Valuation: The Fulcrum of IBC
Core Axiom: Valuation as the Foundation of the Insolvency Regime
“Valuation is the foundation on which entire stake and structure of IBC is dependent. The Insolvency and Bankruptcy Process as defined under IBC, 2016 determines whether a business will continue its life cycle or not as Insolvency Process aims at saving the businesses that are viable and enables the exit of those that are not. With the globalisation and ever-increasing competition in the market, many corporates have entered into various business segments. In this journey of their business life cycle, we all have witnessed numerous companies going into either Merger and Amalgamation (M&A) or Sale of Businesses or Liquidation or Voluntary Liquidation or Insolvency process for Corporates, Pre-package etc. every day. All these strategic business decisions impact each and every stakeholder including the smallest investor/stakeholder to a great extent.”
1. The Insolvency Process & The Primacy of Asset Valuation
This whole process of insolvency involves various steps and procedures and necessitates the need of many professionals and their expertise. This process starts broadly with Application to NCLT for commencement of insolvency resolution process, acceptance of which leads to appointment of IRP and then the Moratorium period begins (a calm period) during which the Insolvency Resolution Professional (IRP) will call for claims, analyse and verify them, also a Committee of Creditors (CoC) is formed to whom the Resolution Plan is presented (at first) for approval and thereafter to NCLT. Non-approval of the same may lead to Liquidation: the end of business life cycle.
Further, there are many intricate processes that are being involved and undertaken, such as estimating the value of the assets, preparation of Asset Memorandum etc. The key objective under this process of IBC is to maximize the value of assets of the Corporate Debtor and consequently value for its stakeholders. This value is a critical element towards achieving the transparent and credible determination of the value of the assets to enable comparison and informed decision making by the CoC.
The Benchmark for Commercial Decisions & Haircut Assessment:
The decision by the CoC and the NCLT w.r.t. approval of the Resolution Plan is dependent upon the fair value and liquidation value ascertained by the Registered Valuers which enables the comparison of both i.e., the value of the assets of the company as per the Registered Valuer and the haircut as envisaged in the Resolution Plan.
The Valuation Report of the Valuer becomes a fundamental basis on which crucial decisions of the Committee of Creditors are dependent such as continuation with the resolution process or liquidation of the Corporate Debtor. Moreover, it also facilitates the resolution professional to invite prospective resolution plans and the inaccuracies in determining the liquidation value could undermine the resolution plan that may be approved on the basis of an incorrect liquidation value. Therefore, the future of the corporate debtor and its stakeholders hinge on an accurate valuation of assets.
2. Statutory Framework: Section 247, Valuation Rules & CIRP Regulations
The Code read with the Regulations has been framed in a way that it mandates the valuations required under the Code and the Regulations made thereunder shall be conducted by a Registered Valuer. The Valuation acts as the steering wheel which runs the entire process of resolution process in its desired direction. So, it becomes extremely crucial to arrive at a correct valuation by the Valuer due to the reason that a faulty valuation may lead to incorrect comparison and consequently erroneous decision on the part of CoC leading to disruption of the business and the economy.
Section 247 & Valuation Rules, 2017
Owing to the huge importance of Valuation in resolution process and uniqueness involved in the nature of every valuation assignment, the need of a special class of professional was emphasised and made effective from 1st February 2019 through Section 247 of the Companies Act, 2013.
It mandates valuation by a person having necessary qualifications and experience, who is a member of a Registered Valuer Organisation (RVO). The Central Government notified the Companies (Registered Valuers and Valuation) Rules, 2017, delegating regulatory authority to the Insolvency and Bankruptcy Board of India (IBBI).
Regulations 27 & 35 of CIRP Regulations
Regulation 27 read with Regulation 35 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 mandates that valuation must be conducted by two Registered Valuers appointed by the RP to determine the ‘fair value’ and ‘liquidation value’ of the Corporate Debtor.
Where the RP is not satisfied with the two Valuation Reports and where the variance between these values is significant, the RP may require a third valuer to be appointed.
