Tanuj Agarwal, Institute of Law, Nirma University, Ahmedabad
“All intelligent investing is value investing, acquiring more that you are paying for.”
(Vice-Chairman, Berkshire Hathaway)
Merger & Acquisition (M&A) deals have witnessed robust challenges, firmly because of financial distress posed due to the Covid-19 outbreak. Where the companies have observed their all-time high valuations and market capitalisation in a momentous bull market, the Covid-19 pandemic has led to the deterioration of the commercial activities and financial market to a great extent. Many desirable and credit-worthy companies are unable to discharge their financial obligation owing to the economic fallout. This will surge the M&A activity in these financially distressed companies.
Consequently, these companies are desirable targets for the various acquisitive and opportunistic conglomerates. These conglomerates may look for companies with wide market exposure, credible balance sheet, and have the competence to flourish in the future, though facing financial distress in the short-run.Notably, it raises pertinent concern as to the structuring of the deal in order to ensure that there is no acquisition of unwarranted liabilities that may frustrate the purpose of having the deal.
Accordingly, this article discusses the appropriate deal structure that may be deliberated by the buyer to procure the most out of the company in a distressed situation. Further, the precise analysis is provided of the Reliance-Future Group Deal to discern as to how the suggested structure is applied, and also the unregulated aspects of such a deal structure. Furthermore, the article explores the US regime for a similar deal structure and how the Indian regulatory framework can embrace a similar regulation for the better mutual protection of the parties in the M&A deal.
Structuring the distress M&A deals
M&A deals can be structured either by the acquisition of common stock of the company or by acquiring the specific business unit or assets of the company.Notably, most of the M&A deals involve transactions of the shares of the company rather than the asset/slump sale transaction.Given the economic fallout and financial distress at the time Covid-19, a better way to structure a deal is the circumvention of the unwarranted and unidentified liabilities and fraudulent transfer. Consequently, the deal structured in a transaction of business or asset rather than the common stock of the company would limit the acquirer’s risk in a financially distressed company. Such transactions encompass the acquisition of specific asset/s or a business unit of the company.[i]While undertaking the distress M&A, the buyer is at a higher negotiating position as the counter-party has the risk of non-complying certain representations & warranties and financial claims in the future. Accordingly, the acquirer would prefer to cherry-pick the asset/s or capable business unit, with certain liabilities. This will grant the acquirer an opportunity to evade the unknown, unwarranted, and contingent liabilities. Arguably, a common stock deal would lead to the acquisition of all the assets and liabilities of the company as a successor to the business, which may also bring in numerous un-bargained and unknown obligations as the company is in distressed condition.
Reliance-Future Group Deal: An Opportunistic Slump Sale?
Future Group is facing a dark time as the company is under the debt of approximately Rs. 12,989 crores. The shares held by the promoter are pledged with the lenders. It has barely dodged the default by paying Rs. 100 crores on its foreign bonds. Considered a retail giant, even the deep pocketed Future Group has been under a financial distress. With such market coverage and well-established distribution and logistics channel, the business units and assets of the Future Group would be an attractive option for any conglomerate. Reliance through its unit Reliance Retail Ventures Limited (RRVL) went ahead to cherry-pick the Future Group and structured the acquisition of its retail & wholesale business as well as logistics & warehousing business on a slump sale basis for an amount of Rs. 24,713 crores. As per the scheme, the retail and wholesale business units are being transferred to RRVL’s wholly-owned subsidiary Reliance Retail and Fashion Lifestyle (RRFLL). RRVL & RRFLL will also acquire specific liabilities and pay the balance consideration by cash. The deal is subjected to approval by shareholders and regulatory authorities such as CCI, NCLT, SEBI, etc.
The pertinent thing to note here is that Reliance acquired the defined and valuable business units which have extensive distribution chain encompassing key retail players such as Big Bazar, FBB, Central, Brand Factory, etc. Moreover, it has also equivocated various business obligations and warranties by specifically acquiring certain liabilities as a part of the consideration. RRVL, which has robust financials, would not require establishing the retail, wholesale, logistics and warehousing units. The deal is indeed favorable to the Reliance.
