Most of us have at least once visited Cafe Coffee Day (CCD), which fits right between the local tea stall and overly expensive coffee houses. CCD was recently dragged to NCLT (National Company Law Tribunal) by IndusInd Bank and may be placed under Corporate Insolvency Resolution Proceedings (CIRP) due to non-repayment of dues. This means either wind up your business or figure out your shit and repay the creditors.
Now in this case, if any moratorium or restructuring resolution is passed in NCLT, CCD will try to revive the business, or else, NCLT can direct CCD to shut down its business forever and simply liquidate all its assets or sell the entire company.
It generally takes a lot of time to complete the insolvency process, according to IBC - 330 days (528 days on average), but the company still has to operate during the CIRP for more than a year. The company has to buy raw materials, pay salaries, incur business expenses etc. They may have to take debt to bear such expenses, but in a situation where no one is willing to lend to them.
This is where Interim Financing comes into the picture and how you, a retail investor, can invest in a scheme that was once reserved only for the Ultra HNIs.
Now before continuing our cafe story and explaining to you the schemes of interim financing, I would like to dig a bit deeper into the Bankruptcy Resolution scene in India to get a picture of what we are dealing with.
Analysis Of Bankruptcy Resolution In India
Below we can observe that if a company goes for liquidation, on average only 7% of the total amount lent is recovered by the financial creditors, while in resolution, financial creditors were able to get back 42% of the total credited amount.
This means that a resolution plan in most cases is favorable for creditors, while liquidation doesn't bring any value. But this is where the trouble starts brewing, NCLT is plagued with 48% of cases ending up in liquidation. This translates to dismal recovery for creditors. (Overall recovery of 24%)
Another set of data that is quite interesting is the time taken for resolution under IBC. Even though Corporate Insolvency Resolution Proceedings (CIRP) should be completed within 180 days with one time 90-day extension which can be granted by NCLT, still 75% of the cases take more than 270 days to resolve.
But when these results are compared to the previous resolution regime which consisted of SARFAESI, Lok Adalat and DRT, IBC makes the entire resolution process one-stop and streamlined.
My views? Even though IBC has greatly improved the condition of bankruptcy proceedings in India, it still has a lot to achieve and current performance is simply not enough.
Now that we have that sorted out, let's start by defining the term - 'Interim Financing' (I know a few people must have gotten bored by now, but trust me it gets exciting once the money-making part starts).
What is interim financing
This term is related to bankruptcy law and accounting and hence I would define it in 3 ways, Legal, Accounting and English definition.
Legal - As per section 5(15) of the Insolvency and Bankruptcy Code, 2016 (IBC), "interim finance" means any financial debt raised by the resolution professional (RP) or the company during the insolvency resolution process period.
Accounting - funds raised by the company during CIRP to retain the going concern nature of the entity and to carry out regular expenditure required for the same, until a resolution plan is approved by the Creditors and NCLT.
In plain English, It simply means any debt raised during the CIRP to fund business expenses and keep the company running.
Features Of Interim Finance
Let's say CCD wants to raise 10cr during CIRP to cover their working capital, salaries and other business-related costs. Given they are bankrupt, lenders will hesitate to give them loans and suppliers won't extend lines of credit.
Thus, IBC 2016 created a provision, to help companies stuck in this situation. This provision allows companies to raise high-priority debt also referred to as super senior loan.
Such debts will be repaid before any other debt on the balance sheet and will be treated as a cost incurred in insolvency resolution and not as finance costs.
How can Retail Investors Participate
Currently, LegalPay is the only company providing interim finance investment opportunities to retail investors.
Now let's get back to our example if CCD wants to raise 10cr through interim financing. If this number would have been 300-400cr, they would have approached a category-1 AIF offering Special Situation Fund (SSF). But for investors like you and me, who don't have 10cr (minimum investment in SSF) lying around our house, SSF is not for us but we do have the ability to fund smaller ticket-size investments.
