India: Valuation Of Assets Under The Insolvency And Bankruptcy Code, 2016: Understanding The Term 'Liquidation Value'

Valuation of assets is one of the core features of the corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016 (Code). However, there are various clarifications that are yet to be provided by the Insolvency and Bankruptcy Board of India (Board) in relation to provisions pertaining to valuation of assets as provided under the Code and the Regulations. One of the prominent controversies in relation to valuation of assets is the lack of clarity surrounding interpretation of the term 'liquidation value' under the Code.

The term "liquidation value" is defined under Regulation 35(1) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution for Corporate Persons) Regulations, 2016 (CIRP Regulations) as 'the estimated realizable value of assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date'. Regulation 35(2) of the CIRP Regulations prescribes the method for determining liquidation value. From a bare reading of the said definition, it emerges that liquidation value is the notional realizable value that assets of the corporate debtor would fetch, should the corporate debtor be liquidated on the insolvency commencement date (and not the value that may be actually realized under a resolution plan). However, the ambiguity arises with respect to determining "estimated realizable value" in the context of the insolvency resolution process as opposed to valuation in an out-and-out liquidation of assets. Typically, a valuation report often comprises more than one sale value for an asset based on valuation under different scenarios. For instance, a valuation report may provide for a fair market value, realizable value and distressed sale value of an asset. The multitude of jargon and terminology in valuation only adds to the already difficult task that registered valuers (appointed under the Code) and the insolvency professional discharging his/her function as an interim resolution professional (IRP)/resolution professional (RP) face in determining character of asset value that should be considered as liquidation value for purposes of Regulation 35 read with Regulations 36 and 38 of the CIRP Regulations. The determination of 'liquidation value' of assets is an extremely crucial exercise, keeping in view its practical implication on the resolution plan, claims of creditors and prospective investors.

Objective

One of the most important pieces of information that forms part of the Information Memorandum1 is liquidation value. The purpose of having to provide for a liquidation value as part of the Information Memorandum during the corporate insolvency resolution process is in turn to enable compliance with provisions of Regulation 38 of the CIRP Regulations which requires identification (and subsequently payment) of specific sources of funds for payment of dues of operational creditors and dissenting financial creditors at liquidation value in priority to recovery of dues of other financial creditors who approve the resolution plan. In the event a resolution plan is reached and approved, operational creditors and dissenting financial creditors will have to be paid at this "notional" liquidation value in Regulation 35(1) since the corporate debtor would not actually go into liquidation.

Duty of an IRP/RPvis-à-vis the liquidation value of the corporate debtor

One of the key tasks of an IRP/RP is to appoint two registered valuers (as per Regulation 27 of the CIRP Regulations), who in turn will determine liquidation value (as per Regulation 35 of the CIRP Regulations) of the corporate debtor and submit the same to the IRP/RP. The registered valuers are required to provide an estimate of liquidation value "computed in accordance with internationally accepted valuation standards, after physical verification of the inventory, and fixed assets of the corporate debtor."2

It is incumbent upon the IRP/RP to observe if there is a significant difference between the two estimates of liquidation value submitted to him/her, in which case, the IRP/RP may appoint a third registered valuer who will submit an estimate of the liquidation value computed in the same fashion as the two valuers first appointed. Thereafter, the IRP/RP will have to consider average of the two closest estimates as liquidation value.

Pursuant to this, the IRP/RP is required to note the said liquidation value of the corporate debtor as well as the liquidation value due to an operational creditor (arrived as per the waterfall mechanism under section 53 of the Code) in the Information Memorandum prepared in terms of Regulation 36 of the CIRP Regulations.

Thus, it is to be noted that the duty of determination of liquidation value is based on the registered valuer and the duty of the IRP/RP in this regard is summarized herein below:

(a) Appointment of two registered valuers (as per Regulation 27);

(b) Observing any discrepancy in the two values submitted by the registered valuers and subject thereto, appointing a third valuer to provide another estimate of the liquidation value, so that the estimate of the two closest values may be taken as the liquidation value (as per Regulation 35(2));

(c) Incorporating the said liquidation value (as provided by the registered valuers) in the Information Memorandum (as per Regulation 36).

