A listed company, being a contract between equity and debt, has equity owners retaining control as long as debt obligations are met. Consequently, a default brings creditors to the forefront, while relegating equity owners to the background. This idea is clearly reflected in both the resolution and the liquidation mechanism prescribed under the Insolvency and Bankruptcy Code (IBC) which embodies the “creditor-in-control” model. Equity shareholders are not only excluded from the mechanism which approves resolution plans, i.e., the Committee of Creditors, but are also placed at the bottom of the liquidation waterfall which is the typical mechanism for the distribution of funds in case of any recoveries through a resolution plan or liquidation of the assets of a sick company.
The IBC, however, overlooking the varying situation of different equity shareholders, treats retail investors and other minority shareholders on a par with promoters and other big investors having a considerable sway in the working of the company. This disparity is also showcased during corporate insolvency resolution process (CIRP), where promoters could use their financial strength to acquire shares at dirt-cheap prices from small investors’ frantically selling shares to mitigate losses.
Similarly, there is no explicit provision underscoring retail investors’ interest in cases of a successful resolution of a financially distressed company’s debt. Besides the fact that the equity shareholders have no role in the approval of the resolution plan, even the continuation of the company’s listing is a decision taken as per discretion of the successful resolution applicant, i.e., the entity acquiring the distressed company under the insolvency resolution process.
The usual practice in cases of continued listing of the erstwhile insolvent company involves the wiping out of the existing promoter shareholding and a proportionate reduction in public shareholding. However, given that the minimum public shareholding requirement for companies implementing resolution plans has been relaxed from the usual 25 per cent to a mere 5 per cent, the amount recuperated by retail investors become next to nil.
Retail investors’ condition further worsens when the resolution applicant chooses to delist the company. Listed companies undergoing resolution are not required to comply with the ordinary delisting regulations and the only protection afforded to retail investor in such cases is the provision of an exit opportunity. However, as this exit price only needs to be equivalent to the price offered to other shareholders, and equity is usually extinguished in case of successful resolution, the acquirer is able to offer retail investors an exit price which is a big “zero” while still complying with the delisting regulations. This happened in the case of DHFL’s insolvency, where the resolution applicant acquired equity shared held by shareholders by way of reduction in paid-up capital at zero rupees. The minimum floor set by the law, according to which every stakeholder should, at the very least, be given a value that they would have got if the company was liquidated, does not help the retail investor’s case as this value, more often than not, is nil.
The vulnerable position of inexperienced and poorly informed retail investors is further highlighted by the fact that they often buy shares of listed companies undergoing the insolvency resolution process in the hope of windfall gains, especially when a big business house applies as a resolution applicant. However, seldom do they realise or factor in contingencies such as the resolution applicants backing out, resolution plans being subject to the approval of the committee of creditors and the buyback/delisting price being almost zero.
This underscores the imperative to incorporate modifications in the existing corporate insolvency regime. The foundational step in effecting these adjustments would involve the recognition of the differential, and to some extent the disadvantaged, position of retail investors’ vis-à-vis promoters and other big institutional investors. This acknowledgement would pave way for the realisation of the need to further sub-classify different categories of equity shareholders in the liquidation waterfall, by distinguishing impuissant retail investors from promoters and other equity investors, as well as the imperative for the provision of differential exit prices for retail investors and other minority stakeholders.
Nevertheless, the utility of an inter se classification of equity shareholders can be criticised, primarily due to the absence of available funds by the time one reaches the bottom of the liquidation waterfall. Remedying the same would involve rethinking the position of retail investorsvis-à-vis creditors and other stakeholders in the waterfall mechanism. This can be done either by tweaking the waterfall hierarchy or by incorporating special provisions to protect the interest of retail investors.
Learnings can be drawn from the reconfiguration of the status of homebuyers under the IBC to provide homebuyers with an increased degree of protection; given that retail investors, similar to homebuyers, are usually common public who are investing their hard-earned monies through systematic equity and investment plans. This priority order reconfiguration, however, may militate against the creditor-centric model envisaged in the IBC and would require proper deliberation and balancing of the interests of different stakeholders.
A more feasible alternative to safeguard the interest of retail investors can involve enhancing their level of information and vigilance. Given the typical profile of retail investors, they often find themselves unaware of crucial developments in the company that they have invested in. Provision of information regarding important events prior to, during, and after the CIRP would allow retail investors to make more informed decisions and mitigate potential losses.
This approach has gained recognition by SEBI in a consultation paper released on November 10, 2022, where it proposed the inclusion of several CIRP related events as material events under the Listing Obligations and Disclosure Requirements in order to ensure that the retail investor remains well-informed and is able to decide when to pull out their hard-earned investments out of a company.
It goes without saying that interest of the public at large is paramount especially in an economic legislation like IBC, 2016.
While cleaning up of the NPAs of banks is certainly a key aspect of the Code, the common man cannot be short-changed in the process and it’s high time the lawmakers build in protection mechanisms for public and retail investors.
The writer is Partner, Anant Merathia & Associates