However, there also exists a concern regarding the valuation on which the deal is formulated. Numerous market analysts and investment managers observed that the valuation of the business units under a slump sale is around Rs. 30,000 crores. Reliance has structured the scheme in a manner to acquire Rs. 30,000 crores business units by making an investment of around Rs. 24,000 crores. Reliance is simply “acquiring more than[it is] paying for” by using its negotiating position against a distressed company. The opportunistic behaviour on the part of Reliance is much evident. Moreover, the consequence of such a deal structure is that the shares prices of all the listed companies of Future Group have significantly fallen and observed a continuous under-circuit in their share prices.
Need for Regulation
Accordingly, a need arises to regulate such distressed M&A deals in order to protect the interest of the company and shareholders of such distressed companies to have a fair valuation of the business units. The regulatory approvals of NCLT, SEBI, etc. is required. However, it may not be conceivable for these authorities to control the valuation of the scheme determined by the parties. In the case of Mihir H. Mafatlal v. Mafatlal Industries, the Supreme Court stated that High Court (now the powers are vested with NCLT) is not empowered to question the wisdom of members by enquiring in the aspects of valuation. The mere requirement is the approval by members and creditors, and if the scheme is passed by them, the court has to pass the scheme irrespective of the valuation. Pertinently, the case is regarding the valuation of shares, however, the regulatory approach and governance can be discerned by such decisions that the valuation is broadly rests with the decision of members and creditors. Therefore, the resilient and regulated mechanism is required to settle the finest price of the business/asset as far as possible, at the same time not providing the task of valuation to the regulatory authority.
Lesson From the United States
In order to conquer the regulatory issue, the mechanism to provide for the competitive bids of business units or assets is required to have a better valued and regulated price. A comparable regulatory structure as that of 363 sale under the US Bankruptcy Code is required. This enables the company to pay-off debt by the receivable of assets sold as per the provision outside the ordinary course of business. As similar to slump sales, it also enables the purchaser to acquire valuable assets without any unknown obligations. Notably, the provision provides for the highest value of assets by offering competitive bids. The process is supervised by the US Bankruptcy Code. The 363 Sale initiates with the marketing of assets, followed by the offers of interested purchasers. Afterward, the highest bid acts as a stalking horse and the price works as a base price for the auction of assets.[ii] This preserves the distressed company from opportunistic lower bids.
The Indian regulatory framework also reflects a provision for competitive bids, however, it is limited to the acquisition by purchase of common stock of the company.[iii]The regulation providing for the competitive bids of the business/assets acquisition and the settlement of base price would shield the distressed company from the high negotiating position of the conglomerate acquirer. At the same time, it would suffice the court’s approach in such M&A deals not to question the valuation, since the role of regulatory authority, if any, would only be limited to the supervision of competitive bids.This would blossom the mutual interest of the parties as well as the shareholders of the distressed company.
The Indian conglomerates have undertaken a robust approach to avoid unwarranted liabilities by structuring the acquisition of worthy assets/business. Principally, there is no harm in such structuring as it leads to effective appropriation of the business. However, the opportunistic behavior of acquisition in a distressed situation is detrimental for the transferor and its investors. Thus, a suggested mechanism similar to 363 Sale would curb such opportunistic acquisition, and it is also in conformity with the prevailing regulatory approach of the Supreme Court regarding valuation.In view of that,“acquiring more than what you are paying for” is indeed value investing, however opportunistic behavior in a distressed environment should be condemned as it may hamper public interest.
[i] Nikhil Narayanan, An Introduction to the Key Concepts and Practical Considerations in Indian M&A Transactions for an International Lawyer, 19 Bus. L. Int’l 101, 116 (2018).
[ii]John J. Hurley, Chapter 11 Alternative: Section 363 Sale of All of the Debtor’s Assets Outside a Plan of Reorganization, 58 Am. Bankr. L.J. 233 (1984).
[iii] Regulation 20, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.