annamalai university...2019/06/04 · m.k., power plant engineering, phi learning private...

ANNAMALAI UNIVERSITY

DIRECTORATE OF DISTANCE EDUCATION

M.Sc. Plant and Machinery Valuation

Second Year

VALUATION OF PLANT AND MACHINERY - II

LESSONS : 1 - 14

Copyright Reserved

(For Private Circulation Only)

886E260

1 – 14

MACHINE PROOF: DT-07-02-2018

AUDDEAUDDE

M.Sc. PLANT AND MACHINERY VALUATION

SECOND YEAR


Editorial Board

Members

Dr. C. Antony Jeyasehar

Dean Faculty of Engineering & Technology

Annamalai University Annamalainagar

Internals

Dr. G. Ganesan

Professor and Head

Manufacturing Engineering Faculty of Engineering & Technology

Annamalai University

Annamalainagar

Dr. A. Prabaghar

Associate Professor & Wing Head Engineering Wing, DDE

Annamalai University

Annamalainagar

Lesson Writer

Mr. P.K. Ranganathan

Valuer, Plant and Machinery 3C Grand Residency

137, Valacherry Main Road Velacherry

Chennai- 42

AUDDEAUDDE

1


SECOND YEAR


SYLLABUS

Overview of Special Valuation requirements

Valuation for special purposes:

a. Financial Reporting

b. Liquidation

c. Security against loan

d. Slump sales

e. NPA – shut down / defunct / impaired assets

f. Mergers & acquisitions

Valuation for special purposes vis a vis specialized assets:

DISINVESTMENTS OF PSU S

a. Infrastructure assets – electricity transmission network, water / gas / oil

transmission / transportation network, telecommunication networks.

Salient features of Securitization and Reconstruction of Financial, Assets and Enforcement of Securities Interest Act 2002 (SARFAESI Act), Salient features of Banking Regulation Act, 1949. Case studies.

References

1) Kirit Budhbhatti, Valuation of Plant & Machinery - Theory & Practice, Kirit

Budhbhatti Pub, 2nd edition, 2002.

2) Guidance Notes published by International Valuation Standard Committee

(IVSC) on Valuation, (https://www.ivsc.org/).

3) C.J.C. Derry, Valuation of Plant and Machinery, Centre for Advanced Land

Use Studies, College of Estate Management, 1985.

4) Property Valuation Hand Book: An Introduction, Published by Centre for

Advanced Land Use Studies, College of Estate Management, 1979.

5) Baxter. W.T, Inflation Accounting by Longman Higher Education; illustrated

edition, 1984.

6) Karslake and Nichols, Industrial Valuation, Published by Estate Gazettes U.K.

1974.

7) Appraising of Machinery and Equipment, Edited by John Alico, Published by

American Society of Appraisers, ISBN - 07-001475-2, Mc Graw Hill, 1988.

8) Gupta. M.K., Power Plant Engineering, PHI Learning Private Limited-New

Delhi, 2012.

9) Martin Killcross, Chemical and Process Plant Commissioning Handbook: A

Practical Guide to Plant System and Equipment Installation and Commissioning,

Butterworth-Heinemann Publication, 1st Edition, 2011.

10) Shan K. Wang, Handbook of Air Conditioning and Refrigeration, McGraw-Hill

Publication, 2nd Edition, 2000.

AUDDEAUDDE

ii


SECOND YEAR


CONTENT

Lesson

No. Title

Page

No.

1. IVS 101 & 102 Scope of work & Methodology (Extracted from IVS 2017) 1

2. IVS 104 Bases of Value (Extracted from IVS 2017) 7

3. IVS 300- 2017 Plant & Equipment Valuation (Extracted From IVS 2017) 17

4. Valuation Under Liquidation 26

5. Auction Sale 36

6. IFRS, IAS and Valuation Requirements 45

7. Slump Sale – Valuation Considerations 55

8. Valuation under Companies Act 2013 60

9. SARFAESI Act 67

10. Overview - Banking Regulations in India 79

11. Mergers & Acquisitions 86

12. Public Service Assets& Valuation 102

13. Public Service Assets& Valuation 114

14. Public Sector Undertakings – Disinvestments 133

AUDDEAUDDE

1

LESSON - 1

IVS 101 & 102

SCOPE OF WORK & METHODOLOGY

(EXTRACTED FROM IVS 2017)

1.1 INTRODUCTION

Valuation profession now has a global Standard that is universal and

applicable for all types of valuation. IVS 101 & 102 are common standards and

applicable for Plant & Equipment also. The standard is reproduced for purposes of

education only.

1.2 OBJECTIVE

Valuation exercise requires a sound knowledge of the basic objectives &

principles of Valuation. IVS 101 & 102 deal with defining scope of work &

methodology for valuation exercise. This lesson deals with the requirements of

Standards essential for valuation.

1.3 CONTENT

1.3.1 IVS 101 Scope of Work

1.3.2 General Requirements

1.3.3 Changes to Scope of Work

1.3.4 IVS 102 Investigations and Compliance

1.3.5 Valuation Record

1.3.6 Compliance with other Standards

1.3.1 IVS 101 Scope of Work

A scope of work (sometimes referred to as terms of engagement) describes the

fundamental terms of a valuation engagement, such as the asset(s) being valued,

the purpose of the valuation and the responsibilities of parties involved in the

valuation.

This standard is intended to apply to a wide spectrum of valuation

assignments, including:

a. valuations performed by valuers for their own employers (“in-house

valuations”),

b. valuations performed by valuers for clients other than their employers (“third-

party valuations”), and

c. valuation reviews where the reviewer may not be required to provide their own

opinion of value.

1.3.2. General Requirements

1. All valuation advice and the work undertaken in its preparation must be

appropriate for the intended purpose.

2. A valuer must ensure that the intended recipient(s) of the valuation advice

understand(s) what is to be provided and any limitations on its use before it is

finalised and reported.

AUDDEAUDDE

2

3. A valuer must communicate the scope of work to his client prior to completion

of the assignment, including the following:

(a) Identity of the valuer: The valuer may be an individual, group of

individuals or a firm.

“Disclosure requirement”: If the valuer has any material connection or

International Valuation Standards involvement with the subject asset or

the other parties to the valuation assignment or if there are any other

factors that could limit the valuer’s ability to provide an unbiased and

objective valuation, such factors must be disclosed at the outset.

If such disclosure does not take place, the valuation assignment is not in

compliance with IVS.

If the valuer needs to seek material assistance from others in relation to

any aspect of the assignment, the nature of such assistance and the extent

of reliance must be made clear.

(b) Identity of the client(s) (if any): Confirmation of those for whom the valuation

assignment is being produced is important when determining the form and

content of the report to ensure that it contains information relevant to their

needs.

(c) Identity of other intended users (if any): It is important to understand

whether there are any other intended users of the valuation report, their

identity and their needs, to ensure that the report content and format meets

those users’ needs.

(d) Asset(s) being valued: The subject asset in the valuation assignment must be

clearly identified.

(e) The valuation currency: The currency for the valuation and the final valuation

report or conclusion must be established. For example, a valuation might be

prepared in euros or US dollars. This requirement is particularly important for

valuation assignments involving assets in multiple countries and/or cash flows

in multiple currencies.

(f) Purpose of the valuation: The purpose for which the valuation assignment is

being prepared must be clearly identified as it is important that valuation advice

is not used out of context or for purposes for which it is not intended. The

purpose of the valuation will also typically influence or determine the

basis/bases of value to be used.

(g) Basis/bases of value used: As required by IVS 104 Bases of Value, the

valuation basis must be appropriate for the purpose of the valuation. The

source of the definition of any basis of value used must be cited or the basis

explained. This requirement is not applicable to a valuation review where no

opinion of value is to be provided and the reviewer is not required to comment

on the basis of value used.

AUDDEAUDDE

3 (h) Valuation date: The valuation date must be stated. If the valuation date is

different from the date on which the valuation report is issued or the date on

which investigations are to be undertaken or completed then where appropriate,

these dates should be clearly distinguished.

(i) The nature and extent of the valuer’s work and any limitations thereon:

Any limitations or restrictions on the inspection, enquiry and/or analysis in the

valuation assignment must be identified (see IVS Framework, paras 60.1-60.4)

If relevant information is not available because the conditions of the assignment

restrict the investigation, these restrictions and any necessary assumptions or

special assumptions (see IVS 104 Bases of Value, paras 200.1-200.5) made as a

result of the restriction must be identified.

(j) The nature and sources of information upon which the valuer relies: The

nature and source of any relevant information that is to be relied upon and the

extent of any verification to be undertaken during the valuation process must

be identified.

(k) Significant assumptions and/or special assumptions: All significant

assumptions and special assumptions that are to be made in the conduct and

reporting of the valuation assignment must be identified.

(l) The type of report being prepared: The format of the report, that is, how the

valuation will be communicated, must be described.

(m) Restrictions on use, distribution and publication of the report: Where it is

necessary or desirable to restrict the use of the valuation or those relying on it,

the intended users and restrictions must be clearly communicated.

(n) That the valuation will be prepared in compliance with IVS and that the

valuer will assess the appropriateness of all significant inputs: The nature

of any departures must be explained, for example, identifying that the valuation

was performed in accordance with IVS and local tax regulations. See IVS

Framework paras 60.1-60.4 relating to departures.

4. Wherever possible, the scope of work should be established and agreed between

parties to a valuation assignment prior to the valuer beginning work.

However, in certain circumstances, the scope of a valuation engagement may

not be clear at the start of that engagement. In such cases, as the scope

becomes clear, valuers must communicate and agree the scope of work to their

client.

5. A written scope of work may not be necessary. However, since valuers are

responsible for communicating the scope of work to their client, a written scope

of work should be prepared.

6. Some aspects of the scope of work may be addressed in documents such as

standing engagement instructions, master services agreements or a company’s

internal policies and procedures.

AUDDEAUDDE

4 1.3.3. Changes to Scope of Work

1. Some of the items in para 20.3 may not be determinable until the valuation

assignment is in progress, or changes to the scope may become necessary

during the course of the assignment due to additional information becoming

available or matters emerging that require further investigation. As such, whilst

the scope of work may be established at the outset, it may also be established

over time throughout the course of the assignment.

2. In valuation assignments where the scope of work changes over time, the items

in para 20.3 and any changes made over time must be communicated to the

client before the assignment is completed and the valuation report is issued.

1.3.4 IVS 102 Investigations and Compliance

General Principle

To be compliant with IVS, valuation assignments, including valuation reviews,

must be conducted in accordance with all of the principles set out in IVS that are

appropriate for the purpose and the terms and conditions set out in the scope of

work.

Investigations

Investigations made during the course of a valuation assignment must be

appropriate for the purpose of the valuation assignment and the basis (es) of value.

References to a valuation or valuation assignment in this standard include a

valuation review.

Sufficient evidence must be assembled by means such as inspection, inquiry,

computation and analysis to ensure that the valuation is properly supported. When

determining the extent of evidence necessary, professional judgement is required to

ensure the information to be obtained is adequate for the purpose of the valuation.

Limits may be agreed on the extent of the valuers investigations. Any such

limits must be noted in the scope of work. However, IVS 105 Valuation Approaches

and Methods, para 10.7 requires valuers to perform sufficient analysis to evaluate

all inputs and assumptions and their appropriateness for the valuation purpose.

If limitations on investigations are so substantial that the valuer cannot

sufficiently evaluate the inputs and assumptions, the valuation engagement must

not state that it has been performed in compliance with IVS.

When a valuation assignment involves reliance on information supplied by a

party other than the valuer, consideration should be given as to whether the

information is credible or that the information may otherwise be relied upon

without adversely affecting the credibility of the valuation opinion.

Significant inputs provided to the valuer (e.g., by management/owners), may

require consideration, investigation and/or corroboration. In cases where credibility

or reliability of information supplied cannot be supported, such information should

not be used.

AUDDEAUDDE

5

In considering the credibility and reliability of information provided, valuers

should consider matters such as:

a. the purpose of the valuation,

b. the significance of the information to the valuation conclusion,

c. the expertise of the source in relation to the subject matter, and

d. whether the source is independent of either the subject asset and/or the recipient of the valuation (see IVS 101 Scope of Work, paras 20.3 (a)).

20.6. The purpose of the valuation, the basis of value, the extent and limits on the

investigations and any sources of information that may be relied upon are

part of the valuation assignment’s scope of work that must be

communicated to all parties to the valuation assignment (see IVS 101 Scope

of Work).

20.7. If, during the course of an assignment, it becomes clear that the

investigations included in the scope of work will not result in a credible

valuation, or information to be provided by third parties is either unavailable

or inadequate, the valuation assignment will not comply with IVS.

1.3.5 Valuation Record

1. A record must be kept of the work performed during the valuation process

and the basis for the work on which the conclusions were reached for a reasonable

period after completion of the assignment, having regard to any relevant statutory,

legal or regulatory requirements. Subject to any such requirements, this record

should include the key inputs, all calculations, investigations and analyses relevant

to the final conclusion, and a copy of any draft or final report(s) provided to the

client.

1.3.6 Compliance with Other Standards

1. As noted in the IVS Framework, when statutory, legal, regulatory or other

authoritative requirements must be followed that differ from some of the

requirements within IVS, a valuer must follow the statutory, legal, regulatory or

other authoritative requirements (called a “departure”). Such a valuation has still

been performed in overall compliance with IVS.

2. Most other sets of requirements, such as those written by Valuation

Professional Organisations, other professional bodies, or firms’ internal policies and

procedures, will not contradict IVS and, instead, typically impose additional

requirements on valuers. Such standards may be followed in addition to IVS

without being seen as departures as long as all of the requirements in IVS are

fulfilled.

1.4 REVISION POINTS

1. Investigation, compliance, valuation

1.5 INTEXT QUESTIONS

1. Write a short note on IVS 101, Scope of work for a valuer when he takes up a

project?

AUDDEAUDDE

6

2. What are the general requirements to be fulfilled when a valuation is done?

3. Write a short note on IVS 102, investigations and Compliance.

1.6 SUMMARY

We looked at scope of work IVS 101 & investigations & compliance

requirements IVS 102 as defined under IVS 2017. Scopes of work requirements are

common across a wide range of valuation purposes. It emphasises the need to

undertake the Valuation exercise based on purpose, need & identity of the client

and the type of assets. Minimum requirements that need to be studied & specified

are listed. Investigations must be appropriate & sufficient evidence must be

assembled by means such as inspection, inquiry, computation and analysis to

ensure that the valuation is properly supported. Professional judgement is required

to ensure the information to be obtained is adequate for the purpose of the

valuation. Deviations & inadequacies should be spelt out. A record of the study &

information gathered should be kept by the Valuer.

1.7 TERMINAL EXERCISES

1. What are the general requirements of valuation?

2. What is the Investigation of valuation?

1.8 SUPPLEMENTARY MATERIALS

1. www.vbsa.in/plantmachinery

2. https://www.marriottc.co

1.9 ASSIGNMENT

1. Write short notes on

a. Investigation b. Compliance

1.10 SUGGESTED READINGS / REFERENCES

1. “Valuation of Plant and Machinery –Theory and Practice” by Kirit Budhbhgatti

Pub 2nd edition, 2002.

1.11 LEARNING ACTIVITIES

1. Group discussion on during (PCP days)

2. Valuation reporting

1.12 KEY WORDS

1. Valuation reporting, methodology

AUDDEAUDDE

7

LESSON - 2

IVS 104 BASES OF VALUE


2.1 INTRODUCTION


applicable for all types of valuation. IVS 104 deals with bases of value that forms

the foundation for the valuation process. The standard is reproduced for purposes

of education only.

2.2 OBJECTIVE

To familiarize the student with provisions of Valuation Standard, requirements

and methodology for Plant & Equipment valuation process.

2.3 CONTENTS

2.3.1 Bases of Value

2.3.2 IVS-Defined Basis of Value –market Value

2.3.3 IVS – Defined Basis of Value – Market Rent

2.3.4 IVS-Defined Basis of Value – Equitable Value

2.3.5 IVS-Defined Basis of Value – Investment Value/Worth

2.3.6 IVS-Defined Basis of Value – Synergistic Value

2.3.7 IVS-Defined Basis of Value – Liquidation Value

2.3.8 Other Basis of Value – Fair Value (International Financial Reporting

Standards)

2.3.9 Other Basis of Value – Fair Market Value (Organisation for Economic

Co-operation and Development (OECD))

2.3.10 Other Basis of Value – Fair Market Value (United States Internal

Revenue Service)

2.3.11 Other Basis of Value – Fair Value (Legal/Statutory) in different

Jurisdictions

2.3.12 Premise of Value / Assumed Use

2.3.13 Premise of Value – Highest and Best Use


Introduction

1. Bases of value (sometimes called standards of value) describe the

fundamental premises on which there ported values will be based. It is

critical that the basis (or bases) of value be appropriate to the terms and

purpose of the valuation assignment, as a basis of value may influence

or dictate a valuer’s selection of methods, inputs and assumptions, and

the ultimate opinion of value.

2. A valuer may be required to use bases of value that are defined by

statute, regulation, private contract or other document. Such bases have

to be interpreted and applied accordingly.

AUDDEAUDDE

8

3. While there are many different bases of value used in valuations, most have certain common elements: an assumed transaction, an assumed date of the transaction and the assumed parties to the transaction.

4. Depending on the basis of value, the assumed transaction could take a

number of forms:

a. a hypothetical transaction,

b. an actual transaction,

c. a purchase (or entry) transaction,

d. a sale (or exit) transaction, and/or

e. a transaction in a particular or hypothetical market with specified characteristics.

5. The assumed date of a transaction will influence what information and

data a valuer consider in a valuation. Most bases of value prohibit the

consideration of information or market sentiment that would not be

known or knowable with reasonable due diligence on the

measurement/valuation date by participants.

6. Most bases of value reflect assumptions concerning the parties to a

transaction and provide a certain level of description of the parties. In

respect to these parties, they could include one or more actual or

assumed characteristics, such as:

(a) hypothetical,

(b) known or specific parties,

(c) members of an identified/described group of potential parties,

(d) whether the parties are subject to particular conditions or motivations at the assumed date (eg, duress), and/or

(e) an assumed knowledge level.

Bases of Value

1. In addition to the IVS-defined bases of value listed below, the IVS have also

provided a non-exhaustive list of other non-IVS-defined bases of value

prescribed by individual jurisdictional law or those recognised and adopted by

international agreement:

(a) IVS-defined bases of value:

1. Market Value (section 30),

2. Market Rent (section 40),

3. Equitable Value (section 50),

4. Investment Value/Worth (section 60),

5. Synergistic Value (section 70), and

6. Liquidation Value (section 80).

(b) Other bases of value (non-exhaustive list):

i. Fair Value (International Financial Reporting Standards) (section

90),

AUDDEAUDDE

9

ii. Fair Market Value (Organisation for Economic Co-operation and

Development) (section 100),

iii. Fair Market Value (United States Internal Revenue Service) (section

110), and

iv. Fair Value (Legal/Statutory) (section 120):

c. the Model Business Corporation Act, and

d. Canadian case law (Manning v Harris Steel Group Inc).

2. Valuers must choose the relevant basis (or bases) of value according to the terms

and purpose of the valuation assignment.

The valuer’s choice of a basis (or bases) of value should consider instructions

and input received from the client and/or its representatives.

However, regardless of instructions and input provided to the valuer, the valuer

should not use a basis (or bases) of value that is inappropriate for the intended

purpose of the valuation.

(for example, if instructed to use an IVS-defined basis of value for financial

reporting purposes under IFRS, compliance with IVS may require the valuer to

use a basis of value that is not defined or mentioned in the IVS).

3. In accordance with IVS 101 Scope of Work, the basis of value must be

appropriate for the purpose and the source of the definition of any basis of value

used must be cited or the basis explained.

4. Valuers are responsible for understanding the regulation, case law and other

interpretive guidance related to all bases of value used.

5. The bases of value illustrated in sections 90-120 of this standard are defined by

organisations other than the IVSC and the onus is on the valuer to ensure they

are using the relevant definition.

2.3.2 IVS-Defined Basis of Value – Market Value

1. Market Value is the estimated amount for which an asset or liability should

exchange on the valuation date between a willing buyer and a willing seller in

an arm’s length transaction, after proper marketing and where the parties had

each acted knowledgeably, prudently and without compulsion.

2. The definition of Market Value must be applied in accordance with the following

conceptual framework:

(a) “The estimated amount” refers to a price expressed in terms of money

payable for the asset in an arm’s length market transaction. Market Value is

the most probable price reasonably obtainable in the market on the

valuation date in keeping with the market value definition. It is the best

price reasonably obtainable by the seller and the most advantageous price

reasonably obtainable by the buyer. This estimate specifically excludes an

estimated price inflated or deflated by special terms or circumstances such

AUDDEAUDDE

10

as atypical financing, sale and leaseback arrangements, special

considerations or concessions granted by anyone associated with the sale, or

any element of value available only to a specific owner or purchaser.

(b) “An asset or liability should exchange” refers to the fact that the value of an

asset or liability is an estimated amount rather than a predetermined

amount or actual sale price. It is the price in a transaction that meets all the

elements of the Market Value definition at the valuation date.

(c) “On the valuation date” requires that the value is time-specific as of a given

date. Because markets and market conditions may change, the estimated

value may be incorrect or inappropriate at another time. The valuation

amount will reflect the market state and circumstances as at the valuation

date, not those at any other date.

(d) “Between a willing buyer” refers to one who is motivated, but not compelled

to buy. This buyer is neither over eager nor determined to buy at any price.

This buyer is also one who purchases in accordance with the realities of the

current market and with current market expectations, rather than in

relation to an imaginary or hypothetical market that cannot be

demonstrated or anticipated to exist. The assumed buyer would not pay a

higher price than the market requires. The present owner is included among

those who constitute “the market”.

(e) “And a willing seller” is neither an over eager nor a forced seller prepared to

sell at any price, nor one prepared to hold out for a price not considered

reasonable in the current market. The willing seller is motivated to sell the

asset at market terms for the best price attainable

in the open market after proper marketing, whatever that price may be. The

factual circumstances of the actual owner are not a part of this

consideration because the willing seller is a hypothetical owner.

(f) “In an arm’s length transaction” is one between parties who do not have a

particular or special relationship, e.g., parent and subsidiary companies or

landlord and tenant, that may make the price level uncharacteristic of the

market or inflated. The Market Value transaction is presumed to be between

unrelated parties, each acting independently.

(g) “After proper marketing” means that the asset has been exposed to the market

in the most appropriate manner to effect its disposal at the best price

reasonably obtainable in accordance with the Market Value definition. The

method of sale is deemed to be that most appropriate to obtain the best price in

the market to which the seller has access. The length of exposure time is not a

fixed period but will vary according to the type of asset and market conditions.

The only criterion is that there must have been sufficient time to allow the asset

to be brought to the attention of an adequate number of market participants.

The exposure period occurs prior to the valuation date.

AUDDEAUDDE

11

(h) “Where the parties had each acted knowledgeably, prudently” presumes that

both the willing buyer and the willing seller are reasonably informed about

the nature and characteristics of the asset, its actual and potential uses,

and the state of the market as of the valuation date. Each is further

presumed to use that knowledge prudently to seek the price that is most

favourable for their respective positions in the transaction. Prudence is

assessed by referring to the state of the market at the valuation date, not

with the benefit of hindsight at some later date. For example, it is not

necessarily imprudent for a seller to sell assets in a market with falling

prices at a price that is lower than previous market levels. In such cases, as

is true for other exchanges in markets with changing prices, the prudent

buyer or seller will act in accordance with the best market information

available at the time.

(i) “And without compulsion” establishes that each party is motivated to

undertake the transaction, but neither is forced or unduly coerced to

complete it.

3. The concept of Market Value presumes a price negotiated in an open and

competitive market where the participants are acting freely. The market for an

asset could be an international market or a local market. The market could

consist of numerous buyers and sellers, or could be one characterised by a

limited number of market participants. The market in which the asset is

presumed exposed for sale is the one in which the asset notionally being

exchanged is normally exchanged.

4. The Market Value of an asset will reflect its highest and best use (see paras

140.1-140.5). The highest and best use is the use of an asset that maximises

its potential and that is possible, legally permissible and financially feasible.

The highest and best use may be for continuation of an asset’s existing use or

for some alternative use. This is determined by the use that a market

participant would have in mind for the asset when formulating the price that it

would be willing to bid.

5. The nature and source of the valuation inputs must be consistent with the

basis of value, which in turn must have regard to the valuation purpose. For

example, various approaches and methods may be used to arrive at an opinion

of value providing they use market-derived data. The market approach will, by

definition, use market-derived inputs. To indicate Market Value, the income

approach should be applied, using inputs and assumptions that would be

adopted by participants. To indicate Market Value using the cost approach, the

cost of an asset of equal utility and the appropriate depreciation should be

determined by analysis of market-based costs and depreciation.

6. The data available and the circumstances relating to the market for the asset

being valued must determine which valuation method or methods are most

relevant and appropriate. If based on appropriately analysed market-derived

AUDDEAUDDE

12

data, each approach or method used should provide an indication of Market

Value.

30.7. Market Value does not reflect attributes of an asset that are of value to a

specific owner or purchaser that are not available to other buyers in the

market. Such advantages may relate to the physical, geographic, economic

or legal characteristics of an asset. Market Value requires the disregard of

any such element of value because, at any given date, it is only assumed

that there is a willing buyer, not a particular willing buyer.

2.3.3 IVS-Defined Basis of Value – Market Rent

1. Market Rent is the estimated amount for which an interest in real property

should be leased on the valuation date between a willing less or and a willing

lessee on appropriate lease terms in an arm’s length transaction, after proper

marketing and where the parties had each acted knowledgeably, prudently and

without compulsion.

2. Market Rent may be used as a basis of value when valuing a lease or an interest

created by a lease. In such cases, it is necessary to consider the contract rent

and, where it is different, the market rent.

3. The conceptual framework supporting the definition of Market Value shown

above can be applied to assist in the interpretation of Market Rent. In

particular, the estimated amount excludes a rent inflated or deflated by special

terms, considerations or concessions. The “appropriate lease terms” are terms

that would typically be agreed in the market for the type of property on the

valuation date between market participants. An indication of Market Rent

should only be provided in conjunction with an indication of the principal lease

terms that have been assumed.

4. Contract Rent is the rent payable under the terms of an actual lease. It may be

fixed for the duration of the lease, or variable. The frequency and basis of

calculating variations in the rent will be set out in the lease and must be

identified and understood in order to establish the total benefits accruing to the

lessor and the liability of the lessee.

5. In some circumstances the Market Rent may have to be assessed based on

terms of an existing lease (eg, for rental determination purposes where the lease

terms are existing and therefore not to be assumed as part of a notional lease).

6. In calculating Market Rent, the valuer must consider the following:

a. in regard to a Market Rent subject to a lease, the terms and conditions of

that lease are the appropriate lease terms unless those terms and

conditions are illegal or contrary to overarching legislation, and

b. in regard to a Market Rent that is not subject to a lease, the assumed terms

and conditions are the terms of a notional lease that would typically be

agreed in a market for the type of property on the valuation date between

market participants.

AUDDEAUDDE

13 2.3.4 IVS-Defined Basis of Value – Equitable Value

1. Equitable Value is the estimated price for the transfer of an asset or liability

between identified knowledgeable and willing parties that reflects the respective

interests of those parties.

2. Equitable Value requires the assessment of the price that is fair between two

specific, identified parties considering the respective advantages or

disadvantages that each will gain from the transaction. In contrast, Market

Value requires any advantages or disadvantages that would not be available to,

or incurred by, market participants generally to be disregarded.

3. Equitable Value is a broader concept than Market Value. Although in many

cases the price that is fair between two parties will equate to that obtainable in

the market, there will be cases where the assessment of Equitable Value will

involve taking into account matters that have to be disregarded in the

assessment of Market Value, such as certain elements of Synergistic Value

arising because of the combination of the interests.

4. Examples of the use of Equitable Value include:

a. determination of a price that is equitable for a shareholding in a non-

quoted business, where the holdings of two specific parties may mean that

the price that is equitable between them is different from the price that

might be obtainable in the market, and

b. determination of a price that would be equitable between a lessor and a

lessee for either the permanent transfer of the leased asset or the

cancellation of the lease liability.

2.3.5 IVS-Defined Basis of Value – Investment Value/Worth

1. Investment Value is the value of an asset to a particular owner or prospective

owner for individual investment or operational objectives.

2. Investment Value is an entity-specific basis of value. Although the value of an

asset to the owner may be the same as the amount that could be realised from

its sale to another party, this basis of value reflects the benefits received by an

entity from holding the asset and, therefore, does not involve a presumed

exchange. Investment Value reflects the circumstances and financial objectives

of the entity for which the valuation is being produced. It is often used for

measuring investment performance.

2.3.6 IVS-Defined Basis of Value – Synergistic Value

Synergistic Value is the result of a combination of two or more assets or

interests where the combined value is more than the sum of the separate values. If

the synergies are only available to one specific buyer then Synergistic Value will

differ from Market Value, as the Synergistic Value will reflect particular attributes

of an asset that are only of value to a specific purchaser. The added value above the

aggregate of the respective interests is often referred to as “marriage value.”

AUDDEAUDDE

14 2.3.7 IVS-Defined Basis of Value – Liquidation Value

1. Liquidation Value is the amount that would be realised when an asset or group

of assets are sold on a piecemeal basis. Liquidation Value should take into

account the costs of getting the assets into saleable condition as well as those of

the disposal activity. Liquidation Value can be determined under two different

premises of value:

(a) an orderly transaction with a typical marketing period (see section 160), or

(b) a forced transaction with a shortened marketing period (see section 170).

2. A valuer must disclose which premise of value is assumed.

2.3.8 Other Basis of Value – Fair Value (International Financial Reporting Standards)

1. IFRS 13 defines Fair Value as the price that would be received to sell an asset

or paid to transfer a liability in an orderly transaction between market

participants at the measurement date.

2. For financial reporting purposes, over 130 countries require or permit the use of

International Accounting Standards published by the International Accounting

Standards Board. In addition, the Financial Accounting Standards Board in the

United States uses the same definition of Fair Value in Topic 820.

2.3.9 Other Basis of Value – Fair Market Value (Organisation for Economic Co-Operation and Development (OECD))

1. The OECD defines Fair Market Value as the price a willing buyer would pay a willing seller in a transaction on the open market.

2. OECD guidance is used in many engagements for international tax purposes.

2.3.10 Other Basis of Value – Fair Market Value (United States Internal Revenue Service)

1. For United States tax purposes, Regulation §20.2031-1 states: “The fair market

value is the price at which the property would change hands between a willing

buyer and a willing seller, neither being under any compulsion to buy or to sell

and both having reasonable knowledge of relevant facts.”

2.3.11 Other Basis of Value – Fair Value (Legal/Statutory) in Different Jurisdictions

1. Many national, state and local agencies use Fair Value as a Basis of value in a

legal context. The definitions can vary significantly and may be the result of

legislative action or those established by courts in prior cases.

2. Examples of US and Canadian definitions of Fair Value are as follows:

(a) The Model Business Corporation Act (MBCA) is a model set of law prepared

by the Committee on Corporate Laws of the Section of Business Law of the

American Bar Association and is followed by 24 States in the United States.

The definition of Fair Value from the MBCA is the value of the corporation’s

shares determined:

i. immediately before the effectuation of the corporate action to which the

shareholder objects,

ii. using customary and current valuation concepts and techniques

generally employed for similar businesses in the context of the

transaction requiring appraisal, and

AUDDEAUDDE

15

iii. without discounting for lack of marketability or minority status except, if

appropriate, for amendments to the articles pursuant to

section 13.02(a) (5).

(b) In 1986, the Supreme Court of British Columbia in Canada issued a ruling in

Manning v Harris Steel Group Inc. that stated: “Thus, a ‘fair’ value is one

which is just and equitable. That terminology contains within itself the

concept of adequate compensation (indemnity), consistent with the

requirements of justice and equity.”

2.3.12 Premise of Value /Assumed Use

1. A Premise of Value or Assumed Use describes the circumstances of how an

asset or liability is used. Different bases of value may require a particular

Premise of Value or allow the consideration of multiple Premises of Value.

Some common Premises of Value are:

(a) highest and best use,

(b) current use/existing use,

(c) orderly liquidation, and

(d) forced sale.

2.3.13 Premise of Value – Highest and Best Use

1. Highest and best use is the use, from a participant perspective, that would

produce the highest value for an asset. Although the concept is most frequently

applied to non-financial assets as many financial assets do not have alternative

uses, there may be circumstances where the highest and best use of financial

assets needs to be considered.

2. The highest and best use must be physically possible (where applicable),

financially feasible, legally allowed and result in the highest value. If different

from the current use, the costs to convert an asset to its highest and best use

would impact the value.

3. The highest and best use for an asset may be its current or existing use when it

is being used optimally. However, highest and best use may differ from current

use or even be an orderly liquidation.

4. The highest and best use of an asset valued on a stand-alone basis may be

different from its highest and best use as part of a group of assets, when its

contribution to the overall value of the group must be considered.

5. The determination of the highest and best use involves consideration of the following:

a. To establish whether a use is physically possible, regard will be had to what

would be considered reasonable by participants.

b. To reflect the requirement to be legally permissible, any legal restrictions on

the use of the asset, e.g., town planning/zoning designations, need

c. to be taken into account as well as the likelihood that these restrictions will

change.

AUDDEAUDDE

16

d. The requirement that the use be financially feasible takes into account

whether an alternative use that is physically possible and legally permissible

will generate sufficient return to a typical participant, after taking into

account the costs of conversion to that use, over and above the return on

the existing use.

2.4 REVISION POINTS

1. Fair value, market rent, premise of value


1. What do you understand by Bases of Value under IVS?

2. Name some common elements in Bases of Value and its relevance in valuation?

3. What are the IVS defined Bases of Value?

2.6 SUMMARY

Bases of Value under IVS 2017 are the foundation on which Valuation exercise

is undertaken. It is based on the purpose for which the exercise is undertaken and

requirement as appropriate for the purpose. Common IVS-defined bases of values

are Market Value, Market Rent, Equitable Value, Investment Value/Worth,

Synergistic Value, Liquidation Value (orderly liquidation & forced sale), Fair Value

(IFRS). The Valuer must choose the appropriate value for the purpose and use the

IVS defined basis only for arriving at the value conclusion. A Premise of Value or

Assumed Use describes the circumstances of how an asset or liability is used.

Some common Premises of Value are- highest and best uses, current use/existing

use, orderly liquidation, and forced sale. Valuation exercise has to be undertaken

based on purpose, for given basis (Value) with assumptions & premises as

appropriate for the assignment.


1. What is the IVS defined Bases of Market Value?

2. What is the IVS defined Bases of Equitable Value?


1. www.rbse.in/plantmachinery

2. http://www.marriottco.co

2.9 ASSIGNMENTS

1. Distinguish between Liquidation value – orderly liquidation & forced sale.

2.10 SUGGESTED READINGS/ REFERENCE BOOK

See in the first pages syllabus

2.11 LEARNING ACTIVITIE

Group discussion on during (PCP days)

2.12 KEY WORDS

Investment value, Market value, equitable value

AUDDEAUDDE

17

LESSON - 3

IVS 300 – 2017 : PLANT & EQUIPMENT VALUATION


3.1 INTRODUCTION


applicable for all types of valuation. IVS 300 is applicable for Plant & Equipment.

