While the market for interim finance in India is relatively undeveloped, based on experience with DIP lending in the United States, interim finance's super-priority status, the potential for "priming" existing secured lenders and the high rates of interest on offer suggest this area will attract substantial interest from nontraditional players, existing lenders and new lenders...
A critical aspect of rescuing a company in financial distress is ensuring that it has access to sufficient cash to continue operating while the business is restructured. The recently introduced Insolvency and Bankruptcy Code 2016 (the "IBC") acknowledges this, with specific provisions on "interim finance" intended to encourage lending to companies that have entered the Corporate Insolvency Resolution Process (the "Resolution Process") under the IBC. While this is a new concept in India, the United States Bankruptcy Code (the "Bankruptcy Code") has had similar provisions, specifically those on debtor-in-ossession ("DIP") financing to companies in Chapter 11 proceedings ("Chapter 11"), in place for a number of years.1 This article considers the interim finance provisions in the IBC, and how the market for interim finance may develop based on experience with DIP lending in the United States.
Interim finance provisions of the IBC
The IBC defines interim finance as "any financial debt raised by the resolution professional during the insolvency resolution process period".2 The approvals required for interim finance differ depending on whether it is raised: by Interim Resolution Professionals ("IRPs") during the 30-day period following commencement of the Resolution Process, and prior to formation of the Committee of Creditors (the "CoC"); or after formation of the CoC and appointment of the Resolution Professional (the "RP").3 In the former case, IRPs may raise any unsecured amount they consider necessary without the subsequent approval of the CoC.4 They may also grant security over encumbered property for interim financing without the relevant secured creditors' approval where the value of such property is not less than twice the amount of the existing debt secured against it.5 The RP may only raise interim finance on terms approved by a 75% majority of the CoC.6 However, such terms may include the grant of "super-senior" security (in DIP lending, this practice is referred to as "priming").
Any interim finance raised, whether secured or unsecured, is treated as part of the "insolvency resolution process costs" (the "IRP Costs")7, which enjoy "super-priority" status. Any resolution plan proposed during the Resolution Process is required to provide for these costs be paid in priority to all other claims.8 This position is maintained if the Resolution Process fails and the borrower enters liquidation: IRP Costs are payable in priority to all other claims in the liquidation waterfall;9 and secured creditors are required to deduct their share of the IRP Costs from the proceeds of any realization of their secured interests following commencement of the liquidation.10
The provisions on DIP finance
under the Bankruptcy Code
are broadly similar to the IBC
provisions on interim finance. In
particular, the Bankruptcy Code
provides for unsecured DIP finance
to be granted "super-priority"
status and allows for "priming" of
existing secured lenders. As such,
experience with DIP lending should
provide a useful reference point for
how the market for interim finance
Potential developments based on the US experience
The provisions on DIP finance under the Bankruptcy Code are broadly similar to the IBC provisions on interim finance. In particular, the Bankruptcy Code provides for unsecured DIP finance to be granted "super-priority" status and allows for "priming" of existing secured lenders.11 As such, experience with DIP lending should provide a useful reference point for how the market for interim finance may develop. On this basis, potential developments include the following:
New participants in the market: Participants in the DIP lending market may be broadly divided into three categories: existing lenders who provide new loans to protect their pre-Chapter 11 exposure, for example to achieve a sale of collateral at going concern value, or to avoid another lender taking priority over their security (such loans are referred to as "Defensive DIPs"); new lenders who lend with the aim of eventually controlling or owning the debtor or its assets (such loans are referred to as "Offensive DIPs"); and lenders with spare capital, including non-traditional lenders such as hedge funds and private equity firms, who are incentivized to lend because of the prospect of high yields and the "superpriority" status granted to DIP loans. Initial indications are that interim finance is being provided exclusively by a niche within the third category - onshore Asset Reconstruction Companies ("ARCs").12 This may, to an extent, be due to the difficulties faced by existing lenders, particularly those that are state-owned, in obtaining the requisite approvals to provide further funds to distressed companies. However, based on experience in the DIP finance market: offshore credit and special situations funds may look to take advantage of the high yields on offer (initial indications are that yields are in the range of 16 to 24%)13 within relatively short time frames (the Resolution Process must be completed within 180 days, extendable by a maximum of 90 days)14; and existing and new lenders may begin using interim finance for "defensive" and "offensive" purposes.
