This article has also been published on the InsolvencyTracker.in blog- see here

-Megha Mittal

(mittal@vinodkothari.com)

As per Regulation 39 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”), a liquidator shall endeavour to maximize recovery and realisation from all assets of and dues to the corporate debtor. Realisation from assets of the corporate debtor shall be done by way of sale as per regulation 32/ 32A of the Liquidation Regulations.

Schedule I of the Liquidation Regulation further states that the reserve price (colloquially, base price) for the sale shall be arrived at in accordance with the valuations figures arrived at u/r 35.

While liquidation sales have generally followed the practice of sale at disclosed reserve price, here, the Author has made an attempt to highlight the lags that come along with the disclosed reserve prices and suggest/ analyse the desirability of such sales at undisclosed reserve prices

Problem Statement-

The valuations arrived at by the registered valuation is based on the regulations and guidelines laid down under the Companies (Registered Valuers and Valuation) Rules, 2017. While the methods for determining the liquidation value aims to depict the true value at which realisation is expected, it has been observed that the value which prospective buyers intend to offer, generally varies from the reserve price. This difference between the reserve price as per regulations vis-à-vis value that buyers intend to offer, often leads to a failed sale attempts or a realisation lower than the optimum level.

Here, we may define two prominent terms, viz ‘Valuation by Valuers’ and ‘Market Values’

  • Valuation by Valuers (VV) represents the value determined as per the Liquidation Regulations and the Companies (Registered Valuers and Valuation) Rules, 2017. It is computed as the average of the values received from the valuers appointed under the liquidation process;
  • Market Values (MV), on the other hand, represents the value that the interested buyers are ready to pay at a given point in time- it reflects the market sentiments towards the sale asset and its sellability.

As mentioned above, a common variation has been observed between the VV and MV. Irrespective of whether this difference is positive or negative, it would lead to a loss to the liquidation estate- below we explain how.

Case I- VV > MV

Where VV is higher than MV, the sale attempt is bound to fail; thereby leading to delay in sale process. Pursuant to failure of the auction process, the liquidator shall either have to re-float invitation at the same reserve price, or adopt the phased reduction method- both implying a delay in the eventual sale.

Case II- VV < MV

Where the disclosed VV is lower than MV, it is natural that the interested buyer would only offer the VV and not MV, as it would enable the buyer to acquire the asset at a lower price. This would deprive the liquidation estate of the higher value that could have been realised had the VV not been disclosed.

Hence, the present practise of disclosing the reserve price on auction has a dual disadvantage in both cases, as discussed above.

Similar provision under insolvency resolution process

Further, it must be noted that in case corporate insolvency resolution process is not disclosed to the resolution applicant, so that while placing the proposal, the resolution applicant factors market reality and is not prejudiced by the disclosed value[1]. The tenet behind doing away with the requirement of mentioning the liquidation value in the information memorandum was that upon access to such value, the interested buyers were only likely to proposed bids closer to the liquidation value, rather than value on going-concern basis.

It must be noted that the problem is similar where the reserve price is disclosed. Price discovery is restricted to a value slightly above the VV. However, unlike the CIRP Regulations, there has not been any corresponding amendment in the Liquidation Regulations. As such, even though it is not mandatory per se, sale at a disclosed reserve price has been a common practice, thereby portraying the assets on a degraded level, even when a higher value could be fetched.

Thus, sale at an undisclosed reserve prices may be adopted, in the manner mentioned below, such that the liquidator’s responsibility of ensure a beneficial liquidation with maximum realisation without compromising with the existing regulations.

Types of Auction

While there are several ways of conduction e-auction, varying on the basis of transparency, level of competition and number of expected bidders, below we discuss few commonly found auction types. The said discussion would form the basis of deducing a suitable manner of auction, which may be a hybrid of one or more types, to tackle the afore-mentioned dual disadvantage of a disclosed reserve price.

(i)        English Auction

Known as the most common form of third-party online auction format, English Auctions are where bids are announced, and winner is the highest bidder and price is the highest bid. The sub-type of English Auctions which finds even more relevance is the “ascending-price auction” which is often seen as a “dominant strategy” to stay in the auction until the price reaches the bidder’s desired value.