The standard is reproduced for purposes of education only.

3.2 OBJECTIVE

To familiarize the student with provisions of Valuation Standard IVS 300,

requirements and methodology for Plant & Equipment valuation process.

3.3 CONTENT

3.3.1 Overview


3.3.3 Valuation Approaches and Methods

3.3.4 Market Approach

3.3.5 Income Approach

3.3.6 Cost Approach

3.3.7 Financing Arrangements

3.3.1 OVERVIEW

The principles contained in the General Standards apply to valuations of plant

and equipment. This standard only includes modifications, additional principles or

specific examples of how the General Standards apply for valuations to which this

standard applies.

Introduction

1. Items of plant and equipment (which may sometimes be categorised as a type of

personal property) are tangible assets that are usually held by an entity for use

in the manufacturing / production or supply of goods or services, for rental by

others or for administrative purposes and that are expected to be used over a

period of time.

2. For lease of machinery and equipment, the right to use an item of machinery

and equipment (such as a right arising from a lease) would also follow the

guidance of this standard.

It must also be noted that the “right to use” an asset could have a different life

span than the service life (that takes into consideration of both preventive and

predictive maintenance) of the underlying machinery and equipment itself and,

in such circumstances, the service life span must be stated.

3. Assets for which the highest and best use is “in use” as part of a group of assets

must be valued using consistent assumptions. Unless the assets belonging to

the sub-systems may reasonably be separated independently from its main

system, then the sub-systems may be valued separately, having consistent

AUDDEAUDDE

18

assumptions within the sub-systems. This will also cascade down to sub-sub-

systems and so on.

4. Intangible assets fall outside the classification of plant and equipment as sets.

However, an intangible asset may have an impact on the value of plant and

equipment assets.

For example, the value of patterns and dies is often inextricably linked to

associated intellectual property rights. Operating software, technical data,

production records and patents are further examples of intangible assets that

can have an impact on the value of plant and equipment assets, depending on

whether or not they are included in the Asset Standards – IVS 300 Plant and

Equipment valuation.

In such cases, the valuation process will involve consideration of the inclusion of

intangible assets and their impact on the valuation of the plant and equipment

assets. When there is an intangible asset component, the valuer should also

follow IVS 210 Intangible Assets.

5. A valuation of plant and equipment will normally require consideration of a

range of factors relating to the asset itself, its environment and physical,

functional and economic potential.

Therefore, all plant and equipment valuers should normally:

inspect the subject assets to ascertain the condition of the plant

determine if the information provided to the misusable and related to the

subject assets being valued.

Examples of factors that may need to be considered under each of these

headings include the following:

(a) Asset-related

1. the asset’s technical specification,

2. the remaining useful, economic or effective life, considering both preventive

and predictive maintenance,

3. the asset’s condition, including maintenance history,

4. any functional, physical and technological obsolescence,

5. if the asset is not valued in its current location, the costs of decommissioning and

removal, and any costs associated with the asset’s existing in-place location, such

as installation and re-commissioning of assets to its optimum status,

6. for machinery and equipment that are used for rental purposes, the lease

renewal options and other end-of-lease possibilities,

7. any potential loss of a complementary asset, e.g., the operational life of a

machine may be curtailed by the length of lease on the building in which it is

located,

AUDDEAUDDE

19

8. additional costs associated with additional equipment, transport, installation

and commissioning, etc, and

9. in cases where the historical costs are not available for the machinery and

equipment that may reside within a plant during a construction, the valuer

may take references from the Engineering, Procurement, Construction (“EPC”)

contract.

(b) Environment-related

1. the location in relation to the source of raw material and market for the product.

The suitability of a location may also have a limited life, e.g., where raw

materials are finite or where demand is transitory,

2. the impact of any environmental or other legislation that either restricts

utilisation or imposes additional operating or decommissioning costs,

3. radioactive substances that may be in certain machinery and equipment have a

severe impact if not used or disposed of International Valuation Standards Asset

Standards – IVS 300 Plant and Equipment appropriately. This will have a major

impact on expense consideration and the environment,

4. toxic wastes which may be chemical in the form of a solid, liquid or gaseous

state must be professionally stored or disposed of. This is critical for all

industrial manufacturing, and

5. licenses to operate certain machines in certain countries maybe restricted.

(c) Economic-related:

1. the actual or potential profitability of the asset based on comparison of operating

costs with earnings or potential earnings (see IVS 200Business and Business

Interests),

2. the demand for the product manufactured by the plant with regard to both

macro- and micro-economic factors could impact on demand, and

3. the potential for the asset to be put to a more valuable use than the current use

(i.e., highest and best use).

6. Valuations of plant and equipment should reflect the impact of all forms of obsolescence on value.

7. To comply with the requirement to identify the asset or liability to be valued in

IVS 101 Scope of Work, para 20.3.(d) to the extent it impacts on value,

consideration must be given to the degree to which the asset is attached to, or

integrated with, other assets.

For example

(a) assets may be permanently attached to the land and could not be removed without substantial demolition of either the asset or any surrounding structure or building,

(b) an individual machine may be part of an integrated production line where its

functionality is dependent upon other assets,

AUDDEAUDDE

20

(c) an asset may be considered to be classified as a component of the real

property (eg, a Heating, Ventilation and Air Conditioning System(HVAC)).

In such cases, it will be necessary to clearly define what is to be included or

excluded from the valuation. Any special assumptions relating to the

availability of any complementary assets must also be stated (see also para

20.8).

8. Plant and equipment connected with the supply or provision of services to a

building are often integrated within the building and, once installed, are not

separable from it. These items will normally form part of the real property

interest.

Examples include plant and equipment with the primary function of supplying

electricity, gas, heating, cooling or ventilation to a building and equipment such

as elevators.

If the purpose of the valuation requires these items to be valued separately, the

scope of work must include a statement to the effect that the value of these

items would normally be included in the real property interest and may not be

separately realisable.

When different valuation assignments are undertaken to carry out valuations of

the real Asset Standards Asset Standards – IVS 300 Plant and Equipment

property interest and plant and equipment assets at the same location, care is

necessary to avoid either omissions or double counting.

9. Because of the diverse nature and transportability of many items of plant and

equipment, additional assumptions will normally be required to describe the

situation and circumstances in which the assets are valued.

In order to comply with IVS 101 Scope of Work, para 20.3.(k) these must be

considered and included in the scope of work.

Examples of assumptions that may be appropriate in different circumstances

include:

a. that the plant and equipment assets are valued as a whole, in place and as

part of an operating business,

b. that the plant and equipment assets are valued as a whole, in place but on

the assumption that the business is not yet in production,

c. that the plant and equipment assets are valued as a whole, in place but on

the assumption that the business is closed,

d. that the plant and equipment assets are valued as a whole, in place but on

the assumption that it is a forced sale (See IVS 104 Bases of Value),

e. that the plant and equipment assets are valued as individual items for

removal from their current location.

AUDDEAUDDE

21 10. In some circumstances, it may be appropriate to report on more than one set of

assumptions, e.g., in order to illustrate the effect of business closure or

cessation of operations on the value of plant and equipment.

11. In addition to the minimum requirements in IVS 103 Reporting, a valuation

report on plant and equipment must include appropriate references to matters

addressed in the scope of work. The report must also include comment on the

effect on the reported value of any associated tangible or intangible assets

excluded from the actual or assumed transaction scenario, e.g., operating

software for a machine or a continued right to occupy the land on which the

item is situated.

12. Valuations of plant and equipment are often required for different purposes

including financial reporting, leasing, secured lending, disposal, taxation,

litigation and insolvency proceedings.

3.3.2 BASES OF VALUE

1. In accordance with IVS 104 Bases of Value, a valuer must select the appropriate

basis(es) of value when valuing plant and equipment.

2. Using the appropriate basis(es) of value and associated premise of value(see IVS

104 Bases of Value, sections 140-170) is particularly crucial in the valuation of

plant and equipment because differences in value can be pronounced,

depending on whether an item of plant and equipment is valued under an “in

use” premise, orderly liquidation or forced liquidation (see IVS104 Bases of

Value, para 80.1). The value of most plant and equipment is particularly

sensitive to different premises of value.

3. An example of forced liquidation conditions is where the assets have to be

removed from a property in a timeframe that precludes proper marketing

International Valuation Standards Asset Standards – IVS 300 Plant and

Equipment, because a lease of the property is being terminated.

The impact of such circumstances on value needs careful consideration. In order to

advise on the value likely to be realised, it will be necessary to consider any

alternatives to a sale from the current location, such as the practicality and cost of

removing the items to another location for disposal within the available time limit

and any diminution in value due to moving the item from its working location.

3.3.3 VALUATION APPROACHES AND METHODS

1. The three principal valuation approaches described in the IVS may all be applied

to the valuation of plant and equipment assets depending on the nature of the

assets, the information available, and the facts and circumstances surrounding

the valuation.

3.3.4 MARKET APPROACH

1. For classes of plant and equipment that are homogenous, e.g., motor vehicles and

certain types of office equipment or industrial machinery, the market approach is

commonly used as there may be sufficient data of recent sales of similar assets.

AUDDEAUDDE

22 However, many types of plant and equipment are specialised and where direct

sales evidence for such items will not be available, care must be exercised in

offering an income or cost approach opinion of value when available market

data is poor or non-existent. In such circumstances it may be appropriate to

adopt either the income approach or the cost approach to the valuation.

3.3.5 INCOME APPROACH

1. The income approach to the valuation of plant and equipment can be used where

specific cash flows can be identified for the asset or a group of complementary

assets, e.g., where a group of assets forming a process plant is operating to

produce a marketable product.

However, some of the cash flows may be attributable to intangible assets and

difficult to separate from the cash flow contribution of the plant and equipment.

Use of the income approach is not normally practical for many individual items

of plant or equipment; however, it can be utilised in assessing the existence and

quantum of economic obsolescence for an asset or asset group.

2. When an income approach is used to value plant and equipment, the valuation

must consider the cash flows expected to be generated over the life of the

asset(s) as well as the value of the asset at the end of its life.

Care must be exercised when plant and equipment is valued on an income

approach to ensure that elements of value relating to in tangible assets,

goodwill and other contributory assets is excluded (see IVS 210Intangible

Assets).

3.3.6 COST APPROACH

1. The cost approach is commonly adopted for plant and equipment, particularly in

the case of individual assets that are specialised or special-use facilities.

The first step is to estimate the cost to a market participant of replacing the

subject asset by reference to the lower of either reproduction or replacement

cost. The replacement cost is the cost of obtaining an alternative asset of

equivalent utility; this can either be a modern equivalent providing the same

functionality or the cost of Asset Standards Asset Standards – IVS 300 Plant

and Equipment reproducing an exact replica of the subject asset.

After concluding on a replacement cost, the value should be adjusted to reflect

the impact on value of physical, functional, technological and economic

obsolescence on value.

In any event, adjustments made to any particular replacement cost should be

designed to produce the same cost as the modern equivalent asset from an

output and utility point of view.

2. An entity’s actual costs incurred in the acquisition or construction of an asset

may be appropriate for use as the replacement cost of an asset under certain

circumstances. However, prior to using such historical cost information, the

valuer should consider the following:

AUDDEAUDDE

23

(a) Timing of the historical expenditures: An entity’s actual costs may not be

relevant, or may need to be adjusted for inflation/indexation to an

equivalent as of the valuation date, if they were not incurred recently due to

changes in market prices, inflation/deflation or other factors.

(b) The basis of value: Care must be taken when adopting a particular market

participant’s own costings or profit margins, as they may not represent what

typical market participants might have paid. The valuer must also consider

the possibility that the entity’s costs incurred may not be historical in nature

due to prior purchase accounting or the purchase of used plant and

equipment assets. In any case, historical costs must be trended using

appropriate indices.

(c) Specific costs included: A valuer must consider all significant costs that have

been included and whether those costs contribute to the value of the asset

and for some bases of value, some amount of profit margin on costs incurred

may be appropriate.

(d) Non-market components: Any costs, discounts or rebates that would not be

incurred by, or available to, typical market participants should be excluded.

3. Having established the replacement cost, deductions must be made for effect the

physical, functional, technological and economic obsolescence as applicable

(see IVS 105 Valuation Approaches and Methods, section 80). Cost-to-Capacity

Method

4. Under the cost-to-capacity method, the replacement cost of an asset with an

actual or required capacity can be determined by reference to the cost of a

similar asset with a different capacity.

5. The cost-to-capacity method is generally used in one of two ways:

(a) to estimate the replacement cost for an asset or assets with one capacity

where the replacement costs of an asset or assets with a different capacity

are known (such as when the capacity of two subject assets could be

replaced by a single asset with a known cost), or

(b) to estimate the replacement cost for a modern equivalent asset with capacity

that matches foreseeable demand where the subject asset has excess

capacity (as a means of measuring the penalty for the lack of utility to be

applied as part of an economic obsolescence adjustment).

International Valuation Standards Asset Standards – IVS 300 Plant and

Equipment 80

6. This method may only be used as a check method unless there is an existence of

an exact comparison plant of the same designed capacity that resides within

the same geographical area.

7. It is noted that the relationship between cost and capacity is often not linear, so

some form of exponential adjustment may also be required.

AUDDEAUDDE

24 8. Special Considerations for Plant and Equipment

9. The following section Financing Arrangements addresses a non-exhaustive list of

topics relevant to the valuation of plant and equipment.

3.3.7 FINANCING ARRANGEMENTS

1. Generally, the value of an asset is independent of how it is financed. However, in

some circumstances the way items of plant and equipment are financed and the

stability of that financing may need to be considered in valuation.

2. An item of plant and equipment may be subject to a leasing or financing

arrangement. Accordingly, the asset cannot be sold without the lender or less or

being paid any balance outstanding under the financing arrangement. This

payment may or may not exceed the unencumbered value of the item to the

extent unusual/excessive for the industry.

Depending upon the purpose of the valuation, it may be appropriate to identify

any encumbered assets and to report their values separately from the

unencumbered assets.

3. Items of plant and equipment that are subject to operating leases are the

property of third parties and are therefore not included in a valuation of the

assets of the lessee, subject to the lease meeting certain conditions.

However, such assets may need to be recorded as their presence may impact on

the value of owned assets used in association. In any event, prior to

undertaking a valuation, the valuer should establish (in conjunction with client

and/or advisors) whether assets are subject to operating lease, finance lease or

loan, or other secured lending. The conclusion on this regard and wider

purpose of the valuation will then dictate the appropriate basis and valuation

methodology.

3.4 REVISION POINTS

1. Market approach, Base of value


1. Define Plant & Equipment.

2. What are intangible assets related to P & M and how do they impact value?

3.6 SUMMARY

Plant and equipment are tangible assets that are usually held by an entity for

use in the manufacturing / production or supply of goods or services, for rental by

others or for administrative purposes and that are expected to be used over a

period of time. Sometimes value of Plant & Equipment are impacted by intangibles

like software, brand name etc. Plant and equipment related to supply or provision

of services to a building and integrated with the building will normally form part of

the real property interest. Plant and equipment valuers should normally, inspect

the subject assets to ascertain the condition of the plant &determine if the

information provided to them is usable and related to the subject assets being

valued. Study should include asset related aspects, environment related aspects &

AUDDEAUDDE

25 Economy related aspects that have a material influence on the value of the asset.

Assumptions forming part of bases of valuation like – going concern or shut down

not operational, valuation in-situ or ex-situ should be made as appropriate. A

proper approach or choice between Market approach, income approach and Cost

approach should be made and chosen method suitably justified. In case of leased

assets or asset with lien a proper mention of the same should be made along with

the impact on valuation.


1. What are asset related factors that have an impact on valuation?

2. What are the different approaches used in valuation? Explain.


1. www.rbsa.in/plantmachinery

2. http://www.marriottco.co

3.9 ASSIGNMENTS

1. What are economic related factors that affect valuation of tangible assets?

3.10 REFERENCE BOOKS

1. See in the syllabus



2. Plant equipment valuation

3.12 KEY WORDS

1. Base of value market approach, valuation approach

AUDDEAUDDE

26

LESSON 4

VALUATION UNDER LIQUIDATION

4.1 INTRODUCTION

Insolvency is the unfortunate condition of a business where the entity is unable

to repay its debts and its functioning / sustenance has become uneconomical. This

leads to Liquidation of the entity. Usually under these circumstances the entity has

total liabilities that exceed the total value of assets. Liquidation can be initiated by

the Lender (Bank) or Govt. or a creditor to recover dues or sometimes by the

Person/ Entity itself.

4.2 OBJECTIVE

Banks (lenders), creditors & Government take measures to force the entity into

liquidation when they are unable to realise their dues in a reasonable time and feel

further loss of time may lead to more erosion. In Valuation practice, Valuers are

expected to estimate the future value of the asset when offered under these

circumstances. In this lesson we learn about aspects of Valuation under liquidation

conditions.

4.3 CONTENT

4.3.1 The Scenarios can be

4.3.2 Valuing an insolvent business involves

4.3.3 Types of insolvency

4.3.4 Going concern & liquidation value

4.3.5 Liquidation Valuation process

4.3.6 Considerations for liquidation value

4.3.7 Forced vs. orderly liquidation

4.3.8 Business Valuation

4.3.9 Liquidation of Tangible Assets: (Existing & current use)

4.3.10 Liquidation under compulsion

Valuation under Liquidation involves several considerations. The first question

that arises is the situation in relation to the asset, under which value under

liquidation is sought.

4.3.1 The Scenarios can be

a. The entity is presently operational as a going concern & good standing –

liquidation value is sought by secured lending institution as part of lending

process to ascertain the risk.

b. The entity is presently under stress – however “going concern” assumption is

valid. The plant or asset may be functioning, but not at its full utilisation level

for various reasons.

c. The entity or asset may be under shut down – going concern assumption not

valid.

AUDDEAUDDE

27

It is obvious that the situation under which valuation is being called plays an

important role in the considerations adopted for the valuation process. Valuer

should understand the difference between business valuation, intangible assets

valuation and tangible asset valuation under liquidation conditions. First we must

recognize that there is a relationship between these 3 values. Generally for

intangible value to exist, value in-situ of the entity (as existing) must be in excess of

the physical replacement cost. A potential investor would rather acquire a new

plant (asset) than acquire an existing asset but for this advantage.

Business valuation makes sense only where an operational entity has more

value by means of its earnings potential than the sum of tangible assets value of

the entity. Business valuation focuses on future cash flow and hence must

necessarily assume a product mix and market scenario for the product mix that

can be generated from the use of the asset / entity. In contrast tangible asset value

focuses on quantity, quality, capacity, location, application & such factors of the

physical assets of the entity to arrive at value. Tangible assets valuation can be said

to be generic while business valuation is product specific.

The valuation of businesses in insolvency is important to the creditors,

shareholders, and other stakeholders as a basis for negotiations between these

parties over the future of the business. For each stakeholder in an insolvent

business, the relevant question is, how to maximize their respective position.

It is also sometimes necessary to value insolvent businesses for the purposes of

dispute resolution – for example, if a Claimant has been forced into insolvency by

the wrongful actions of a Respondent.

The two main routes that an insolvent business can take are

(a) to restructure its debts to manageable levels and continue trading as a going

concern, or

(b) to liquidate the business, selling off business or physical assets piecemeal, and

returning the proceeds to creditors.

4.3.2 Valuing an Insolvent Business Involves

a. identifying alternative scenarios for the business

b. assessing the value of the business as a going concern in each scenario.

c. assessing the value by means of disposal of assets

For the purpose of restructuring an insolvent entity, each party will then

typically identify the value it will achieve in each scenario, and enter negotiations

over the future strategy of the business. It is possible to adopt partial disposal in

some cases, so that the entity can continue business with pared debt. When all else

fails assets of the company are offered for sale either piecemeal or whole depending

on the nature of the asset and value realizable.

4.3.3 Types of Insolvency

The ability of a business to pay its debts as they fall due is a measure of its

short-term solvency, while a business with liabilities in excess of its debts is

AUDDEAUDDE

28 insolvent in the long-term. A business that is unable to pay its debts as they fall

due, but with assets in excess of its liabilities, may be able to avoid restructuring or

bankruptcy if it is able to borrow against its assets – that is, to exchange some of

the inherent long-run value in the business for cash, the ultimate short-term asset.

By contrast, a business that has liabilities in excess of its assets, but can meet

its obligations in the short term, requires restructuring but in the absence of

immediate pressures from creditors may be able to choose the timing and nature of

such restructuring. Restructuring may involve selling off certain assets, closing

down certain activities, or writing down debts.

A business that is both unable to meet its short-term obligations, and with

excess liabilities, will find itself in urgent need of restructuring.

4.3.4 Going Concern & Liquidation Value

In general, the stakeholders in a business, solvent or insolvent, can at any

point decide to liquidate the business and invest the proceeds in other ventures.

Stakeholders will continue to operate a business as a going concern only if the

returns so generated exceed the returns that the stakeholders would expect from

investing the proceeds of liquidation.

Insolvent businesses differ from solvent businesses in that, the need for a

decision on the future of the business as a going concern or in liquidation is urgent,

while many solvent businesses continue for years without closely examining this

question.

For example, consider a business owning and operating a hotel that is making

profits of Rs.1crore a year and has no debts. This business is solvent. If the hotel

could be sold for Rs.5crores, and expected returns on equity capital are 16 %, then

the owners of the hotel will prefer to operate the hotel as a going concern generating

Rs.1 crore a year than to sell the hotel and invest the proceeds elsewhere with the

expected return of Rs.80 lakhs a year (16% of Rs.5 crores).

However, if the hotel could be sold for Rs.10 crores, the owners would prefer to

sell (liquidate) and generate an Rs.1.6 crores annual return (16% of Rs.10 Crores),

than to realise Rs.1 crores a year profits in the hotel. In this way it may be

profitable to liquidate a solvent business.

Now consider the same hotel business, with debts of Rs.12 crores at a

borrowing rate of 10%, giving rise to interest payments of Rs.1.2 crore a year. This

business is insolvent, in that it cannot meet its liabilities including interest

payments as they become due from its Rs.1 crore a year pre-interest profits. If the

hotel can be sold for Rs.5 crores, and the creditors force a liquidation, they will

recover Rs.5 crores of their loan and write off the remaining Rs.7 crores of the

Rs.12 crores debts.

If, however, the creditors accept a write-down of their debts to Rs.9 crores, the

hotel will be able to make the associated interest payments of Rs.90 lakhs a year

and continue as a going concern with after-interest profits of Rs.10 lakhs a year,

AUDDEAUDDE

29 and the creditors will suffer a Rs.3 crores write-down, smaller than the Rs.7 crores

write-down in the liquidation scenario.

In this way, it may be beneficial for an insolvent business to continue as a

going concern. If the hotel could be sold for Rs.20 crores, then (as above) both the

owners and the creditors would be better off liquidating the business.

The above example, although simplified, illustrates the importance to each

group of stakeholders of identifying both the going concern and liquidation values

of an insolvent business in deciding the appropriate course of action for that

business. In both the solvency and the insolvency scenarios above the business was

more valuable to its stakeholders as a going concern when the value of the hotel

asset was Rs.5 crores, and more valuable liquidated when the value of the hotel

asset was Rs.20 crores.

This illustrates that it is the profitability of an enterprise relative to the

liquidation value of its assets, and not the current capital structure of the

enterprise, that determines whether the enterprise is more valuable as a going

concern or in liquidation. As such, the problem of valuing insolvent businesses

relates in the first instance to identifying its going concern value in comparison to

its liquidation value, both assessed before repayment of debts. This measure of

value is the so-called “enterprise value” of a business, the value of the debt plus the

equity in the business

4.3.5 Liquidation Valuation Process

The International Valuation Standards has defined liquidation value as value

arising in “… a situation where a group of assets employed together in a business

are offered for sale separately, usually following a closure of the business.”

As such, liquidation values for particular assets are most closely associated to

the concept of market value – the value that an asset could achieve if sold.

However, market values may themselves be assessed by reference to the benefits

that the sold assets may bring to the new owner (the stream of profits arising from

a hotel, for example), that is by the income approach, and/ or by the cost to create

a similar asset (the cost to build a similar hotel, for example), that is by the cost

approach.

Expenses associated with liquidation (sales fee, commissions, taxes, other

closing costs, administrative costs during close-out and loss of value in inventory)

may also be estimated and deducted from the various asset values, where

mandated.

4.3.6 Considerations for Liquidation Value

As discussed above, the liquidation value of an insolvent entity sets a floor for

the value of the entity, which may or may not have higher value as a going concern.

Tangible and intangible assets Liquidated assets typically include: cash and

working capital that can readily be realised for cash, such as accounts receivables

and inventory; less liquid tangible assets, such as plant and equipment; identifiable

AUDDEAUDDE

30 intangible assets such as patents or brands; as well as business intangibles such

as goodwill in the event that an part of the business being liquidated is sold as a

going concern.

The liquidation value of all types of asset may be more, or less, than their

accounting value. Working capital items, such as inventory and accounts

receivable, are generally the easiest to liquidate.

However, discounts to the typical values of such items are likely, as there may

be additional costs of recovery of receivables in a business that customers no longer

see as a key supplier. Moreover, outside the production context of the insolvent firm

it may be harder to convert work-in-progress items into finished product. Relatedly,

it may be hard to sell inventory of finished goods to final customers in the possible

absence of the insolvent firm’s normal sales and marketing team.

Traditionally, in liquidation the value of most intangible assets tends toward

zero and the value of all tangible assets reflects the circumstance of liquidation.

The figure below gives an illustration of traditional values of tangibles and

intangibles in an insolvency situation. The concept of “value in use” here relates to

the value of the relevant asset deployed within the insolvent business. Intangible

assets such as patents and brands may have generated significant value for the

insolvent business but is of limited use to third parties.

Goodwill, the ultimate intangible asset, is essentially a measure of residual

value and the fact of insolvency typically indicates that the value of any previously-

existing goodwill is highly impaired.

Source: Smith, Gordon V. and Russell L.Parr. Valuation of Intellectual Property and Intangible Assets; Second

Edition, Jon Wiley and Sons Inc. 1994

The relative value of tangible and intangible assets changes by industry and

over time. For example, technology companies have created large amounts of value principally based on intangible assets.

It is necessary to investigate whether an enterprise has separable or

inseparable intangible assets. Typically patents, brand name & market penetration

strengths can be assessed as separable intangible assets under IVS 210. They can

be sold separately leaving the tangible assets like buildings & equipment for sale on

piece meal basis. Thus it may be prudent to value intangible assets & tangible

assets separately and compare with enterprise value, while arriving at the best

Liquidation process.

AUDDEAUDDE

31 4.3.7 Forced Vs. Orderly Liquidation

If a business is able to perform an orderly liquidation, without undue time

pressure, it will typically achieve a better result for its stakeholders than in a forced

liquidation. An orderly liquidation will be a particularly appropriate response for a

company that is able to pay its current debts but perceives long-term liabilities in

excess of its assets and does not see going concern scenarios that are more

favourable than an orderly liquidation.

If an orderly liquidation is chosen, and is expected over a period of years,

valuation of the business may require discounting the resulting liquidation cash

flows over a period of time, as in a DCF analysis. It is possible that certain tangible

or intangible assets can be disposed of to reduce debt. This may enable the entity to

continue its business.

For example consider the case of an entity with multiple plants. It is possible to

dispose of certain plants and reduce debt. This may enable the entity to sustain

itself by operating the balance plants in a profitable manner. In recent times sale of

certain lot of cement plants by Jaiprakash Associates to Ultratech Cements ongoing

concern basis, under the supervision of Lender’s Consortium is a classic example.

Another example can be sale of tangible assets like – surplus land parcels,

office complexes plant & equipment to reduce debt. In all these cases it is possible

to find buyers without undue pressure on time, to get the best price for the assets.

Forced liquidations, by contrast, can lead to significant value destruction. The

absence of time to market assets to potential buyers can lead to low realisation on

asset values, and the inability to redeploy or wind down a workforce can in some

countries trigger very high statutory redundancy payments. The very fact that the

seller is under compulsion to sell, drives value down.

Two further issues arise in the context of liquidations. Some liquidations may

involve significant professional fees & relocation costs to the potential buyer

(valuation ex-situ) that need to be factored in to the values identified.

Second, resistance to liquidation: Some companies may be more valuable as a

going concern in public good. Under these circumstances, special factors,

considerations which have wider social, economic and political consequences can

bring about government intervention to ensure the entity remains a going concern.

Uncertainty, and the value of insolvent companies

4.3.8 Business Valuation

Estimating cash flows: For Income approach &business valuation process to be

acceptable, it should be possible to identify with reasonable certainty the cash flows

accruing to insolvent companies. In many cases cash flow estimates especially in

the context of a failed enterprise, can be very tricky. Deviations can lead to a range

of results that can often vitiate the process.

There is always the possibility that, a business that on a balanced estimate can

be restructured as a going concern with a small loss to creditors may still, following

restructuring, nevertheless be subject to a significant possibility of liquidation. It

should be remembered that the business was justified using cash forecasting

AUDDEAUDDE

32 models earlier. Most failed businesses are also associated with a failed DCF

forecasting model.

In general firms in liquidation generally find it harder to collect their

receivables, and revive the brand. Earlier bad experiences of vendors & customer

tend to linger. The resulting expenses and losses in such a downside liquidation

scenario may impose very considerable further write-offs on creditors that are

much larger than the gains that would be achieved if the business traded

somewhat better than anticipated at restructuring. An assessment of the value of

the restructured debt would need to take into account this significant chance of a

much worse-than-expected outcome for creditors.

A related point underlies the tension between shareholders and creditors in

insolvency situations. Shareholders face unlimited upside to their investment once

creditors have been satisfied, but in financial terms are neutral between situations

in which creditors achieve 99% recovery or 1% recovery. The positions of different

creditor groups vary, but in essence a creditor group will have its capital returned if

value above a certain threshold is achieved, and will for the large part be indifferent

whether that value threshold is exceeded in small or in large part.

As we saw in the case of Hotel example, sometimes it is possible to arrive at

win-win situation even under liquidation conditions – provided “going concern”

assumption is valid.

4.3.9 Liquidation of Tangible Assets: (Existing & Current use)

Valuation of tangible assets under liquidation scenario presents many

challenges.

First we need to establish whether it is feasible to operate the assets under

similar conditions at the same location. Highest best use (HABU) scenario should

be looked from an operational point of view rather than application point of view.

Hence premise of Existing & current use may be more appropriate.

Considering that the company operating in the location has become insolvent,

or is performing in a sub-optimal level, normally it is fair to surmise that the local

operations also played a role in the process of erosion of profitability.

If it is to be assumed that the assets may need to be relocated or even

repositioned in a significantly different layout – an estimate of costs involved in the

process of re-commissioning may need to be considered.

Next we need to examine whether the assets can be used in its existing form

without significant rework or reconfiguration expenses. If yes, then the assumption

of existing & current use is valid. Replacement cost of equipment as existing can be

a good starting point.

Use of assets for purposes other than as presently utilized presents another

challenge. While it is possible some of the assets can be utilized in much the same

manner there may be many assets that may not be so flexible. The premise of

current use may not be valid. If they are to be valued on alternate use model then it

AUDDEAUDDE

33 may be necessary to make assumptions on process &application. Value of assets as

reconfigured / relocated may be significantly different.

There can be other challenges, in valuation under alternate use:

Some assets may not lend themselves to alternate use. They may be product /

process specific. These equipment may require such prohibitive costs for conversion

to alternate application that the exercise is not viable. Under such circumstances it

may be prudent to look at Salvage value.

Some assets lose value on dismantling. Typical examples are electrical cabling,

insulation, piping, support structures for P & M etc. Although significant costs are

incurred in build as new, value in liquidation for alternate use can be residual

value or scrap value.

Examples

1. Diesel Generating Sets: This asset has wide applications across industries and

used for the same application in all industries. So this asset has a higher resale

value and relocation costs are not significant. Air compressors are also similar

assets.

2. Machine tools: Let us consider a reputed make CNC vertical machining center.

This asset has multiple uses and can be used for a wide variety of jobs, in many

industries. This asset also has a higher resale value and relocation costs are not

significant. However this is a production machine and belongs to another

category different from DG sets or Air compressors which are universal.

3. EOT crane: This asset is site specific and built to suit structure. Span of crane

has to match building in which it is housed. Lifting Capacity of the crane is

decided by the process in which the crane participates. Change of process can

erode the in-situ value of the crane. And ex-situ value of EOT crane suffers

significant erosion and is closer to its residual value.

4. Chemical process plant: Chemical process plants have to be considered as

aggregated asset. Different components of the plant are designed to suit certain

specific processes and capacities. They are positioned sequentially based on

process requirement. Any piece meal sale of the plant will reduce it to scrap

value. While some plants may be versatile to allow processing of a range of

products, some plants may be product specific. Usually external influences

dictate operational profitability of a chemical process plant – like market

demand, raw material or finished product prices and in certain cases Govt.

directives in public good.

Alternative scenarios are very difficult to visualize. Both in-situ & ex-situ

valuations may be close to salvage value.

While arriving at Liquidation value, these aspects need to be kept in mind.

4.3.10 Liquidation under Compulsion

This in banking parlance is called Forced Sale value or Distressed Value or

Auction Sale value. IVS recognizes this terminology. So let us look at aspects that

AUDDEAUDDE

34 need attention under this scenario. First all issues that have been considered under

normal Liquidation sale are applicable to Liquidation under compulsion. However

there are quite a few more aspects that need to be considered while estimating

value under this condition. There can be different scenarios depending on the

situation.

We need to establish the status of the asset / entity at the time of valuation.

Entity / asset can be in any one of these situations:

a. Going concern: The entity is operational even if at a lower output

b. Shut down: well maintained: Entity / asset is not presently operational –

however it is fair to assume that Entity / asset can be made operational at

short notice without any significant expenditure. Assumption of going concern

& premise of existing and current use may still be valid. Valuation methodology

can be chosen on this basis.

c. Shut down: condition not known: Entity / asset are not operational and have

been under shut down for an extended period of time. It is not possible

determine the state of readiness of the plant / asset, by visual observations.

Going concern assumption may no more be valid. However premise of existing

& current use may still be valid. Valuer may be required to estimate repair /

restoration costs as part of valuation.

d. Dilapidated/state of dis-repair: Entity has not been not operational, has not

been subjected to any maintenance / not stored properly. It is fair to say that

entity / asset may need to incur significant costs to make it operational again.

Hence, going concern assumption not valid. Existing & current use also may

not be valid. It may prudent to look at salvage value or residual value.

e. Beyond repair/restoration: Entity / asset has suffered serious damage physical

/ corrosion / pilferage or any combination of all these factors. In this case

assets need to be valued on the premise of residual value.

Valuer is expected to assess the condition of asset in all cases and assess value

based on his findings. Various considerations influencing value should be

documented properly. Encumbrances on value should be considered applied. It

is possible that Valuer may need to take expert assistance from other parties to

help assess value. It is necessary that the employer (person / entity that has

called for the report) is kept informed of the need to source expertise and

concurrence obtained.

