Importance of Valuation in CIRP November 10, 2018 CA Rajan Wadhawan

Valuation is critical to the entire Resolution Process… Creditors Bidders/ Resolution Applicants Liquidator Resolution Professional

An Overview Valuation Requirements under IBC Liquidation Value 1 February 2014 An Overview 1 Valuation Requirements under IBC 2 Liquidation Value Definition and its Significance Challenges and Key Considerations 3 Fair Value

Valuation requirements under IBC

At commencement of CIRP At the time of Liquidation Valuation requirements under IBC Governing regulation - Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 At commencement of CIRP Appointment of Registered Valuers (Regulation 27) Resolution Professional (“RP”) to appoint two Registered Valuers; Each Valuer to determine the Liquidation Value and Fair Value of the Assets of Corporate Debtor (“CD”) Fair Value and Liquidation Value (Regulation 2(hb), 2(k) and 35) Fair Value and Liquidation Value of the Assets to be determined in accordance with internationally accepted valuation standards. Valuers to also conduct physical verification of inventory and assets. RP appoints a third valuer if estimates of the two Valuers are significantly different. The average of two closest value estimates (for each Fair Value and Liquidation Value) is considered as the final value At the time of Liquidation Liquidator relies on the valuation done under the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 or Undertakes a fresh valuation if not done earlier

Liquidation Value

Liquidation Value – Definition and Significance Definition as per Code estimated realizable value of the assets of the corporate debtor, if the corporate debtor were to be liquidated on the insolvency commencement date Significance Assumes sale of a single asset or group of assets on a piecemeal basis Assumes orderly sale (reasonable amount time to sell assets) and not forced sale (fire sale) Indicative floor value to RP/CoC and the likely ‘haircut’ on the loans in the event of no feasible Resolution Plan; Relevant for liquidator in liquidation

Challenges and Key Considerations Liquidation Value Challenges and Key Considerations Liquidation Value of Assets as at the insolvency commencement date vs the actual realization on Liquidation may be different on account of: Cost to sell/ liquidate Time required to sell Impact of Cases / litigations Change in Scenario as on Appointed Date vs Liquidation Date Asset specific key considerations : Leasehold Land Consideration of Terms of Leases – Restrictions on transferability i.e. payments/ permissions required for transfer, balance lease term, amount already paid Non transferable leases may have a very low value (even when the balance lease term is significant and value of continued use i.e. Fair Value is high)

Challenges and Key Considerations Liquidation Value Challenges and Key Considerations Buildings Buildings are made for specific requirements – In general Factory Buildings are considered at knock down value (salvage value) However, Liquidation Value of Residential buildings may be close to Fair Value (subject to the micro-market conditions and restrictions), as they could be sold on an as-is basis….. Plant & Machinery Will require adjustments/discounts to the fair value based on nature of the assets, usage, prospective market, possibility of it being sold on a piecemeal basis and the likely salvage / scrap value Soft costs like installation & commissioning and dismantling costs require adjustment while assessing Liquidation Value

Challenges and Key Considerations Liquidation Value Challenges and Key Considerations Intangibles Brand/ Tradenames may be valuable on a standalone basis, even for non operating businesses Assessment would be subject to availability of detailed financial information such as business plan, intangible asset specific revenues/ cash flows Other intangibles (Customer Relationships/ Distribution Networks) – needs to be evaluated on a case to case basis Investments - Unquoted Requirement to assess the value of the investment held in such Companies and NOT the Liquidation Value of the Assets of such Investee companies May require adjustments/ discounts to the Fair Value of such investment – consideration to be given to interdependencies/ relationships with holding company and availability of information

Challenges and Key Considerations Liquidation Value Challenges and Key Considerations Trade Receivables Recoverability assessed based on audited accounts, ageing and discussions Balance confirmations (a time consuming audit procedure) is not possible Inventory Consideration of the recent Net Selling prices, inventory movement, ageing Challenge in estimating value of in-process inventory – require assessment of the stage where the in-process inventory is. At times such data is not available Other Assets (Loans and advances, other advances etc.) Require discussion with RP/Company’s employees and audited accounts Assessing recoverability of related party loans – require additional information/discussion Valuation is carried out within a specified timeline Impact of forensic audit, change in industry dynamics/ any other findings cannot be factored Physical Verification of inventory happens at a date much later than the Insolvency Commencement Date

Fair Value

Fair Value – Definition and Significance estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion Significance Enables RP/Committee of creditors (“CoC”) to better evaluate the Resolution Plan of bidders and compare the bids with estimated the value of Assets under existing use Provides the value of assets on as-is where is basis (going concern basis) Provides a benchmark to the potential bidders to evaluate the cost to create vis-à-vis the cost to acquire

Challenges and Key Considerations Fair Value Challenges and Key Considerations Assets vs Business? Currently, Regulations mention Fair Value of Assets RP, in discussions with CoC, may also request for Fair Value of the Business. Fair Value of Business subsumes value of all intangibles whether recorded in the Financial Statements or not Fair Value of Business – Challenges and Considerations Availability of reliable business plans especially for listed companies Fair Value of Business if lower than Fair Value of Assets indicates impairment/ economic obsolescence for the existing use of the Assets Value to each Buyer may be different (higher or lower than Value of Assets) – Different Cost of Capital, Strategic/Synergy Benefits, Business Plan

Challenges and Key Considerations Fair Value Challenges and Key Considerations Fair Value of Assets Intangibles Assets Intangibles such as Brand/ Tradename/ Customer Relationships/ Distribution Network are valuable especially in consumer centric business (B2C) Bidder/buyer may look to capitalize on the existing intangibles and possible synergies, which makes them a key factor in their resolution plan Intangibles - not included in FS Requires detailed information such as business plan, Intangible specific revenues/ cash flows and revival expenses in case of non-operational brand/ tradenames Difficulties in getting such information for non-operational business or for listed companies

Challenges and Key Considerations Fair Value Challenges and Key Considerations Fair Value of Assets Unquoted Investments/ Value of Subsidiaries/ Associates/ JVs Availability of information i.e. latest financial statements and projections Holding Company’s interdependencies with the Subsidiaries/ Associates/ JVs may affect its Fair Value e.g. Subsidiary / associate may supply key raw material or provide key utilities like power to the Holding Company At time subsidiaries may be of equal or even higher value than Holding Company – may require separate assessment Unavailability of projections of Subsidiaries/ Associates/ JVs results in reliance on Net Asset Value Approach which may be higher or lower than the Fair Value

Challenges and Key Considerations Fair Value Challenges and Key Considerations Fair Value of Assets Physical Verification Inventory movement: Physical Verification (PV) happens at a date much later than the Insolvency Commencement Date – Consider Inventory Movement sheet Limited time - Focus on high value items Physical Verification of Raw Material and WIP considering its nature and stage of operations Physical Verification does not include quantity surveying, technical assessment of grade/ quality of raw materials

Key Takeaways Liquidation Value and Fair value is “Central” to the resolution process and NOT just a REQUIREMENT At the commencement of Valuation it should be agreed that : Which the Intangible assets (not in the balance sheet) are to be valued Whether value of Business is to be assessed The subsidiaries / investments which also needs to be fair valued (would depend on the available information) Key Information which is required and who would be providing the same Understanding the basis of Fair Value and the reasons for divergence with Liquidation Value enables better evaluation of the resolution plans

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