‘Material Adverse Change’ – How Covid crisis threatens to disrupt India’s bankruptcy process

Bankruptcy (representational image) | thebluediamondgallery

When private equity firm Sycamore Partners walked away from beleaguered lingerie chain Victoria’s Secret, some of the loudest gasps came from India, Asia’s busiest market for distressed assets.

Acquirers felt emboldened to seek legal advice. Could they at least renegotiate prices by arguing that the coronavirus was a material adverse change? Also known as MAC, this is an unforeseen event that durably depresses the value of a target company.

Judges usually set the bar high for allowing a deal to be killed because of MAC. In the Victoria’s Secret case, Sycamore argued that the clause had been triggered because current owner L Brands Inc. failed to pay rent and furloughed thousands of workers. The pandemic was “no defense” for L Brands violating terms of the agreement, the buyer said in its complaint in the Delaware Chancery Court.

In the U.S., Mirae Asset Global Investment Co. is pleading that Anbang Insurance Group Co. breached the terms of its  $5.8 billion hotel chain sale by shuttering properties. That the closures came in response to the outbreak is “irrelevant,” Mirae said in court papers. A unit of Anbang (now known as Dajia Insurance Group) has sued to force the Korean investor to complete the transaction.

The MAC risk has come to M&A globally, with 52 publicly filed agreements in the U.S. so far this year excluding pandemics from the definition of material adverse change, the highest in any year, according to Bloomberg Law analyst Grace Maral Burnett. As she explains, a longer list of exclusions typically helps sellers by “limiting the situations in which the acquirer is able to walk away from a deal.”

These moves and lawsuits are being watched closely in India. Creditors seeking to recover something from hundreds of billions of dollars of soured corporate loans are nervous. Successful bidders may try to use the pandemic to wriggle out of commitments — or stall payments. Buyers are wary of overpaying for assets whose future earnings potential may have been permanently damaged by Covid-19 and the ensuing lockdowns.

For buyout firms, the clock is ticking. They have raised money globally to pick up an interest in the debt of stressed Indian businesses. India’s 2016 bankruptcy law brought them to the country. Long delays in concluding large transactions, like the $5.9 billion sale of Essar Steel India Ltd. to ArcelorMittal, weren’t unexpected, but they did eat into the typical seven-year life of a fund.

If wranglings around MAC drag on in tribunals and courts, India’s appeal may fade amid an oversupply of distressed assets everywhere. More than $38 billion in defaulted Indian loans are awaiting resolution, according to an analysis of 245 cases by restructuring services firm Alvarez & Marsal.

A yearlong suspension of new bankruptcy filings ranks among the relief measures recently announced by the government of Prime Minister Narendra Modi. The logic is easy to see. Even before the pandemic, only one or two bidders were showing up in small in-court bankruptcies. With the economy in a tailspin — Goldman Sachs Group Inc. forecasts it will shrink an annualized 45% this quarter — the ratio of four liquidations to one corporate rebirth will balloon. A quarter of the workforce is without jobs. A further spike in unemployment could ignite social strife. Yet by acknowledging that the pandemic merits special treatment in bankruptcy, India may have unwittingly shown buyers a way out.

So far, there’s only one reported case of an Indian company citing the lockdown to renegotiate a bid, involving the sale of a small auto-parts maker. Large acquirers are hesitant. No one wants to be first to tell creditors they want to pay less: Lenders would seek to get the errant buyer barred from future auctions. The government might not take kindly to such moves, either. State-owned banks are carrying the can of dud loans; the less the buyers put up, the higher the taxpayers’ burden. However, if there’s a barrage of bankruptcy litigation — for instance, around the Covid-19 related debt the government says will be excluded from the definition of default — then those seeking to use MAC to renegotiate or stall may quietly join the slugfest.

In light of the pandemic’s extreme impact, “there may be circumstances” in which a court might find a material adverse change occurred when it wouldn’t have under more normal conditions, M&A counsel Gail Weinstein of Fried, Frank, Harris, Shriver & Jacobson LLP and others wrote in a Harvard Law School article last month.

Buyers in India’s distressed market are hoping for just this outcome. Lawyers are tingling with anticipation. Banks are dreading it. And investors who bought defaulted debt are praying that any fresh proceedings will be conducted swiftly, on merit, and won’t end up derailing the bankruptcy gravy train.-Bloomberg