4.4 REVISION POINTS

1. Business valuation, Liquidation value, Liquidation


1. Write a short note on Valuation under Liquidation.

2. Explain valuation of a business in insolvency.

3. Explain valuation of a going concern under liquidation with an example.

AUDDEAUDDE

35

4. What are the factors affecting Liquidation value?

5. What is valuation of a forced liquidation Vs an orderly liquidation?

6. Define business valuation.

7. Explain valuation of tangible assets under liquidation with some examples.

8. What is valuation under compulsion?

4.6 SUMMARY

Valuation in an insolvency scenario requires clarity on the nature and purpose

of the required valuation. For what purpose is the valuation being performed? For

whose use, and what in particular are they interested in? What information is being

used as the basis of the valuation, and is that information stated free of bias? What

cross-checks can the valuer perform to gain comfort in the results of his or her

valuation? Are there important asymmetries in outcome for relevant parties if

things turn out slightly better, or slightly worse, than expected? Turning to the

impact on value maximisation in insolvency scenarios, the selection of a valuation

basis(going concern or liquidation) does not directly affect value in insolvency

scenarios. However, the selection of a strategy of going concern or liquidation may

have a significant effect on the recovery of stakeholders in the insolvent business.

Although each insolvent business is insolvent in its own unique way, in general a

liquidation strategy is more likely to be safer but lead to lower recovery, while a

going concern strategy will often be riskier but generate higher returns – the

business could trade its way out of difficulty, or could incur further losses followed

by a later liquidation.


1. Define business valuation?



4.9 ASSIGNMENTS

1. What is the valuation of a forced liquidation Vs an orderly liquidation?

2. Explain valuation of tangible assets under liquidation with some examples


1. Going concern versus liquidation valuations, the impact on value

maximization in insolvency situations Howard Rosen, James Nicholson, and

Jeff Rodgers, FTI Consulting International Arbitration Practice Group, April

2011



4.12 KEY WORDS

1. Liquidation, Valuation, Business valuation

AUDDEAUDDE

36

LESSON - 5

AUCTION SALE

5.1 INTRODUCTION

Auction Sale is a kind of Sale, where asset is sold or proposed to be sold at the

highest price in a transparent manner, where participants have an opportunity to

express their bid and in some cases revise their bid during the process. The

purpose of the auction is to fetch the highest price for the asset. Auction can be

held as a physical event at a publicized premise, at which people are invited to

compete or make offers, or at a virtual marketplace as in an e-auction. In secured

lending practice, auction sale is the last resort for the lender to recover their dues.

5.2 OBJECTIVE

In valuation practice determination of Auction Sale value or Forced Sale Value

or Distressed Value plays an important role. In this lesson we look at some aspects

of Auction sale.

5.3 CONTENT

5.3.1 The term Auction sale is defined in the Sale of Goods Act.

5.3.2 Important features of the Auction Sale

5.3.3 Rights and Duties of Auctioneer

5.3.4 Sales Under Statute and By Order of the Court

5.3.5 Proclamation of Sales by Public Auction

5.3.6 Mode of making Proclamation

5.3.7 Time of Sale

5.3.8 Sale by Public Auction

5.3.9 Delivery of Movable Property

5.3.1 The Term Auction Sale is defined in the Sale of Goods Act

A sale by auction is a public sale, where goods are offered to be taken by the

highest bidder.

Section – 64 of the Sale of Goods Act deal with AUCTION SALE - in case of a

sale by auction:

(1) Goods are put for sale in lots; and each lot is prima facie deemed to be the

subject of a separate contract of sale;

(2) The sale is complete when the auctioneer announces its completion with the fall

of the hammer or in other customary / accepted manner; and until such

announcement is made, any bidder may retract his bid;

(3) A right to bid may be reserved expressly by or on behalf of the seller and, where

such right is expressly so reserved, but not otherwise, the seller or any one

person on his/her behalf may, subject to the provisions hereinafter contained,

bid at auction;

(4) Where the sale is not notified to be subject to a right to bid on behalf of the

seller, it shall not be lawful for the seller to bid himself/herself or to employ any

AUDDEAUDDE

37

person to bid at such sale or for the auctioneer knowingly to take any bid from

the seller or any such person; and any sale contravening this rule may be

treated as fraudulent by the buyer;

(5) The sale may be notified to be subject to a reserved or upset price;

(6) If the seller makes use of pretended bidding to raise the price, the sale is

voidable at the option of the buyer.

Some important definitions:

a. Auction property (assets) means the entire lot of property (assets) as

specified in the lot subject such specifications, terms & conditions of offer

b. Auction price means the offer or bid price as offered at its current highest

level

c. Auctioneer means the person or entity conducting auction

5.3.2 Important Features of the Auction Sale

1. Publicity: Sufficient effort should be made by appropriate means to attract the

attention of potential buyers for the assets on offer. This is very important to

ensure adequate participation by interested parties. Publicity can be by way of:

a. Advertisements: newspaper advertisements to be inserted in related News

Paper sufficiently & correctly coordinated with date of Auction so as attract

potential buyers.

b. By personal calls, letters, emails etc., addressed to potential buyers

c. By arranging meetings where potential buyers are invited to present the best

features of the asset

The aim of the exercise to ensure that maximum number of persons / entities

participate in the auction process in a fair & transparent manner.

2. Details of Auction: Publicity shall include the following details:

a. Description of goods (assets). Description should offer sufficient details to

enable a prospective buyer to understand, appreciate and evaluate the value

of the asset on offer.

b. Conditions of offer: Terms & conditions of offer should be clearly mentioned.

c. Constraints / deficiencies: There shall not be any mis-statements or vague

statements that can deter a potential buyer. Any special conditions shall be

explicitly stated.

If either party by guilt, fraud or of deceitful misrepresentation, whereby the

bidders are misled; or if either party acts under a mistake as to a material and

essential particular, the sale is thereby rendered voidable as to the party

affected by the fraud or misrepresentation or the mistake so that he/she can,

within a reasonable time, retract.

a. Date, time, venue of auction sale shall be stated clearly.

AUDDEAUDDE

38

b. The name of the auctioneer or the Auctioning authority & his contact details

shall be stated clearly

c. Where a reserve price has been fixed the reserve price shall be stated.

3. Particulars and Catalogues: Where perusal of documents can result in better

clarity and better participation – relevant documents should be made available

at a specified location. These documents can include – copy of title document,

court orders, brochures, photographs, maps etc,

4. Conduct of Sale: Publicity material shall include statement specifying how the

auction sale will be conducted, mode, procedures etc.

5. Auction Sale in Lots

Auction can be in lots; each lot is subject of a separate contract under Sec. 64

(1), and this may be excluded by intention of parties to the contrary.

Where goods are sold in separate lots by auction, each lot is prima facie the

subject of a separate contract.

The goods are displayed in lots, and the auctioneer’s call to bid can amount to

mere invitation, and each bid received would be an offer that could quality to

become a contract, on acceptance by the auctioneer or his agent.

6. The seller may withdraw goods: The seller may withdraw goods or the bidder

may retract his bid at any time before the bid is accepted (unless locked) so long

as the final consent of both parties are not signified by the blow of the hammer,

or in any other manner as specified and agreed prior to the commencement of

the auction.

7. 1.1.6 Reserve Price: Normal practice is to sell the goods or property to the

highest bidder.

Where reserve price is intended, it is necessary to disclose the fact of reserve

price. It is a good practice to disclose reserve price value (not mandatory as per

Act) to ensure better results at the Auction. Unless condition of reserve price is

made known to the buyer under notification, the reserve price cannot be

applied, post facto.

8. Right to Bid: Every bidding is nothing more than an offer on the one side, and

not binding on either party till confirmed on the other. The Bidder may

withdraw the bid before the fall of the hammer.

Any condition prohibiting retraction is bad in law in view of Sec. 64(2) of the

Sale of Goods Act. No contract of sale is complete until it is accepted and

remains merely an offer. Refusal of the buyer to carry through the bid or

confirm the bid till the completion of the auction by the auctioneer and

acceptance of the bid, there would be no cause of action for or in favour of the

buyer. The auctioneer is equally competent to refuse, as is the buyer to

withdraw the offer before acceptance. (AIR 1965 Mad. 14, Coffee Board Vs.

Famous Coffee & Tea Works.)

AUDDEAUDDE

39 9. In case of a sale by government auction: In case of a sale by government

auction the sale is not complete until the bid is accepted in the form of the

confirmation of the collector / competent authority. (Muthu Pillai Vs. Secy of

State, 1923 Mad. 582.)

10. Once an offer is accepted: Once an offer is accepted the goods become the

property of the buyer on fall of hammer (1969 S.C. 569, A.V. Thomas & Co. Ltd.

Vs. Deputy Commissioner of Agricultural Income Tax & Sales Tax Trivandrum).

It is immaterial whether there is any condition like goods not to be removed till

payment received. Once the sale is completed, the buyer is the owner and can

sell the property immediately.

11. The Seller (person offering the asset for sale): The Seller (person offering the

asset for sale)cannot bid either directly in person or through other employees.

Such sale is voidable in the interest of public policy and equity.

Seller can bid only if he has reserved his right to do so in the condition notified,

otherwise which is prevented under sec. 64(6).

12. Bidding Agreement– Knock Out / Syndication:

Combination or agreement between intending bidders not to bid against each

other, or refrain from doing so, it is illegal and is known as “Knock out” or

syndication.

The object of conducting public sale is to secure as much price or revenue as

possible to redeem the debt of the debtor or to secure maximum price to the

exchequer for use of public purpose. If such a contract to form a ring among the

bidders was to peg down the price and to have the property knocked out at a

low price would defeat the above economic interest of the debtor or public

welfare. Thereby the agreement becomes fraudulent and opposed to public

policy and is void under Section 23.

13. Statements on the Rostrum in a physical Auction: Any offer or retraction by

either party should, however, be made so loud as to be heard by the others.

14. But as soon as the hammer is struck down or acceptance is evidenced,

which is the typical notification by the seller that the offer of the buyer is

accepted, the bargain is considered as concluded, and the seller has no right

afterwards to accept a higher bid, nor the buyer to withdraw from the contract.

15. Memorandum of Sale: The auctioneer has to record each and every offer with

regard to its sequence and timing, and ultimately the final bid and its

confirmation to avoid any mismanagement during the auction, so as to trace

out the bidding agreement of the buyers in case there is any, or to keep in

check.

16. Duties of Vendor, Purchaser and Public

It is the duty of the vendor (offeror) to represent the correct description of the

goods to be sold in auction under a advertisement/proclamation. The duty of

AUDDEAUDDE

40

the purchaser is to deposit the auction money with the auctioneer of the seller

and complete the sale procedure as the time stipulated in such auction sale.

17. The deposit: the bidder becomes purchaser as soon as his offer is final on and

it is his duty thereafter to deposit the amount as specified in the condition of

auction and subsequently to complete the payment as per the condition of

mode of payment as specified in the advertisement.

Auctioneer and Authority of Auctioneer: The Auctioneer is an agent of the

owner, the seller, with the authority to sell.

Authority of the Auctioneer:

i) Implied authority to sell the goods on behalf of the seller

ii) Implied authority to sign the contract on behalf of the seller, but this does not

extend to sale of unsold goods

iii) To receive the deposit from the buyer as per the condition of the auction sale

iv) To receiver consideration price.

An auctioneer cannot, in general, bind his principal by receiving payment

otherwise than in money, as by taking a bill of exchange in payment, unless he was

expressly authorized so to do, or unless it was customary, in like cases, to settle by bill.

The authority committed to an auctioneer is a personal trust, which he cannot

delegate to another without the consent of the owner. He cannot, therefore

authorize his clerk to act as agent for his employer, in his absence.

An auctioneer, like every other agent, cannot, ordinarily, purchase the goods of

his principal either on his own account, or on behalf of a third person, which may

tend directly to the furtherance of fraud.

The auctioneer has no authority to:

i. Sell by private contract - even if this were to fetch more price than the

reserved price.

ii. To rescind the contract.

iii. To warrant the goods sold.

iv. To deliver the goods sold without payment of price.

v. To allow the buyer to set off dues to him from the seller.

5.3.3 Rights and Duties of Auctioneer

(a) Rights: The auctioneer is the agent of the vendor for the purpose of sale, and

has ordinary rights and liabilities of a special agent. He has therefore, a claim

on compensation, which is ordinarily in the form of a commission for services,

and is determined, in absence of any special agreement, by the common usage

and also a right to claim a reimbursement for all expenses and advances,

properly incurred by him in the course of his agency.

He is also entitled to sue either party, while he has a beneficial interest. He

may, therefore, personally sue his principal for damages, or expenses, or for

AUDDEAUDDE

41

his commission, or he may as representative of the seller sue the buyer for the

price of goods.

(b) Duties: The duties of the auctioneer are in the first place, to take care of the

goods, sent to him for sale. Again it is his duty to observe strictly all the

instructions of his principal and all the conditions of the sale. If he deviates

from them, he will be personally liable for the consequences.

Where an auctioneer, after a sale by public auction, receives a deposit thereof

from the vendee, it is his duty, as the agent, or rather as the stakeholder of

both vendor and vendee, to retain the deposit until the sale is complete, and it

is ascertained to whom the money belongs.

5.3.4 Sales Under Statute and by Order of the Court

The auction sale under any execution proceedings of a decree, or any order or

judgment of any court falls under the provisions of Order XXI of the Code of Civil

Procedure 1908.

The purpose of auction is to disburse the claim of decree-holder, in execution of

the decree obtained by him to attach the property, by the judgment of Court.

Under normal auction seller or owner of the goods or property puts his property

or goods in auction.

Any court executing a decree may order that any property attached by it and

liable to sale, or such portion thereof as may seem necessary to satisfy the decree,

shall be sold, and that the proceeds of such sale, or a sufficient portion thereof,

shall be paid to the party entitled under the decree to receive the same.

Every sale shall be conducted by an officer of the court or by such other person

as the court may appoint in this behalf and shall be made by public auction in

manner prescribed.

5.3.5 Proclamation of Sales by Public Auction

(i) Where any property is ordered to be sold by public auction in execution of a

decree, the court shall cause a proclamation of the intended sale to be made in

the language of such court.

(ii) Such proclamation shall be drawn up after notice to the decree-holder and the

judgment- debtor and shall state the time and place of sale, and specify as fairly

and accurately as possible:

(a) the property to be sold, or where a part of the property would be sufficient to

satisfy the decree, such part;

(b)the revenue assessed upon the estate or part of the estate, where the property

to be sold is an interest in an estate or in part of an estate paying revenue to

the Government;

(c) any encumbrance to which the property is liable.

(d) the amount for recovery of which the sale is ordered and every other thing

which the court considers material for a purchaser to know in order to judge of

AUDDEAUDDE

42

the nature and value of the property, provided further that notice of the date for

settling the terms of the proclamation has been given to the judgment-debtor by

means such as notice of attachment affixed in court of the property attached.

The proclamation shall include the estimate of the value of the property if any

given by either or both of the parties.

(iii) Every application for an order for sale under this rule shall be accompanied by

statement signed and verified in the manner prescribed for the signing and

verification of pleadings and containing, so far as they are known to or can be

ascertained by the person making the verification.

(iv) For the purpose of ascertaining the matters to be specified in the proclamation,

the court may summon any person whom it thinks necessary to summon and

may examine him in respect of any such matters and require him to produce

any document in his possession or power relating thereto.

5.3.6 Mode of Making Proclamation

1. Every proclamation shall be made and published, as nearly as may be, in the

manner prescribed under the rule.

2. Where the court so directs, such proclamation shall also be published in the

Official Gazette or in a local newspaper, or in both, and the costs of such

publication shall be deemed to be the costs of the sale.

3. Where property is divided into lots for the purpose of being sold separately, it

shall not be necessary to make a separate proclamation for each lot, unless

proper notice of the sale cannot, in opinion of the court, otherwise be given.

5.3.7 Time of Sale

Where the movable property in the possession of judgment-debtors, and the

property attached by actual seizure and taken in custody of attaching officer,

unless the property is perishable or expense of it or storage is more. No sale shall,

without the consent in writing of the judgment-debtor, take place until after the

expiration of at least fifteen days in case of immovable property, and of at least

seven days in the case of movable property, calculated from the date on which the

copy of the proclamation has been affixed in the court-house of the judge ordering

the sale.

The Court may adjourn or stop the sale in its discretion to a specific day and hour.

The defaulting purchaser answerable for the loss on re-sale any deficiency of

price which may occur on re-sale by reason of the purchaser’s default, and all

expenses attending such re-sale, shall be certified to the court by the officer and

shall, at the instance of either the decree-holder or the judgment debtor, be

recoverable from the defaulting purchaser under the provisions relating to the

execution of a decree for the payment of money.

The Decree-holder cannot bid for or buy the property without permission of the

Court.

AUDDEAUDDE

43

A Mortgagee cannot bid at sale without the leave of the court; if leave to bid is

granted to such mortgagee, then the court shall fix a reserve price as regards the

mortgagee, or as the court directs.

No officer or other person having any duty to perform in connection with any

sale shall, either directly or indirectly, bid for acquiring or attempt to acquire any

interest in the property sold.

5.3.8 Sale by Public Auction

Where movable property is sold by public auction, the price of each lot shall be

paid at the time of sale, or as soon after as the officer or other person holding the

sale directs, and in default of payment, the property shall forthwith be re-sold.

(1) On payment of the purchase-money, the officer or other person holding the sale

shall grant a receipt for the same, and the sale shall become absolute.

(2) Where the movable property to be sold is a share in goods belonging to the

judgment-debtor and co-owner, and two or more persons, of whom one is such

co-owner, respectively bid the same sum for such property or for any lot, the

bidding shall be deemed to be the bidding of the co-owner.

5.3.9 Delivery of Movable Property

Where the property sold is movable property of which actual seizure has been

made, it shall be delivered to the purchaser.

Where the property sold is movable property in the possession of the some

person other than the judgment-debtor, the delivery thereof to the purchaser shall

be made by giving notice to the person in possession, prohibiting him from

delivering possession of the property to any person except the purchaser.

5.4 REVISION POINTS

1. Auction sale, time of sale, public action


1. What do you understand by term Auction?

2. What is bidding and bidding agreement?

3. How does auction conduct under court’s order?

4. Explain the features of an Auction Sale?

5.6 SUMMARY

AUCTION SALE is defined under the Sale of Goods Act. Typically in an auction

sale Goods are offered for sale in lots, each lot is a subject of a separate contract of

sale, sale is complete when the auctioneer announces its completion in a pre-

agreed manner. Sufficient effort should be made by appropriate means to attract

potential buyers for the assets to participate. Assets offered should be clear,

properly identified and preferably available for inspection. Reserve price if any

should be notified so that the prospective buyer is aware of the requirement.

Auction sale can result from re-possession of assets by banks or by order of Courts.

Once the assets is knocked out in favor of the bidder, it is incumbent upon the

AUDDEAUDDE

44 Auctioneer to deliver the assets and equally upon the successful bidder to abide by

the terms of the auction & accepted bid.


1. Explain Knock-out.

2. Who is the auctioneer? What are his rights, duties and liabilities?



5.9 ASSIGNMENTS

1. How does action conduct under court’s order?

2. Explain the features of an action sales.

5.10 REFERENCE BOOK

1. See in syllabus page


1. Group discussion during (PCP days) action sale

5.12 KEY WORDS

1. Action sale, time of sale, auctioneer

AUDDEAUDDE

45

LESSON - 6

IFRS, IAS AND VALUATION REQUIREMENTS

6.1 INTRODUCTION

India is fast moving towards synchronizing its economy with the Global Market.

As investments & decision making involve cross border activities it becomes

necessary to harmonies reporting systems on a global scale. International Financial

Reporting Standards Foundation is the apex body developing common standards

for financial accounting & reporting. Valuation requirements & methodology have

been specified under IAS as part of this effort.

6.2 OBJECTIVE

To give an overview of International Accounting Standards, with focus on

Valuation requirements. IAS forms the basis for IndAS – Indian Accounting

Standards.

6.3 CONTENT

6.3.1 Benefits of IFRS adoption by member countries

6.3.2 International Accounting Standards Board (IASB)

6.3.3 Summary of IAS 16

6.3.4 Measurement subsequent to initial recognition

The IFRS Foundation is a not-for-profit, public interest organization established

to develop a single set of high-quality, understandable, enforceable and globally

accepted accounting standards—IFRS Standards—and to promote and facilitate

adoption of the standards. IFRS Standards are set by the IFRS Foundation’s

standard-setting body, the International Accounting Standards Board (IASB).

Accounting standards are a set of principles companies follow when they

prepare and publish their financial statements, providing a standardised way of

describing the company’s financial performance. Publicly accountable companies

(those listed on public stock exchanges) and financial institutions are legally

required to publish their financial reports in accordance with agreed accounting

standards.

Mission of IFRS is to bring transparency, accountability and efficiency to

financial markets around the world by developing IFRS Standards. IFRS work

serves the public interest by fostering trust, growth and long-term financial stability

in the global economy.

6.3.1 BENEFITS OF IFRS ADOPTION BY MEMBER COUNTRIES

Ensure transparency by enhancing international comparability and quality

of financial information, enabling investors and other market participants to

make informed economic decisions.

Strengthen accountability by reducing the information gap between the

providers of capital and the people to whom they have entrusted their

money.

AUDDEAUDDE

46

Our Standards provide information needed to hold management to account.

As a source of globally comparable information, IFRS Standards are also of

vital importance to regulators around the world.

IFRS Standards contribute to economic efficiency by helping investors to

identify opportunities and risks across the world, thus improving capital

allocation.

For businesses, the use of a single, trusted accounting language lowers the

cost of capital and reduces international reporting costs.

6.3.2 INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)

IASB is an independent group of experts chosen with broad geographical

diversity, who come with an appropriate mix of recent practical experience in

setting accounting standards, in preparing, auditing, or using financial reports, and

in accounting education, re. is also required.

IASB members are responsible for the development and publication of IFRS

Standards, including the IFRS for SMEs. The Board is also responsible for

approving Interpretations of IFRS Standards as developed by the IFRS

Interpretations Committee (formerly IFRIC).

IASB has set out various standards for Financial Accounting & Reporting.

Indian Accounting Standards (Ind AS) are expected to largely conform to IAS, except

where they are contrary or in conflict of Indian Law. Some features are being

implemented with a time delay. However in course of time Ind AS will be in sync

with IAS. Out of various Standards set out by IASB we have selected 4 standards

that are of interest to Valuation practice.

They are:

1. IAS 16: Property, Plant and Equipment – Fixed Assets Value

2. IAS 36: Impairment of Assets (Recognition of loss of value)

3. IAS 38: Intangible Assets

4. IAS 40: Investment Property

6.3.3 SUMMARY OF IAS 16

Objective: The objective of IAS 16 is to prescribe the accounting treatment for

property, plant, and equipment. The principal issues are the recognition of assets,

the determination of their carrying amounts, and the depreciation charges and

impairment losses to be recognised in relation to them.

Scope: IAS 16 applies to the accounting for property, plant and equipment,

except where another standard requires or permits differing accounting treatments.

Differing treatment examples:

Assets classified as held for sale in accordance with IFRS 5

Non-current Assets Held for Sale and Discontinued Operations biological assets

related to agricultural activity accounted for under IAS 41 Agriculture.

AUDDEAUDDE

47

Exploration and evaluation assets recognised in accordance with IFRS 6

Exploration for and Evaluation of Mineral Resources mineral rights and mineral

reserves such as oil, natural gas and similar non-regenerative resources.

However

The standard does apply to property, plant, and equipment used to develop or

maintain the last three categories of assets. [IAS 16.3]

The cost model in IAS 16 also applies to investment property accounted for

using the cost model under IAS 40 Investment Property. [IAS 16.5]

The standard does apply to bearer plants but it does not apply to the produce

on bearer plants. [IAS 16.3]

Recognition

Items of property, plant, and equipment should be recognised as assets when it

is probable that: [IAS 16.7]the future economic benefits associated with the asset

will flow to the entity, and the cost of the asset can be measured reliably.

This recognition principle is applied to all property, plant, and equipment costs

at the time they are incurred. These costs include costs incurred initially to acquire

or construct an item of property, plant and equipment and costs incurred

subsequently to add to, replace part of, or service it.

IAS 16 does not prescribe the unit of measure for recognition – what

constitutes an item of property, plant, and equipment. [IAS 16.9]

Component Accounting: Note, however, that if the cost model is used (see

below) each part of an item of property, plant, and equipment with a cost that is

significant in relation to the total cost of the item must be depreciated separately.

[IAS 16.43]

IAS 16 recognises that parts of some items of property, plant, and equipment

may require replacement at regular intervals. The carrying amount of an item of

property, plant, and equipment will include the cost of replacing the part of such an

item when that cost is incurred if the recognition criteria (future benefits and

measurement reliability) are met. The carrying amount of those parts that are

replaced is de-recognised in accordance with the de-recognition provisions of IAS

16.67-72. [IAS 16.13]

Also, continued operation of an item of property, plant, and equipment (for

example, an aircraft) may require regular major inspections for faults regardless of

whether parts of the item are replaced. When each major inspection is performed,

its cost is recognised in the carrying amount of the item of property, plant, and

equipment as a replacement if the recognition criteria are satisfied. If necessary, the

estimated cost of a future similar inspection may be used as an indication of what

the cost of the existing inspection component was when the item was acquired or

constructed. [IAS 16.14]

AUDDEAUDDE

48 Initial measurement

An item of property, plant and equipment should initially be recorded at cost.

[IAS 16.15]

Cost includes all costs necessary to bring the asset to working condition for its

intended use. This would include not only its original purchase price but also

costs of

site preparation,

delivery and handling,

installation,

related professional fees for architects and engineers, and

the estimated cost of dismantling and removing the asset and restoring the

site (see IAS 37 Provisions, Contingent Liabilities and Contingent Assets). [IAS

16.16-17]

If payment for an item of property, plant, and equipment is deferred, interest

at a market rate must be recognised or imputed. [IAS 16.23]

If an asset is acquired in exchange for another asset (whether similar or

dissimilar in nature), the cost will be measured at the fair value unless (a) the

exchange transaction lacks commercial substance or (b) the fair value of neither the

asset received nor the asset given up is reliably measurable. If the acquired item is

not measured at fair value, its cost is measured at the carrying amount of the asset

given up. [IAS 16.24]

6.3.4 Measurement subsequent to initial recognition

Cost model & Revaluation model

Cost model: The asset is carried at cost less accumulated depreciation and

impairment. [IAS 16.30]

Revaluation model: The asset is carried at a revalued amount, being its fair

value at the date of revaluation less subsequent depreciation and impairment,

provided that fair value can be measured reliably. [IAS 16.31]

The revaluation model

Revaluations should be carried out regularly, so that the carrying amount of

an asset does not differ materially from its fair value at the balance sheet date.

[IAS 16.31]

If an item is revalued, the entire class of assets to which that asset belongs

should be revalued. [IAS 16.36]

Revalued assets are depreciated in the same way as under the cost model (see

below).

If a revaluation results in an increase in value, it should be credited to other

comprehensive income and accumulated in equity under the heading "revaluation

surplus" unless it represents the reversal of a revaluation decrease of the same

AUDDEAUDDE

49 asset previously recognised as an expense, in which case it should be recognised in

profit or loss. [IAS 16.39]

A decrease arising as a result of a revaluation should be recognised as an

expense to the extent that it exceeds any amount previously credited to the

revaluation surplus relating to the same asset. [IAS 16.40]

When a revalued asset is disposed of, any revaluation surplus may be

transferred directly to retained earnings, or it may be left in equity under the

heading revaluation surplus. The transfer to retained earnings should not be made

through profit or loss. [IAS 16.41]

Depreciation (cost and revaluation models)

For all depreciable assets:

The depreciable amount (cost less residual value) should be allocated on a

systematic basis over the asset's useful life [IAS 16.50].

The residual value and the useful life of an asset should be reviewed at least at

each financial year-end and, if expectations differ from previous estimates, any

change is accounted for prospectively as a change in estimate under IAS 8. [IAS

16.51]

The depreciation method used should reflect the pattern in which the asset's

economic benefits are consumed by the entity [IAS 16.60]; a depreciation

method that is based on revenue that is generated by an activity that includes

the use of an asset is not appropriate. [IAS 16.62A]

Note: The clarification regarding the revenue-based depreciation method was

introduced by Clarification of Acceptable Methods of Depreciation and

Amortisation, which applies to annual periods beginning on or after 1 January

2016.

The depreciation method should be reviewed at least annually and, if the

pattern of consumption of benefits has changed, the depreciation method should be

changed prospectively as a change in estimate under IAS 8. [IAS 16.61]

Expected future reductions in selling prices could be indicative of a higher rate

of consumption of the future economic benefits embodied in an asset. [IAS 16.56]

Note: The guidance on expected future reductions in selling prices was

introduced by Clarification of Acceptable Methods of Depreciation and

Amortisation, which applies to annual periods beginning on or after 1 January

2016.

Depreciation should be charged to profit or loss, unless it is included in the

carrying amount of another asset [IAS 16.48].

Depreciation begins when the asset is available for use and continues until the

asset is de-recognised, even if it is idle. [IAS 16.55]

AUDDEAUDDE

50 Recoverability of the carrying amount

IAS 16 Property, Plant and Equipment requires impairment testing and, if

necessary, recognition for property, plant, and equipment.

An item of property, plant, or equipment shall not be carried at more than

recoverable amount. Recoverable amount is the higher of an asset's fair value less

costs to sell and its value in use.

Any claim for compensation from third parties for impairment is included in

profit or loss when the claim becomes receivable. [IAS 16.65]

Derecognition (retirements and disposals)

An asset should be removed from the statement of financial position on

disposal or when it is withdrawn from use and no future economic benefits are

expected from its disposal.

The gain or loss on disposal is the difference between the proceeds and the

carrying amount and should be recognised in profit and loss. [IAS 16.67-71]

If an entity rents some assets and then ceases to rent them, the assets should

be transferred to inventories at their carrying amounts as they become held for sale

in the ordinary course of business. [IAS 16.68A]

Disclosure

Information about each class of property, plant and equipment shall be

furnished for each class of property, plant, and equipment, [IAS 16.73]

Basis for measuring carrying amount depreciation method(s) used:

Useful lives or depreciation rates gross carrying amount and accumulated

depreciation and impairment losses reconciliation of the carrying amount at the

beginning and the end of the period, showing:

additions disposals acquisitions through business combinations

revaluation increases or decreases

impairment losses reversals of impairment losses

depreciation

net foreign exchange differences on translation

other movements

Additional disclosures

The following disclosures are also required: [IAS 16.74]

Restrictions on title and items pledged as security for liabilities expenditures to

construct property, plant, and equipment during the period contractual

commitments to acquire property, plant, and equipment compensation from third

parties for items of property, plant, and equipment that were impaired, lost or given

up that is included in profit or loss.

IAS 16 also encourages, but does not require, a number of additional

disclosures. [IAS 16.79]

AUDDEAUDDE

51 Revalued property, plant and equipment

If property, plant, and equipment is stated at revalued amounts, certain

additional disclosures are required: [IAS 16.77] the effective date of the revaluation

whether an independent valuer was involved for each revalued class of property, the

carrying amount that would have been recognised had the assets been carried

under the cost model the revaluation surplus, including changes during the period

and any restrictions on the distribution of the balance to shareholders.

Entities with property, plant and equipment stated at revalued amounts are

also required to make disclosures under IFRS 13 Fair Value Measurement.

Summary of IAS 36 – Impairment

The core principle in IAS 36 is that an asset must not be carried in the

financial statements at more than the highest amount to be recovered through its

use or sale.

If the carrying amount exceeds the recoverable amount, the asset is described

as impaired. The entity must reduce the carrying amount of the asset to its

recoverable amount, and recognise an impairment loss.

IAS 36 also applies to groups of assets that do not generate cash flows

individually (known as cash-generating units).

Underlying the standard’s prescriptions is a set of key definitions that include

the following (IAS 36.6):

Carrying amount: the amount at which an asset is recognized after deducting

any accumulated depreciation (amortization) and accumulated impairment

losses thereon.

Cash-generating unit (CGU): the smallest identifiable group of assets that

generates cash inflows that are largely independent of the cash inflows from

other assets or groups of assets.

Costs of disposal: incremental costs directly attributable to the disposal of an

asset or CGU, excluding finance costs and income tax expense.

Impairment loss: the amount by which the carrying amount of an asset or CGU

exceeds its recoverable amount.

Fair value: the price that would be received to sell an asset or paid to transfer a

liability in an orderly transaction between market participants at the

measurement date.

Recoverable amount: the recoverable amount of an asset or a CGU is the

higher of its fair value less costs of disposal and its value in use.

Value in use: the discounted present value of the future cash flows expected to

be derived from an asset or CGU.

AUDDEAUDDE

52 Summary of IAS 38 - Intangible Assets

IAS 38 sets out the criteria for recognising and measuring intangible assets and

requires disclosures about them. An intangible asset is an identifiable non-

monetary asset without physical substance. Such an asset is identifiable when it is

separable, or when it arises from contractual or other legal rights. Separable assets

can be sold, transferred, licensed, etc.

Examples of intangible assets include computer software, licenses, trademarks,

patents, films, copyrights and import quotas.

Goodwill acquired in a business combination is accounted for in accordance

with IFRS 3 and is outside the scope of IAS 38.

Internally generated goodwill is within the scope of IAS 38 but is not recognised

as an asset because it is not an identifiable resource.

The cost of generating an intangible asset internally is often difficult to

distinguish from the cost of maintaining or enhancing the entity’s operations or

goodwill. For this reason, internally generated brands, mastheads, publishing titles,

customer lists and similar items are not recognised as intangible assets.

The costs of generating other internally generated intangible assets are

classified into whether they arise in a research phase or a development phase.

Research expenditure is recognised as an expense. Development expenditure that

meets specified criteria is recognised as the cost of an intangible asset.

Intangible assets are measured initially at cost. After initial recognition, an

entity usually measures an intangible asset at cost less accumulated amortisation.

It may choose to measure the asset at fair value in rare cases when fair value can

be determined by reference to an active market.

IAS 40 – Investment Property

Investment property is land or a building (including part of a building) or both

that is:

held to earn rentals or for capital appreciation or both;

not owner-occupied;

not used in production or supply of goods and services, or for administration;

and

not held for sale in the ordinary course of business.

Investment property may include investment property that is being

redeveloped. An investment property is measured initially at cost.

The cost of an investment property interest held under a lease is measured in

accordance with IAS 17 at the lower of the fair value of the property interest and

the present value of the minimum lease payments.

For subsequent measurement an entity must adopt either the fair value model

or the cost model as its accounting policy for all investment properties.

AUDDEAUDDE

53

All entities must determine fair value for measurement (if the entity uses the

fair value model) or disclosure (if it uses the cost model). Fair value reflects market

conditions at the end of the reporting period.

Under the fair value model, investment property is re-measured at the end of

each reporting period. Changes in fair value are recognised in profit or loss as they

occur. Fair value is the price at which the property could be exchanged between

knowledgeable, willing parties in an arm’s length transaction, without deducting

transaction costs (see IFRS 13).