Option A: Interim Finance via Instruments
So, CCD will approach LegalPay to finance them during CIRP. LegalPay will provide a platform for CCD to sell its debt Instruments. Investors' funds will be invested in super senior instruments issued by CCD. These instruments are typically fixed-income bonds/debentures, having a fixed coupon and maturity date.
CCD will utilize its cashflows from regular operations to service these instruments until maturity. If in case, the company were to go for liquidation, thanks to IBC (amendment) 2018, the unpaid coupon will accrue for one year or until the company receives the proceed from the sale of assets. And even during the sale of assets, interim finance repayment will be the highest priority.
Option B: Interim Finance via loan
LegalPay could also choose to offer interim financing via a term loan. In this case, Legalpay will pool money from Investors which will be lent to CCD. Debtor will not issue any bonds rather an agreement will be reached between LegalPay and CCD regarding the terms & conditions of the loan.
The T&C of the loan may include information on the payment cycle, maturity period, restructuring clause etc. which should be checked before investing in this scheme.
In this case, though, investors cannot withdraw their money before the maturity period. Even if you decide to exit before the maturity period, you are not eligible to get the accrued returns (if any) on the loan. (This condition depends on the Interim Financing Company's LLP agreement)
Structure for Option B
Just like most of the 'pooling of funds' schemes, Interim financing companies set up a Special Purpose Vehicle (SPV) in the form of an LLP. The investors are declared as partners in the LLP and get shares in proportion to their investments. The equity share capital is used for the purpose of interim finance loans.
Priority Repayment - As stated before, the main feature of this investment is that the instruments are super-senior bonds. These bonds will come at the top when payment is distributed to creditors even if the company is liquidated.
Regulations - Heavily regulated by NCLT under the newly established IBC 2016, thus corporate governance and regulatory issues should be less of a problem.
High Returns - Given that you are financing a company on the verge of bankruptcy, the returns on these instruments are very high. (High Risk = High Return)
Option to liquidate Interim Finance Bonds in the secondary market at the current market price as the security will be held in your demat account.
Default Risk - If you have read the above paras, the risks should be quite clear. The company you are financing is on the verge of bankruptcy, thus chances are instead of high returns you will end up with pennies on the dollar.
Duration Risk - IBC specifies that insolvency proceedings should be completed within 180-330 days, but NCLT could grant an extension. Similarly, in the case of liquidation, investors have no concrete timeframe for coupon repayment.
Cashflow Risk - If the company goes for liquidation, the time taken to liquidate assets could be years. The coupon accrual though, will stop after 1 year and hence your coupon income will stop.
Fraud Risk - If you are becoming a partner in LLP, you have to be confident in the abilities of the designated partner to find the right interim financing opportunities legally. Any fraud done by them could have serious consequences for you as well.
Now concluding, why should you be excited about this investment scheme? These products give you exposure to an asset class that was available only for the Ultra HNIs. And just like many other alternate investment options, they offer high returns at higher risks. Interim Finance bonds can offer close to 18% return while financing via loan can offer close to 23%.
And the reasons that might not get you too excited - High risk of default and uncertain cash flows. Another part that may sting investors is the absurd taxation on unlisted bonds. Now, it is up to you to decide whether the risk is worth the returns and taxes.
Please note that this is an opinion blog and not official research advice. I am not a registered RIA in India. This blog aims to promote informed decision-making and does not discourage you from investing in any deals.
We plan to come up with more blogs discussing different types of instruments available in the world of startup investing, write on due diligence for some platforms, and also existing and upcoming alt investment deals in the Indian market. If you want to stay updated on the latest blogs, please subscribe to our newsletter so you get notified automatically.
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IBC (Amendment) 2018, Vinod Kothari - Here
IBBI Annual Data (2021-2022) - Here
Presentable IBBI Data (2021-2022) - Here
Charts Summarising IBC in India (till 2019) - Here
Taxation explained by Groww - Here
LegalPay Investor Section - Here
Personal Favorite Article on the 'Code' and SREI Bankruptcy - Here (must read)