Seven years have passed since the enactment of the Insolvency and Bankruptcy Code (IBC). The passage of time has resulted in some awareness of its features for those directly affected — that is, shareholders, lenders (both secured and unsecured), deposit-holders, debenture-holders, homebuyers, workers, employees, and the suppliers of goods and services. However, the market participants, other than the ones above, should be aware of critical features of insolvency, for informed investment choices, especially when alternative investment opportunities are on the horizon.
Recently, a Gurgaon based electric taxi start-up came up with a scheme, wherein individuals were to buy an electric vehicle and lease it back to the start-up for a period of four years and earn an annual return of 14-plus per cent through fixed monthly rentals paid at the beginning of the month. In addition, the start-up would take care of the repairs and maintenance of the vehicle. In an era where environment issues are at the forefront this seemed like a perfect investment opportunity to the climate conscious.
The question that was left unanswered on the start-ups’ website is about the hypothetical situation of the start-up going belly-up. In an insolvency situation the lessors would be classified as operational creditors and thus the lease rentals would be amongst the last in priority to be paid, if at all. The insolvency professional appointed by the courts may not allow lessors possession of the vehicles, despite default on lease rentals, to keep the start-up as a going concern.
More such schemes are in the offing, solar panels, fractional aircraft, etc. In the case of solar panels, the investors must purchase the panels and lease them back to the platform. The platform in turn will install and maintain the rooftop solar project. The investors earn annual returns in the range of 10-13 per cent. In this situation too, if the end-user of electricity becomes insolvent, the lessor would be classified as an operational creditor. However, if the lessor opts to remove the panels, the insolvency professional may not argue going concern as above, but as electricity is defined as an essential good under IBC, and cannot be disconnected, it may be equally difficult to retrieve the panels.
A recent news item is another example of a transaction that one should evaluate carefully. This is about the purported transaction by the founder of a start-up mortgaging his house, those of his family as well as an under-construction villa to pay the overdue salaries of employees. A counterparty, that is, a mortgagee in this case, or in the case of sale, a buyer to such transactions, runs the risk of transaction being reversed, if public knowledge of distress is widely known, either of the corporate or the director of such a corporate.
This is because the court may adjudge such a transaction as preferential or undervalued, in either the insolvency of the corporate or the bankruptcy of the individual.
Similarly, sale and leaseback transactions with a distressed corporate and/or director may be flagged as undervalued or preferential.
Real estate project
Whilst on houses, an allottee in a real estate project is deemed to be a financial creditor in an insolvency. However, this may not be true in all cases. If the agreement between the buyer and seller does not give due importance to the rights of allottee/buyer as defined under RERA, but gives predominance to the provision of buyback by the builder or the developer, the allottee may not be classified as a financial creditor.
Though the Supreme Court is yet to pronounce its verdict on the matter, at present, the content of agreement or memorandum of understanding will determine the status of the creditor. As several builders have been advertising buybacks it may be worthwhile to read the fine print.
In sum, the adage “if an investment is too good to be true, it probably is” holds true.
Beware of insolvency risks.
The writer is an INSOL Fellow and a restructuring adviser