Under the cost model, investment property is measured at cost less

accumulated depreciation and any accumulated impairment losses. Fair value is

disclosed.

Gains and losses on disposal are recognised in profit or loss.

6.4 REVISION POINTS

1. IFRS, IAs - Valuation


1. Write a short note on IFRS and its benefits in valuation.

2. Write a short note on IASB (International Accounting Standards Board)

3. What you understand by the term Recognition in IAS 16.7

4. What is meant by Initial Measurement? (IAS 16.15)

5. Why is revaluation important? Explain

6. What do you understand by the term Disclosure and Additional Disclosure

in valuation?

6.6 SUMMARY

International Financial Reporting System (IFRS) Foundation is a not for profit

organization set up to foster integration and development of common Standards for

financial accounting. Mission of IFRS is to bring transparency, accountability and

efficiency to financial markets around the world by developing IFRS Standards.

International Accounting System Board (IASB) is part of IFRS Foundation,

entrusted with the task of setting up Standards. We have selected 4 standards that

are of interest to Valuation practice, namely IAS 16: Property, Plant and Equipment

– Fixed Assets Value , IAS 36: Impairment of Assets (Recognition of loss of value),

IAS 38: Intangible Assets &IAS 40: Investment Property

IAS 16 applies to the accounting for property, plant and equipment. The

objective of IAS 16 is to prescribe the accounting treatment for property, plant, and

equipment. The principal issues are the recognition of assets, the determination of

their carrying amounts, and the depreciation charges and impairment losses to be

recognised in relation to them. An item of property, plant and equipment should

initially be recorded at cost. Expenditures related to cost are defined in IAS 16.

AUDDEAUDDE

54 Subsequently IAS 16 allows “depreciation accounting” on cost basis as well as

“revaluation” basis. Under IAS 16 Property, Plant and Equipment requires

impairment testing and, where necessary, recognition of impairment for property,

plant, and equipment. An item of property, plant, or equipment shall not be carried

at more than recoverable amount. Recoverable amount is the higher of an asset's

fair value less costs to sell and its value in use.

IAS 36 deals with Impairment. The core principle in IAS 36 is that an asset

must not be carried in the financial statements at more than the highest amount to

be recovered through its use or sale.IAS 38 sets out the criteria for recognising and

measuring intangible assets and requires disclosures about them. An intangible

asset is an identifiable non-monetary asset without physical substance.

IAS 40 deals with Investment Property. Investment property may include

investment property that is being redeveloped. An investment property is measured

initially at cost.

The cost of an investment property interest held under a lease is measured in

accordance with IAS 17 at the lower of the fair value of the property interest and

the present value of the minimum lease payments.


1. What do you understand by the term Impairment Value in valuation? What

are the factors that affect such a valuation?



6.9 ASSIGNMENTS

1. What is the impact of depreciation in valuation?

2. What do you understand by the term disclosure and additional disclosure in

valuation?

6.10 REFERENCE BOOK

1. IFRS Foundation – IASB


1. Group discussion during (PCP days)

6.12 KEY WORDS

1. Disclosure, Investment property, IFRS, IAS

AUDDEAUDDE

55

LESSON 7

SLUMP SALE – VALUATION CONSIDERATIONS

7.1 INTRODUCTION

Slump sale refers to the business practice where an entire segment of

operations of a business is offered for sale on an aggregated whole asset basis on a

going concern basis. In valuation practice certain types of assets should be valued

only on whole asset basis and offered on slump sale basis. Any attempt to sell on

piecemeal basis may result in considerable erosion of value to stakeholders.

7.2 OBJECTIVE

To study aspects of assets that are best valued on whole asset basis as a going

concern & valuation considerations for the same.

7.3 CONTENT

7.3.1 What is ‘slump sale?’

7.3.2 Income tax & capital gains considerations

7.3.1 What is ‘Slump Sale’

‘Slump sale’ is transfer of a whole or part of business concern as a going

concern. The entity is offered as a block comprising – land, buildings, plant &

machinery, licenses & permissions, as a business proposal. Potential buyers are

expected to continue in the same or similar business and enjoy the fruits of a ready

for exploitation asset.

7.3.2 Income Tax & Capital Gains Considerations

As per section 2(42C) of Income -tax Act 1961, ‘slump sale’ means the transfer

of one or more undertakings as a result of the sale for a lump sum consideration

without values being assigned to the individual assets and liabilities in such sales.

‘Undertaking’ has the same meaning as in Explanation 1 to section 2(19AA)

defining ‘demerger’. As per Explanation 1 to section 2(19AA), ‘undertaking’ shall

include any part of an undertaking or a unit or division of an undertaking or a

business activity taken as a whole, but does not include individual assets or

liabilities or any combination thereof not constituting a business activity.

Explanation 2 to section 2(42C) clarifies that the determination of value of an

asset or liability for the payment of stamp duty, registration fees, similar taxes, etc.

shall not be regarded as assignment of values to individual assets and liabilities.

Thus, even if value is assigned to land for stamp duty purposes, the transaction will

continue to qualify as slump sale under section 2(42C)

A “slump sale” offer or agreement must satisfy the following quick test:

1. Business is sold off as a whole and as a going concern

2. Sale for a lump sum consideration

3. Bill of Materials available on record do not indicate item-wise value of the

assets transferred. Sale value has to be on whole asset basis.

AUDDEAUDDE

56

The consideration for transfer is a lump sum consideration. This consideration

should be arrived at without assigning values to individual assets and liabilities.

The consideration may be discharged in cash or by issuing shares of Transferor

Company.

Possibility of identification of price attributable to individual items (plant,

machinery and dead stock) which are sold as part of slump sale, may not entitle a

transaction to be qualified as slump sale — CIT vs. Artex Manufacturing Co., [227

ITR 260 (SC)]. However, in case of slump sale which includes land/building where

separate value is assigned to it under the relevant stamp duty legislation, the

slump sale will not be adversely affected in the light of Explanation 2 to section

2(42C).

Valuation Considerations

Why Whole asset Valuation?

There are many asset classes where by the nature of the assets – aggregation is

essential requirement to ensure production & productivity – the purpose of the

entity. Banks as lenders require Valuers to estimate value in liquidation – realizable

value & Distressed Value. For many assets the valuer has to state as part of his

report that the Asset should be offered for sale only on slump sale basis.

For example take the case of a Windmill Generator.

Usually, WMG s are part of a wind farm. Wind farms are promoted by large

WMG manufacturing companies directly or through their subsidiaries. Each wind

farm may consist of multiple number of WMGs together generating a viable

quantum of power for evacuation. Wind farms are located in far flung areas.

Locations are decided based on wind velocity & pattern studies. A lot of logistical

requirements need to be factored to make the farm viable – examples: Sanctions &

approvals, Power evacuation & grid connectivity, access roads, Annual Operation &

Maintenance Contracts etc. The wind farm promoters offer individual WMG s for

sale with a commitment to manage the WMG. Viability considerations require that

support from WMG manufacturer is essential for economical operation of WMG s

and earning reasonable returns. Under such circumstances, individual WMG

owners have options only to the extent in or out. The plant has to be sold as an

operating entity only. Land cannot be sold separately. Usually the parcel of land is

land locked & can be accessed only through private road operated by the AMC

company. WMG without the land cannot exist in that location. Issues on grid

connectivity, AMC & other issues remain. WMG as P & M loses significant value

erosion if it is required to be relocated.

Hence it is prudent to value WMG only on whole asset basis– including land,

buildings & WMG.

Another example is the case of an Integrated Sugar Mill. Typically this

comprises of Sugar Mill, co-gen plant, distillery and effluent treatment plants.

Sugar mills need to procure sugar cane and proximity to cane growing areas is of

AUDDEAUDDE

57 prime concern. Delay in crushing post-harvest leads to reduced yield. Licenses,

permissions, approvals take a long time. The plant works on all or none basis. That

is when mill is crushing, all segments of the sugar plant except Distillery have to

compulsorily work. Any break down downstream leads to stoppage of crushing.

Land buildings, plant & machinery all are located based on specific process

requirements. Usually it is very difficult to find alternative uses for individual

segments.

Hence any disposal arrangement necessarily has to be on whole asset basis.

However it is possible to spin off Co-gen plant and Distillery as separate units and

sell them when required. In this case, by whole asset, we mean sugar mill &

effluent treatment plants as one unit, co-gen & power plant as one unit and

distillery & effluent treatment plant as another unit. Valuation process has to be

done accordingly.

So a practicing valuer needs to recognize the need to aggregate assets as an

entity to maximize value where applicable. Most chemical process plants will

generally fall under this category.

Valuation Process

Valuation methodology requires that all assets are enumerated & physically

verified. Hence it is necessary to prepare a detailed list of assets that comprise the

entity.

It is possible to procure individual assets – say in the case of Sugar plant:

a. individual Mill or mill drive

b. all utilities like – Transformers, air compressors etc

c. Sulphitors, calandrias, evaporators, centrifuges etc.

d. packing & stacking equipment

e. boiler, FD fan, ID fan ESP etc

f. TG set, condenser etc

g. Individual distillation columns in distillery

h. Individual tanks in tank farm

Quotations can be made available, and procurement done for individual

equipment. Therefore there definitely exists a determinable value for each of these

equipment at macro & micro levels.

As part of valuation process Valuer is expected to consider these assets

separately. It is quite possible that age of many of these assets is indeterminate in

view of periodic refurbishments, modernisations and replacements. Valuer needs to

apply due diligence while arriving at value conclusion for each of these assets which

by themselves can be said to be aggregated.

Since valuation methodology is driven by purpose, it becomes necessary to

determine the purpose for which valuation is sought.

AUDDEAUDDE

58

For example for purposes of insurance it is a good idea to have detailed list of

assets and their value – based on replacement or re-instatement as new basis.

For purposes of secured lending we may need to aggregate as whole asset. This

is because Lender is interested in knowing Realizable Value & Distressed Value.

Assets can be reasonably disposed of only on whole asset basis.

Estimate of value by Valuer is likely to be very different from book value as per

balance sheet that is financial accounting system. We have already seen that

income tax calculation is based on Companies Act & capital gains based on IT Act.

Hence there can be a conflict of interest at the time of disposal, where Tangible

asset based Valuation is used as part of assessment of sale value.

There is a tendency to value the asset on business valuation basis, and take

tangible assets value at WDV or book value. Excess over book value is treated as

intangible asset value. This method serves the purpose of present owner in terms of

Capital gains taxation.

However it is very likely that tangible asset value is under stated and intangible

asset value is over stated. For an investor, intangible asset value is of great interest

since this parameter is an indicator of earnings potential. Overstated intangible

asset value & understated tangible asset value can lead to distortion in

measurement of performance & assessing investment potential. Of course the issue

of avoided capital gains tax is of concern to the Govt.

Governments are alive to this issue. IFRS amendments, seek to bridge the gap

between market value &book value (WDV) –periodically so as to remove this

conflict.

Ideally we shall reach the stage where results of financial valuation & technical

valuation can be rationally correlated and accepted. IVS 2017 sets out methodology for

business valuation & intangible asset valuation separately under IVS 200 & IVS 210.

Once the correlation between, Asset valuation based on future cash flow,

tangible asset valuation and intangible asset valuation is established – conflicts will

be considerably reduced.

7.4 REVISION POINTS

1. Slump sale, Income tax, capital


1. Explain the term slump Sale.

7.6 SUMMARY

‘Slump sale’ is transfer of a whole or part of business concern as a going

concern. The entity is offered as a block comprising – land, buildings, plant &

machinery, licenses & permissions, as a business proposal. Potential buyers are

expected to continue in the same or similar business and enjoy the fruits of a ready

for exploitation asset. As per section 2(42C) of Income -tax Act 1961, ‘slump sale’

means the transfer of one or more undertakings as a result of the sale for a lump

sum consideration without values being assigned to the individual assets and

AUDDEAUDDE

59 liabilities in such sales. However IT Act allows separate values for land / building

for purposes of determining stamp duty for registration. There are many asset

classes where aggregation is essential requirement to ensure production &

productivity. Banks require – Realizable value & Distressed Value. Many assets

may require the valuer to state that the Asset should be offered for sale only on

slump sale basis. Quotations can be made available, and procurement can be done

for individual equipment. There definitely exists a determinable value for each of

these equipment at macro & micro levels. It is quite possible that age of many of

these assets is indeterminate in view of periodic refurbishments, modernisations

and replacements. There is a tendency to take tangible assets value book value.

Excess over book value is treated as intangible asset value. It is very likely that

tangible asset value is under stated and intangible asset value is over stated.

Overstated intangible asset value & understated tangible asset value can lead to

distortion in measurement of performance & assessing investment potential.


1. What is meant by whole asset Valuation? Explain with an example.



7.9 ASSIGNMENTS

1. Explain the features and process of a whole asset valuation.

7.10 REFERENCE BOOK

1. Bombay Chartered Accountant’s Society- Article



7.12 KEY WORDS

1. Valuation, asset, slump sale

AUDDEAUDDE

60

LESSON 8

VALUATION UNDER COMPANIES ACT 2013

8.1 INTRODUCTION

The Companies Act 2013 is a landmark legislation that overhauls the system of

Corporate Governance in India and seeks to harmonies our financial reporting

system with global practices. Companies Act 2013 provides for Valuation and rules

for Registered Valuers. Recently GOI have notified Draft rules(May 2017) for

Registered Valuers under the Companies Act 2013. This regulation is expected to

transform Valuation profession. Insolvency & Bankruptcy Board of India(IBBI) have

been designated as the Regulator for Valuation profession.

8.2 OBJECTIVE

To familiarize the student with salient aspects of Companies Act 2013 that

are of special interest to Valuers & Valuation profession.

8.3 CONTENT

8.3.1 Valuation under Companies Act 2013

8.3.2 Responsibility & Liability of Valuer

The Companies Act, 2013, aims to improve corporate governance, simplify

regulations, enhances the interests of minority investors and for the first time

legislates the role of whistle-blowers. The new law replaces the nearly 60-year-old

Companies Act, 1956.Co Act 2013 provides an opportunity to catch up and make

our corporate regulations more contemporary, more transparent & in tune with

IFRS and Global practices.

The Co. Act 2013 is more of a rule-based legislation containing only 470

sections, which means that the substantial part of the legislation will be in the form

of rules. Co. Act 2013 and rules provide for phased implementation of the

provisions. Rules for a vast majority of the sections have been already notified. Only

certain sub-sections of Co. Act 1956 are still valid. Hence it is fair to say that Co.

Act 2013 is the law in force and consequently all corresponding sections of the Co.

Act 1956 are no more relevant and have become obsolete.

The Co. Act 2013 Act has introduced the concept of a 'Registered Valuer' under

a separate chapter which intends to cover all kinds of valuation requirements. As

per Chapter XVII Section 247 of the Act, where a valuation is required to be made

in respect of any property, stocks, shares, debentures, securities or goodwill or any

other assets or net worth of a company or its liabilities under the provision of this

Act, it must be valued by a Registered Valuer.

The concept of valuation as a code is new for the 2013 Act. The rationale

behind introducing this is to set certain valuation standards and regulate the

practice which will bring transparency and better governance during a valuation

exercise. Chapter XVII Section 247 of the 2013 Act is read with Rule 17 of Rules

(under notification), which lay down the criteria for registration, rights of the valuer,

approach and methods to be used by registered valuers and contents of the

AUDDEAUDDE

61 Valuation Report. Under the notification, Insolvency & Bankruptcy Board of

India(IBBI) have been designated as the Regulator for Valuation profession.

As per the Co. Act 2013, all valuations need to be carried out by a Registered

Valuer and for valuation requirement of a company, the Registered Valuer shall be

appointed by the Audit Committee or in its absence, by its Board of Directors. The

Draft Rules define "Registered Valuer" and state that a person to be eligible to act

as a valuer, must register with the Central Government or institution or agency

notified by the Central Government by filing an application for registration as a

valuer. The Govt. has notified, IBBI as the Regulator for Valuation profession.

8.3.1 VALUATION UNDER COMPANIES ACT 2013

Valuation has been declared as necessary for the following Purposes under

Co. Act 2013.

Section wise Requirement of Registered Valuers

Section 62(1)(c): For Valuing further Issue of Shares

Section 192(2): For Valuing Assets involved in Arrangement of Non Cash

transactions involving Directors

Section 230(2)(c)(v): For Valuing Shares, Property and Assets of the company

under a Scheme of Corporate Debt Restructuring

Section 230(3) and 232(2)(d): For Valuation including Share swap ratio

under a Scheme of Compromise/Arrangement, a copy of Valuation Report by

Expert, if any shall be accompanied

Section 232(3)(h): Where under a Scheme of Compromise/Arrangement the

transferor company is a listed company and the transferee company is an

unlisted company, for exit opportunity to the shareholders of transferor

company, valuation may be required to be made by the Tribunal

Section 236(2): For Valuing Equity Shares held by Minority Shareholders

Section 260(2)(c): For preparing Valuation report in respect of Shares and

Assets to arrive at the Reserve Price or Lease rent or Share Exchange Ratio for

Company Administrator

Section 281(1)(a): For Valuing Assets for submission of report by Company

Liquidator

Section 305(2)(d): For report on the Assets of the company for preparation of

declaration of solvency under voluntary winding up

Section 319(3)(b): For Valuing the interest of any dissenting member of the

transferor company who did not vote in favour of the special resolution, as

may be required by the Company Liquidator

Section 325(1)(b): For valuation of annuities and future and contingent

liabilities in winding up of insolvent company

AUDDEAUDDE

62 Method of Valuation

Registered Valuer shall make valuation of any asset as on the Valuation date

and in accordance with applicable standards, if any stipulated for this purpose.

Registered Valuer shall make valuation of any asset in accordance with any one

or more of the following methods:

1. Net Asset Value Method (NAV)

2. Market Price Method

3. Yield Method / PECV Method

4. Discounted Cash Flow Method (DCF)

5. Comparable Companies Multiples Method (CCM)

6. Comparable Transaction Multiples Method (CTM)

7. Price of Recent Investment Method (PORI)

8. Sum of the parts Valuation Method (SOTP)

9. Liquidation Value

10. Weighted Average Method

11. Any other method accepted or notified by RBI, SEBI or Income Tax Authorities

12. Any other method that valuer may deem fit provided adequate justification for

use of such method (and not any of the above methods) is provided

Contents of the Valuation Report (as per Form No. 17.3)

Valuation Report - Title [Pursuant to section 247(2)(c) and rule 17.7]

Contents Sub-Contents

1) Valuer Details

a. Name of the Valuer

b. Address of the Valuer

c. Registration number of the Valuer

d. e-mail ID

2) Description of Valuation Engagement

a. Name of the client

b. Other intended users

c. Purpose for valuation

3) Description of Business/ Asset /Liability being valued

a. Nature of business or asset / liability

b. Legal background

c. Financial aspects

d. Tax matters

AUDDEAUDDE

63 4) Description of the Information underlying the Valuation

a. Analysis of past results

b. Budgets, with underlying assumptions

c. Availability and quality of underlying data

d. Review of budgets for plausibility

e. Statement of responsibility for information received

5) Description of specific Valuation of Assets used in the Business

a. Basis or bases of value

b. Valuation Date

c. Description of the procedures carried out

d. Principles used in the valuation

e. The valuation method used and reasoning

f. Nature, scope and quality of underlying data

g. The extent of estimates and assumptions together with considerations

underlying them

6) Confirmation that the valuation has been undertaken in accordance with these

Rules

7) Further it is certified that valuation has been undertaken after taking into

account relevant conditions/regulations/rules/notifications, if any, issued by

the Central/State Government(s) from time to time.

8) Valuation Statement

Apart from this, some key/additional information to be included in the

Valuation Report:

i. The valuation report must clearly state the significant assumptions upon which

the value is based. When reporting, there may be instances where there are

confidential figures, these must be summarised in a separate exhibit.

ii. In the valuation report, the Registered Valuer must set out a clear value or range

of values along with the reasoning.

iii. In case the Registered Valuer has been involved in valuing any part of the

subject matter of valuation in the past, the past valuation report(s) should be

attached and referred to herein. In case, a different basis has been adopted for

valuation (than adopted in the past), the Valuer should justify the reason for

such differences.

8.3.2 Responsibility & Liability of Valuer

As per the Companies Act 2013,

a valuer is expected to assume the following responsibilities while carrying out

a valuation engagement:

must exercise due diligence and care.

AUDDEAUDDE

64 must make an impartial, true and fair valuation of assets that are being

valued.

must make the valuation in accordance with the prescribed rules.

is prohibited to undertake valuation of assets in which he has a direct or

indirect interest or becomes interested at any time during or after the valuation

of that asset.

Penalties in case of violation / contravention of provisions:

A valuer violating the provisions of the requirements shall be punishable with

a fine of Rs.25,000 extending up to Rs.1 lakh.

In case of intention to defraud the company or its members, imprisonment

has been additionally provided as a penal provision. If charges are proved,

Valuer can be asked to refund remuneration received and also liable for

damages. Punishment can be imprisonment up to 1 year and Fine 1,00,000

to 5,00,000 as may be decided.

A valuer, sentenced to a term of imprisonment for any offence or found guilty

of misconduct in his professional capacity shall be removed from the register

of valuer and he will cease to act as a valuer.

The Rules provide for removal and restoration of names of valuers from

register maintained by the Central Government or any authority, institution

or agency.

Also, as per the Rules, a valuer in case aggrieved by an order of the Central

Government can file an appeal against the order to the Tribunal.

8.4 REVISION POINTS

1. Valuation, Liability of valuer


1. What are the aims and objectives of the Companies Act 2013?

2. What are the different methods of valuation that can be adopted by a

registered valuer during a valuation?

3. Chart out a typical format of contents of a valuation report.

8.6 SUMMARY

The Companies Act, 2013, aims to improve corporate governance, simplify

regulations, enhances the interests of minority investors and for the first time

legislates the role of whistle-blowers. The Co. Act 2013 is more of a rule-based

legislation. Rules for a vast majority of the sections have been already notified. The

Co. Act 2013 Act has introduced the concept of a 'Registered Valuer' under a

separate chapter which intends to cover all kinds of valuation requirements. As per

Chapter XVII Section 247 of the Act, where a valuation is required to be made in

respect of any property, stocks, shares, debentures, securities or goodwill or any

other assets or net worth of a company or its liabilities under the provision of this

Act, it must be valued by a Registered Valuer. Chapter XVII Section 247 of the 2013

AUDDEAUDDE

65 Act is read with Rule 17 lays down the criteria for registration, rights of the valuer,

approach and methods to be used by registered valuers and contents of the

Valuation Report. Under the notification, Insolvency & Bankruptcy Board of

India(IBBI) have been designated as the Regulator for Valuation profession. All

valuations need to be carried out by a Registered Valuer and for valuation

requirement of a company, the Registered Valuer shall be appointed by the Audit

Committee or in its absence, by its Board of Directors.

Valuation has been declared as necessary for the following Purposes: Section

62(1)(c) : For Valuing further Issue of Shares, Section 192(2) – For Valuing Assets

involved in Arrangement of Non Cash transactions involving Directors , Section

230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a

Scheme of Corporate Debt Restructuring, Section 230(3) and 232(2)(d) – For

Valuation including Share swap ratio under a Scheme of

Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be

accompanied, Section 232(3)(h) - Where under a Scheme of

Compromise/Arrangement the transferor company is a listed company and the

transferee company is an unlisted company, for exit opportunity to the

shareholders of transferor company, valuation may be required to be made by the

Tribunal, Section236(2) – For Valuing Equity Shares held by Minority Shareholders,

Section 260(2)(c) – For preparing Valuation report in respect of Shares and

Assets to arrive at the Reserve Price or Lease rent or Share Exchange Ratio for

Company Administrator , Section 281(1)(a) – For Valuing Assets for submission of

report by Company Liquidator , Section 305(2)(d) – For report on the Assets of the

company for preparation of declaration of solvency under voluntary winding up ,

Section 319(3)(b) – For Valuing the interest of any dissenting member of the

transferor company who did not vote in favour of the special resolution, as may be

required by the Company Liquidator , Section 325(1)(b) – For valuation of annuities

and future and contingent liabilities in winding up of insolvent company. Registered

Valuer shall make valuation in accordance with applicable standards, if any

stipulated for this purpose in accordance with any one or more of the following

methods:

Net Asset Value Method (NAV) , Market Price Method , Yield Method / PECV

Method , Discounted Cash Flow Method (DCF), Comparable Companies Multiples

Method (CCM), Comparable Transaction Multiples Method (CTM) , Price of Recent

Investment Method (PORI) , Sum of the parts Valuation Method (SOTP) ,

Liquidation Value , Weighted Average Method or any other method accepted or

notified by RBI, SEBI or Income Tax Authorities or Any other method that valuer

may deem fit provided adequate justification for use of such method (and not any of

the above methods) is provided. Contents of the Valuation Report (as per Form No.

17.3). Responsibility & Liability of Valuer have also been defined under the Act. A

valuer must exercise due diligence and care, must make an impartial, true and fair

valuation of assets that are being valued, must make the valuation in accordance

AUDDEAUDDE

66 with the prescribed rules and is prohibited to undertake valuation of assets in

which he has a direct or indirect interest or becomes interested at any time during

or after the valuation of that asset.

Penalties in case of violation / contravention of provisions have been

prescribed. A valuer violating the provisions of the requirements shall be

punishable with a fine of Rs.25,000 extending up to Rs.1 lakh. In case of fraud or

collusion, stiffer penalties and criminal prosecution are prescribed.


1. What are the responsibilities of a valuer under the Companies act 2013?


1. www.fbsa.in/plantmachinery

8.9 ASSIGNMENTS

1. What are penalties that a valuer is likely to face for violation of rules under the

companies Act 2013?

8.10 REFERENCE BOOK

1. Companies Act 2013 – Key highlights & Analysis – PWC – Nov 2013

2. Implications of Companies Act 2013 – Valuation – Grant Thornton

3. Companies Act 2013 – Consolidated Financial reporting – EY


1. Group discussion on during PCP days, Companies act 2013

8.12 KEY WORDS

1. Companies act, valuation report, market price

AUDDEAUDDE

67

LESSON - 9

SARFAESI ACT

9.1 INTRODUCTION

Banks face numerous difficulties in recovery of loans from defaulters.

SARAFESI Act was necessitated because the previous legislation enacted for

recovery of the default loans like Recovery of Debts due to Banks and Financial

Institutions Act, 1993, did not produce desired results. Debt Recovery Tribunals

and Debt Recovery Appellate Tribunals followed judicial procedures for resolution

and proved to be inadequate in the Indian Context. The Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002,

(SARFAESI Act) is an extra-judicial process that allows banks and financial

institutions to take coercive action including auction of secured assets of defaulting

borrowers.

9.2 OBJECTIVE

SARFAESI Act 2002 & Amendments made have provided Banks with a

powerful tool to manage NPA s. Valuation is an essential part of recovery process

under SARFAESI Act. This lesson in intended to familiarize the student with salient

features of SARFAESI Act.

9.3 CONTENT

9.3.1 Historical Background

9.3.2 SARFAESI ACT 2002 – A Brief Study

9.3.3 SARFAESI Act – Section 13. Enforcement of security interest

9.3.4 Liquidation of Assets taken under possession under section 13.4

9.3.5 SARAFESI Act & Bank NPA resolution

9.3.6 International Perspective – Experience of USA

9.3.1 Historical Background

The banking sector forms the backbone of every monetized economy in the

world and is the primary route for debt creation in the Indian economy. While the

social agenda of the banking sector is matter of debate, the Indian banking sector,

about 90 % of whose assets are managed by PSB s, are in distress. Growth of NPA s

has been a regular feature from 1970.

By 1991 NPA s were reaching significant levels. Systemic problems in debt

management and meeting RBI criteria led to many scams. While the ratio of gross

operating profit of the scheduled commercial banks rose from 0.8% (of assets) in

the seventies to 1.5% in the early nineties, the net profit of the banks declined.

By the nineties, inadequate debt recovery mechanisms in the existing banking

&legal system began to cast a burden on the Banking industry. Non-Performing

Assets (NPA) were increasing and remained unrecovered on the balance sheets of

banks leading to a situation of “credit crunch” in lending.

AUDDEAUDDE

68

In 1996, selective credit controls on all sensitive commodities except sugar were

removed. Banks were also allowed much greater flexibility about the proportion of

the cash credit component of the loans. 1997 witnessed further elimination of

credit controls with banks no longer subjected to the instructions pertaining to

Maximum Permissible Bank Finance (MPBF) and were allowed to evolve their own

methods for assessing the credit needs of the potential borrowers. Further, banks

were no longer required to form consortiums to lend in excess of INR 500 million,

and restrictions on their ability to provide term loans for projects were withdrawn.

In 1998, the RBI initiated the second generation of banking reforms based on

the recommendations of the Narasimham Committee II. This was the first bold

reform start point. The major recommendations of the committee were:

Capital Risk-Adequacy Ratio (CRAR) defined - 10% for the year 2002

A risk weight of 5% for market risk of government-approved securities

NPA provisioning

Income recognition and asset classification - applied to government advances

Dis-investment in PSU Banks – GOI Equity in PSB s and SBI should be

brought down from 51% to 33%

NPA issues &need to bring reforms in the existing legal system for speedy

recovery of the debts of the banks and financial institutions were becoming more

serious. A Standing Committee was constituted in August 1999 under the aegis of

Industrial Development Bank of India (IDBI). In year 2000 and hyarjuna

Committee was constituted to suggest changes in the existing legal system. Finally,

Umarji Committee framed the Securitisation and Reconstruction of Financial Assets

and Enforcement of Security Interest Act, 2002 (SARFAESI).

9.3.2 Sarfaesi Act 2002 – A brief study

The SARFAESI Act consists of 41 sections in 6 Chapters and a Schedule.

Chapter-1: contains 2 sections dealing with the applicability of the

Securitisation Act and definitions of various terms.

Chapter-2: contains 10 sections providing for regulation of securitisation and

reconstruction of financial assets of banks and financial institutions, setting up of

securitisation and reconstruction companies and matters related thereto.

Chapter-3: contains 9 sections providing for the enforcement of security

interest and allied and incidental matters.

Chapter-4: contains 7 sections providing for the establishment of a Central

Registry, registration of securitisation, reconstruction and security interest

transactions and matters related thereto.

Chapter-5: contains 4 sections providing for offences, penalties and

punishments.

Chapter-6: contains 10 sections providing for routine legal issues.

AUDDEAUDDE

69 The Act deals with three aspects:

1. Enforcement of Security Interest by secured creditor (banks/financial

institutions)

2. Transfer of non-performing assets to Asset Reconstruction Company, which

subsequently handles disposing of those assets and realisation of the proceeds

3. Providing a legal framework for securitisation of assets

The Act stipulates four conditions to be met prior to enforcement of rights by a

creditor:

The debt is secured

The debt has been classified as an NPA by the banks

The outstanding dues are INR 1,00,000 (one lakh) and above and more than

20% of the principal loan amount and interest there on

The security to be enforced is not an agricultural land

9.3.3 Sarfaesi Act – Section 13. Enforcement of Security Interest

Section 13 deals with recovery & possession of secured assets for purposes of

recovering amounts due to Banks. We give below the key features of the provisions:

(1) No recourse to Courts or Tribunals in the normal course.

Security interest created in favour of any secured creditor may be enforced,

without the intervention of court or tribunal.

(2) Demand Notice (60 days): A defaulting borrower whose account is classified by

the secured creditor as non-performing asset, can be directed by notice in

writing to discharge in full his liabilities to the Bank within sixty days from the

date of notice failing which the secured creditor shall be entitled to exercise all

or any of the rights under subsection (4).

(3) Demand notice to borrower shall specify details of dues & secured assets. The

notice under sub-section (2) shall give details of the amount payable by the

borrower and the secured assets intended to be enforced by the secured

creditor in the event of non-payment of secured debts by the borrower.

(3A) Obligation of Bank to respond within 7 days to any objections or

representations.

If, on receipt of the notice under sub-section (2), the borrower makes any

representation or raises any objection, the secured creditor shall consider such

representation or objection and if the secured creditor comes to the conclusion

that such representation or objection is not acceptable or tenable, he shall

communicate within one week of receipt of such representation or objection the

reasons for non-acceptance of the representation or objection to the borrower:

(4) Possession: In case the borrower fails to discharge his liability in full within the

period specified in sub-section (2), the secured creditor may take recourse to

one or more of the following measures to recover his secured debt, namely:--

(a) take possession of the secured assets of the borrower including the right to

transfer by way of lease, assignment or sale for realising the secured asset;

AUDDEAUDDE

70

(b) take over the management of the business of the borrower including the

right to transfer by way of lease, assignment or sale for realising the secured

asset:

(c) appoint any person (hereafter referred to as the manager), to manage the

secured assets the possession of which has been taken over by the secured

creditor;

(d) require at any time by notice in writing, any person who has acquired any of

the secured assets from the borrower and from whom any money is due or

may become due to the borrower, to pay the secured creditor, so much of the

money as is sufficient to pay the secured debt.

(5) Any payment made by any person referred to in clause (d) of sub-section (4) to

the secured creditor shall give such person a valid discharge as if he has made

payment to the borrower.

(6) Any transfer of secured asset after taking possession thereof or takeover of

management under sub-section (4), by the secured creditor or by the manager

on behalf of the secured creditor shall vest in the transferee all rights in, or in

relation to, the secured asset transferred as if the transfer had been made by

the owner of such secured asset.

(7) Recovery of costs from borrower: Where any action has been taken against a

borrower under the provisions of sub-section (4), all costs, charges and

expenses which, in the opinion of the secured creditor, have been properly

incurred by him or any expenses incidental thereto, shall be recoverable from

the borrower.

(8) Borrower can repay at any time before sale date. If the dues of the secured

creditor together with all costs, charges and expenses incurred by him are

tendered to the secured creditor at any time before the date fixed for sale or

transfer, the secured asset shall not be sold or transferred by the secured

creditor, and no further step shall be taken by him for transfer or sale of that

secured asset.

(9) Joint financing by lenders: need for 75 % agreement: In the case of financing

of a financial asset by more than one secured creditors or joint financing of a

financial asset by secured creditors, no secured creditor shall be entitled to

exercise any or all of the rights conferred on him under or pursuant to sub-

section (4) unless exercise of such right is agreed upon by the secured creditors

representing not less than three-fourth in value of the amount outstanding as

on a record date and such action shall be binding on all the secured creditors:

(10) Insufficient fulfillment: Where dues of the secured creditor are not fully

satisfied with the sale proceeds of the secured assets, the secured creditor

may file an application in the form and manner as may be prescribed to the

Debts Recovery Tribunal having jurisdiction or a competent court, as the case

may be, for recovery of the balance amount from the borrower.

(11) Guarantors liability not extinguished: Without prejudice to the rights

conferred on the secured creditor under or by this section, the secured

AUDDEAUDDE

71

creditor shall be entitled to proceed against the guarantors or sell the pledged

assets without first taking any of the measures specified in clauses (a) to (d) of

sub-section (4) in relation to the secured assets under this Act.

