Buying distressed assets in India

Practical Guide

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What is a distressed asset?

In simple words, when a person or business needs immediate cash and wants to sell an asset at less than its value, it becomes a distressed asset. Distressed assets belong to individuals or companies having major financial difficulties, and in default, or close to it. Distressed assets can occur due to a variety of reasons such as economic slowdown, market fluctuations and poor management.

Some people invest in distressed assets as they can often be purchased at a significant discount to their true value, with the potential for an upside if the asset is successfully turned around. However, investing in distressed assets also carries a higher level of risk as there is no guarantee that the asset will be successfully turned around or that the investor will be able to recoup the investment.

When a company is in likelihood of insolvency?

A company is in the likelihood of insolvency when it is unable to meet its payment obligations as they become due. The company may have difficulty accessing credit, have high levels of debt, or experiencing cash flow problems.

In most cases, when a company is likely to be become insolvent, it will seek to restructure its debts or obtain additional financing to help it address its financial difficulties. If these efforts are unsuccessful, the company may become insolvent and will have to undergo insolvency proceedings.

What are the legal risks for the buyer in buying distressed assets?

Buying distressed assets can carry legal risks for the buyer, and it is important to perform an in-depth due diligence and carefully consider risks before making any purchase. Buyers of distressed assets may inherit liabilities associated with the asset such as outstanding tax liabilities. Distressed assets may also be subject to regulatory compliance requirements that the buyer may not be aware of such as zoning laws. Failure to comply with these regulations can result in fines or penalties. In the case of immovable property, there may be liens or encumbrances on the property or disputes over ownership. In certain cases, distressed assets may be subject to existing contracts or leases that the buyer may have to assume and if the seller is in bankruptcy proceedings, the sale may be subject to approvals under the insolvency laws.

How can risks be avoided or limited without resorting to pre-insolvency or insolvency procedures under bankruptcy/insolvency law?

Risks can be avoided by conducting a thorough due diligence to identify potential risks and liabilities associated with the asset. Once the potential risks are identified, the buyer should carefully negotiate the terms of the purchase agreement and obtain appropriate representations, warranties and indemnities from the seller. Further, buyers may obtain applicable insurance to protect against certain risks.

How can risks be avoided or limited by using pre-insolvency or insolvency procedures under bankruptcy/insolvency law?

A pre-insolvency or insolvency procedure can be used to restructure the business and address its financial difficulties. This can include renegotiating contracts, reducing debt, or selling non-core assets to raise cash. Further, pre-insolvency or insolvency procedures may also provide protection from creditors such as a stay on enforcement actions/moratorium, allowing the business or asset to continue operating while a restructuring plan is developed. In some cases, pre-insolvency or insolvency procedures may help by removing the existing management that may have been responsible for the financial difficulties of the asset. This can help to bring in new management with fresh ideas and a different approach to the business/asset. Lastly, insolvency procedures can also be used to sell assets in a controlled and orderly manner that can help maximize the value of the asset and limit the risks associated with it.

Buyer's liabilities when the purchase is made in pre-insolvency or insolvency procedures.

In some cases, the buyer may inherit liabilities associated with the distressed asset as a successor to the previous owner. This can include outstanding tax liabilities or other debts or obligations. Further, a buyer may be required to return the asset where the transfer is held to be a fraudulent transfer. This may happen if the seller of the distressed asset was insolvent at the time of the sale, or if the sale was made for less than fair market value. However, the buyer may not be subject to any liabilities where it is shown that the buyer purchased the asset in good faith and at a fair value.

The buyer may also be liable for any regulatory compliance issues associated with the distressed asset such as violations of zoning laws, building codes, or environmental regulations.

To mitigate these liabilities, buyers should conduct thorough due diligence and obtain appropriate legal advice prior to the purchase. The purchase agreement should also include appropriate representations and warranties from the seller, indemnification provisions, and other protections that limit the buyer's exposure to liabilities and risks.

Is a public tender mandatory when the purchase is made in pre-insolvency or insolvency procedures?

In India, when a company is undergoing insolvency proceedings, the resolution professional invites prospective resolution applicants (who fulfill the criteria laid down by the resolution professional) to submit a resolution plan. Resolution plan means a plan proposed by any person for the insolvency resolution of the corporate debtor as a going concern. It may include provisions for the restructuring of the corporate debtor including by way of merger, amalgamation and demerger. The resolution plan that receives the highest votes from the committee of creditors is considered approved. There is generally no public tender for sale of individual assets as such.

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