In such cases, the price is successively raised until only one bidder remains. Here there is also a concept of a minimum price/ reservation price, below which no bids would be accepted. If nobody bids more than the reservation price, then the good is not sold. It must be noted that there is no standardised method or formula of computing such minimum price- it can be stipulated at the discretion of the seller.

(ii)       Dutch Auction

A Dutch auction is when interested parties are required to put their best offer in writing by a certain time and date; the property will then be sold to the highest bidder.  Each offer is sealed in an envelope.  When all offers are in, the envelopes are opened and the highest bidder wins the auction.

In view of the fact that there is essentially no competition as the bidders are not aware of the quotes placed by other bidders, Dutch Auctions are generally avoided, as it may not lead to optimum realisation.

(iii)     First-price Sealed Bid

First-price sealed-bid auctions are when a single bid is made by all bidding parties and the single highest bidder wins, and pays what they bid. The main difference between this and English auctions is that bids are not openly viewable or announced as opposed to the competitive nature which is generated by public bids. It may be considered strategically equivalent to the Dutch auction; that is, in both auctions the bidders will be using the same bidding strategies.

(iv)     Swiss-Challenge Method

The “Swiss-Challenge” method of bidding is one of the relatively modern techniques of auction. The Swiss-Challenge method works in a fashion similar to English Auction, with the primary and most important difference being that the bidders are given a chance to improve their bids in order to beat the highest bidder. Finally, based on the final bids the highest bid and bidder shall be declared.

The prospect of introducing the Swiss Challenge was recently envisaged in a Discussion Paper for bidding in resolution plans- the same has however, not been adopted in the corporate insolvency resolution process. Nevertheless, there have been several instances of approval of resolution plans via Swiss Challenge Method, the leading example being the case of Ruchi Soya.

Suggested Solution-

So as to avoid the loss due to difference between VV and MV, the liquidator may explore the option of sale at an undisclosed reserve price. It must be noted that nothing in the Liquidation Regulation obligates the liquidator to disclose the reserve price- the liquidator is only required to ascertain the same.

The proposed modus of sale would essentially be similar to an English Auction, with an undisclosed reserve price-

Step 1- Ascertainment of Reserve Price

The reserve price shall be determined as the average of the values received from the two registered valuers. The same shall be ascertained, but not disclosed in the public invitation floated for inviting interests.

Step 2- Invitation for participating in sale, disclosing a ‘Floor Price’

  • The invitation for participation in the sale process shall be floated with preliminary details of the sale asset and a “Floor Price”.
  • Here, “Floor Price” would mean a certain percentage of the Reserve Price (calculated as the average of the VV), below which no bids can be made in the auction process. It must be noted that this Floor Price shall not be equal to and/ or indicative of the Reserve Price. It is merely a tool to rule-out frivolous participants from the auction process.
  • The prospective buyers/ interested persons would be required to submit the EoI along with the Earnest Money Deposit of Rs. x, and self-certification of eligibility u/s 29A.
  • Upon submission of the EoI and the EMD, the liquidator shall share the Information Memorandum w.r.t. the sale asset.

Step 2- Auction

Those intended buyers/ participants who submit the required EoI along with EMD and eligibility certificate, will participate in the e-auction, where the H1 bidder shall be the successful buyer. However, the auction shall be successful only if the bid placed by the H1 bidder is equal to or higher than the Reserve Price.

It must be noted that at no stage in the aforementioned process shall the Reserve Price be disclosed- it shall only be considered by the Liquidator as a benchmark to ascertain whether the auction is successful.

Checks and Balances-

Sale at the undisclosed reserve price would enable better price discovery. Where in the process set-out above, the H1 price is lower than the Reserve Price, it would not be considered for auction- hence, there is no question of sale at a lower price. On the contrary, where the H1 bid is more than the Reserve Price, it would only lead to better realisation and hence, is preferable.

From an economical and/ or commercial perspective, a Floor Price, which would naturally be lower than the Reserve Price, is expected to attract more buyers. Such increased participation would lead to a healthier competition and better price discovery- both being in line with the Code’s objective of ensuring maximum realisation.