(12) The rights of a secured creditor under this Act may be exercised by one or

more of his officers authorised in this behalf in such manner as may be

prescribed. 9 An authorized officer for this purpose in a PSB is a Level 4

officer in the rank of Chief Manager or above)

(13) No borrower shall, after receipt of notice referred to in sub-section (2), transfer

by way of sale, lease or otherwise (other than in the ordinary course of his

business) any of his secured assets referred to in the notice, without prior

written consent of the secured creditor.

9.3.4 Liquidation of Assets Taken Under Possession Under Section 13.4

The SARFAESI Act proposes securitisation and reconstruction of financial

assets through Securitisation Companies (SCO) and Reconstruction Companies

(RCO) in corporate under the Companies Act. SARFAESI Act requires compulsory

registration of SCO and RCO under the Securitisation Act before commencing its

business.

Further a minimum financial stability requirement is also provided by requiring

SCO and RCO to possess owned fund (Owned Fund is aggregate of paid up capital,

paid up preference capital, reserves and surplus excluding revaluation reserve, as

reduced by debit balance on P&L account, miscellaneous expenditure (to the extent

not written off), intangible assets, diminution in value of investments/short

provisions against NPA and further reduced by shares acquired in SCO/RCO and

deductions due to auditor qualifications) of INR 20 million or up to 15% of the total

financial assets acquired or to be acquired. The RBI has the power to specify the

rate of owned fund from time to time with the provision of different rates for

different classes of SCO and RCO.

SARFAESI Act provides three alternative methods for recovery of NPAs:

AUDDEAUDDE

72

Securitization: Issue of security for raising of receipts or funds by SCOs/RCOs

from the Qualified Institutional Buyers (QIB) by forming schemes for acquiring

financial assets.

Asset Reconstruction: It implies acquisition by any SCO/RCO of any right or

interest of any bank or financial institution in any financial assistance for the

purpose of realization of such financial assistance.

The SCO/RCO, for the purpose of asset reconstruction, should provide for any

one or more of the following measures:

Proper management of the business of the borrower, by change in, or takeover

of the management of the business of the borrower

Sale or lease of a part or whole of the business of the borrower

Rescheduling of payment of debts payable by the borrower

Enforcement of security interest by taking possession of secured assets in

accordance with the provisions of this Act

Setting up of Central Registry (CR):"Central Registry of Securitization Asset

Reconstruction and Security Interest of India" has been created by the Government

of India, to prevent frauds in loan cases involving multiple lending from different

banks on the same immovable property. This Registry has become operational on

March 31, 2011. for the purpose of operating and maintaining the Central Registry

under the provisions of the SARFAESI Act.

A register called the Central Register maintained both in electronic and non-

electronic form will be kept at the head office of the Central Registry for entering the

particulars of the transactions including creation of security/satisfaction or

payment on any security interest relating to securitization and reconstruction of

financial assets and shall be open for inspection by any person during the business

hours on payment of prescribed fee.

Amendments

Banks permitted to convert any portion of the debt due to them by the

borrower into equity shares of the borrower company

The banks have been permitted to purchase the immovable property which has

been furnished to them as security and which is being sold under an auction

process provided the purchase price offered by other auctioneers in respect

thereto, is below the reserve price set by the bank.

DRT cannot grant any stay order unless both parties (borrower and lending

bank) are heard

banks and financial institutions can enter into settlement or compromise with

the borrower. Debt Recovery Tribunals can pass an order acknowledging any

such settlement or compromise

AUDDEAUDDE

73 9.3.5 Sarafesi Act & Bank NPA resolution

The SARFAESI Act has proven to be one of the most efficient remedies to the

problems in the debt recovery process in India. The figures speak in favour of the act.

Cases referred under SARFAESI have been rising constantly.

According to the report “Trend and Progress of Banking in India, 2012-13”

released by RBI, banks have been able to recover approximately INR 18,500 crore

through the SARFAESI Act.

Percentage of NPAs Recovered through SARFAESI

50.00 %

70.00 %

60.00 %

80.00 %

90.00 %

40.00 %

20.00 %

30.00%

10.00%

2004 - 05 2012 -132005 - 06 2006 - 07 2007 - 08 2008 - 09 2009 -10 2010 - 11 2011 -12

46.05 %

38.18%

51.22%

58.00%53.60%

56.81%

73.90%70.13 %

79.70%

NPAs of SCBs recovered through SARFAESI over last few years

As is clear from the figure, a large amount of debt recovery is being done through

the Act and it has proven to be an important tool for banking companies. In 2012-13,

80% of the NPAs recovered by the banks were through the SARFAESI route.

Further, banks remained the most important subscribers of securitised assets of

SCOs/RCOs. Another way of measuring effectiveness of SARFAESI is to check whether

the NPAs of banks as a percentage of loans and advances have gone down or not.

The below figure displays the trend in NPAs of Scheduled Commercial Banks

(SCB) before and after the SARFAESI Act coming into being. The initial major fall in

NPA ratio after 2002 signals the effectiveness of the SARFAESI act.

NPA Movements of SCBs 50.00 %

40.00 %

30.00%

Fall in NPA Rat io

slow ing down duet

recession

20.00 %SARFAESIAct

int roduced10.00 %

0.00%

10.00%

20.00%

30.00%

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Net NPAas % ageof Net Advances %age fall in net NPA rat io f rom last year Issues persisting PSBs post SARFAESI Act

AUDDEAUDDE

74

There are many execution &legal issues with SARFAESI that have need

mitigation. Some issues that need to be addressed are:

Collusion of asset reconstruction companies and the borrower:

Many RCOs are found act in collusion with defaulters, in what is called as a

“sweetheart deal”. RCOs were found to be undervaluing the assets and then

selling it back to the borrowers or related organisations.

Knock out (syndication) Collusion / “understanding” between interested

parties to drive down price by entering into secretive understanding

Some borrowers have termed SARFAESI as draconian. Some borrowers have

alleged collusion by Bank officials to pressurize borrowers to surrender their

properties

Right to appeal at Debt Recovery Tribunal. In a number of cases, DRTs have

given stay orders without any major basis due to the claim of irreparable loss

to the borrower in case of the bank taking over the security.

despite the orders of Supreme Court stating that the appellant can only

approach courts after the exhaustion of existing alternatives, high courts have

been entertaining the appeal of borrowers

Government dues being the first priority

NBFCs and cooperative banks getting excluded from SARFAESI:

Auction value and selection of properties

Under the stipulation of SARFAESI Act, once the time limit has passed, the

bank can go ahead with the selling of the property unilaterally and banks generally

do not consider the view of the borrower. Moreover, there is no stipulation on the

auction value of the asset. Banks have more than enough discretion to decide on

the sale value in the auction and even if a particular asset has a greater value than

the debt, banks can sell it at the debt price and the borrower need not get any

residuals. Again, given a host of properties/assets with the borrower, banks have

the right to select which property to enforce without the advice of the borrower

Latest Developments in Debt Recovery Space

Demand to remove the clause of old management restoration after debt recovery

RCOs have asked RBI to relook at the norm that forces them to restore the old

management once the recovery of dues is done. They have also asked RBI to

provide legal immunity to the new management. This is primarily because RCOs

have the power of restructuring the management in case of default and to bring in

new management, for which incentives are needed.

It becomes difficult to bring in new management when by norms the RCOs

would need to replace them with old management after debt recovery. This also

poses the problem of moral hazard as the new management knows that as soon as

the debt recovery is done they will have to leave their positions.

Will full Defaulters: Introduction of a new category (non-co-operative)

borrowers: RBI is considering introducing a new category of borrowers called as

non-co-operative who use legal means to stall any move of debt recovery.

AUDDEAUDDE

75

The Reserve Bank of India (RBI) defines a willful defaulter as: If a “borrower has

defaulted in meeting his payment or repayment obligations to the lender even when

he has the capacity to honour the said obligations”.

9.3.6 International Perspective – Experience Of USA

Consumer Protection in Asset securities Market, USA:

Unlike India, the US has a trend of Third Party Collectors which collect debt on

behalf of banks. In general creditors go for these collectors only when their in house

efforts have failed. The industry of debt collection in US has been growing with

time. During 1900’s The Federal Deposit Insurance Corporation (FDIC) and

Resolution Trust Corporation (RTC) started selling non-performing loan portfolios to

private buyers.

Federal Trade Commission (FTC) first laid out guidelines on ideal collection

practices for creditors in 1968.The Fair Debt Collection Practices Act came into

effect in 1977. It was originally established in order to put an end to unfair and

deceptive debt collection practices in the USA. The debt covered under this act has

to be consumed for personal/household/family purposes only and the law does

not cover corporate debt. The Federal Trade Commission (FTC), a consumer

protection agency enforces the act. Thus, consumers can use this law to raise their

voice against unlawful debt recovery practices by banks. Still there have been

claims of FDCPA not being adequate for protecting consumer rights and need for

more stringent laws. In comparison, the SARFAESI Act was introduced in order to

facilitate the debt recovery for banks and to eliminate the legal impediments in the

process.

The debt collection in the US has more legal remedies than those in India. For

example, creditors can get their recovery through a direct deduction from debtor’s

pay-check. At the same time consumers have other legal remedies in their hands

such as filing for bankruptcy.

The Uniform Commercial Code (UCC) Article 9, part 6 provides many such legal

remedies. The following are some of those remedies:

Collection of liquid assets

Collecting collateral of accounts, deposit accounts and other rights to payment

in a commercially reasonable manner

Assembly of collateral: Collecting tangible collateral which is not in secured

party’s possession. The debtor has to collect such assets and make them available

to creditors at a location reasonably convenient to both parties. This can be done

pre or post default

Repossession of collateral: It authorizes secured party to take possession of

collateral by removing from the debtor’s site and take its possession or even make it

unusable or dispose it off after default. This should be done without breaching

peace or else judicial process has to be followed

AUDDEAUDDE

76

Disposition of collateral: It authorizes secured party to sell lease license or

sell or dispose all or part of the collateral in a commercial reasonable manner. The

UCC does not define “commercially reasonable” though, leaving it to judgment on a

case by case basis. The secured party has to give notice of proposed disposition

Strict Foreclosure: The secured party acquires collateral in full or partial

satisfaction of the secured obligation without the need for a disposition. The

consent of the debtor and extent of the same plays an important role here

Execution Sale: Here the secured party or the creditor can sue the debtor to

collect the secured asset and it further seeks to liquidate the same. Here there is no

risk of doing disposition or repossession improperly

Redemption: It gives the debtor a right to redeem the collateral until the

creditor has not collected or disposed of it. Of course the debtor has to fulfil the

debt to be able to do so

Thus, creditors should make use of all the available remedies along with

negotiation fully.

USC Commercial Banks NPA / Total Loans % 6.00

5.00

4.00

3.00

1990 - 05 - 07 1995 -10 - 28 2001 - 04 -19 2006 -10 -10 2012 - 04 -01 2017 - 09 -22 Source: Economic Research, Federal Reserve Bank of St Louis

9.4 REVISION POINTS

1. Liquidation, SARAFESI Act, Interest Act


1. What is SARFAESI ACT and what are its objectives?

2. What are the different aspects of the SARFAESI ACT and what are the pre-

conditions to be fulfilled before the act is enforced?

3. What do you understand by the term Demand Notice under the SARFAESI ACT?

4. What do you understand by the term Possession under the SARFAESI ACT?

5. Define the following terms under the Uniform Commercial Code (UCC)

Article9, Part.6

a) Assembly of Collateral

b) Repossession of collateral

c) Disposition of collateral

AUDDEAUDDE

77

d) Strict Foreclosure

e) Execution Sale

f) Redemption

9.6 SUMMARY

The banking sector forms the backbone of every monetized economy in the

world and is the primary route for debt creation in the Indian economy. In 1998,

the RBI initiated the second generation of banking reforms, based on Narasimham

Committee II. The major recommendations of the committee were: defining Capital

Risk-Adequacy Ratio (CRAR), risk weight for market risk of government-approved

securities, NPA provisioning, Income recognition and asset classification - applied

to government advances & Dis-investment in PSU Banks.

In year 2000 Andhyarjuna Committee was constituted to suggest changes in the

existing legal system. Finally, Umarji Committee framed the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

(SARFAESI). The SARFAESI Act consists of 41 sections in 6 Chapters and a Schedule.

The Act deals with three aspects, Enforcement of Security Interest by secured

creditor (banks/financial institutions), Transfer of non-performing assets to Asset

Reconstruction Company & Providing a legal framework for securitisation of assets

The Act stipulates four conditions to be met prior to enforcement of rights by a

creditor, the debt is secured, debt has been classified as an NPA by the banks ,

outstanding dues are INR 1,00,000 (one lakh) and above and more than 20% of the

principal loan amount and interest there on and the security to be enforced is not

an agricultural land. Section 13 deals with recovery & possession of secured assets

for purposes of recovering amounts due to Banks. Major provisions are - No

recourse to Courts or Tribunals in the normal course, Demand Notice - A

defaulting borrower can be directed by notice in writing to discharge in full his

liabilities to the Bank within sixty days from the date of notice failing which the

secured creditor shall be entitled to exercise all or any of the rights under

subsection (4).Demand notice to borrower shall specify details of dues & secured

assets. Obligation of Bank to respond within 7 (15) days to any objections or

representations. Possession: In case the borrower fails to discharge his liability in

full within the period specified in sub-section (2), the secured creditor may take

recourse to one or more of the following measures to recover his secured debt,

namely:--(a) take possession of the secured assets of the borrower including the

right to transfer by way of lease, assignment or sale for realising the secured

asset;(b) take over the management of the business of the borrower including the

right to transfer by way of lease, assignment or sale for realising the secured asset.

The SARFAESI Act proposes securitisation and reconstruction of financial assets

through Securitisation Companies (SCO) and Reconstruction Companies

(RCO)incorporated under the Companies Act. Some amendments have been

introduced recently to improve the Act. Banks are permitted to convert any portion

of the debt due to them by the borrower into equity shares of the borrower company

. The banks have been permitted to purchase the immovable property which has

been furnished to them as security. DRT cannot grant any stay order unless both

parties (borrower and lending bank) are heard. Banks and financial institutions can

AUDDEAUDDE

78 enter into settlement or compromise with the borrower. Debt Recovery Tribunals

can pass an order acknowledging any such settlement or compromise.

We discuss some cases & experiences on SARFAESI Act in recent times.


1. What are the alternate methods for recovery of NPA’s under the SARFAESI ACT?

2. Define the term “Willful defaulter”.



9.9 ASSIGNMENTS

1. Define the following term

a. Redemption b. Execution sale c. Trict fore closure


1. Pritam Saha (1311034) Yashad Vasant Kashar (1311167) Atirek Kumar (1311291) 8-

12-2014.

2. The Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002.

3. Economic Systems 32 (2008) 177–196 - "Does lending behaviour of banks in

emerging economies vary by ownership? Evidence from the Indian banking sector" by

Sumon Kumar Bhaumik and Jenifer Piesse.

4. Legal history before passing SARFAESI Act by: C.P.S. Ramachary

(http://www.lawyersclubindia.com/articles/Legal-history-before-passing- SARFAESI-Act

4688.asp#.U-fPn_mSwVt).

5. IJMSSR Volume 2, No. 1, January 2013, "Implementation of SARFAESI Act - some

issues" by V. Sekar and Dr. V. Balachandran.

6. Seminar on Corporate Rescue and Insolvency, “SARFAESI Act, 2002 & Role of Asset

Reconstruction”, 10th September 2010.

7. Indian Company Law: Critical issues under SARFAESI Act, 2002?

8. Live Samachar – “Bring non-banking finance companies under SARFAESI Act: study”

9. Indian Corporate Law: Supreme Court exempts Co-Operative Banks from claiming

under Recovery of Debts Due to Banks and Financial Institutions Act.

10. ASSOCHAM suggests NBFCs under SARFAESI Act, Sunday, February 23, 2014.

11. RBI’s own guidelines may hamper Raghuram Rajan’s NPA drive, By Sangita Mehta,

ET Bureau | 21 Jan, 2014.

12. CBI probes IDBI Bank loan to Kingfisher Airlines, livemint, Sat, Aug 09 2014.

13. “Non-performing loans securitization in the PRC”, Johnny P Chen, Dept. of

Economics, Stanford University.

14. “Enforcing security interests under Article 9 of the UCC”, Alan M Christenfeld,

Barbara M Goodstein.

15. “Collecting Consumer debt in America”, Robert M Hunt.


Group discussion on during PCP days “SARFAES.ACT”.

9.12 KEY WORDS

Assets, Liquidation of Assets.

AUDDEAUDDE

79

LESSON 10

INSOLVENCY & BANKRUPTCY CODE 2016

10.1 INTRODUCTION

India currently ranks 136 out of 189 countries in the World Bank's index on

the ease of resolving insolvencies. India's weak insolvency regime, its significant

inefficiencies and systematic abuse are some of the reasons for the distressed state

of credit markets in India today. The Code promises to bring about far-reaching

reforms with a thrust on creditor driven insolvency resolution. It aims at early

identification of financial failure and maximising the asset value of insolvent firms.

The Code also has provisions to address cross border insolvency through bilateral

agreements and reciprocal arrangements with other countries.

The unified regime envisages a structured and time-bound process for

insolvency resolution and liquidation, which should significantly improve debt

recovery rates and revitalise the ailing Indian corporate bond markets.

10.2 OBJECTIVE

It is expected that IBC 2016 will usher a new era in insolvency resolution and

ease of liquidation. It is expected to present great opportunities for Valuers. This

lesson is intended to provide an overview of IBC.

10.3 CONTENT

10.3.1 Background

10.3.2 Priority of Claims

10.3.1 BACKGROUND

At present, there are multiple overlapping laws and adjudicating forums

dealing with financial failure and insolvency of companies and individuals in India.

The current legal and institutional framework does not aid lenders in effective and

timely recovery or restructuring of defaulted assets and causes undue strain on the

Indian credit system. Recognising that reforms in the bankruptcy and insolvency

regime are critical for improving the business environment and alleviating

distressed credit markets, the Government has enacted Insolvency and Bankruptcy

Code Bill.

Insolvency & Bankruptcy Code 2016 (IBC)

Objective of IBC

“An act to consolidate and amend the laws relating to reorganisation and

insolvency resolution of corporate persons, partnership firms and individuals in a

time bound manner for maximisation of value of assets of such persons, to promote

entrepreneurship, availability of credit and balance the interests of all the

stakeholders including alteration in the order of priority of payment of Government

dues and to establish an Insolvency and Bankruptcy Board of India, and for

matters connected therewith or incidental thereto.”

IBC offers a uniform, comprehensive insolvency legislation encompassing all

companies, partnerships and individuals (other than financial firms). The

AUDDEAUDDE

80 Government is proposing a separate framework for bankruptcy resolution in failing

banks and financial sector entities.

One of the fundamental features of the IBC is that it allows creditors to assess

the viability of a debtor as a business decision, and agree upon a plan for its revival

or a speedy liquidation. IBC creates a new institutional framework, consisting of a

regulator, insolvency professionals, information utilities and adjudicatory

mechanisms, that will facilitate a formal and time bound insolvency resolution

process and liquidation.

This code offers simplified alternative resolution solution in preference to the

following Acts

Chapter XIX & Chapter XX of Companies Act, 2013

Part VIA, Part VII & Section 391 of Companies Act, 1956

Recovery of Debts Due to Banks and Financial Institutions Act, 1993

(DRT)

SARFAESI Act, 2002

SICA Act, 1985

The Presidency Towns Insolvency Act, 1909

The Provincial Insolvency Act, 1920

Chapter XIII of the LLP Act, 2008

The code can be implemented on a pro-active basis without first having to wait

for a default to initiate action.

The IBC envisages a “creditor in control” regime with financial creditors

exercising control through IPs in the event of a single default in repayment of any

loan or interest.

This can be effected without any notice and the law is very stringent as

compared to the SARFAESI Act, 2002. As a result, stressed/ distressed every

corporate need to implement an accurate cash flow forecasting mechanism to

identify mismatches of inflows with commitments on a timely basis. If there is a

possibility of a potential default that can trigger IBC, an effective turnaround plan

should be devised and communicated to all stakeholders in advance – including

financial and operating creditors, employees, etc. Such a plan should include

aspects of financial restructuring, operational improvement and sale of assets

which can be monetised.

Structure of the System for Resolution

Insolvency & Bankruptcy Board of India, has been formed and is the regulator

& administrator for Resolution process under IBC.

IBBI – Insolvency& Bankruptcy Board of India – apex body for promoting

transparency & governance in the administration of the IBC; will be involved in

setting up the infrastructure and accrediting insolvency professionals (IPs)

&Information Utilities (IUs).

AUDDEAUDDE

81

IUs - centralised repository of financial and credit information of borrowers;

would accept, store, authenticate and provide access to financial data provided by

creditors.

IPA – Insolvency Professional Agency : Recognised by IBBI and sets the

standards for IP s

IPs- persons enrolled with IPA and regulated by Board and

IP will conduct resolution process; to act as Liquidator/ bankruptcy trustee;

appointed by creditors and override the powers of board of directors.

Adjudicating authority (AA) - would be the NCLT for corporate insolvency; to

entertain or dispose any insolvency application, approve/ reject resolution plans,

decide in respect of claims or matters of law/ facts thereof.

HIGHLIGHTS

1. Corporate Debtors: Two-Stage Process

To initiate an insolvency process for corporate debtors, the default should be at

least INR 100,000 (which limit may be increased up to INR 10,000,000 by the

Government).

IBC proposes two independent stages:

a. Insolvency Resolution Process, during which financial creditors assess

whether the debtor's business is viable to continue and the options for

its rescue and revival; and

b. Liquidation, if the insolvency resolution process fails or financial

creditors decide to wind down and distribute the assets of the debtor.

c. The Insolvency Resolution Process (IRP)

The IRP provides a collective mechanism to lenders to deal with the overall

distressed position of a corporate debtor. This is a significant departure from the

existing legal framework under which the primary onus to initiate a reorganisation

process lies with the debtor, and lenders may pursue distinct actions for recovery,

security enforcement and debt restructuring.

The Code envisages the following steps in the IRP:

(i) Commencement of the IRP

A financial creditor (for a defaulted financial debt) or an operational creditor (for

an unpaid operational debt) can initiate an IRP against a corporate debtor at the

National Company Law Tribunal (NCLT).

The defaulting corporate debtor, its shareholders or employees, may also

initiate voluntary insolvency proceedings.

(ii) Moratorium

The NCLT orders a moratorium on the debtor's operations for the period of the

IRP. This operates as a 'calm period' during which no judicial proceedings for

recovery, enforcement of security interest, sale or transfer of assets, or termination

of essential contracts can take place against the debtor.

AUDDEAUDDE

82 (iii) Appointment of Resolution Professional

The NCLT appoints an insolvency professional or 'Resolution Professional' to

administer the IRP. The Resolution Professional's primary function is to take over

the management of the corporate borrower and operate its business as a going

concern under the broad directions of a committee of creditors.

This is similar to the approach under the UK insolvency laws, but distinct from

the "debtor in possession" approach under Chapter 11 of the US bankruptcy code.

Under the US bankruptcy code, the debtor's management retains control while the

bankruptcy professional only oversees the business in order to prevent asset

stripping on the part of the promoters.

Therefore, the thrust of IBC is to allow a shift of control from the defaulting

debtor's management to its creditors, where the creditors drive the business of the

debtor with the Resolution Professional acting as their agent.

(iv) Creditors Committee and Revival Plan

The Resolution Professional identifies the financial creditors and constitutes a

creditors committee. Operational creditors above a certain threshold are allowed to

attend meetings of the committee but do not have voting power. Each decision of

the creditors committee requires a 75% majority vote. Decisions of the creditors

committee are binding on the corporate debtor and all its creditors.

The creditors committee considers proposals for the revival of the debtor and

must decide whether to proceed with a revival plan or liquidation within a period of

180 days (subject to a one-time extension by 90 days). Anyone can submit a revival

proposal, but it must necessarily provide for payment of operational debts to the

extent of the liquidation waterfall.

The Code does not elaborate on the types of revival plans that may be adopted,

which may include fresh finance, sale of assets, haircuts, change of management

etc.

(b) Liquidation

Under the Code, a corporate debtor may be put into liquidation in the following

scenarios:

(i) A 75% majority of the creditor's committee resolves to liquidate the corporate

debtor at any time during the insolvency resolution process;

(ii) The creditor's committee does not approve a resolution plan within 180 days (or

within the extended 90 days);

(iii) The NCLT rejects the resolution plan submitted to it on technical grounds; or

(iv) The debtor contravenes the agreed resolution plan and an affected person

makes an application to the NCLT to liquidate the corporate debtor.

Once the NCLT passes an order of liquidation, a moratorium is imposed on the

pending legal proceedings against the corporate debtor, and the assets of the

debtor (including the proceeds of liquidation) vest in the liquidation estate.

AUDDEAUDDE

83 10.3.2 Priority of Claims

IBC significantly changes the priority waterfall for distribution of liquidation

proceeds. After the costs of insolvency resolution (including any interim finance),

secured debt together with workmen dues for the preceding 24 months rank

highest in priority. Central and state Government dues stand below the claims of

secured creditors, workmen dues, employee dues and other unsecured financial

creditors. Under the earlier regime, Government dues were immediately below the

claims of secured creditors and workmen in order of priority.

Upon liquidation, a secured creditor may choose to realise his security and

receive proceeds from the sale of the secured assets in first priority. If the secured

creditor enforces his claims outside the liquidation, he must contribute any excess

proceeds to the liquidation trust. Further, in case of any shortfall in recovery, the

secured creditors will be junior to the unsecured creditors to the extent of the

shortfall.

2. Insolvency Resolution Process for Individuals/Unlimited Partnerships

For individuals and unlimited partnerships, the Code applies in all cases where

the minimum default amount is INR 1000 and above (the Government may later

revise the minimum amount of default to a higher threshold).

The Code envisages two distinct processes in case of insolvencies: automatic

fresh start and insolvency resolution.

Under the automatic fresh start process, eligible debtors (basis gross income)

can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not

exceeding a specified threshold, allowing them to start afresh.

The insolvency resolution process consists of preparation of a repayment plan

by the debtor, for approval of creditors. If approved, the DRT passes an order

binding the debtor and creditors to the repayment plan. If the plan is rejected or

fails, the debtor or creditors may apply for a bankruptcy order.

3. Institutional Infrastructure

(a) The Insolvency Regulator

IBC provides for the constitution of a new insolvency regulator i.e., the

Insolvency and Bankruptcy Board of India (Board).

Its role includes:

(i) overseeing the functioning of insolvency intermediaries i.e., insolvency

professionals, insolvency professional agencies and information utilities; and

(ii) regulating the insolvency process.

(b) Insolvency Resolution Professionals

IBC provides for insolvency professionals as intermediaries who would play a

key role in the efficient working of the bankruptcy process. IBC contemplates

insolvency professionals as a class of regulated but private professionals having

minimum standards of professional and ethical conduct.

AUDDEAUDDE

84

In the resolution process, the insolvency professional verifies the claims of the

creditors, constitutes a creditors committee, runs the debtor's business during the

moratorium period and helps the creditors in reaching a consensus for a revival

plan. In liquidation, the insolvency professional acts as a liquidator and bankruptcy

trustee.

(c) Information Utilities

A notable feature of the Code is the creation of information utilities to collect,

collate, authenticate and disseminate financial information of debtors in centralised

electronic databases. The Code requires creditors to provide financial information of

debtors to multiple utilities on an ongoing basis. Such information would be

available to creditors, resolution professionals, liquidators and other stakeholders

in insolvency and bankruptcy proceedings. The purpose of this is to remove

information asymmetry and dependency on the debtor's management for critical

information that is needed to swiftly resolve insolvency.

(d) Adjudicatory authorities

The adjudicating authority for corporate insolvency and liquidation is the

NCLT. Appeals from NCLT orders lie to the National Company Law Appellate

Tribunal and thereafter to the Supreme Court of India.

For individuals and other persons, the adjudicating authority is the DRT,

appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme

Court.

In keeping with the broad philosophy that insolvency resolution must be

commercially and professionally driven (rather than court driven), the role of

adjudicating authorities is limited to ensuring due process rather than adjudicating

on the merits of the insolvency resolution.

10.4 REVISION POINTS

1. Insolvency, Claims


1. Define IBC (Insolvency & Bankruptcy Code 2016) and state its purpose.

2. What are the 2 stages to initiate the insolvency process.

3. What are the steps in Insolvency resolution Process?

10.6 SUMMARY

IBC offers a uniform, comprehensive insolvency legislation encompassing all

companies, partnerships and individuals. This code offers simplified alternative

resolution solution in preference to the following Acts, Chapter XIX & Chapter XX of

Companies Act, 2013, Recovery of Debts Due to Banks and Financial Institutions

Act, 1993 (DRT), SARFAESI Act, 2002, SICA Act, 1985, The Presidency Towns

Insolvency Act, 1909, The Provincial Insolvency Act, 1920, Chapter XIII of the LLP

Act, 2008. Insolvency &Bankruptcy Board of India(IBBI), has been formed and is

the regulator & administrator for Resolution process under IBC. They shall

establish & monitor IUs - centralised repository of financial and credit information

AUDDEAUDDE

85 of borrowers, IPA – Insolvency Professional Agency, IPs- Insolvency Professionals.

Adjudicating authority (AA) - would be the NCLT for corporate insolvency. IBC

proposes two independent stages, Insolvency Resolution Process, during which

financial creditors assess whether the debtor's business is viable to continue and

the options for its rescue and revival; and Liquidation, if the insolvency resolution

process fails or financial creditors decide to wind down and distribute the assets of

the debtor. The entire process is expected to be completed within 180 days.


1. What do you understand by the term Liquidation?


www.fbsa.in/plantmachinery

10.9 ASSIGNMENT

Explain the Insolvency Resolution Process for Individuals and corporate.


1. Insolvency & Bankruptcy Code 2016

2. Mondaq –Trilegal article June 2016


Group discussion on during PCP days “Insolvency & Bank rupay code 2016

10.12 KEY WORDS

Insolvency, Tribunal, Resolution process

AUDDEAUDDE

86

LESSON -11

OVERVIEW - BANKING REGULATIONS IN INDIA

11.1 INTRODUCTION

Industry in India is dependent on Bank finance for meeting CAPEX as well as

working capital requirements. Traditionally term loans have financed bulk of project

capital requirements. Public sector banks have played a stellar role in the

Industrialization process of India. As the nation move on to a more liberalized era,

Banks have to change with times. Banking regulations guide the operations of Banks.

11.2 OBJECTIVE

To familiarize the student with basics of Banking regulations in India.

11.3 CONTENT

11.3.1 Historical perspective

11.3.2 Regulatory architecture: overview of banking regulators and key

Regulations

11.3.3 Corporate Debt Restructuring (CDR) measures

11.3.4 Revised External Commercial Borrowings (“ECBs”) Framework

11.3.1 Historical Perspective

Various banking related loans, advances, & bills of exchange were practiced

even in ancient India. However, organized Banking as we know today, complete

with legislation began under British colonial rule in the mid-1800s. Banking sector

in pre-independence India catered primarily to the needs of the colonial government

and traders. After independence, the Govt. of India started focusing on promotion

of Industry as a means of growth. Banks were encouraged to lend to industry.

The Reserve Bank of India, was established in April 1935, but was nationalised

on 1 January 1949 & appointed as the Central Bank with powers to regulate,

control, and inspect the Banks in India.

The Banking Regulation Act also provides that no new bank or branch of an

existing bank can be opened without a license from the RBI, and no two banks

could have common directors.

The Indian banking sector can be broadly classified into scheduled banks and

non-scheduled banks. The scheduled banks are those included under the 2nd

Schedule of the Reserve Bank of India Act, 1934. The scheduled banks are further

classified into: Nationalised Banks, State Bank of India and its associates, Regional

Rural Banks (RRBs), Indian private sector banks and foreign banks. The term

commercial banks refers any scheduled and non-scheduled commercial banks

regulated under the Banking Regulation Act.

1969-70 saw a major development in Banking industry. The Government of

India by an ordinance nationalised 14 largest commercial banks with effect from

the midnight of 19 July 1969. These banks managed 85 percent of bank deposits in

the country. A second dose of nationalisation of 6 more commercial banks followed

in 1980. With this Government of India controlled around 91% of the banking

AUDDEAUDDE

87 business of India. The stated reason for the nationalisation was to give the

government more control of credit delivery, the prevailing political view being that

private sector commercial banks were not adequately primed to address the needs

of India’s developing economy and society. These nationalized banks came to be

known as Public Sector Banks (PSB).

This eventually led to a dearth of private banking and the dominance of social

banking over commercial banking. While socially progressive, this approach also

led to inefficiency and raised costs, and affected banks’ quality of assets.

Sustained populist polices coupled with external events like oil shock & gulf

war resulted in ballooning trade deficit. India reached a crisis situation by 1991.

India’s credit rating got downgraded. The country was on the verge of defaulting on

its international commitments and was denied access to the external commercial

credit markets.

Banking system increasingly came under stress, and by 1991, non-performing

assets (“NPAs”) and relatively low capital base among PSBs compulsorily triggered a

reform agenda. Reforms in the last two decades have been wide-ranging and

detailed (and have included introducing international practices and systems), the

policy approach has been cautious and methodical. An indication of growing

strength of the post-reform Indian financial system was the manner in which India

survived the Southeast Asian financial crisis of the late 1990s.

The financial recession of 2007–09, caused by financial bubble of sub-prime

loans and collapse of Lehman Brothers again caused great stress on the Indian

banking system. Indian Government leaned on the PSB s to ease credit norms and

increase credit in an effort to protect the Indian economy. To a certain extent the

present situation of alarming NPA s of PSBs can be attributed to our response to

2007-09 financial crisis that engulfed the world.

Today (2017), India’s banking and financial system faces formidable challenges,

the most significant being the large proportion of stressed assets &NPAs in PSB

Banks portfolio. NPA estimates are being routinely increased – beginning with 3

lakh cores in 2014 to about 10 lakh crores in 2017. The clock is still ticking and

more NPA s are likely to be declared, as PSB s are finally forced give up the practice

of “ever greening”.

The official Economic Survey 2016–17 (“Economic Survey”) of the Government

of India (“GoI”) notes the criticality of continuously high NPAs, which are rising

significantly, to such an extent that provisioning was beginning to overwhelm

operating earnings. Indian regulatory authorities have introduced various targeted

regulations over the past few years, including tighter guidelines on recognising and

reporting bad loans. Among other measures considered in the Economic Survey is

the creation of a ‘Public Sector Asset Rehabilitation Agency’ (“PARA”), charged with

working out the largest and most complex cases, whereby such debts would be

centralised in one agency and separate the loan resolution process of such debts

from concerns about bank capital.

AUDDEAUDDE

88

A number of ambitious reforms and policy initiatives have been & are being

proposed, implemented or legislated in the Indian banking sector in the last few

years, making period beginning 2015 very eventful years for the Banking Industry.

11.3.2 Regulatory Architecture: Overview of Banking Regulators and Key Regulations

a) Reserve Bank of India (RBI)

RBI: Established pursuant to the Reserve Bank of India Act, 1934, it is the

primary regulator of the banking sector in India (i.e., the “banker of Indian banks”)

with its headquarters in Mumbai. RBI is a fully government-owned entity and its

central board is appointed by GoI.