Roll-ups and boot strapping: These are two controversial methods which Defensive DIP lenders employ to protect their pre-Chapter 11 commitments. "Roll-ups" refers to the practice of existing lenders providing DIP finance on a super-senior basis which: is largely used to pay off their pre-Chapter 11 commitments, thereby improving their priority position; and infuses minimal new money, usually just enough to liquidate the secured lenders' collateral at going concern rather than liquidation value. "Bootstrapping" involves lenders providing DIP finance secured against new assets acquired following the Chapter 11 petition (for example, receivables and inventory) on the condition that such assets are also used to secure their pre-Chapter 11 loans, thereby expanding the value of their security or "cross-collateralizing". Existing lenders in India may begin using these and other methods as they begin to appreciate the potential of the interim finance provisions as a means to protect their exposure.
Loan-to-own: Offensive DIP lenders have used DIP finance as a means of acquiring control of the borrower or a particular asset of the borrower (referred to as a "loan-to-own" strategy"). Such lenders include, for example, existing suppliers with large receivables or customers looking for backward integration. They have typically sought to achieve this through terms in the loan documents seeking to control the restructuring process, for example: requiring their approval for any plan of reorganization or asset sale; giving them rights to convert outstanding amounts on the DIP loan into equity; allowing for them to be paid first from the proceeds of any particular asset sale; and allowing them to use the secured debt claims represented by a DIP loan to make a credit bid for the assets of the borrower. We may see "offensive" lenders begin to utilize such provisions in the interim finance market. However, the challenges they will face include the following issues: providers of interim finance are not entitled to a seat on the CoC, and therefore their ability to influence the Resolution Process is limited; and there is a moratorium in effect during the Resolution Process, so they would not be able to enforce compliance with covenants through the Courts.
In summary, while the market for interim finance in India is relatively undeveloped, based on experience with DIP lending in the United States, interim finance's super-priority status, the potential for "priming" existing secured lenders and the high rates of interest on offer suggest this area will attract substantial interest from non-traditional players who specialize in distressed lending and special situations, existing lenders looking to defend their exposure and new lenders looking to implement loan-to-own strategies.15 Potential techniques employed in the DIP lending market which such new entrants may include roll-ups, boot strapping and covenants seeking to impose controls on the Resolution Process.
Footnote: 1. See in particular §364 (Obtaining credit), Bankruptcy Code. 2. §5(15), IBC. 3. The CoC may by a 75% majority at their first meeting either appoint the IRP as the RP or replace him or her with another suitably qualified professional (§22(2)(c), IBC). 4. §20(2)(c), IBC. 5. §20(2)(c), IBC. 6. §28(1)(a), IBC. 7. §5(13), IBC. Such costs include the RP's fees and costs incurred in running the business of the debtor as a going concern. 8. §30(2)(a), IBC. 9. §53(1)(a), IBC. 10. §52(8), IBC. 11. §364(c)(1) and (d), Bankruptcy Code. 12. http://www.livemint.com/Industry/fVH9148vveEGjy3p3IX0WK/ARCs-NBFCs-eye-interim-finance-market-as-bank-credit-to-dis.html. 13. http://www.livemint.com/Industry/fVH9148vveEGjy3p3IX0WK/ARCs-NBFCs-eye-interim-finance-market-as-bank-credit-to-dis.html. 14. §12(1) and (3), IBC. 15. At the time of writing, there were reports in the media that an offshore special situations fund was bidding to provide interim financing to the RP of Amtek Auto Ltd: https://www.debtwire.com/intelligence/view/2530986?utm_source=Notifications&utm_medium=Email&utm_campaign=Alert&utm_
Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.