Further, from a regulatory aspect also, it must be noted that above process is also in conformity with the extant Liquidation Regulations, inter-alia

Sl. No.Regulation No. Remarks
(i)                   32/ 32AThe manner of sale, viz. going-concern, slump sale, piecemeal etc., shall not be affected by the aforementioned manner/ process
(ii)                 33The mode of sale shall not be affected
(iii)                34Asset Memorandum would have to be prepared irrespective of the aforementioned sale process. Considering that the Asset Memorandum is only required to be submitted to the AA, details required therein, inter-alia, valuation details, expected realisations etc- would remain undisclosed to interested buyers
(iv)                35The Valuation by Valuers shall be done in accordance with this regulation only- as such the Reserve Price shall be in conformity with the Code and Regulations
(v)                 Schedule INo provision of Schedule I is being breached by the intended mode of sale- the auction shall still be done as an e-auction, with basic requirements such as eligibility scanning, submission of EMD, declaration of reserve price prior to sale etc.

International Practice-

Auctioning at undisclosed reserve prices is not a novel idea, and is a common feature in other jurisdictions also. Similar to the modus proposed above, most jurisdictions suggest that the auction shall be considered as being successful where the highest bid is greater than the reserve price.

In the literature pertaining to auctions, we find that McAfee & Vincent (1992) argue that whilst reserves should have a positive relationship with the sale price obtained, they will have a negative impact with respect to the likelihood of sale. The rationale behind this is that, naturally, if the vendor imposes a higher minimum price then he/she is less likely to witness a bid of that magnitude, hence a reduced probability of sale. However, if that level is achieved, then it is likely that the proceeds from the sale will be enhanced. Further potential participants may be discouraged if the reserve was either above or equal to their potential maximum bid.

Over the years, auctions in Ireland have been significantly characterised by undisclosed reserve price, or intimation of a minimum price (floor price) only; and the numbers suggest that the results have been quite favourable.

The Property Services (Regulation) Act, 2011[2] (PSR Act) discusses three different values- (a) the valuation, which is what a valuer advises the property is really worth; (b) the price given in the advertisements, usually with some qualifying words; (c) there is the price below which the vendor really will not sell. Drawing a parallel with the discussion in the foregoing paragraphs, the concepts identified under PSR Act, the may be considered similar to the concepts of MV, Floor Price and the Reserve Price (VV), respectively.

While studying the residential property auctions in Dublin, Ireland, authors Simon Stevenson and James Young, in their Paper titled “The Role of Undisclosed Reserves in English Open Outcry Auctions” state that, “the results obtained illustrate that whilst higher reserve prices increase the revenue obtained for the seller, they also reduce the probability of sale. The findings also highlight the importance of auction participation, with the number of individual bidders and the number of bids significant in most specifications.”

Having said so, it must be noted that a substantial chunk of auctions conducted in Ireland pertain to higher market, and as such may reflect scenarios similar to weaker market conditions.

Thus, to make a case for sale at undisclosed reserve prices during liquidation under the Code, it would be more prominent to understand its relevance and success in comparatively weaker market conditions. Contrary to the Irish, high market auctions, in markets such as the US and Singapore, a large proportion of auction sale are on account of distressed sales/ bankruptcy sales.

Conclusion

From the discussion above, it may be deduced that the debate of disclosed vs. undisclosed reserve prices cannot be given a definitive answer- it would essentially be subject to factors such as the expected recovery, difference between the market realisation and the valuers valuation etc.

However, in view of the double disadvantage of disclosing reserve price, as discussed above, in distressed sales, makes a fit case for allowing and encouraging sale at undisclosed reserve prices, and ensures that the essence of a beneficial liquidation process is endorsed while acting within the ambit of the Liquidation Regulations.


[1] Vide Amendment dated 31st December, 2017 in the IBBI (Insolvency Process for Corporate Persons) Regulations, 2016

[2] http://www.irishstatutebook.ie/eli/2011/act/40/enacted/en/print#sec2