Core Purpose

To foster monetary and financial stability conducive to sustainable economic

growth and to ensure the development of an efficient and inclusive financial

system.

To foster confidence in the internal and external value of the rupee, and

contribute to macro-economic stability;

To regulate markets and institutions under its ambit to ensure financial

system stability and consumer protection;

To promote the integrity, efficiency, inclusiveness and competitiveness of the

financial and payments system;

To ensure efficient management of currency as well as banking services to

the Government and banks; and

To support the balanced, equitable and sustainable economic development

of the country.

RBI operates and performs its functions through the Board for Financial

Supervision to regulate the activities of the FIs, banks and NBFCs. The BFS is

chaired by RBI’s governor, with four deputy governors as its ex officio members.

Apart from the Foreign Exchange Management Act, 1999, RBI governs and

administers various other regulations such as the Banking Act, the PSS Act and the

SARFAESI Act.

b) National Bank for Agriculture and Rural Development (“NABARD”)

NABARD was established in 1981 through the National Bank for Agriculture

and Rural Development Act with its headquarters at Mumbai. NABARD is the

regulator attending to institutional credit for agricultural activities and promotes

sustainable agriculture.

c) Small Industries Development Bank of India (“SIDBI”)

SIDBI is a government-owned and controlled bank, established in 1990

through the Small Industries Development Act, and is the principal institution for

financing and development of medium, small and micro enterprises in India.

(d) National Housing Bank (“NHB”)

National Housing Bank is a wholly owned subsidiary of RBI, set up under the

National Housing Bank Act, 1997 with the objective of promoting housing finance

AUDDEAUDDE

89 as well as dedicated institutions to stabilise the housing finance market and serve

public housing needs.

e) Export-Import Bank of India (“EXIM”)

EXIM is the principal institution providing and coordinating the finance of

export and import of goods and services in order to promote India’s international

trade.

Primary banking statutes/regulations

The banking sector in India is regulated by the Ministry of Finance, GoI, with

the Reserve Bank of India (“RBI”) as the primary regulator.

Commercial banks (including PSBs), account for the largest share of banking

and financial services in India. India’s financial system also has other categories of

service providers, such as local area banks, small finance banks and payment

banks in the private sector, aimed at serving credit and remittance needs of small

businesses, the unorganised sector, low income households, farmers and migrant

workers.

Accordingly, RBI recently opened up two new categories of banks, i.e.

(i) Small Finance Banks (“SFBs”), and

(ii) Payments banks;

RBI has issued specific guidelines for the operation of such banks and has

licensed a small number of such SFBs/payment banks. The provisions of the

Banking Act & RBI guidelines will continue to govern the operations for

differentiated banks.

RBI is considering other categories of differentiated banks, and issued its

Discussion Paper on Wholesale & Long-Term Finance Banks (“WLFBs”) on April 7,

2017. If cleared for licensing, WLFBs as a category will focus primarily on lending

to the infrastructure sector and small/medium and corporate businesses and

mobilise liquidity for banks and financial institutions directly originating priority

sector assets. These banks would provide refinance to lending institutions and

engage with capital markets as aggregators.

Non-Banking Financial Companies (“NBFCs”), are another category of service

providers existing in the banking and finance sector. NBFC s also carry out

activities such as providing loans and advances, acquisition of securities, asset

finance etc., and are governed by specific guidelines issued by RBI.

However NBFCs

Can offer similar financial services as banks

Cannot accept fixed deposits from public

Do not form part of the payment and settlement system

Are governed by specific guidelines issued by RBI from time to time,

including governance, operational and prudential guidelines.

AUDDEAUDDE

90

All banking companies and NBFCs are also subject to the provisions of the

Companies Act, 2013 (“Companies Act”), which provides the basic framework for

corporate organisation, governance and related issues for Indian companies.

Regional Rural banks& Co-operative banks: One of the aims of Government has

been financial inclusion, particularly of marginalised or financially weak sections of

society. Government felt it was necessary to have focused Banks for this purpose.

This aspect is specifically addressed by the twin sub-systems of regional rural

banks (“RRBs”) and cooperative banks.

RRBs operate only in rural areas, while cooperative banks operate in both

urban and rural areas. RRBs and cooperative banks are governed by specific

guidelines issued by RBI from time to time, including governance, operational and

prudential guidelines, which take into account the specific social goals of RRBs and

cooperative banks.

Key legislation and regulations – Banking Industry

Banking Regulation Act, 1949 (“Banking Act”): In accordance with the

provisions of the Banking Act, a banking company may engage only in specified

business activities, including, inter alia:

borrowing or lending of money with or without security; the guarantee and

indemnity business;

drawing and dealing in bills of exchange, promissory notes, warrants,

debentures and other instruments/securities;

granting/issuing currency, traveler’s cheques, letters of credit;

buying and selling foreign exchange;

providing safe deposit vaults; the collecting and transmitting of money and

securities;

underwriting, participating and managing of any issue (public or private) of

any loans or of shares, stock, debentures, or debenture stock and lending

money for such purpose;

undertaking and executing trusts; undertaking the administration of

estates as executor, trustee or otherwise;

acquiring the whole or any part of the business (if specified under the

Banking Act) of any person or company; and any other business which the

government may specify from time to time.

However, the Banking Act also places restrictions on the activities of banks,

which, inter alia, cannot undertake the following:

dealing in the buying or selling or bartering of goods, except for realisation

of security, and engaging in any trade, or buying, selling or bartering of

goods for others (except for bills of exchange received for collection or

negotiation);

AUDDEAUDDE

91

holding any immovable property, except as required for their own use, for

any period exceeding seven years from acquisition of such property (and

must be disposed of within such period or any other prescribed period);

holding shares in any company, whether as pledge, mortgagee or absolute

owner, in an amount exceeding 30% of the paid-up share capital of that

company or 30% of its own paid-up share capital and reserves (whichever is

less); providing loans to any company for buy-back of its own securities;

and acting as managing agent or secretary or treasurer of a company.

The Payment and Settlements Act, 2007 (“PSS Act”):

Subject to certain conditions, any entity operating a payment system (i.e. a

system enabling payments between a payer and beneficiary, involving clearing,

payment or settlement service) is required to obtain an authorisation from RBI,

which is the nodal authority for payment systems. Based on experience under the

PSS Act, GoI has, as part of the Union Budget 2017, proposed the creation of a six-

member Payments Regulatory Board in the RBI to initiate certain structural

reforms in the regulatory framework (this would replace the existing Board for

Regulation and Supervision of Payment and Settlement Systems).

Negotiable Instruments Act, 1881 (“NI Act”): The NI Act regulates negotiable

instruments, e.g.: promissory notes, bills of exchange and cheques, and their

circulation and transfer; and addresses the dishonouring of cheques. In its Union

Budget 2017, GoI proposed a further amendment of the NI Act to effectively deal

with high volumes of dishonoured cheque cases and reduce the time taken for

redress.

Circulars/Notifications by RBI

The operations of banks are also monitored and governed by the instructions of

RBI through various circulars/notifications from time to time. Every year RBI

consolidates these by topic as “Master Directions” or “Master Circulars” (e.g. in

relation to know your customer (“KYC”) norms, prudential norms for NBFCs,

external commercial borrowings, etc.).

Recovery proceedings by banks and financial institutions (“FIs”)

Banks and FIs have the option of approaching various for a in relation to

recovery of dues and enforcement of security interest (including by way of

insolvency proceedings):

i. With the passing of the Insolvency and Bankruptcy Code and the setting of the

National Company Law Tribunal (“NCLT”) in 2016, the legal framework now

contemplates NCLT as the primary forum for enforcement and recovery of debt

in respect of corporate persons having limited liability status.

However, banks and FIs (which are recognised for such purpose under the

relevant statutes) continue to have access to certain other for a (subject, inter

alia, to certain thresholds/ limitations/categories of debtors), including:

ii. Debt Recovery Tribunals (“DRT”) and Debt Recovery Appellate Tribunals

(“DRAT”) under the Recovery of Debts Due to Banks and Financial

Institutions Act, 1993 (“RDDB Act”).

AUDDEAUDDE

92

iii. Banks or FIs can appoint asset reconstruction or securitisation companies

under the securitization and the Reconstruction of Financial Assets and

Enforcement of Securities Interest Act, 2002 (“SARFAESI Act”) for acquiring

the secured financial assets of borrowers. Such entities are then deemed to

be lenders for debt-recovery purposes.

Civil Suits: Lenders also continue to have access to India’s civil courts, in

accordance with the Code of Civil Procedure, 1908, but subject, inter alia, to

certain provisions/limitations/thresholds as prescribed under the specific

debt recovery/insolvency statutes.

Recent regulatory themes and key regulatory developments in India

Recent developments

The Indian banking sector has recently witnessed numerous measures aimed at:

(i) providing efficient mechanisms for debt recovery and enforcement of dues;

(ii) ensuring non-default of loans to reduce the NPA burden on PSBs;

(iii) ensuring flow of finance to the industrial/corporate sector;

(iv) curbing the parking of black money outside India; and

(v) promoting governance best practices.

Some key developments include the following.

The Insolvency & Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code, 2016 (the “Code”) was passed by the

Indian Parliament and notified by GoI on May 28, 2016 (however, specific

provisions of the Code are being brought into effect in phases, along with the

accompanying regulations and process-related rules). The primary tenet of the

Code is to detect distress as soon as possible and resolve it. To this end, it enables

the corporate insolvency resolution process (“CIRP”) to be triggered by the

occurrence of a single default through a prescribed process (specified for debtors,

financial creditors and operational creditors). The Code also sets out the detailed

operation of the CIRP and entitles foreign and domestic creditors (both financial

and operational) as well as corporate debtors to initiate a CIRP on the occurrence of

a payment default of more than INR 100,000.

Apart from the CIRP provisions, the provisions dealing with (i) voluntary

liquidation of corporate persons, and (ii) setting up and regulation of information

utilities (“IUs”) were recently notified by GoI (with effect from April 1,

2017). Additionally, the Insolvency and Bankruptcy Board of India (“IBBI”)

simultaneously notified the Insolvency and Bankruptcy Board of India (Voluntary

Liquidation Process) Regulations, 2017 and the Insolvency and Bankruptcy Board

of India (Information Utilities) Regulations, 2017.

The key objects/principles of the Code are as follows:

(a) replace the current multi-pronged corporate insolvency laws by a single

comprehensive law and empower all categories of creditors (whether secured,

AUDDEAUDDE

93

unsecured, domestic, international, financial or operational) to trigger

insolvency resolution processes, while permitting only “financial creditors” to

participate in the decision-making;

(b) enabling the resolution process(es) to start at the earliest sign of financial

distress (upon the occurrence of a payment default) with a linear liquidation

mechanism;

(c) providing for a single regulator and adjudicating forum to oversee/implement

all insolvency and liquidation proceedings (certain institutional infrastructure

has been put into place to assist the regulator/adjudicating forum in this

process); and

(d) providing a finite time limit (180 days with certain permitted extensions) within

which the debtor’s viability can be assessed, after which an order for

liquidation will be passed.

e. “Fast Track CIRP” available for corporate debtors with relatively low levels of

assets and income (and such classes of creditors or such amount of debt as

may be notified by the central government). Fast Track CIRP provides, inter

alia, for an insolvency resolution to take place in a more condensed period of

90 days (extendable by a maximum of another 45 days).

Further, while the objective of the Code is to provide a one-stop, consolidated

law to address insolvency/debt recovery, it may be noted that the passing of this

law has not, to date, led to the repeal of other existing laws, although such laws

(such as the RDDB Act and the relevant sections of the Companies Act) have been

amended to some extent to account for and harmonies with the provisions and

processes provided for by the Code. In our view, the debt recovery/insolvency

regime will continue to evolve in the coming years based on the experience with

NCLT and the interaction of these laws.

11.3.3 Corporate Debt Restructuring (CDR) Measures

Partly as a result of the global economic crisis, many players in India’s

corporate sector face financial stress, leading the Indian banking system to

increased NPAs. GOI and RBI have issued various directives to ensure that banks

recover their dues and that defaulters (especially companies and their

promoters/directors) are held accountable for losses to lenders. The overall CDR

principle is that a company’s shareholders bear the first loss rather than its

lenders.

(a) RBI directives on loan defaults: In 2014, RBI released the framework for

revitalising distressed assets in the economy. This corrective action plan

(“CAP”) is aimed at early identification of problematic loans, timely

restructuring of accounts that are viable and prompt steps by banks for

recovery or sale of unviable accounts. Its key features include, inter alia: (i)

incentivised early formation of the joint forum of the lenders (“JLF”) to

formulate a debt restriction plan for recovery; (ii) compulsory independent

AUDDEAUDDE

94

evaluation of large value restructurings, with a focus on viable plans and fair

sharing of losses between promoters and creditors; (iii) more expensive future

borrowing for borrowers who do not co-operate with banks; and (iv) more

liberal regulatory treatment for asset sales. Such framework allowed lenders to

stipulate change in management control and accordingly gave them the option

of requiring: (a) transfer of equity of the borrower company (from its promoters)

to the lenders; (b) promoters to infuse further equity into their companies; or (c)

transfer of the promoters’ holdings to a security trustee/escrow until

turnaround is achieved.

The JLF scheme was further substantiated by the RBI by the introduction of

the “Strategic Restructuring Scheme” (“SDR”) vide its circular dated June 8,

2015. Through the SDR, RBI has laid down the broad framework for the

conversion of debt by banks and FIs into equity. Certain prudential guidelines

for the JJLF and SDR schemes were added in February 2016.

(b) Guidelines by Securities and Exchange Board of India (“SEBI”) on wilful

defaulters: Given the wilful non-payment of loans by many corporate borrowers,

SEBI approved certain stringent restrictions for wilful defaulters in relation to

accessing the markets through a circular dated May 25, 2016, amending its

existing SEBI (Issue of Capital and Disclosure Requirements)

Regulations. Accordingly, in furtherance of RBI’s regime on wilful defaulters, SEBI

has prohibited any public issue of equity shares/debt security/non-convertible

redeemable preference shares, if the issuer company or its promoter or director is

on RBI’s list of wilful defaulters. Earlier, such restriction on market access applied

only to a wilful defaulter seeking to issue convertible debt

instruments. Simultaneously, by way of an amendment to the existing SEBI

(Substantial Acquisition Of Shares And Takeovers) Regulations, wilful defaulters

were disallowed from taking control over other listed entities (but may make a

competitive bid if another party has already made an acquisition bid).

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of

Tax Act, 2015, effective from April 1, 2016, deals with undisclosed foreign income

and assets and the related tax avoidance. It also amends the Prevention of Money

Laundering Act, 2002 (“PMLA”) by including tax evasion as an offence there under,

thus easing the confiscation of undisclosed foreign assets and prosecution of the

involved persons.

Recent Developments Relating to the Code and Corporate Debt Restructuring

(CDR) measures

There have been some interesting, fresh developments in the battle to control

NPAs of Indian banks at the time of going to print: on May 4, 2017, the President of

India promulgated an ordinance (“Ordinance”) that amended the Banking Act,

introducing two new sections (Sections 35AA and 35AB of the Banking

Act). Further to this, the RBI has revised and clarified important aspects of its

AUDDEAUDDE

95 previous circulars on JLF and CAP (partly using its powers under one of the newly

introduced sections of the Banking Act).

Interestingly, under the new sections 35AA and 35AB, the RBI is empowered to

direct any ‘banking company’ which includes foreign banking companies licensed to

operate in India.

The RBI’s circular of May 5, 2017 (issued partly under the new 35AB of the BR

Act), inter alia:

(a) contains a clarification setting out the various options regarding the

CAP which a JLF must arrive at;

(b) lowers the decision-making threshold for the JLF to 60% of creditors by

value and 50% of creditors by number (from 75% by value and 50% by

number);

(c) directs scheduled commercial banks to ensure that they implement the

JLF decision without any additional conditions;

(d) directs the boards of directors of scheduled commercial banks to

empower their executives to implement the JLF decision without

requiring further approval from the board; and

(e) reminds scheduled commercial banks that non-adherence to the RBI’s

instructions (above) and timelines for JLF to form and implement a

CAP will attract monetary penalties under the Banking Act.

While the existing section 35A of the BR Act already gave RBI broad powers to

issue directions to banking companies, the Ordinance now gives RBI specific

powers and leaves no ambiguity as to whether it has the power to take actions

referred to in the newly introduced sections. The amendments via the Ordinance

may be seen to serve as a ‘legislative’ push to the RBI by GoI, indicating to RBI and

the banks that more needs to be done, and quickly.

“Demonetisation” of Certain Currency Notes, 20161

As recorded in the Economic Survey: GoI announced an historic measure, with

profound implications for the Indian economy on November 8, 2016. Currency

notes in the two largest denominations, i.e., INR 500 and INR 1,000, were deprived

of their legal tender status, except for a few specified activities (“Demonetisation”

has become the popularly accepted term for this dramatic move by GoI). So with

immediate effect, about 86% of the cash in circulation in the Indian economy was

rendered invalid (the public was required to deposit all such notes held by it in

banks by December 30, 2016, while restrictions were placed on cash withdrawals).

As stated in the Economic Survey: the aim of the action was fourfold – to curb:

(i) corruption; (ii) counterfeiting; (iii) the use of high denomination notes for terrorist

activities; and (iv) the accumulation of “black money”, generated by income that has

not been declared to the tax authorities (this last being the key focus of the

Demonetisation initiative). While it is too early to quantify the direction and

magnitude of long-term changes, there are already some indications.

AUDDEAUDDE

96

One intermediate objective of the Demonetisation initiative was to create a less-

cash or “cash-lite” economy, to channel more savings through the formal financial

system and improve tax compliance (rather than keeping such saving in cash form,

often outside of banking channels). According to an estimate by

PricewaterhouseCoopers (2015), India has a very high predominance of consumer

transactions carried out in cash relative to other countries (estimated to account for

about 68% of total transactions by value and 98% by volume).

Following Demonetisation, GoI has taken various initiatives to overhaul

banking mechanisms/access, and facilitate and incentivise the move to a digital

economy, including, inter alia (i) launch of a money interface app for smart phones,

based on a new Unified Payments Interface, which has created inter-operability of

digital transactions, (ii) launch of the Aadhaar Merchant Pay scheme, aimed at the

citizens who do not have phones (to enable anyone with just an Aadhaar number

and a bank account to make merchant payments using biometric identification),

and (iii) tax benefits to incentivise digital transactions.

11.3.4 Revised External Commercial Borrowings (“ECBS”) Framework

Revised External Commercial borrowings (“ECBs”) Framework: RBI’s Master

Directions dated January 1, 2016 had the objective of increasing access by Indian

each and every corporate to this source of debt funding through a number of

critical, liberalising changes, including:

(a) Minimum Average Maturity: ECBs earlier followed a clearly prescribed

minimum average maturity (three to five years and above five years), based on

the amount being raised (two “tracks”). However, the revised ECB framework

will comprise of three tracks: (i) Track I – medium-term ECBs; (ii) Track II –

long-term ECBs; and (iii) Track III – INR-denominated ECBs with a minimum

average maturity of three to five years.

Track III provides for a new regime for INR-denominated ECBs

(introduced vide RBI’s circular dated September 29, 2015) where the currency

risk is borne by the lender. This route has raised much interest and excitement

in the Indian financial market, and is being tapped by way of what are known as

‘masala bonds’ (described below).

(b) End-Use Restrictions: While the permitted end-use under ECBs has

traditionally been highly restricted, these have been eased considerably on

borrowings under Track II and Track III (with very limited restrictions, inter alia,

on use of proceeds for real estate activities, for domestic equity investments and

purchase of land). Thus, ECBs could be used even for working capital purposes

under Track II and III (constituting a significant liberalisation from the earlier

regime).

(c) Eligible Borrowers and Recognised Lenders: The entities eligible to raise ECB

have been expanded to include shipping and airline companies, real estate

investment trusts and infrastructure investment trusts governed by SEBI

(which were previously only allowed to raise Rupee-denominated

AUDDEAUDDE

97

bonds). Recognised lenders have also been expanded to include insurance

companies, pension funds, sovereign wealth funds and overseas

branches/subsidiaries of Indian banks. Under the new regime, an ECB can be

guaranteed/credit-enhanced/insured by overseas parties (provided they qualify

as recognised lenders as per the earlier ECB framework).

Masala Bonds: RBI’s latest Master Directions on ECBs set out the framework

for issuance of Rupee-denominated bonds overseas (popularly termed “Masala

Bonds”). Eligible resident entities can issue only plain vanilla Rupee-

denominated bonds overseas in Financial Action Task Force (FATF) compliant

financial centres, under the automatic route (without prior regulatory approval)

or approval route (requiring prior approvals). Borrowings up to INR 50bn

equivalent in a financial year can be undertaken under the automatic route,

whereas any issuance in excess of INR 50bn would require prior approval from

RBI. Further, such bonds can be issued on a private placement basis or listed

on stock exchanges as per the regulations of the host country. The proceeds

can be used for various purposes, subject to limited restrictions.

Plan for Revamp of PSBs

Plan for Revamp of PSBs: GoI in 2015 issued its “Indradhanush” (i.e.

“Rainbow”) plan for PSBs, containing a spectrum of remedial measures,

including, inter alia, internal governance measures, provision of additional

capitalisation (for which the GoI had allocated INR 700bn up to financial year 2018)

and strengthening of risk control and NPA disclosures. Based on the experience so

far, which has raised some serious challenges in the plan for revitalisation of PSBs,

it is proposed to initiate a revised plan (“Indradhanush 2.0”) upon completion of the

next asset quality review of such banks by RBI in 2017.

Benchmark Lending Rate: RBI on December 17, 2015 issued guidelines for

the computation of the benchmark lending rate, using the ‘marginal cost of funds’

method. Accordingly, banks are now required to implement the new Marginal Cost

of Funds based Lending Rate (MCLR), which came into effect from April 1,

2016. The MCLR is a tenor linked internal benchmark, and lending rates are

determined by adding the components of spread to the MCLR.

Foreign Exchange Management (Remittance of Assets) Regulations, 2016:

RBI made ground-breaking changes to the regulation of remittance of assets

outside India by any person, whether or not such person is an Indian

resident. While the general prohibition on remittance of assets by a person from

India still holds good (and is subject to prior RBI approval), RBI has carved out a

general permission for remittance of assets on closure or remittance of winding up

proceeds of any branch office/liaison office (other than a project office).

Foreign Banks in India: In accordance with RBI’s Scheme for Setting Up of

Wholly Owned Subsidiaries by Foreign Banks in India (2013), a foreign bank: (i)

commencing or seeking to commence banking business in India after August 2010;

and which (ii) satisfies certain other prescribed conditions, can operate only

AUDDEAUDDE

98 through a wholly owned subsidiary (“WOS”) rather than through a “branch

office”. To encourage foreign banks to commence operations in India, RBI has

offered near national treatment with respect to expansion plans of foreign banks

that adopt the WOS structure.

Bank governance and internal controls

It has been widely observed that banking regulation in India shifted from a

prescriptive to prudential approach in the 1990s, resulting in a shift from top-down

regulation towards corporate governance and internal control mechanisms. In the

current regulatory eco-system, banks benefit from relatively unfettered flexibility to

draw up business plans and implementation strategies as appropriate from a

strategic market perspective. The relevant regulations are contained in the

Banking Act as well as various circulars released by RBI, some key requirements of

which include:

Board of Directors: Bank boards are required to assume the primary

responsibility and also exercise informed judgment on various strategies and policy

choices. Some key requirements regarding the boards of banks under the Banking

Act are indicatively set out below:

(a) Directors must have professional or other experience and at least 51% of the

Board must have special knowledge or practical experience in either: (i)

accountancy; (ii) agriculture and rural economy; (iii) banking; (iv) co-operation;

(v) economics; (vi) finance; (vii) law; and (viii) small-scale industry, or any other

matter which in the RBI’s opinion would be useful to the Bank; and of such

directors, at least two must have special knowledge in agriculture and rural

economy, co-operation or small-scale industry.

(b) Further, no director of a bank can have a substantial interest in, or be

connected with, whether as employee, manager or managing agent in: (i) any

company; or (ii) firm, which carries on any trade, commerce or industry and

which, in either case, is not a small-scale industrial concern. Directors of

banks are not permitted to be proprietors of any trading, commercial or

industrial concern.

(c) No director, other than the chairman or whole-time director, can hold office

continuously for a period exceeding eight years.

(d) No bank can have a director on its board that is a director of any other bank,

unless such director is appointed by RBI. No bank can have more than three

directors who are directors of companies which among themselves are entitled

to exercise voting rights in excess of 20% of the total voting rights of all the

shareholders to the Bank.

(e) Each bank must appoint one director as chairman of the board. A whole-time

basis chairman is entrusted with management of whole of the affairs of the

Bank, subject to the superintendence, control and direction of the board.

Compliance Function and Management of Risk:

RBI has acknowledged the importance of corporate governance norms as set

out by the Basel Committee on Banking Supervision and, vide its specific

AUDDEAUDDE

99 guidelines in this regard. It has prescribed the “Compliance Function” of banks, to

ensure strict observance of all statutory provisions contained in various legislations

such as the Banking Act, the Reserve Bank of India Act, the Foreign Exchange

Management Act, the Prevention of Money Laundering Act, etc., as well as to ensure

observance of other regulatory guidelines issued from time to time, and also each

bank’s internal policies and fair practices code. Compliance rules generally cover

matters such as observing proper standards of market conduct, managing conflicts

of interest, treating customers fairly, and ensuring the suitability of customer

advice and also include specific areas such as the prevention of money laundering

and terrorist financing, and may extend to tax laws that are relevant to the

structuring of banking products or customer advice. Each bank is required to

formulate a “Compliance Function”, and it is the responsibility of each bank’s

compliance officer/s to assist the senior management of the bank in effectively

managing the compliance risks faced by the bank.

Risk Based Supervision (RBS): Highly specific templates oriented towards a

compliance assessment have been introduced and RBI expects Chief Compliance

Officers to ensure total compliance with all specified guidelines (to be updated on

an annual basis). Examination of compliance rigour prevalent in banks will be

suitably factored in risk assessment, and be factored in by RBI in evaluating the

risk scores of banks.

Conflict of interest and independence of compliance functions: The compliance

function and the audit function of the bank are required to be clearly separated.

Bank capital requirements

RBI issued guidelines based on the Basel III reforms (“Basel III”) on capital

regulation on May 2, 2012 (as applicable to Indian banks and foreign banks

operating in India) based on three mutually reinforcing pillars; namely, minimum

capital requirements, supervisory review of capital adequacy and market discipline.

Banks are required to comply with regulatory limits prescribed under Basel III,

on an ongoing basis. Basel III has been implemented from April 1, 2013 in phases,

and is expected to be fully implemented by March 31, 2019. To ensure smooth

transition to Basel III, appropriate transitional arrangements have been provided for

meeting the minimum Basel III capital ratios, full regulatory adjustments to the

components of capital, etc.

CRAR: Under Basel III, a bank has to comply with the capital adequacy ratio

requirements at a consolidated and standalone level. Banks are required to

maintain a minimum total capital to risk-weighted assets ratio (“CRAR”) of 9%

(other than capital conservation buffer and countercyclical capital buffer, etc.). For

the purpose of computation of CRAR, total capital will consist of the sum of the

following categories: (i) Tier 1 capital comprising of ‘Common Equity’ and ‘Additional

capital’ (which would include paid-up equity capital, statutory reserves etc.); and (ii)

Tier 2 capital (which would include instruments that are fully paid-up, non-

redeemable, unsecured, subordinated, etc.).

AUDDEAUDDE

100

Allowances to PSBs: At a time when PSBs have been struggling with a low

capital base, the RBI has allowed banks to shore up their capital adequacy by

unlocking additional capital. The RBI has made some amendments to the

treatment of certain balance sheet items (including certain items such as property

value, foreign exchange for calculation of Tier 1 capital, subject to certain

conditions) to effectively boost their regulatory capital.

Rules governing Banks’ relationship with customers and third parties

KYC norms: RBI Circular on Know Your Customer Norms: Indian banks and

FIs must follow specific customer identification procedures while setting up

accounts and subsequently monitor and report suspicious financial

transactions. Such KYC norms are broadly based on the recommendations of FATF

on Anti Money Laundering (“AML”) standards and combatting the financing of

terrorism. Any contravention would invite a statutory penalty.

In India, the relevant legislation is the Prevention of Money-Laundering Act,

2002 and the Prevention of Money-Laundering (Maintenance of Records) Rules,

2005 (“PML Rules”). Under the PML Rules, a Central KYC Records Registry was

required to be established to receive, store, safeguard and retrieve all KYC records

in digital form.

Keeping in mind various logistical issues, an existing record keeping entity, i.e.,

the Central Registry of Securitisation Asset Reconstruction and Security Interest of

India (“CERSAI”), set up under SARFAESI Act to record mortgages and other

security creation, has been designated to act as, and to perform the functions of the

CKYCR – GoI authorised this to “go live” in a phased manner after July 2016.

RBI has mandated that all banks and FIs should broadly base their KYC policy

on four pillars, and accordingly, banks are required to:

(a) Customer Acceptance Policy (“CAP”): develop clearly specified CAPs identifying

high-risk individuals.

(b) Customer Identification Procedure (“CIP”): ensure that no accounts are opened

in fictitious names by conducting adequate diligence.

(c) Monitoring: regularly monitor transactions to ensure that the customer profile

matches the nature of transactions. Further, banks are required to trace the

source of funds.

(d) Risk Management: undertake management and mitigation of various AML risks.

The KYC norms also require banks to comply with RBI’s stringent reporting

standards and adhere to the United Nations Sanctions Lists.

RBI Guidelines for Customer Service

Customer Services: Under RBI’s guidelines for customer servicing, banks are

required to have adequate policies for management of branches for providing proper

banking and infrastructure facilities to customers. Each bank’s board should have

a customer service committee and adequate customer grievance mechanisms for

expeditious resolution of customer complaints.

AUDDEAUDDE

101

Consumer Protection Act, 1986 (“Consumer Protection Act”): An aggrieved

customer can approach the appropriate forum including the National Consumer

Protection Commission under the provisions of the Consumer Protection Act, which

also covers banking and financial services. The courts of India have reiterated the

fact that banks (being service providers) are liable for deficient and inadequate

services to customers.

Indian Contract Act, 1872 (“Contract Act”): The relationship in the nature of

debtor-creditor, principal-agent, pledgor-pledgee or bailor-bailee between banks

and customers are also subject to the provisions of the Contract Act as laws

governing agency, pledge, bailment, indemnity and guarantee are codified in the

Contract Act.


1. Non-performing assets, External commercial borrowing


1. Write a note on the beginning of banking services in India and its evolution.

2. What are the Core Purposes of Reserve Bank of India?

3. Write a note on RBI regulated bodies such as NABARD, SIDBI, NHB and EXIM

4. What are SFB’s and NBFC’s in banking sector?

5. State at least 7 legislations and regulations in the Banking Industry.

6. What do you understand by the term CDR (Corporate Debt Restructuring)

measures?

7. Write a short note on the recent demonetization initiative in 2016.

8. Write a note on rules governing Bank’s relationship with customers and third

parties.

11.6 SUMMARY


1. Write a short note on The Black Money & Imposition of Tax Act 2015.



11.9 ASSIGNMENT

1. Write short note on the recent demonetization initiative in 2016?


1. Global Legal Insights – Ms.Shuchi Sinha, AZB & Partners

2. RBI – www.rbi.org.in


1. Group discussion in during PCP days “Banking regulation in India”

11.12 KEY WORDS

1. Banking regulations, Commercial, Borrowing

AUDDEAUDDE

102

LESSON -12

MERGERS & ACQUISITIONS

12.1 INTRODUCTION

Mergers and acquisitions (M&A) are defined as consolidation of companies.

M&A is one of the major aspects of corporate finance world. The general reason

behind M&A is that two separate companies together create more value. Hence the

objective of wealth maximization, and long term survival are major drivers of merger

or acquisition. As India is going through a rapid growth phase, many firms look at

M & A as a route to expansion & growth.

12.2 OBJECTIVE

One of the essential requirements of M & A exercise is Valuation. In this

lesson we study the process of M &A and some instances of M&A.

12.3 CONTENT

12.3.1 Types of Mergers and Acquisitions

12.3.2 Reduction of share capital

Mergers and acquisitions (M&A) is a general term that refers to the

consolidation of companies or assets. M&A can include a number of different

transactions, such as mergers, acquisitions, consolidations, tender offers, purchase

of assets and management acquisitions. In all cases, two companies are involved.

Mergers & Acquisitions can take place,

by purchasing assets,

by purchasing common shares

by exchange of shares for assets

by exchanging shares for shares

12.3.1 TYPES OF MERGERS AND ACQUISITIONS:

Merger or amalgamation may take two forms: merger through absorption or

merger through consolidation. Mergers can also be classified into three types from

an economic perspective depending on the business combinations, whether in the

same industry or not, into horizontal (two firms are in the same industry), vertical

(at different production stages or value chain) and conglomerate (unrelated

industries). From a legal perspective, there are different types of mergers like short

form merger, statutory merger, subsidiary merger and merger of equals.

Reasons for Mergers and Acquisitions: M&A activity usually results in

Financial synergy for lower cost of capital

Improving company's performance and accelerate growth

Economies of scale

Diversification for higher growth products or markets

To increase market share and positioning giving broader market access

Strategic realignment and technological change

AUDDEAUDDE

103

Tax considerations

Under valued target

Diversification of risk

The mergers and acquisitions (“M&A”) activities in India in the year 2016 hit a

record high of over US$64bn worth of deals, surpassing all previous records set

since 2001. India contributed almost 8.8% of the total M&A in the Asia-Pacific

region. Inbound activity also surged to approximately US$ 30bn in 2016 from US$

19bn in 2015. Such heightened M&A activity could be attributed to the

Government’s drive to revamp the legal and regulatory landscape of the country. In

addition to the above, the norms relating to Foreign Direct Investment have been

relaxed further, which is one of the main factors that led to an increase of

approximately 62% in the inbound activity in 2016 as compared to 2015. Domestic

M&A also picked up after experiencing a drop of 58% in 2015 as compared to

2014. In fact, domestic and outbound M&A activity drove the M&A space in

2016. Private Equity (“PE”), on the other hand, declined almost by half compared

to 2015.

Legal framework

The following governs the regulatory framework of M&A in India:

Law governing companies

Companies Act 2013, and subsequent notifications governs provisions on

Mergers & Acquisitions. Valuation has been declared as necessary for the following

Purposes under Co. Act 2013.

Section wise Requirement of Registered Valuers

Section 62(1)(c) : For Valuing further Issue of Shares

Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash

transactions involving Directors

Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the

company under a Scheme of Corporate Debt Restructuring

Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio

under a Scheme of Compromise/Arrangement, a copy of Valuation Report

by Expert, if any shall be accompanied

Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the

transferor company is a listed company and the transferee company is an

unlisted company, for exit opportunity to the shareholders of transferor

company, valuation may be required to be made by the Tribunal

Section 236(2) – For Valuing Equity Shares held by Minority Shareholders

Section 260(2)(c) – For preparing Valuation report in respect of Shares and

Assets to arrive at the Reserve Price or Lease rent or Share Exchange Ratio

for Company Administrator

AUDDEAUDDE

104

Section 281(1)(a) – For Valuing Assets for submission of report by Company

Liquidator

Section 305(2)(d) – For report on the Assets of the company for preparation

of declaration of solvency under voluntary winding up

Section 319(3)(b) – For Valuing the interest of any dissenting member of the

transferor company who did not vote in favour of the special resolution, as

may be required by the Company Liquidator

Section 325(1)(b) – For valuation of annuities and future and contingent

liabilities in winding up of insolvent company

Methodology for valuation is covered under another lesson.