(d) Ensuring that every resolution plan identifies sources of funds, and provides for making payment of claims of operational creditors at liquidation value in priority to financial creditors and within 30 days of its approval (Regulation 38(1)(b) of the CIRP Regulations); and

(e) Ensuring that every resolution plan identifies sources of funds to make payment of claims of the dissenting financial creditors at liquidation value in priority to recovery by other financial creditors who approve the resolution plan (Regulation 38(1)(c) of the CIRP Regulations).

Liquidation value visà- vis Realizable value

The term 'Liquidation value' as generally understood is the value of an asset which is arrived at when a seller is under extreme compulsion to sell. As mentioned earlier, Regulation 35 of the CIRP Regulations, which defines the term 'liquidation value' specifies that the said value is to be a notional value, which should be arrived at considering a hypothetical scenario of liquidation of the Corporate Debtor on the date of insolvency commencement. In other words, it will be an estimated value calculated by registered valuers if the Corporate Debtor were to be liquidated on the insolvency commencement date. This is similar to the concept of "vertical comparison" under Chapter 11 of the United Stated Bankruptcy Code, and an accepted definition for arriving at liquidation value under English insolvency laws.

It is observed that the definition of the term 'liquidation value' uses the term "realizable value", thereby indicating that liquidation value is the notional realizable value arrived at the time of liquidation of the Corporate Debtor, in terms of provisions of the Code. In view of the aforesaid, it may be pertinent to consider the procedure to realize assets during liquidation of the Corporate Debtor, as more particularly provided under Chapter III of the Code, read with the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (Liquidation Process Regulations). In this regard, Regulations 32, 33 and Schedule 1 of the Liquidation Process Regulations, provide that a liquidator appointed as per the Code, may sell the assets either on a stand-alone basis or sell the assets in a slump sale /a set of assets collectively /the assets in parcels. However, it is stated that the mode of sale shall ordinarily be through auction, unless,

(1) the asset is perishable; or

(2) likely to deteriorate in value significantly if not sold immediately; or

(3) is fetching a better price than the reserved price of a failed auction; or

(4) has the permission of the Adjudicating Authority, in which case the liquidator shall sell the assets by means of a private sale.

The Schedule I to the Liquidation Process Regulations, under part (1) item (4), specifies that for the purposes of auction, the reserve price would be the value of the asset determined by the registered valuers in terms of Regulation 35.

Thus, it becomes evident that identification of an asset plays a crucial role in determining liquidation value. In ordinary circumstances, the liquidation value of an asset is likely to be the notional reserve price at which such an asset would be sold in an auction. However, if the nature of the asset is perishable or such that its value may depreciate significantly if not sold immediately, then the value of such an asset may be determined on the basis of a private sale. It may be stated herein that the methodology to be adopted for determining the aforesaid values is to be as per internationally accepted valuation standards, after physical verification of assets of the Corporate Debtor.

Conclusion

Valuation is a quintessential part of the corporate insolvency resolution process, and a proper understanding of liquidation value is crucial to protect the interest of stakeholders and to formulate a compliant resolution plan. Any errors in determining liquidation value in the corporate insolvency resolution process can have farreaching consequences, including the effect of undermining of reversing any resolution plan that may be approved on the basis of an incorrect liquidation value. In fact, a case of allegedly incorrect determination of liquidation value under the CIRP of Hotel Gaudavan Private Limited has already resulted in a criminal complaint against officers of a private securitization company and the resolution professional3. It is therefore crucial for insolvency professionals, and more importantly, for registered valuers, to have a correct understanding of the definition of liquidation value under the Code read with CIRP Regulations. While one expects the understanding of valuers and a customization of valuation methods to more accurately determine liquidation value in the corporate insolvency resolution process, any clarification on liquidation value under the CIRP Regulations and the Code by the Board or the Adjudicating Authority would be a welcome move that would help bring about consensus on this much debated issue.

Footnotes

1 Refer to Regulation 36 of the CIRP Regulations

2 Refer to Regulation 36(2)(a) of the CIRP Regulations 3 http://www.business-standard.com/article/pti-stories/resolution-professional-others-booked-for-cheatinghotelier-117082000681_1.html

Originally published in Legal Era | www.legaleraonline.com, September 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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