Shareholders hurt in financial bailouts

One of the most contentious resolutions under the Insolvency and Bankruptcy Code (IBC) is that of Dewan Housing Finance, a case that involved one of the largest declared loot by a promoter right under the gaze of the bankers, auditors, credit rating agencies and a so-called board of directors. The RBI, which had failed to supervise and monitor a finance company that was among the biggest in the country with an asset size of around ₹1 lakh crore, pretended to have done its job by superseding the board of the company, appointing an administrator and referring the case to IBC, to break new ground of an NBFC coming up for resolution.

This is the maiden IBC involving public investors in debt, who were hardly represented in the committee of creditors. Putting the public at par with the banks, which actually should be charged with criminal negligence for not having caught Kapil Wadhwan in time when the swindle was going on for years, is perhaps the high point of injustice in this case.

The shares of DHFL were in active trading till a few days back, though the belief that sustained that and, in fact, helped raise the prices to meaningless levels was hard to divine. But that is the nature of the market and the reasons should be independently investigated by the exchanges concerned.

And then came the news like a thunderbolt that the completion of the resolution culminated in the de-listing and the ultimate cancellation of the shares. Irate investors have challenged it in the highest court.

Most IBC cases have involved change of ownership, necessitating writing down the existing shares to nil value and cancelling them in toto. This has necessitated the de-listing and the consequential challenge by the shareholders. Videocon is another recent case where the news reports confirm de-listing and cancellation.

It is time to pause and raise a fundamental question: do the shareholders see a logical value to their shares when even the secured debt holders have been settled for a value far lower than the face value?

In other words, DHFL’s assets as valued by the acquirer was far lower than its liabilities and hence its shares cannot have any value. Are the shareholders chasing the will-o’-the-wisp in seeking to stamp some value on the shares? They are, no doubt. But they have every right to and should have been allowed to pursue it. The resolution plan has wronged them by denying this option.

This issue surfaced in the Lakshmi Vilas Bank (LVB) resolution that happened by a government fiat when it was merged with DBS.

The shareholders were given nil value for the same reason that debts were not fully settled. Logically this was right. But the shareholders have filed a writ in the courts and it is pending. Did the shareholders initiate a meaningless litigation? No.

The value of the shares of any company is a derivative of its business value. In both LVB and DHFL, the acquirers paid a value for the undertaking and got a write-down of the debts to match it. If in those instances the undertakings got sold and the company left alone, this controversy would have been obviated.

Why didn’t it happen?

To go back in time to a little over five decades ago, the much criticised nationalisation of private banks in 1969 was not carried out the way the corporates are being hawked nowadays. With much thought behind it, the law enacted to nationalise dealt only with the business of banking carried on by the relevant entities and left the entity (company) itself untouched.

In that instance, a compensation that was payable was paid to the company left behind and the shareholders of the company had full freedom to deal with the company which held the consideration received.

In the IBC cases and in LVB the differentiator is that no compensation arose since the business value was negative.

Still, the corporate entity of DHFL or LVB is distinct and the IBC process should have enabled the acquirer to take over the entire business leaving the shareholders to deal with the shell entity.

It is the committee of creditors that decides every aspect of the resolution unilaterally. Contrast this with traditional corporate restructuring under company law or under the sick industries law, where the shareholders had full participation as an affected party.

All these entities would have significant tax losses having a monetary value, as by implication an insolvent business is one that has losses overflowing its equity. Strictly, these losses can be independently used by the leftover entity after the separation of the business.

It is a reasonable presumption to make that in the resolution plans of, say, Videocon or DHFL, the value paid by the acquirer would not include the tax benefits accruing. If it is to the contrary, the agencies concerned can disprove this by transparently sharing the valuation basis with the affected shareholders.

The Videocon settlement amount of about ₹2,900 crore is perhaps a third of the value of only its deferred tax assets due to the accumulated tax losses.

This is more than a sweetener or an icing on the cake in the acquisition. Already, the resolutions that have concluded have left behind the strong suspicion that they were grossly undervalued and the banks accepted a level of sacrifice clearly more than what meets the eye. And a tax benefit of a few thousand crore going unreckoned.

DHFL had more than ₹5,000 crore of deferred tax asset on its books even in 2020 and this figure should have doubled given the huge write-offs in the resolution. And the grouse of undervaluation was without any awareness of this fact.

The Supreme Court had held that the crown debts get no priority in an IBC process and the write-off applies to that as well.

So, the acquirer wins on both side of the coin.

The writer is a chartered accountant

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