National Company Law Tribunal (“NCLT”) and National Company Law Appellate

Tribunal (“NCLAT”)

The second half of 2016 witnessed an iconic change in relation to corporate re-

structuring in India. The National Company Law Tribunal (“NCLT”) and National

Company Law Appellate Tribunal (“NCLAT”) have been constituted under the new

2013 Act to provide for a single-window clearance mechanism for corporate

restructuring activities.

In relation to this, with effect from 15th December 2016, the MCA transferred

all the proceedings relating to the compromise arrangements and reconstruction of

companies under the 1956 Act, pending with the State High Courts of the country,

to the jurisdictional NCLTs. The NCLT/NCLAT has now taken over the powers of

the State High Courts for corporate restructuring.

Compromises, arrangements and amalgamations

The new provisions under the 2013 Act concerning schemes of mergers,

amalgamations, demerger, compromise or arrangement amongst the companies,

their shareholders and/or creditors were enforced towards the end of

2016. However, provisions under the 2013 Act contemplating merger or

amalgamation of an Indian company with a foreign company are yet to be

notified. the intention of the legislature appears to be to shorten the time period for

completing amalgamations and/or demergers. Also, the current provisions have

been revamped to include seeking comments and inputs from authorities regulating

the sector where the M & A activity is envisaged.

The provisions relating to the compromise, arrangement and amalgamation of

companies under the 2013 Act provide for a fast-track route for certain

companies. M&A between two unrelated small companies (companies which do not

have a paid-up share capital of more than INR 5m), and between a holding

company and its wholly owned subsidiary, are possible without approaching the

NCLT.

Furthermore, the new provisions under the 2013 Act put an embargo on

shareholders holding less than 10% of the shareholding or creditors having an

outstanding debt of less than 5% of the overall debt, as per the latest audited

AUDDEAUDDE

105 balance sheet, from objecting to the compromise, arrangement or amalgamation –

which is intended to keep frivolous objections at bay. Additionally, the provisions

relating to compromises, arrangements and amalgamations are also aimed at

providing transparency to the entire procedure as it also contemplates the

requirement of obtaining a valuation report from registered valuers, a certificate on

accounting treatment from the statutory auditors for private and public companies.

For streamlining the procedure relating to compromises, arrangements and

amalgamations under the 2013 Act, the MCA, in December 2016, notified the

Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 which

specifically provide for the procedure to be followed by the NCLT/NCLAT in cases

involving compromises, arrangements or amalgamations.

12.3.2 Reduction of Share Capital

Rules relating to the reduction of the share capital of companies under the

2013 Act have also come into force. The National Company Law Tribunal

(Procedure for Reduction of Share Capital of Company) Rules, 2016 were also

notified in December, 2016 which provides the entire procedure for the reduction of

share capital of companies. A company desirous of restructuring its capital can

make an application to the NCLT in the manner prescribed under the Rules.

Takeover Code and Listing Agreement

The Securities and Exchange Board of India (“SEBI”) regulates M&A

transactions involving entities listed on recognised stock exchanges in India. Listed

public companies, unlike unlisted companies, are required to be in compliance with

applicable SEBI laws and the listing regulations. The Securities and Exchange

Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

(in short − Takeover Code) regulates both the direct and indirect acquisition of

shares, voting rights and control in listed companies that are traded over the stock

market.

SEBI has also notified the SEBI (Listing Obligations and Disclosure

Requirements) Regulations, 2015 (“Listing Regulations”) which have replaced the

erstwhile Listing Agreements (entered into by a company with a recognised stock

exchange). This holds importance when the company listed on the stock

exchange(s) is involved in a merger.

Until now, the requirement for executing a Listing Agreement with stock

exchanges in respect of equity shares, Indian Depository Receipts, non-convertible

debt securities etc., were specified under different regulations. All obligations

under different Listing Agreements have now been consolidated under the Listing

Regulations. Entities are now required to execute a fresh Uniform Listing

Agreement with stock exchange(s), in the format prescribed by SEBI in this regard.

Laws regulating Foreign Direct Investment

The Foreign Exchange Management Act, 1999 (“FEMA”), and the rules and

regulations made there under, regulate foreign exchange transactions. The Reserve

Bank of India is responsible for the formulation and enforcement of foreign

AUDDEAUDDE

106 exchange regulations. Foreign direct investment is regulated by the FEMA and the

Foreign Direct Investment (“FDI”) Policy, formulated by the Department of

Industrial Policy and Promotion of the Ministry of Commerce and Industry of the

Government of India. FDI Policy provides for sector-specific regulations, in the form

of investment caps, requirements for investment, and sectors in which FDI is

prohibited (such as gambling, atomic energy and agricultural activities). Under the

FDI Policy, an overseas investor can make an investment in India either under the

‘automatic route’ [i.e., without requiring any prior approval from the Foreign

Investment Promotion Board (“FIPB”), Government of India] or under the ‘approval

route’ (i.e., requiring prior approval of the FIPB, Government of India). Any inflow

that is covered under the ‘approval route’ and is more than INR 5,000 Crore (INR

50bn) (increased from INR 30bn by FDI Policy 2016) requires a prior approval of the

Cabinet Committee on Economic Affairs (“CCEA”), a special committee formed to

oversee the economic policy framework of the Government of India.

Competition/Anti-trust laws

Anti-trust issues in India are regulated by the Competition Act, 2002

(“Competition Act”) which replaced the Monopolies and Restrictive Trade Practices

Act, 1969. The Competition Commission of India (“CCI”) has notified the

Competition Commission of India (Procedure in regard to the transaction of

business relating to combinations) Regulations, 2011 (“Combination

Regulations”), which regulate ‘combinations’ such as mergers and acquisitions

which are likely to cause an appreciable adverse effect on competition in the

relevant market in the country.

Other relevant laws

Other relevant laws that govern M&A transactions are the Income-tax Act,

1961, laws relating to service tax, value-added tax/sales tax, and stamp duty on

certain instruments.

Significant deals and highlights

Energy, Mining and Utilities (“EMU”)

M&A activity in the EMU sector reached new heights in the year 2016. The

deals in this sector marked an increase as much as three times that of 2015, with a

total value of approximately US$ 17bn.

Rosneft – Essar (Energy)

This inbound deal bolstered the M&A activity of 2016. Indian debt-struck

conglomerate, Essar Group, sold a combined 98% stake in Essar Oil Company, the

second-largest private oil firm in the country, to Rosneft Oil Company, Russia’s

biggest listed oil producer, along with its partners Trafigura Group Pte and United

Capital Partners (UCP) for US$ 12.9bn. Rosneft acquired a 49% stake in the

refinery and the Vadinar port in Gujarat and all the petrol pumps across India. On

the other hand, Netherland’s Trafigura Group Pte, one of the largest commodity

trading and logistics companies in the world, and Russia’s investment fund UCP

divided the other 49% stake, equally.

AUDDEAUDDE

107

This arrangement between the parties was announced in October, 2016 at the

BRICS Summit in Goa, India in the presence of Mr. Narendra Modi, Prime Minister

of India, and Mr. Vladimir Putin, President of the Russian Federation. This deal

saw the biggest inflow of FDI in the Indian refinery.

Indian Oil Corporation (“IOC”), Oil India Limited (“OIL”) and Bharat Petroleum

Corporation Limited (“BPCL”) – Rosneft (Energy)

Earlier in September 2016, the Indian consortium consisting of IOC, OIL and

Bharat Petro Resources Limited, a 100% subsidiary of BPCL, successfully acquired

a 29.9% stake in Russian oil fields LLC Taas-Yuryakh Neftegazodobycha, and a

23.9% stake in JSC Vankorneft from Rosneft Oil Company, for a combined value of

approximately US$ 3.14bn.

As can be seen from this outbound deal, India is aiming at increasing its

participation in the oil sector and, on the other hand, paving the way for increased

participation by the Russian oil giants in its growing fuel market.

Financial services

The insurance market in 2016 saw large amounts of activity. This increase

could be attributed to the increase in the FDI cap in the sector to 49% under the

automatic route from the earlier 26%. This increase had a ‘trickle effect’ of

increasing the share of already existing partners. Furthermore, the rise in the

sectoral cap for FDI in insurance has made this sector more lucrative for new

entrants.

HDFC Life – Max Financial (Life Insurance)

This multi-layered transaction worth approximately US$ 3bn was one of the

most notable deals of 2016. Announced in August 2016, the composite scheme of

arrangement between HDFC Standard Life Insurance Company Ltd. (“HDFC Life”),

Max Life Insurance Company Ltd. (“Max Life”), Max Financial Services Ltd. (“Max

Financial Services”) and Max India Ltd. (“Max India”) contemplated a merger and

a demerger between the parties to create the largest private sector insurer in the

country.

As per the transaction, in the first stage, Max Life would merge with Max

Financial Services. Thereafter, the life insurance business of Max Financial

Services would demerge into HDFC Life and the residual business of Max Financial

Services would merge with Max India. Eventually, HDFC Life (the merged entity)

would be listed on the stock exchanges and would have an approximate market of

11% in the life insurance space.

Even though the completion of the transaction is subject to many regulatory

approvals including the Insurance Regulatory and Development Authority (“IRDA”)

and CCI, this is one of the first big mergers in the life insurance sector. It appears

that this merger between two big ticket parties would pave the way for further,

similar deals in the coming year.

AUDDEAUDDE

108 HDFC ERGO – L&T Insurance (General Insurance)

The buyout of L&T General Insurance Company Limited (“L&T Insurance”) by

HDFC ERGO General Insurance Company Limited (“HDFC ERGO”) for US$ 5.51bn

was the first such transaction in the general insurance business after the

relaxation of FDI in the insurance sector. By September 2016, the deal had

received the required approvals from IRDA and CCI. This deal has pushed HDFC

ERGO to a higher ranking in the private sector insurance segment and is reflective

of comparable forthcoming deals.

Domestic M&A

In 2015, there was a significant dip in domestic M&A transactions to US$

7.3bn as compared with US$ 19bn in the year 2014. However, domestic M&A

dominated the M&A space in 2016. Domestic M&A increased to 82% in the first

half of 2016. The period from January to March 2016 saw unprecedented activity

in domestic M&A. The deal value in this period increased by almost 125% as

compared to the same period in 2015. The smaller and younger companies saw

many transactions which could be credited to the increased competition by the

large players in the market. The consolidation between companies may be for

increasing their market space and their target customers and for marking a

relevant geographical presence in the ever-evolving economy. A liberalised

economy, with government policies favouring entrepreneurship, has boosted M&A

transactions in India.

For instance, in one of the first M&As in the cab aggregator market, Ola Cabs

acquired TaxiForSure for US$ 200m. This consolidation may help the Indian taxi

aggregator to give competition to its rival, Uber.

In another deal, Tata Power Company entered into an agreement to purchase

the green energy portfolio of Welspun Energy Private Limited for US$ 1.4bn, which

is one of the biggest M&A transactions in the renewable energy sector in Asia.

The digital payment platform Paytm (of One97 Communications Pvt. Ltd)

acquired the platform Shifu, which analyses the usage pattern of the device, for

US$ 8m in January 2016.

Other large-scale acquisitions include: Make My Trip acquiring GoIbibo for

approximately US$ 2bn, creating one of India’s biggest online travel services; Titan

Industries acquiring a 62% stake in Carat Lane, the biggest online jeweller in India,

among others.

Other notable deals were in the manufacturing and building, telecommunications,

and chemical sectors. Some prominent deals are discussed below.

Videocon – Airtel (Telecommunications)

In March 2016, Bharti Airtel bought the rights to use the spectrum (airwaves)

of Videocon Telecom in six circles (telecom service areas) out of the 22 circles in the

country, for US$ 660m. The licence, which expires in 2032, provides Airtel the

right to use the 1,800 MHz band allotted to Videocon by the Government of

AUDDEAUDDE

109 India. The Spectrum Trading Guidelines were announced by the Government in

October, 2015. This deal was struck to boost the fourth generation (4G) data

services in the wake of the launch of Reliance Jio (launched in September 2016)

which has the largest 4G network in India.

Jaiprakash Associates – UltraTech Cement (Cement)

Ultra Tech Cement Limited, a part of the Aditya Birla Group, acquired the

business of sale and distribution of cement and clinker cement plants of

Jaiprakash Associates Limited (“JAL”) worth US$ 2.4bn. The deal announced in

the first quarter of 2016, is expected to benefit JAL in paying off its creditors and

strengthening its balance sheet and, on the other hand, would make Ultra Tech’s

position even stronger in the Indian cement market.

Jabong – Myntra (E-commerce)

Flipkart-owned Myntra, an e-commerce company for fashion and other similar

products, acquired Jabong from Global Fashion Group for a sum of US$ 70m. This

deal is noteworthy because it marks the consolidation process in India’s growing e-

commerce trade.

Myntra was acquired by the Flipkart Group, which is the largest online e-

commerce platform in the country, in 2014 for about US$ 300m. This series of

acquisitions by Flipkart is significant for firming up its position as India’s biggest

online fashion player and also for competing with the increasing number of

entrants in the market including Amazon (United States) and Alibaba (China),

among others.

Others

Other sectors such as telecom, chemicals and pharmaceuticals were active in

2016 and contributed to some important transactions of the year. The deal value of

the telecommunications sector increased to approximately US$ 13.6bn in 2016

from US$ 2.5bn in 2015. In one of the major consolidation moves, Reliance

communications and Aircel Limited announced their merger in September 2016 to

create the fourth-largest phone company in India. The merged entity would work

under a new brand name which would be able to exploit the spectrum (4G network)

of Reliance Jio to enter the competitive data services market.

Another sector which saw a number of deals in the first half of 2016 was the

pharmaceutical sector. One of the notable deals was announced in the first quarter

of 2016 by Sun Pharma of its acquisition of around 14 prescription brands of

Novartis, Japan for US$ 293m. By this acquisition, Sun Pharma penetrated the

Japanese pharma market to increase its global presence.

Industry Sector Reforms: EMU Sector

Unlike 2015 when the technology sector dominated M&A activity, 2016 saw a

sharp fall in the sector to just 56 deals in 2016 from 89 deals in 2015. As seen,

2016 broke all previous records in M&A activities. However, the first half of 2016

was slow compared to the second half of the year wherein the major deals were

announced. Only US$ 3bn worth of deals in the EMU sector took place in the

AUDDEAUDDE

110 period of January to June 2016. This was almost a 14% fall in deal value in

comparison to the same period of 2015.

The second half of 2016 saw increased levels of M&A activity in the economy in

general, including this sector. The push to make the EMU sector stand out in the

year 2016 was fuelled by the Rosneft–Essar deal wherein Russia’s Rosneft acquired

the Essar oil unit for a whopping US$ 12.9bn. This deal took the total deal value of

the sector to US$ 17bn for the year, which is almost 25% of the entire deal value of

M&A in 2016. The deal value in EMU increased thrice as compared to 2015.

This increase may be due to the oil-rich nations trying to secure the overseas

market for their production, in the light of the fall in the prices of crude oil and

other commodities. India is one of the largest-growing fuel consumers in the

world. Most of the transactions were a cumulative effect of the Government of

India’s efforts in creating a liberalised India with strong investor confidence. The

deals in EMU accounted for more than a 26% share in the total M&A in the year.

2016 has been an interesting year for M&A-related activities. Amidst the iconic

global changes including the United Kingdom exiting the European Union (Brexit)

and the presidency elections in the United States of America, India has held its

ground and not faltered. In fact, the International Monetary Fund (“IMF”) has

predicted India will be one of the fastest-growing economies in the world in

2017. The improved M&A market since October 2016 is expected to continue in

2017 as well. The pickup in M&A activities has been there since the new

Government was elected in 2014. The last 24 months saw a game-changing

overhaul in the legal and regulatory structures in the country. The initiatives of the

Government of ‘Make in India’, ‘Digital India’, ‘Swachh Bharat’ (Clean India) have

played a very important role in transforming India and pushing the economy to

reach new heights. The Government has also established a friendlier and a more

transparent atmosphere for entrepreneurs and small and medium-sized

enterprises.

Additionally, more and more sectors have opened for FDI, which has amplified

the competitiveness in the economy. Per the reports published by the Government,

FDI since October 2014 to May 2016 grew 46% to UD$ 61bn after the ‘Make in

India’ initiative was launched to promote India as a preferred hub for foreign

investments. In the light of the changing scenario, Apple Inc. has announced its

manufacturing activities to commence in the first half of 2017 in the country. An

enlarged international presence has forced the domestic players and the public

sector units to gear up and restructure their businesses.

Even though the e-commerce and other sectors have seen an upward trend,

sectors such as real estate are still dominated by the Government, which makes it

difficult for other players to penetrate. However, the construction sector was the

most active in the first half of 2016, occupying approximately a 20% share in total

M&A by deal value. A number of reforms have been undertaken by the

AUDDEAUDDE

111 Government to ease doing business in this sector. The Union Budget for FY 2017–

18 has allocated US$ 60bn for building and upgrading India’s infrastructure.

Another historic decision taken by the present Government was the scrapping

of the 60 year-old Planning Commission and replacing it with the National

Institution for Transforming India Aayog (“NITI Aayog”). The NITI Aayog promotes

cooperation between States to build a stronger India. The Prime Minister has

tapped into the age-old principle of ‘united we stand, divided we fall’, and has been

encouraging ‘cooperative and competitive federalism’ among States. Competitive

federalism has been embraced by many States in the country, which makes them a

better destination for foreign investment in comparison to other States which are

not as involved. Most of the reforms undertaken by the States have been in

creating single-window systems, easing construction permits, reforms in indirect

taxation, environment and labour, etc.

The M&A space has been mostly driven by regulatory reforms in the area. The

implementation of GST and the Insolvency and Bankruptcy Code, among others,

are expected to further enhance investor confidence and promote sustainable

growth. The formation of the NCLT/NCLAT is also expected to push M&A and other

restructuring activities. The first half of 2017 may be a testing ground for the

newly formed tribunals in relation to the transfer of pending cases; it is expected to

be in full flow in no time.

Furthermore, the steps taken by the Government to curb corruption and

restrict the flow of black money in the economy, long-term investment and other

M&A activity, look positive. The demonetisation move may have hampered GDP

growth, however; as stated by the Finance Minister in the Union Budget for FY

2017–18, the move is expected to have only transient effects on the economy. In

another move, a ban has been placed on all cash transactions above INR 0.3m

(approximately US$ 4,500) which is proposed to be made effective in the second

half of 2017.

The last couple of years have seen ups and downs in the global economy in

connection with the fall in commodity and crude oil prices. India has taken

strategic steps to sustain itself in times of crisis. The increased deal-making in the

EMU sector is an example of this. 2017 is expected to be an important year in

terms of consolidations in the domestic space. Inbound activity is also expected to

grow with the relaxed FDI norms. All in all, 2017 appears to be a constructive year

for M&A.

The statistics, figures and information contained in this chapter are based on

the reports of Merger market India and VCCEdge India, which are the financial

research platforms, EY report for January–March, 2016 etc., and other financial,

company and government websites.

AUDDEAUDDE

112 12.4 REVISION POINTS

1. Stores, assets, capital


1. Define M & A. (Mergers & acquisitions)

2. What are the different types of mergers and what are its causes and effects?

3. Write a short note on the 2013 Act concerning Compromises, arrangements

and amalgamations.

12.6 SUMMARY

Mergers & Acquisitions can take place, by purchasing assets, by purchasing

common shares, by exchange of shares for assets or by exchanging shares for

shares. Companies Act 2013, and subsequent notifications governs provisions on

Mergers & Acquisitions. Valuation has been declared as necessary for the following

Purposes under Co. Act 2013.Section 62(1)(c) : For Valuing further Issue of Shares,

Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash

transactions involving Directors, Section 230(2)(c)(v) – For Valuing Shares, Property

and Assets of the company under a Scheme of Corporate Debt Restructuring,

Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a

Scheme of Compromise/Arrangement, a copy of Valuation Report by Expert, if any

shall be accompanied, Section 232(3)(h) - Where under a Scheme of

Compromise/Arrangement the transferor company is a listed company and the

transferee company is an unlisted company, for exit opportunity to the

shareholders of transferor company, valuation may be required to be made by the

Tribunal, Section 236(2) – For Valuing Equity Shares held by Minority

Shareholders, Section 260(2)(c) – For preparing Valuation report in respect of

Shares and Assets to arrive at the Reserve Price or Lease rent or Share Exchange

Ratio for Company Administrator, Section 281(1)(a) – For Valuing Assets for

submission of report by Company Liquidator , Section 305(2)(d) – For report on the

Assets of the company for preparation of declaration of solvency under voluntary

winding up , Section 319(3)(b) – For Valuing the interest of any dissenting member

of the transferor company who did not vote in favour of the special resolution, as

may be required by the Company Liquidator ,Section 325(1)(b) – For valuation of

annuities and future and contingent liabilities in winding up of insolvent company.

The National Company Law Tribunal (“NCLT”) and National Company Law

Appellate Tribunal (“NCLAT”) have been constituted under the new 2013 Act to

provide for a single-window clearance mechanism for corporate restructuring

activities. The new provisions under the 2013 Act concerning schemes of mergers,

amalgamations, demerger, compromise or arrangement amongst the companies,

their shareholders and/or creditors were enforced towards the end of 2016.The

Securities and Exchange Board of India (“SEBI”) regulates M&A transactions

involving entities listed on recognised stock exchanges in India. A few cases of M &

A activity in India are discussed.

AUDDEAUDDE

113 12.7 TERMINAL EXERCISES

1. What is the role of SEBI and FEMA in Mergers and acquisitions? Explain giving

an example.



12.9 ASSIGNMENT

1. What are the recent reforms in the EMU sector that has an effect on M & A.


1. Global Legal Insights – Article by M/s: Apoorva Agarwal, Sanjiv Jain &

P.Srinivasan – PRA Law Offices

2. Ernst & Young Report – Mar 2016

3. Reports of Merger market India and VCC Edge India - financial research

platforms

4. Investopedia – M & A

5. EduPristine – M&A


1. Group discussion during PCP days, Mergers & Acquisitions.

12.12 KEYWORDS

1. Merger, Acquisition, stores, assets

AUDDEAUDDE

114

LESSON 13

PUBLIC SERVICE ASSETS & VALUATION

13.1 INTRODUCTION

Public service is a service which is provided by government to people living

within its jurisdiction – directly as by Govt. Dept. or by a Wholly Owned Govt.

Company or Contracting on special terms A Private Company or by Public Private

Partnership Arrangements. All assets created in this process and belonging to these

entities are called Public Service Assets (PSA).

Public Service is associated with Social Responsibility & Common Good.

Usually it arises of a need to offer certain services to all, regardless of income,

physical ability or mental acuity. Most public services are subject to regulation

going beyond that applying to most economic sectors, for social and political

reasons. Profit motive as understood in a limited sense of entity, balance sheet & P

&L account, are not drivers in most Public Services.

As India races ahead in development, better utilisation of Public Service Assets

assume more importance. Valuation of Public Service Assets are an emerging bright

opportunity for Valuers.

13.2 OBJECTIVE

In this lesson we learn about the purpose and intent of Public Service Assets

(PSA) their characteristics and issues to be considered in Valuation of PSA.

12.3 CONTENT

13.3.1 PPP in Indian Experience

13.3.2 Valuation of Public Service Assets

Development of infrastructure is a precondition for the economic growth of a

country. Increasing demand for quality infrastructure can only be met with robust

investment, proficient project management and technological advancement. Huge

investments with asset values of lakhs of crores are locked up in Public Service

Assets. Most governments in emerging economies, including India, are facing severe

fiscal and capacity constraints. To better utilize these assets & meet the avowed

purpose, governments are utilizing the capabilities of the private sector in a big

way. Public–private partnerships (PPP) have become the preferred mode for the

construction and operation of infrastructure projects, both in developed and in

developing countries.

The expression public-private partnership is a widely used concept world over

but is often not clearly defined. There is no single accepted international definition

of what a PPP is (World Bank, 2006). The PPP is defined as “the transfer to the

private sector of investment projects that traditionally have been executed or

financed by the public sector” (IMF, 2004). Any arrangement made between a state

authority and a private partner to perform functions within the mandate of the

state authority, and involving different combinations of design, construction,

operations and finance is termed as Ireland’s PPP model. In UK’s Private Finance

AUDDEAUDDE

115 Initiative (PFI), where the public sector purchases services from the private sector

under long-term contracts is called as PPP program. However, there are other forms

of PPP used in the UK, including where the private sector is introduced as a

strategic partner into a state-owned business that provides a public service.

The PPP is sometimes referred to as a joint venture in which a government

service or private business venture is funded and operated through a partnership of

government and one or more private sector companies. Typically, a private sector

consortium forms a special company called a special purpose vehicle (SPV) to build

and maintain the asset. The consortium is usually set up with a contractor, a

maintenance company and a lender. It is the SPV that signs the contract with the

government and with subcontractors to build the facility and then maintain it.

Thus, the PPP combines the development of private sector capital and

sometimes, public sector capital to improve public services or the management of

public sector assets (Michael, 2001). The PPP may encompass the whole spectrum

of approaches from private participation through the contracting out of services and

revenue sharing partnership arrangement to pure non-recourse project finance,

while sometime it may include only a narrow range of project type. The PPP has two

important characteristics. First, there is an emphasis on service provision as well

as investment by the private sector. Second, significant risk is transferred from the

Government to the private sector. The PPP model is very flexible and discernible in

variety of forms.

Advantages of PPPs

Retain original purpose & objective of specific Public Service

Combines experiences & strengths of public and private sectors

Enable infusion of capital from outside

Improves administration & accountability

The PPP mode, has its own set of challenges& limitations.

Private sector requires investor-friendly regulatory environment

Avoidance of double standards while setting up stipulations

Return on investment should be reasonable based on risk & reward

Table 1: Schemes and Modalities of PPP

Schemes Modalities

Build-own-operate (BOO)

Build-develop-operate (BDO)

Design-construct-manage-finance

(DCMF)

The private sector designs, builds, owns,

develops, operates and manages an asset

with no obligation to transfer ownership to

the government. These are variants of

design-build-finance-operate (DBFO)

schemes.

AUDDEAUDDE

116

Buy-build-operate (BBO)

Lease-develop-operate (LDO)

Wrap-around addition (WAA)

The private sector buys or leases an

existing asset from the Government,

renovates, modernises, and/ or expands

it, and then operates the asset, again with

no obligation to transfer ownership back

to the Government.

Build-operate-transfer (BOT)

Build-own-operate-transfer

(BOOT)Build-rent-own-transfer

(BROT)

Build-lease-operate-transfer (BLOT)

Build-transfer-operate (BTO)

The private sector designs and builds

an asset, operates it, and then transfers it

to the Government when the operating

contract ends, or at some other pre-

specified time. The private partner may

subsequently rent or lease the asset from

the Government.

Source: Public Private Partnership, Fiscal Affairs Department of the IMF.

PPP s – Global experience

A number of OECD countries have well established PPP programs. Other

countries with significant PPP programmes include Australia and Ireland while the

US has considerable experience with leasing. Many continental EU countries,

including Finland, Germany, Greece, Italy, the Netherlands, Portugal and Spain

have PPP projects, although their share in public investment remains modest.

Reflecting a need for infrastructure investment on a large scale, and weak fiscal

positions, a number of countries in Central and Eastern Europe, including the

Czech Republic, Hungary and Poland, have embarked on PPP. There are also PPP

programs in Canada and Japan. The PPP in most of these countries are dominated

by road projects. Similarly, the EU Growth Initiative envisages the use of PPP type

arrangements primarily to develop trans-European road network.

The Private Finance Initiative (PFI) of the UK is another well developed Govt.

PPP program, which includes cooperation between the public and private sectors,

including the provision of guarantees. The PFI projects are viewed primarily as

being about the provision of services, and not about the acquisition of assets.

Under this program, the private sector makes a long-term commitment to maintain

assets and provide services, and the government makes a long-term commitment to

procure those services; significant risk is transferred to the private sector.

The guidance in this paper presumes that the reader is familiar with the

International Valuation Standards (IVSs). Of particular relevance to the application

of this TIP are the concepts and principles discussed in the IVS Frame work and

the provision so fIVS220Plantand Equipment and IVS230Real Property Interests.

13.3.1 PPP in Indian Experience

India has had 881 PPP projects worth more than INR5.4 trillion in

awarded/underway status (i.e., in operational, construction or in stages where at

AUDDEAUDDE

117 least construction/implementation is imminent) as per data available till August

2012.

Roads dominate the PPP scenario in India, accounting for 52% of all PPP

projects.

There is a need for mainstream PPPs in several areas, such as power

transmission and distribution, water supply and sewerage, and railways.

These are sectors where there are significant resource shortfalls, and a need

for efficient delivery of services.

There is also a need to focus on social sectors, especially health and

education, which currently accounts for only 3.7% of PPP projects in India.

Concern: Cost escalations caused by delays in land acquisition,

Environmental Clearances, Judicial delays

Concerns: Impact of Deviations from measurable parameters used at the time

of bidding from actuals over time: For example: Power sector (energy scenario),

Roads (traffic projection), Ports (cargo handling) etc.

In the light of growing PPP trends and policy/institutional intervention, the GoI

had felt the need to have a broad policy framework in place. GOI has a

comprehensive set of PPP rules & policy with a focus on assisting Central and State

Govt. agencies and private investors by:

Undertaking PPP projects through streamlined processes and principles

Ensuring the adoption of value-for-money approach through optimization of

risk-return allocation in project structuring

Attaining adequate public oversight and monitoring of PPP projects

Developing governance structures to facilitate competitiveness, fairness and

transparency

AUDDEAUDDE

118 Regulatory initiatives

The GoI has a progressive financial support system for PPP projects. Some of

the key initiatives include:

Funding: India Infrastructure Project Development Fund (IIPDF),

Viability Gap Funding (VGF), resources for annuities/ availability-based

payments, long-tenor lending, re-financing facility, infrastructure debt

funds, etc.

Legislative and policy support to develop equity, debt, hybrid structures

and appropriate credit enhancement structures.

undertake capacity building interventions to develop organizational and

individual

capacities for the purpose of identification, procurement and managing

of PPPs.

Financial initiatives Bank loans to earning-based PPP infrastructure

projects under concession agreements are to be treated as secured

advances - a boost for BOT roads and power sector projects.

ECB norms have been relaxed to help infrastructure companies raise

more funds from overseas markets. They are allowed to raise bridge

finance from overseas market under the automatic route.

One of the success stories in PPP are about Airports. Airport modernization in

the country has taken a new form, with private players bringing in new

technologies that not only improve airport operations but also enhance customer

experience. Five international airport projects have been undertaken through the

PPP mode — the development of Cochin, Hyderabad and Bengaluru international

airports, and the modernization of Delhi and Mumbai international airports. Of

these, work in the Mumbai airport in still in progress, while work in the airports at

Cochin, Bangalore, Hyderabad and Delhi have already been completed.

13.3.2 VALUATION OF PUBLIC SERVICE ASSETS

Extract from IVSC 2013 – Technical Information Paper (TIP) – Public Assets

Introduction and Scope

1. For the purpose of this TIP a public service asset is an asset that provides a

service for the benefit of the public. This includes assets for the supply of an

essential commodity, such as water or electricity, a service such as

communications or transportation or facilities for recreation or cultural activity.

A public service asset may be owned by a public sector body or a private entity.

2. Assets held to provide a service to the general public may often be similar in

nature or design to assets held for commercial objectives, and because they are

capable of use for either can normally be valued in the same way as the

commercial asset.

An example would be an office building occupied by a government department

to offer a service to the public which was situated in close proximity to similar

AUDDEAUDDE

119

buildings occupied by private sector businesses also offering services to the

public. The value for the government use would be the same as the value for a

commercial use because the government department would be competing with

commercial users for that office space in the market.

3. However, many assets held to provide a public service are specialised. This

specialisation may relate to the design, location, specification, size or any

combination of these factors.

These factors are specific other service being provided, and as a consequence

there is no commercial use against which the value of the asset can be bench

marked. This TIP examines some of the approaches that should be considered

when a valuation of a specialised public service asset is required.

1. Specialised public service assets may be owned by a government or other

public sector entity or by a private sector entity that has contracted with the public

sector to provide the required public service. It is the characteristics of the asset

and the service it provides that are relevant to its valuation, not the identity or legal

status of the owner. Similarly, the service may be provided by another party

(egacharity, private sector entity or other public body) whilst the owner ship of the

asset is retained by a public body.

This TI Pad dresses only real property interests, infrastructure as sets, plant

and equipment that can be described as specialized public service assets.

Other types of as set held in order to provide a service to the general public are

outside the scope of this paper. The guidance in this TIP supplements guidance in

TIP1 Discounted Cash Flow and TIP2 The Cost Approach for Tangible Assets and

only discusses matters relating these methods that are of particular relevance to

specialized public service assets. For general guidance on these methods the

relevant TIP should be consulted.

It is not uncommon or there to be laws or regulations that stipulate how

valuations of public service assets are to be under taken for different purposes. This

TIP takes no account to any such national or other requirements.

Some Relevant Definitions used in this Paper

The following definitions apply in the context of this TIP. R e f e r t o I V S

Glossary of Valuation Terms for a comprehensive list of defined words and terms

commonly used in valuation.

Future Economic Benefit

A measure of the capacity of an asset to provide monetary benefits to those

that hold or own that as set.

Heritage Asset: An asset having some cultural, environmental or historic

significance.

Historic Property: Real property publicly recognised or officially designated by

a government - charte red body as having cultural or historic importance because

AUDDEAUDDE

120 of its association with an historic event or period, with an architectural style, or

with the nation’s heritage.

Infrastructure Assets: The system of public works in a country, state or

region, including roads, utility lines and public buildings

Infra structure assets: Infra structure assets usually display some or all of the

following characteristics:

a. They are part of a system or network;

b. They are specialized in nature and do not have alternative uses;

c. They are immovable; and

d. They may be subject to constraints on disposal.

Service Potential The capacity of an asset to continue to provide goods and

services in accordance with the entity’s objectives.

Social Value The financial and non-financial benefit to the wide community

provided by an asset.

Specialised Public Service Assets

Like other assets, all specialized public service assets provide either service

potential or future economic benefit. Service potential is a measure of the capacity

of an asset to provide services or benefits to those that use that asset. Future

economic benefit is a measure of the capacity of an asset to provide monetary

benefits to those that hold or own that asset.

Some specialized public service assets may provide future economic benefits to

those that own them whilst also providing a public service. Others may provide a

public service with no prospect to direct future economic benefits accruing to the

owner. This fundamental difference can have a significant impact on the value of

such assets.

