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

It is 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

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/RP vis-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 and

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 far-reaching 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.

Footnote:
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

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.