Concept of Insolvency in relation to a company Cross Broader Insolvency OR Write Short Note Corporate Insolvency (June, 2011) Usually, a company or corporate is said to be an insolvent when its liabilities exceed its assets resulting in inability to pay its debts. After becoming insolvent, generally following two ways are available in relation to that company: - Winding up of the Company; (As per Companies Act, 1956) Revival and Rehabilitation of the Company. (As per SICA, 1985) Individual Insolvency: - In case of Individuals there are two Insolvency Acts, one for the presidency towns and other for the rest of the country. The Presidency Towns Insolvency Act, 1909; The Provincial Insolvency Act, 1920. Concept of Cross Boarder Insolvency: - Cross boarder insolvency refers to that situation in which the insolvent home company has non-resident DEBTOR or CREDITOR or CONTRIBUTORY. Evolution of UNCITRAL Model Law: - The United Nations Commission on International Trade Law (UNCITRAL) was established in 1966 as a subsidiary body of the General Assembly of the United Nations with the general mandate to further the progressive harmonization and unification of the law of International Law. India is the member of General Assembly and UNCITRAL. With the global expansion of trade and investment, the incidence of cross boarder insolvencies has been increased. But national laws have not kept pace with the trend, so they are not well equipped to deal with the problems of cross boarder insolvencies. This system was not proper for further international trade developments, and therefore, to counter this situation, UNCITRAL Model Law on Cross Boarder Insolvency was developed. This Model Law is a legislative text that is RECOMMENDED to countries for incorporation into their national law. Incorporation of Model Law is not required to be notified by the enacting country to the UNO or other nations that they have also enacted it. The Model Law in its preamble mention that objects of the Model Law is not to create substantive rights but to give general orientation for users of the Model Law and to provide effective mechanism to deal with cross boarder insolvency.
Objects of Model Law: - Cooperation between the courts and other competent authorities of this State ( Enacting State ) and foreign states involved in cases of cross boarder insolvency. Greater legal certainty for trade and investment; Fair and efficient administration of cross boarder insolvencies that protects the interests of all creditors and other interested persons, including the debtor; Protection and maximization of the value of the debtor s assets; and Provisions relating to protection of creditors, the debtors and other affected persons: - OR Though, UNCITRAL Model Law is not a substantive law, describe what are the protections provided under UNCITRAL Model Law are. Answer: - Under this Model Law, foreign creditors have the same rights regarding the commencement of and participation in a proceeding under the laws of the enacting state relating to insolvency as creditors in the state. The Model Law contains the following provisions for protection of the creditors, debtors and other affected persons: - Availability of temporary relief upon application for recognition of a foreign proceeding; The court may grant the relief, subject to conditions; The court may modify or terminate the relief granted, if situation so requires; Important Terms: - Foreign Proceeding: - Foreign Proceeding means a collective judicial or administrative proceeding in a foreign State pursuant to a law relating to insolvency in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation. Foreign Main Proceeding : - Foreign Main proceeding means a foreign proceeding taking place in the State where the debtor has the Centre of its main business. Foreign Representative: - Foreign Representative means a person or body authorised in a foreign proceeding to administer the reorganization or liquidation of the debtor s assets. Foreign Court: -
Foreign Court means a judicial or other authority competent to control or supervise a foreign proceeding. State: - The term State refers to the country that enacts the Law.
VALUATION Question: - X Ltd is considering the proposal to acquire Y Ltd and the financial information is given below: - X Ltd Y Ltd No of equity shares 10, 00, 000 6, 00, 000 Market Price per Share (Rs.) 30 18 Market Capitalisation (Rs.) 3,00,00,000 1,08,00,000 X Ltd intends to pay Rs. 1, 40, 00, 000 in cash for Y Ltd. If Y Ltd. s market price reflects only its value as a separate entity, calculate the cost of merger when the merger is financed by cash. Give Your Comment, what would be the impact on shareholders of X Ltd when the cost of acquisition become negative. Answer: - When the acquisition is financed by cash, then Cost of Acquisition = (Cash Market Value of Target Company) + (Market Value of Target Company True or Intrinsic Value of Target Company) In the Given Problem: - Cash offered for acquisition Rs. 1, 40, 00, 000 Market Value of Target Company Rs. 1, 08, 00, 000 It is assumed that Market Value of the Target Company and Intrinsic Value of the Target Company is same. Now, Cost of Acquisition = (Rs. 1, 40, 00, 000 1, 08, 00, 000) + (1, 08, 00, 000-1, 08, 00, 000) = Rs. 32, 00, 000 In case of acquisition become negative, shareholders of X Ltd would be benefited by acquiring Y Ltd in terms of market value. Question: - ABC Ltd is considering merger with XYZ Ltd. ABC Ltd shares are currently traded at Rs. 25 per share. It has 2, 00, 000 shares outstanding and its earnings after tax (EAT) amount to Rs. 4, 00, 000. XYZ Ltd has 1, 00, 000 shares outstanding; its current market price is Rs. 12.50 per share and EAT is Rs. 1,00, 000. The merger will be effected by means of a stock exchange ratio. XYZ Ltd has agreed to a plan under which ABC Ltd will offer the current market value of XYZ Ltd s share. i. What are the pre-merger earning per share (EPS) and P/E ratios of both the companies?
Answer: - i. ii. What must the exchange ratio be for ABC Ltd s pre- merger and post-merger EPS to be the same? iii. If XYZ Ltd s P/E ratio is 8, what will be its current market price? What will be the exchange ratio? What will ABC Ltd s post-merger EPS be? ABC Ltd XYZ Ltd No. of shares 2, 00, 000 1, 00, 000 Earning after tax (EAT) Rs. 4, 00, 000 Rs. 1, 00, 000 Market Price per Share (MPS) Rs. 25 Rs. 12.5 Earnings Per Share Rs. 400000/200000 = Rs. 2 Rs. 100000/100000 = Rs. 1 P/E Ratio (MPS/EPS) 25/2 = Rs. 12.5 12.5/1 = Rs. 12.5 ii. Number of shares to be issued by ABC Ltd to maintain pre-merger & post-merger EPS to be the same = = (Post-merger Earnings/Pre-merger EPS) Pre-merger Number of shares = [(Rs. 4, 00, 000 + Rs. 1, 00, 000)/2] 200000 = 250000-200000 = 50, 000 Shares Exchange Ratio = 50, 000/1, 00, 000 = 0.5 iii. XYZ Ltd s P/E Ratio = 8 MPS = 8 x 1 = 8 Exchange Ratio = 8/25 = 0.32 Shares to be allotted = 100000 x 0.32 = 32, 000 shares Post Merger EPS: - Rs. (400000 + Rs. 100000) / (200000 + 32, 000) = Rs. 2.16 per share