Sale of Legal Entity as an Asset: A step towards value maximization

–Megha Mittal 

(resolution@vinodkothari.com)

Maximization of value of assets of the corporate debtor is one of the primary objectives of the Insolvency and Bankruptcy Code, 2016 (“Code”/ “IBC”); and it is towards this objective that the Code requires a mandatory corporate insolvency resolution process to ensue prior to liquidation. The rationale behind such specified order is that under corporate insolvency resolution process, the corporate debtor is taken over as a going concern, which as per settled economic argument attracts a much better value via-a-vis disposal of assets. It is in view of such rationale that the liquidation laws also provide sufficient flexibility to keep the corporate debtor a going-concern even after commencement of liquidation[1].

Having said so, while the Liquidation Regulations allow sale of the corporate debtor as a going-concern, one cannot overlook the fact that the likelihood of the going-concern sale is already rusted by the time the corporate debtor reaches the liquidation stage.

 It is a common economic understanding that sum of parts is better than sum of the parts; and it is by virtue of such principle that going-concern values are generally in excess of value of individual assets. The various assets, stitched together as one, constitute a much greater value than the same assets in isolation.

In this backdrop, what may be considered as a rather unexplored territory is the prospect of sale of the legal entity only, sans the other assets that the corporate debtor may have. In this note, we analyse and put forth a case for saleability of legal entity itself, without other conventional assets, under the Code.

Identifying “Legal Entity” as a Property

In a general context, property is anything having value; and value, like beauty lies with the beholder.

Now, while in dictionary terms “property” is defined as ‘a thing or things belonging to someone; possessions collectively’ or something that is owned’, the definition of “property” as ascribed in section 3 (27) of the Code, provides that

“property” includes money, goods, actionable claims, land and every description of property situated in India or outside India and every description of interest including present or future or vested or contingent interest arising out of, or incidental to, property”

 The definition above clearly implies that the term property is inclusive in nature and as such includes every description of interest and value, unless explicitly excluded. The definition across several other statues viz. the Sale of Goods Act, 1930[2]; the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI)[3]; the Benami Transactions (Prohibition) Act, 1988[4], also hold the same stance of the term “property” having a wide connotation and being inclusive in nature.

Hence, we can safely deduce from the above discussion that the “legal entity” of a company/ corporate debtor fits into the definition of “property”.

Sale of the Legal Entity for its value

Earlier in our discussion, we mention that the excess of going-concern value and aggregate value of assets taken individually may be attributed to the value of the legal entity which binds together the various assets of the company (here, corporate debtor)  giving it a meaning and greater sense.

The question that follows this statement is that how does the legal entity attract such value? In the following paragraphs we endeavour to find an answer.

Legal Entity- Value in its existence

It is a time-settled theory that “persons” can be classified as being (a) natural persons, i.e. human being; and (b) artificial persons, which exist by virtue of law.

Companies, as known to all, are the classic example of artificial persons, which acquire their rights and powers by virtue of a statue, for instance the Companies Act in India. Thus, a company (corporate debtor) is nothing but a “legal entity” constituted under the law; and it is by virtue of such constitution that it has the right to own and control property, carry out business, exercise contractual and other rights. Hence, in a company, the legal entity itself, remote to the other assets that the company may later on acquire, constitutes several rights. It is infact on the basis of such rights that the company is capable of acquiring other assets which lends further value to the company.

A question that may arise at this juncture is that who owns the legal entity? While the answer may seem simple- shareholders, it is important to note that it holds minimal relevance for companies under liquidation. As per the IBBI’s Discussion Paper dated 27.04.2019, in case of transfer of a going-concern sale, the existing shareholders become claimants from liquidation proceeds under section 53 of the Code, and the capital extinguishes. As such, ownership of the legal entity is not a factor to be considered at the time of sale; and hence, the question becomes inconsequential at this stage.

Determining the value of the Legal Entity sans other conventional assets

Having understood that constitution of a legal entity itself comprises of rights, and hence “property”, the next question arises w.r.t. determining the value of such rights.

1. Significant costs incurred at the time of incorporation

Given that existence as a legal entity symbolises “rights”, it is understandable that such right must have been acquired in exchange of some consideration. This “consideration” is nothing but the costs incurred at the time of incorporation of the company.