3. Professional Guidelines, Standards & Conduct for Registered Valuers
The valuation report is developed and prepared by exercising judicious discretion by the Registered Valuer, considering relevant factors such as management capability, present and prospective competition, yield on comparable securities, and market sentiment, which may not be apparent from the Balance Sheet. Valuers must adhere strictly to the following professional code and principles:
4. Comprehensive Practical Challenges Faced by Registered Valuers under CIRP
The process of valuing an asset may seem simple on the surface, but involves huge intricacies and real-world bottlenecks:
Data & Financial Challenges
- Historical Reference Date: Fair and liquidation values are computed as on the Insolvency Commencement Date (ICD), which is historical, making reliable market data collection challenging.
- Absence of Audited Financials: Non-availability of audited balance sheets as on the date of CIRP initiation.
- Specific Financial Assets (SFA) Gaps: Outdated data on receivables, borrower correspondence addresses, loans and advances, and investments.
- Erosion of Ind AS Fair Values: While balance sheets are drawn under Ind AS at fair values, massive erosion occurs immediately once CIRP begins.
- Inventory & Debtors: Special complexities in valuing Raw Materials, Work-in-Progress (WIP), Finished Goods, and disputed Trade Debtors.
Operational & Structural Challenges
- Management Non-Cooperation: Former promoters and management frequently refuse cooperation; lack of access to phone numbers and incumbents.
- Preconceived Notions of Value: Stakeholders often carry preconceived valuation figures before the valuation begins.
- Strict Timeline Pressures: Valuations are demanded without authenticated inputs; substantial time gap between draft and final report.
- Mandatory Appointment Irony: RP must mandatorily appoint valuers even when assets have negligible value.
- Access & Site Visits: Opportunity to visit client factories/sites is often denied for smaller companies; absence of a proper Point of Contact (PoC).
- Fee Realization & Scope: Difficulty in realizing assignment fees; quotations requested without clearly defined scope of work.
5. Multi-Statutory Scope & Judicial Deference to Valuation Experts
The requirement of valuation extends across other IBC tracks and Indian corporate statutes:
Fresh valuation if CIRP valuation is deemed no longer relevant by liquidator.
Valuation of company assets entering voluntary winding up under IBC.
Determination of benchmark value in avoidance and preferential transaction scrutiny.
Ascertainment of Fair and Liquidation value by two Registered Valuers in Pre-packs.
M&A schemes, winding up, share issues (other than rights/ESOP), sweat equity pricing.
Revaluation of PPE, ESOP/SAR accounting, business combinations (Ind AS 103).
Fair value determination in slump sales, specified security, and sweat equity valuations.
Buyback of shares from foreign shareholders, inbound FDI in unlisted entities.
Preferential debt-to-equity conversions, valuation of IP, know-how, and technical value addition.
Judicial Deference to Valuers: Miheer H. Mafatlal Doctrine & Supervisory Jurisdiction
The Supreme Court has consistently held that valuation in its entirety is the most decisive aspect of corporate decision-making. The valuation report is developed by exercising judicious discretion by the Registered Valuer. Hence, the sanctioning court has no power or jurisdiction to exercise appellate functions over the valuation or scheme.
The Court is not a Valuer and does not possess the requisite technical skills or expertise; it cannot substitute its own opinion for that of the experts or shareholders. Its jurisdiction is strictly peripheral and supervisory, not appellate.
In Miheer H. Mafatlal v. Mafatlal Industries Ltd., the Apex Court affirmed that the valuation of shares is a technical and complex problem appropriately left to the consideration of experts in the field of accountancy, as so many imponderables enter the exercise of valuation.
6. The De Facto Fifth Pillar: Valuation as the “Salt in the Dish”
The statutory scheme of the Insolvency and Bankruptcy Code, 2016 explicitly provides for four (4) pillars upon which its architecture rests:
Recognizing Valuation as the Inseparable Fifth Pillar:
However, if we dive deep and give thoughtful consideration to the importance of Valuation under IBC, it can be firmly construed that “Valuation is also one of the key pillars of IBC”.
“The position of ‘Valuation’ in an Insolvency Resolution Process seems similar to that of ‘Salt’ in the dish whose significance may not be clearly evident but is actually the most important element in the whole process. Eliminating the valuation conducted by a Registered Valuer will disturb and tremble the entire process of IBC.” ❖❖❖