the holders of these debentures will get the same treatment as equity, says Agarwal.