In India, when a company is being incorporated under the Companies Act, it is required to pay significant sums towards incorporation, comprising of fee on authorised share capital and stamp duty payable. For instance, for a company which incorporates with an authorised share capital of Rs. 1,00,00,00,000/-, the fee payable on such capital would amount to Rs. 77,06,000/-[5]. In addition to such fee, the company shall also be required to pay Stamp Duty which may vary on the basis of state of registration[6]. Similarly, on any subsequent increase in the authorised share capital, the company is required to pay additional stamp duty on such increased amount.

Thus, transfer of a legal entity would mean that the acquirer would be waived off from the liability of paying such significant incorporation expenses, which would have otherwise been incurred in case of a simple asset-sale. Thus, such incorporation costs can be said to be a component of the value of the entity itself.

2. Credential value

Along with the tangible assets, an entity also derives its value from several soft assets which are otherwise not recorded in the books of a company, and hence, assessed only at the time of a business combination and/ or acquisition. However, economic value accruing from these soft assets such as customer loyalty, brand credentials and long-drawn associations of the company, cannot be tagged to any particular asset or group of assets, and as such is attached to the legal entity of the company.

Hence, factors like strong credentials, customer loyalty lend additional value in case of a going-concern sale vis-à-vis a simple-asset sale where such soft assets get dissolved in the sale process. Further, sale of a legal entity implies transfer of a business name, which is also an indication of such creds being sold.

Therefore, in this pretext, we may conclude that the legal entity of a company, aloof of other assets of the company also holds a significant monetary value, and as such classifies as being an asset in itself.

 Saleability of the Legal Entity as an asset under IBC

From the foregoing discussion we gather that the legal entity of a company, in itself constitutes a property that has significant value, and can be sold.

While the primary objective of the liquidator shall be to endeavour a going-concern sale, that is, sale of the legal entity along with all its assets and rights, it is important to acknowledge that the odds of a successful going-concern sale under liquidation, is rather low.

The IBBI (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”) provides that where a going-concern sale is unsuccessful, the Liquidator may opt for other modes of sale laid down under regulation 32, viz. stand-alone basis; slump-sale; a set of assets collectively and assets in parcels.

The author is of the view that in case of a failed attempt at going-concern sale, the liquidator may treat the legal entity of the corporate debtor as a separate asset which may be put for sale. The said proposal comes in view of the following-

• Liquidator’s duty to ensure maximization of value

Value maximization is not only an objective enshrined in the preamble of the Code, but also a function of the Liquidator, by which s/he must abide. Hence, where there evidently exists significant value in the legal entity of the corporate debtor, it is the duty of the liquidator to take steps to realise the same.

While another school of thought may hold that a company under liquidation without its assets does not have any value, it is important to note that whether or not a thing is of value cannot be generalised- as mentioned earlier, it is a matter of perception. In fact, ignoring the value that a buyer may be ready to give would mean destruction of value- which would be in complete contrast to the principal responsibility of the liquidator.

Hence, given that treating the legal entity as a separate asset does not cause detriment to any, its sale for value would only lead to a beneficial liquidation.

• Dissolution is the last resort

The objective of the Code is not dissolution of companies; and as such, where it is possible to retain the legal entity of a company, all steps must be taken to ensure the same. Hence, where the legal entity can be sold, the same must be proceeded with, rather than dissolution of the company.

Hence, in light of the foregoing discussion and arguments, the author is of the view that sale of the legal entity of a corporate debtor, as an asset in itself, must be considered and endorsed, as a significant step towards achievement of the objective of value maximization under the Code.

[1] Section 35 (1) (e) of the Code requires the Liquidator to carry on the business of the corporate debtor for its beneficial liquidation as he considers necessary.

[2] See section 2(11)

[3] See section 2 (1)(t)

[4] See section 2(c)

[5] Fee for authorised share capital >= Rs.1 crore Rs. (2,06,000 + 75 for every Rs 10,000 or part thereof)- refer schedule of fee laid down in Instruction Kit to Form SH-7.

[6] For details of stamp duty payable at the time of incorporation, see here