The valuation implication soft he asset being specialized are that the

specialised design or features of the asset mean that there are few, if any, similar

assets that are bought or sold in the market and the asset is probably suitable only

for the delivery of the specific service and therefore if demand for the service falls or

ceases then so will the value of the asset.

The valuation implication of the asset being held or operated to provide a public

service is that public service soft neither do not generate income to the owner of the

asset or if they do, that income issubsidised by public funds.

Many public service assets are the subject of specific service obligations

imposed either by conditions on the land use or by obligations on the operating

entity. These obligations may restrict the ability of the owner to deal with the

assets.

The impact of such service obligations will need to be reflected when assessing

value because they impact on the alternative uses available for those assets. These

AUDDEAUDDE

121 restrictions may mean that certain opportunities or alternative uses are not

available and therefore should not be taken in to account when assessing value.

Valuation Purposes

Valuations of public service assets may be undertaken as an input to or for a

range of purposes including:

Inter-departmental transfer

Privatisation

Monopoly pricing

Cost-benefit or economic analyses, (to determine whether a public service asset is being used and managed efficiently)

Financial reporting

Many of these valuation purposes are subject to national legislation or

regulation that may set down the occasion son which valuations are required, the

frequency of valuations, the required bases of value and any other assumptions

that have to be made. Court decisions may also determine how certain legislative

provisions are to be applied. Examination of different national provisions is outside

the scope of this TIP. Some of the more commonly required valuation approaches

and bases are Discussed later in this TIP but these are subject to any specific

requirement of the jurisdictions to which the valuation is subject.

Further guidance on some common valuation requirements for privatisation,

monopoly pricing and financial reporting is provided later in this paper.

Governments and other public entities will, on occasion, elect to acquirel and or

other assets held in the private sector in order to create a specialised public service

asset.

These acquisitions are frequently made under statutory provisions that not

only compel the previous owner of the asset to sell but that also determine the

basis on which the price is to be calculated, which may depart from market value

concepts and principles.

Valuations for the statutory acquisition of assets or land for the creation of

such assets are outside the scope of this paper. The cost of acquiring such assets

or land under statutory provisions is not likely to be relevant in determining the

subsequent value of those assets or land where the compensation arrangements

depart from market value concepts and principles.

Market Value

The required valuation basis for many of the valuation purposes identified in

para 13 is either market value, as defined and described in the IVS Frame work or a

similar market based valuation concept. Under many financial reporting standards,

including the International Financial Reporting Standards (IFRSs) the required

basis of value is fair value. As stated in IVS300 Valuations for Financial Reporting

(paraG2) fair value as defined in IFRS13 Fair Value Measurements will, for most

practical purposes, give the same result as market value. This may also apply in

AUDDEAUDDE

122 other financial reporting standards. It should be noted that the International Public

Sector Accounting Standards Board (IPSASB) has a current project to produce a

Conceptual Frame work for public sector financial reporting that includes

consideration of both when valuation measurements are appropriate and the

appropriate definition of value to use.

The application of market value to many specialized public service assets is

often challenging because the assets are rarely, if ever, exchanged between willing

sellers and willing buyers and therefore market participants cannot be identified.

However, the conceptual frame work for market value in the IVS Framework

para 31 (d) indicates that the present owner is included among those who

constitute a willing buyer. As a consequence, there is deemed to be at least one

buyer in the market, a necessary pre requisite for the hypothetical transaction

described in the transaction. It is necessary to consider what that buyer would pay

to a willing seller to purchase the asset.

The conceptual frame work for market value also excludes special value,

defined as an amount that reflects the particular attributes of an asset that are only

of value to a special purchaser. Obviously an asset that is described as specialized

must have specialized attributes that are of particular value to its owner. However,

if those attributes would also be of value to any other hypothetical market

participant they do not create “special value” as defined; only factors that are

specific to a particular entity have to be disregarded in arriving at market value.

Market valuer effects the highest and best use of an asset. Many specialized

public service assets include land and the public service use of that land may

appear to be suboptimal.

Example, the highest and best use of land in a national park may appear to be

for mining. However, the discussion in the IVS Frame work (para35) makes it clear

that determination of the highest and best use requires only the consideration of

uses that are physically possible, legally permissible and financially feasible.

Consequently although mining in a designated national park may be physically

possible and economically feasible because there are mineral deposits present and

a market for them, it may not be legally permissible because of the statutory

protection of the natural environment and an obligation to maintain the existing

natural state. The potential for mining should therefore be ignored in determination

of the highest and best use.

Example

Likewise land required for utility supply in an urban environment may be

surrounded by land that is high in value, but the uses that generate that high

value would only be possible on the subject land if the utility supply could be

extinguished or economically relocated. In this case the alternative uses may be

AUDDEAUDDE

123 legally permissible, but relocating the supply may be neither physically possible or

financially feasible.

The market value of the complete as set, i.e. the land together with the

buildings and equipment providing the service, should therefore normally be based

on the value of other land suitable for utility supply to that are a rather than the

prevailing value of land for other uses.

Looked at another way, a willing buyer of the utility supply operation would not

normally be willing to pay more than the cost of creating an alternative asset, and

this would involve buying the least expensive land that would be suitable to provide

are placement supply for the area in lieu of the subject asset. That land may not

have the same potential for more valuable alternative use as the subject land.

An additional factor that needs to be considered when considering the highest

and best use in the context of a public service asset is that most entities providing

public services are mandated or directed by government or other legal requirements

to continue to provide the services for which the asset is required.

This means that there is often a stronger presumption that the public service

use of the land will continue to the exclusion of potentially higher value uses than

would be the case with a private use.

It is therefore important to establish the statutory framework around the

provision of the public service in question, and the obligations that this imposes for

the continued use of the land.

It is also important to establish whet her the public service provided is likely to

continue indefinitely. Even if it could reasonably be expected that the necessary

consents and permissions required for a more valuable alternative use could be

obtained, unless there was also are as on able expectation that the public service

would either be no longer be required in this location or that it would be legally,

physically and financially feasible to relocate it, the market value normally would

need to reflect the current use.

Investment Value

An owner of a public service entity may need to establish the investment value

of the asset. In contrast to market value the inputs need not reflect those that

would be made by market participants but may be based on the entity’s own

criteria, such as a target return on capital invested, there turn required to cover the

costs of funding the provision of the asset or various measures of the benefit it can

derive from the service provided.

Investment value is often required to help an entity establish the feasibility of a

proposed investment or acquisition. An owner or operator of a specialised public

service asset is likely to have different criteria for measuring the benefit that it can

derive from that asset than those that would be used by the general body of market

participants.

AUDDEAUDDE

124 Social Value

Sometimes a measure is required of the potential economic impact of

investment in a public service asset by measuring the anticipated benefit in

monetary terms on local employment, property values, tax revenues, health, social

security and welfare costs, etc. This may provide a useful indication of the social

value of a specialized public service asset.

Social value should be distinguished from the other bases discussed in this

TIP. The focus of this TIP is on the valuation of the asset itself. The measurement of

the impact of that asset on other assets in other ownerships or on the wider

community is not related to either the most probable amount that could be

obtained in an exchange or the economic benefits that could be derived by its

owner and therefore is not a “valuation” within the scope of the IVSs. Discussion of

the various socio-economic valuation models that are commonly used for this type

of analysis is outside the scope of this TIP.

Valuation Approaches

All three principal valuation approaches identified in the IVSC Frame work may

be applied to value specialized public service assets.

However, the specialized character and public service use often create

difficulties in applying the market approach. Specialised public service assets are

rarely traded, except by way of internal transfer between government bodies, or as

part of a privatisation project. The specialised features, whether they be the design,

specification or location of the asset mean that reliable comparison scan rarely be

made with the prices of similar assets in the market.

Because many specialized public service assets either do not generate income

to their owner or, if they do that income is subsidized by public funds, it is often

difficult to apply an income approach.

However certain public service assets may be operated and compete in a

commercial environment (such as certain transport and utilities infra structure)

and in those cases an income approach to valuation may be an appropriate

valuation approach. The most common method under the income approach is

discounted cash flow (DCF). TIP1 Discounted Cash Flow gives guidance on the

application of DCF specifically to businesses and real property, but the principles

can also be applied to specialized assets that generate cash flows.

The value of specialized buildings, plant and infrastructure assets is often

measured using the cost approach. The cost approach is described in detail in TIP2

The Cost Approach for Tangible Assets and readers are referred to this

document for guidance on its general application.

While the historical or actual cost of any asset may differ significantly from the

current replacement cost of an equivalent on the valuation date, this is particularly

true in the case of public service assets.

AUDDEAUDDE

125

For example land may have been purchased to provide the public service using

statutory powers at a price that reflected its potential for an alternative higher value

use that would have been possible had it not been for the public service

requirement.

The historic price of acquisition has no relevance to the value of that land once

it is part of the public service asset.

Depreciation adjustments to reflect physical and functional obsolescence are

applied to specialized public service property as described in TIP2. Adjustments for

external obsolescence caused by environmental or locational changes can also be

applied in the same way as they are applied to other types of tangible assets.

However, difficulties can arise with identifying and adjusting for economic

obsolescence given that many public service assets do not generate cash flows or

profits.

Instead of considering the economic performance, i.e. the asset’s ability to

generate profit to the owner, a test of “service potential” can be applied.

Service potential is a measure of the capacity of an asset to provide services or

benefits to those that use that asset. When applying the cost approach to a

specialized public service asset it is therefore necessary to establish the demand for

the service being provided and whether this service is expected to continue.

If there are indications that significant changes in demand for the service are

likely in the near future, the potential of the asset may be impaired and an

adjustment made in the valuation to reflect this.

If there are indications that the service provided may no longer be required

then an alternative valuation approach based on the potential for alternative use of

the asset, or more probably the land on which it is situated, may be more

appropriate.

For the purpose of this TIP specialized public service assets are divided in to

four broad categories. The examples in each of the following lists are illustrative

and not intended to be exclusive.

Transport and utilities infrastructure

Roads

Rail

Ports

Electricity

Gas

Water

Wastewater

Communications

AUDDEAUDDE

126 Governance infrastructure

Parliament and government buildings

Law courts

Prisons and penitentiaries

Emergency services (fire, police and ambulance stations)

Military bases, command centres, munitions depots, firing ranges, etc.

Social infrastructure

Schools, colleges, universities and research institutions

Hospitals

Cemeteries

Cultural, sports and recreational infrastructure

Libraries

Museums

Arts and cultural centres

Botanical gardens

City parks and gardens

National parks and wilderness areas

Within each category the assets share some distinct valuation challenges that

are addressed in this paper.

Transport and Utilities Infrastructure

Depending on the funding model adopted by government, some transport and

utilities infrastructure may be operated as private or publicly owned commercial

business enterprises, as a public-private partnerships (PPP) or as government

subsidized public services.

PPP describes a government service or private business venture which is

funded and operated through a partnership of government and one or more private

sector entities. There are many forms of PPP but most involve a contract between a

public sector authority and a private party, in which the private party provides a

public service or project and assumes financial, technical and operational risk in

the project.

Electricity, gas, ports and communications are all examples of infrastructure

that are often operated as commercial business enterprises, i.e. to provide future

economic benefits to the owner. Toll roads are an example or an asset that may be

operated under a PPP model. The income approach, most commonly discounted

cash flow, is typically used when seeking to establish an enterprise value for such

business enterprises.

However the cost and market approaches may represent appropriate valuation

methods to establish values for the underlying assets used by those enterprises

with appropriate identification and quantification of physical deterioration,

functional and economic obsolescence.

AUDDEAUDDE

127

Infrastructure assets are often by definition, networks or agglomerations of

multiple individual components, each having their own characteristics. If the cost

approach is used, the appropriate level of component is action will need to be

considered.

For instance rail infrastructure comprises earth works, ballast, sleepers, rail,

bridges, culverts, signalling, communications systems, station buildings, etc. Each

may have its own life cycle and therefore need to be addressed separately in the

valuation analysis.

Because such assets are often monopolistic, charges for goods and services

provided by those assets may be regulated by government. Whilst this may have an

impact on the future economic benefits that can be derived from those assets, the

income approach generally remains the most appropriate valuation approach to

establish the market value of the business enterprise to which those assets belong.

However because such a valuation method will capture, by default, both

tangible and intangible assets, it is common practice to use this method in

conjunction with the cost and market approaches to determine the value of the

under lying tangible assets.

Governance Infrastructure

Many buildings used for the administration of government or public protection

are not specialized and therefore fall outside the scope of this paper.

However, many others are specialized and suitable only for the specific use for

which they were designed, and for which there is no active market. The majority of

governance infra structure is operated as a government funded public service and as

a result the cost approach is commonly used to value such assets with appropriate

adjustment to reflect the asset’s service potential(seepara34).

In some jurisdictions, assets such as courts, prisons, military bases and

emergency service facilities may be operated by private sector entities as

commercial business enterprises or PPPs, not withstanding that their income most

likely derived directly from government. As discussed above, where this is the case

the income approach may represent the most appropriate valuation method for the

overall business enterprise.

Many parliament, government and law court buildings are of historical or

heritage value. The current Annexe to IVS230, Historic Property, discusses the

treatment of such assets and is reproduced at Append ix 2 of this paper. It is

proposed to remove this from IVS 230 and include with the future TIP.

Social Infrastructure

Educational institutions and hospitals may either be operated as commercial

business enterprises (possibly with some level of director indirect government

funding) or as fully government funded public services.

If the assets are operated to generate future economic benefits to the owner, for

example under a PPP contract, an income approach is normally appropriate.

AUDDEAUDDE

128

However, where the majority of services are offered to the public and funded

from general taxation rather than a direct charge for the service delivered, it is more

usual to apply the cost approach.

If there are similar assets operated on a commercial basis it may be possible to

extrapolate some data from that market to act as a bench mark and, in particular,

to help in form the appropriated just ments for obsolescence.

Cultural, Sports and Recreational Infrastructure

Some sports and cultural venues, e.g. sporting stadia, theatres, etc, are

operated as commercial business enterprises. These are outside the scope of this

TIP.

However, it is not unusual for sports and recreational property to be owned by

public sector entitiestoprovideservicesthatareeitherfreeofchargeorsubsidisedfrom

public funds. This will often arise where provision of the facility is perceived to be

for the general public benefit but the activity is one that is not regarded as

financially feasible by private providers.

Assets such as public sports centres and swimming pools normally impose an

admission charge but this may be neither reflective of the full cost of providing the

service no rare liable indicator of the value of the facility.

If similar facilities are offered by commercial operators it may be possible to

make comparisons with these operations in order to adjust the cash flows of a

public facility and apply an income approach. If a cost approach is used, the

adjustments for functional and economic obsolescence are often significant for this

type of asset as their popularity and usage is heavily influenced by public trends.

Facilities such as public open space and informal, recreational facilities may

provide an in tangible benefit to the public but only have a tangible value where

there is a reasonable prospect of an alternative use, see paras20–24.

However within such facilities there may be specific assets, e.g. commercial

retail, food outlets, etc., for which a tangible value can be identified.

Valuation Purposes

Financial Reporting

Many assets used to provide public services are owned by public sector entities. In many countries public sector entities are required to produce financial statements in accordance with prescribed accounting standards.

Appendix1*of this TIP discusses the current valuation requirements of the

International Public Sector Accounting Standards (IPSASs) with regard to property,

plant and equipment held by the public sector.(*IPSAS not included)

However, it should be noted that many countries have not adopted the IPSASs

and that there are currently many national variations. It is outside the scope of this

paper to examine the different accounting requirements for public sector entities

indifferent countries and the valuation or other measurement requirements that

they contain.

AUDDEAUDDE

129

The IPSASs are generally based on the principles of the IFRSs but with

supplemental provisions to aid application of those principles to the public sector.

However, the IPSASs do not currently contain an equivalent to IFRS13 Fair Value

Measurement and the IPSASB is currently consulting on the measurement concepts

that under pin the selection of measurement bases for publicly owned assets.

Private sector entities that own specialized public service assets will also need

to produce financial statements in accordance with the relevant accounting

standards. The IFRSs are widely adopted but as in the case of public sector entities,

national standards may prevail. Guidance on the valuation requirements generally

under the IFRSs is contained in IVS300 Valuations for Financial Reporting. Although

the guidance in IVS300 and in this TIP may be applicable where other accounting

standards contain similar provisions, the IVSC makes no assertion as to the

relevance of this guidance to such standards.

The guidance in this TIP on estimating the market value of specialized public

service assets can be applied to financial reporting where IFRS“ fair value” or a

similar basis of value is required.

A particular problem can arise where the relevant accounting standards require

separate values for the land and the buildings for depreciation purposes. The

guidance in IVS300 (para G12) indicates that this is normally done by establishing

the value of the land and then deducting this from the value of the carrying amount

for the real property interest to provide an allocation between the land, which is not

depreciated, and the buildings and improvements that are subject to depreciation.

Difficulties arise with undertaking this allocation for specialized public service

properties because if there is a lack of an active market for the entire asset the

same is likely to be true in relation to the land.

In some cases there may be market evidence for land for a use with similar

characteristics to the actual use that can be used as a proxy in absence of a market

for the actual use. For example, infrastructure for supply of a utility may be on

land that would otherwise be zoned for industrial use and therefore the value of

industrial land would be are as on able basis to use for allocation.

In other cases identifying a proxy use will not be possible due either to the

configuration of the land or its use. For example and corridors required for road,

rail and other network type infrastructure maybe physically unlike any other land

for which there is an active market and may pass through land with many different

uses.

One approach is to value corrid or land by reference to the value of adjoining

land however this has obvious is advantages where the corrid or passes through a

mixture of land uses with greatly differing values, as would be the case with an

intercity highway. This may be addressed by segmenting the land corridor into

sections that reflect the variations in the value of adjoining land. Adjustments may

also be required where the use of the land as an infrastructure corrid or represents

a sub-optimal use of the land.

AUDDEAUDDE

130

Where it is possible to determine a value for the entire infrastructure asset, e.g.

in the case of a tollroad where an income approach can be used to determine a

value that reflects the benefits and usage, a land value may be estimated by

deducting the replacement cost of the infrastructure built on the land, adjusted for

obsolescence, from the value of the whole in order to arrive at an allocation for the

land. Although the cost of acquiring the land will normally be irrelevant to its

current value (seepara16) another approach is to calculate the allocation of the

overall value to the land and the infrastructure based on the ratio of the original

land cost to the original construction cost.

Allocation of an asset’s value to components of that asset for accounting

purposes is a hypothetical exercise and appropriate caveats should be made when

reporting.

Privatisation

Valuations may also be required when assets transition from the public to the

private sector. When governments sell assets to the private sector there is typically

a bidding process in which potential buyers consider the future economic benefits

of ownership of those assets.

These future economic benefits may be quite different to those available to the

government entity that currently owns the assets, especially if that entity operates

as a not-for-profit entity. Accordingly mismatches in value before and after the

transaction may occur.

Monopoly Pricing

Monopoly power may lead to excess profits being made by suppliers if prices

are charged above the true marginal cost of supply. Regulator sat tempt to prevent

operations that are against the public interest by imposing monopoly pricing

arrangements that limit the amount the monopoly asset owner can charge for the

provision of a service.

Such monopoly pricing arrangements typically include some form of regulated

return of and on capital. There turn on capital is typically based on the value of the

assets used to provide the service. The cost approach is often used to determine

such values.

However, due to the circularity between the asset values and there venues,

economic obsolescence is not typically measured in such a valuation whereas

physical and functional obsolescence are typically reflected.

The basis of valuation required is usually defined in the relevant regulatory

frame work. The Organisation for Economic Cooperation and Development (OECD)

promotes Depreciated Optimised Replacement Cost (DORC) which it defines as: “An

approach to allocating the capital costs of a project under which the regulatory

asset base is periodically re-valued to be equal to the price of building or buying a

modern equivalent asset, depreciated to reflect the shorter remaining life of the

existing assets.” It can be seen that DORC is broadly consistent with the principles

AUDDEAUDDE

131 of the cost approach as described in TIP2. The emphasis on the optimization

process is one added by regulators but is implicitinany properly applied cost

approach.

Other definitions of the required basis of valuation, valuation approach or both

will be found in national legislation or regulation, but most involve variations on

establishing a basis of value using a cost approach.


1. Public service, valuations, market value


1. Define Public Service.

2. What do you understand by the term PPP (Public-Private Partnerships)?

Explain and give its advantages and limitations.

3. Write a short note on PPP in India

4. Define these terms with examples: Heritage Assets, Historic assets,

Infrastructure Assets.

5. Write a short note on Specialised Public Service Asset.

6. What could be the reasons for valuations of a Specialised Public Service Asset?

7. Explain Market Value with relevance to a Specialised Public Service Asset.

8. Define the terms Social Value and Investment Value of a Specialised Public

Service Asset.

9. Categories the Specialised Public Service Assets with relevance to Valuation as

per TIP

10. Write a short note on Transport and utilities infrastructure.

13.6 SUMMARY

Development of infrastructure is a precondition for the economic growth of a

country. Huge investments with asset values of lakhs of crores are locked up in

Public Service Assets. Most governments in emerging economies, including India,

are facing severe fiscal and capacity constraints. PPP is defined as “the transfer to

the private sector of investment projects that traditionally have been executed or

financed by the public sector”. Advantages of PPP are: Retain original purpose &

objective of specific Public Service, Combines experiences & strengths of public and

private sectors, Enable infusion of capital from outside , Improves administration &

accountability. Challenges & limitations of PP are: Private sector requires investor-

friendly regulatory environment, Avoidance of double standards while setting up

stipulations, Return on investment should be reasonable based on risk & reward. A

few cases of PPP in India are discussed. We look at the prescription on Valuation of

Public Service Assets, by IVSC in the form of a Technical Information Paper (TIP) –

Public Assets. The paper addresses issues for consideration under categories like

Transport and utilities infrastructure, Governance infrastructure, Social

infrastructure, Cultural, sports and creational infrastructure, National parks and

AUDDEAUDDE

132 wilderness areas. With in each category the assets share some distinct valuation

challenges that are address din this paper.


1. Write a short note on governance infrastructure.

2. What do you understand by the term Monopoly Pricing?


1. www.rbsa.in/plantmachienry

13.9 ASSIGNMENT

1. Write a short not on social infrastructure and Cultural, sports and

Recreational infrastructure.


1. IVSC 2013 - Technical Information Paper – Public assets

2. PPP – www.rbi.org.in

3. PPP – The continuum – Ernst & Young – FICCI paper

4. PPP Cell, Department of Economic Affairs, Ministry of Finance, Government

of India

5. New Delhi-110 001, India. www.pppinindia.com 13.11 LEARNING ACTIVITIES

1. Group discuss on during PCP days, ‘Public service assets’

13.12 KEY WORDS

1. Public services, assets, valuations

AUDDEAUDDE

133

LESSON 14

PUBLIC SECTOR UNDERTAKINGS – DISINVESTMENTS

14.1 INTRODUCTION

Government is planning to sell off or reduce shareholding in Government

undertakings. Valuation is part of any divestment exercise. The present

Government (2014-19) has set an ambitious disinvestment target of Rs. 56,500

crore. As such, it is likely that there are some big ticket disinvestments taking place

in the next few years. Valuation of Government undertakings is specialized and

there are some additional factors to be considered as part of valuation.

14.2 OBJECTIVE

To familiarise the student with Public Sector Undertakings objective, structure

and operations environment. We look at special issues to be considered as part of

valuation effort.

14.3 CONTENT

14.3.1 Historical Perspective

14.3.2 Definition of Disinvestment

14.3.3 Objectives of Disinvestment

14.3.4 Importance of Disinvestment

The government-owned corporations are termed as Public Sector Undertakings

(PSUs) in India. In a PSU majority (51% or more) of the paid up share capital is held

by central government or by any state government or partly by the central

governments and partly by one or more state governments.

14.3.1 HISTORICAL PERSPECTIVE

Industrial growth was accorded high priority by the Government after

Independence. The first 3 five year plans had Industrial growth as a major focus

area. Public Sector or Government was the prime mover or engine of growth, as per

industrial policy. India witnessed the establishment large companies funded by GOI

to spur growth in core sector areas. This policy held sway for almost 40 years till

1991.

However, over time, quality of administration suffered and various external

influences started to take a toll on performance. Public sector grew and

accountability became a casualty. Its shortcomings started manifesting in low

capacity utilisation and low efficiency due to over manning, low work ethics, over

capitalisation due to substantial time and cost over runs, inability to innovate, take

quick and timely decisions, large interference in decision making process etc. By

1990 many PSU s had become a burden on society, requiring annual budgetary

support for keeping them alive. Hence, a decision was taken in 1991 to follow the

path of Disinvestment.

AUDDEAUDDE

134

Period from 1991-92 to 2000-01

The change process in India began in the year 1991-92, with 31 selected PSUs

disinvested for Rs.3,038 crore. In August 1996, the Disinvestment Commission,

chaired by G V Ramakrishna was set up to advice, supervise, monitor and publicize

gradual disinvestment of Indian PSUs. It submitted 13 reports covering

recommendations on privatisation of 57 PSUs. Dr R.H. Patil subsequently took up

the chairmanship of this Commission in July 2001. The Disinvestment Commission

ceased to exist in May 2004.

Against an aggregate target of Rs. 54,300 crore to be raised from PSU

disinvestment from 1991-92 to 2000-01, the Government managed to raise just Rs.

20,078.62 crore (less than half). Interestingly, the government was able to meet its

annual target in only 3 (out of 10) years. In 1993-94, the proceeds from PSU

disinvestment were nil over a target amount of Rs. 3,500 crore.

Some of the reasons for failure of disinvestment efforts were:

Lack of political will

No clear-cut, defined, time bound policy on disinvestment

Lack of transparency in the process

Strident resistance from employees and trade unions

unattractive offers & unacceptable riders for potential investors

Perception of political class in general, as against public good.

So the Govt. took measured small hesitant steps towards disinvestment.

Minority stakes of the PSUs through domestic or international issue of shares in

small tranches, were made to show progress. The value realized through the sale of

shares, even in blue chip companies like IOC, BPCL, HPCL, GAIL & VSNL, however,

was low since the control still lay with the government. Most offers of minority

stakes during this period were picked up by the domestic financial institutions like

LIC &Unit Trust of India at the bidding of Government.

Period from 2001-04, marked a departure. During this time a lot of

disinvestments took place. These took the shape of either strategic sales (involving

an effective transfer of control and management to a private entity) or an offer for

sale to the public, with the government still retaining control of the management.

Some of the companies divested at this time were:

Bharat Aluminium Co. Ltd.

CMC Ltd.

Hindustan Zinc Ltd.

Hotel Corp. Of India Ltd. (partial)

HTL Ltd.

IBP Co. Ltd. (sold to IOCL)

India Tourism Development Corp. Ltd.(18 Hotel Properties)

AUDDEAUDDE

135

Indian Petrochemicals Corp. Ltd.

Jessop & Co. Ltd.

Lagan Jute Machinery Co. Ltd.,

Maruti Suzuki India Ltd.

Modern Food Industries (India) Ltd.

Paradeep Phosphates Ltd.

VSNL (Tata Communications Ltd.)

The valuations realized by this route were found to be substantially higher than

those from minority stake sales. During this period, against an aggregate target of

Rs. 38,500 crore to be raised from PSU disinvestment, the Government managed to

raise Rs. 21,163.68 crore.

Period from 2004-09

The issue of PSU disinvestment remained a contentious issue through this

period. As a result, the disinvestment agenda stagnated during this period. In the 5

years total receipts from disinvestments were only Rs. 8515.93 crore.

2009-16

Government renewed thrust on disinvestments. Again minority stakes in listed

and unlisted (profit-making) PSUs were sold. This period saw disinvestments in

companies such as NHPC Ltd., Oil India Ltd., NTPC Ltd., REC, NMDC, SJVN, EIL,

CIL, MOIL, etc. through public offers.

2016-17 onwards

A new Government took over in 2014 and again the focus has shifted to big

ticket disinvestments. Hopefully we will see many PSU s being privatised in the next

few years. Government is making an effort to improve accountability and quality of

administration in PSU s. Hopefully these efforts will lead to better overall

performance and therefore better valuations.

14.3.2 DEFINITION OF DISINVESTMENT

In economic terms “Investment refers to the conversion of money or cash into

securities, debentures, bonds or any other claims on money. Conversely,

disinvestment involves the conversion of money claims or securities into money or

cash.”

Disinvestment can also be defined as the action of an organisation (or

government) selling or liquidating an asset or subsidiary. It is also referred to as

‘divestment’ or ‘divestiture.’

In most contexts, disinvestment typically refers to sale by the government, a

government-owned enterprise, partly or in full.

14.3.3 OBJECTIVES OF DISINVESTMENT

The new economic policy 1991, clearly indicated that PSUs had shown a very

negative rate of return on capital employed. The national gross domestic product

AUDDEAUDDE

136 and gross national savings were also getting adversely affected by low returns from

PSUs. About 10 to 15 % of the total gross domestic savings were getting reduced on

account of low savings from PSUs.

Inefficient PSUs had become a drag on the Government’s resources. In most

cases equity had been fully eroded and the companies were unable to service debt.

Many undertakings established as engines of growth had become a burden on the

economy. Profitability of PSU s had been considerably eroded and most were

suffering cash losses.

Some factors identified for poor performance of PSU s were:

Lack of autonomy & political interference

Problems of labour, personnel and management

Bureaucratic delays & procedural bottlenecks in procurement, CAPEX &

pricing decisions

Under–utilisation of capacity

Under capitalisation, cost overruns

Political influence on locations, expansions

The Government took a policy decision to move out of non-core businesses,

especially the ones where good private sector players were available. Disinvestment

was seen by the Government as a source of funds for meeting general/specific

needs.

Government has adopted a 'Disinvestment Policy', as a tool to reduce the

burden of financing the PSUs. The following main objectives of disinvestment were

outlined:

To reduce the financial burden on the Government

To improve public finances

To introduce, competition and market discipline

To fund growth

To encourage wider share of ownership

To depoliticise non-essential services

14.3.4 IMPORTANCE OF DISINVESTMENT

It is estimated that Government has about Rs. 2 lakh crore locked up in PSUs.

Government has better avenues for reinvesting these funds to spur growth.

Unlocking these funds by divestment not only makes available funds but also

reduces bleeding of funds.

Reducing fiscal deficit ( reduction in budgetary support )

Reducing Government debt- 40-45% of the Centre’s revenue receipts go

towards repaying public debt/interest

Financing large-scale infrastructure development

For social programs like health and education

AUDDEAUDDE

137

Government adopts primarily three different approaches to disinvestments

Minority Disinvestment

A minority disinvestment is one such that, at the end of it, the government

retains a majority stake in the company, typically greater than 51%, thus ensuring

management control.

Historically, minority stakes have been either auctioned off to institutions

(financial) or offloaded to the public by way of an Offer for Sale. The present

government has made a policy statement that all disinvestments would only be

minority disinvestments via Public Offers.

Examples of minority sales via auctioning to institutions go back into the early

and mid 90s. Some of them were Andrew Yule & Co. Ltd., CMC Ltd. etc. Examples

of minority sales via Offer for Sale include recent issues of Power Grid Corp. of India

Ltd., Rural Electrification Corp. Ltd., NTPC Ltd., NHPC Ltd. etc.

Majority Disinvestment

A majority disinvestment is one in which the government, post disinvestment,

retains a minority stake in the company i.e. it sells off a majority stake.

Historically, majority disinvestments have been typically made to strategic

partners. These partners could be other CPSEs themselves, a few examples being

BRPL to IOC, MRL to IOC, and KRL to BPCL. Alternatively, these can be private

entities, like the sale of Modern Foods to Hindustan Lever, BALCO to Sterlite, CMC

to TCS etc.

Again, like in the case of minority disinvestment, the stake can also be

offloaded by way of an Offer for Sale, separately or in conjunction with a sale to a

strategic partner.

Complete Privatisation

Complete privatisation is a form of majority disinvestment wherein 100%

control of the company is passed on to a buyer. Examples of this include 18 hotel

properties of ITDC and 3 hotel properties of HCI.

Disinvestment and Privatisation are often loosely used interchangeably. There

is, however, a vital difference between the two. Disinvestment may or may not

result in Privatisation. When the Government retains 26% of the shares carrying

voting powers while selling the remaining to a strategic buyer, it would have

disinvested, but would not have ‘privatised’, because with 26%, it can still stall vital

decisions for which generally a special resolution (three-fourths majority) is

required.

Special aspects of PSUs

Government investment in Industry is generally motivated by noble thoughts.

Generally investment considerations are for longer term growth. Government rarely

looks at short term returns. Intangibles like, seeding of technology, changing

consumption patterns, creation of employment can be major motivational factors

AUDDEAUDDE

138 guiding PSU investment. In the long run all these factors do result in value

additions, however not necessarily to the PSU Company itself.

It is of interest to note that practically all countries of the world have some form

of PSU s. There are many areas of critical importance to society that cannot be

served by organisations with a pure profit motive. Some of the countries with the

highest share of PSUs are also important global traders. For instance, the top eight

countries with the highest Government owned Companies are China, United Arab

Emirates, Russia, Indonesia, Malaysia, Saudi Arabia, India and Brazil. These

countries collectively accounted for more than 20% of world trade, with China alone

accounting for more than 10% of the world’s merchandise exports in 2010.

The OECD and World Bank have set out a range of commonly stated reasons

for state ownership of organisations:

Provide public goods (e.g. national defence and public parks)

Provide merit goods (e.g. public health and education), both of which

benefit all individuals within a society (penetration) and where collective

payment through tax may be preferred to users paying individually.

Improve labour relations, particularly in ‘strategic’ sectors.

Limit private and foreign control in the domestic economy.

Increase access to public services. The state could force Govt.

Undertakings to sell certain good and services at reduced prices to

targeted groups as a means of making certain services more affordable

for the public good through cross-subsidisation.

Encourage economic development and industrialisation through:

Sustaining sectors of special interest for the economy, and in particular

to preserve employment.

Launching new and emerging industries by channelling capital into

SOEs which are, or can become, large enough to achieve economies of

scale in sectors where the start-up costs are otherwise significant. This

might be seen as an alternative to regulation, especially where there are

natural monopolies and oligopolies (e.g. electricity, gas and railways).

Controlling the decline of sunset industries, with the state receiving

ownership stakes as part of enterprise restructuring.

imperfect markets or building enabling infrastructure for economic

development e.g. a nationwide electricity grid or water system

State ownership has also been used as a crisis response tool in instances

where events threaten the survival of companies deemed “too big” or “too strategic”

to fail. The most recent large scale example was the bailing out of banks by many

governments during the financial crisis. In a volatile global economic environment,

government ownership may also serve as one of the policy levers governments can

use, not only to maintain jobs, but also to sustain a network of firms that serve as

AUDDEAUDDE

139 suppliers to troubled companies which are under current stress but are still seen to

have a strategic value in the long term.

Valuation Considerations of PSU s.

We now look at issues involved in valuation of PSU assets. There can be 2 types

of Government undertakings.

Partially divested – listed companies

Fully Govt. owned undertakings

In the case of partially divested companies with shares listed on the Exchange,

free market play decides the enterprise value of the asset. Tangible asset valuation

can be done in the same manner as for private companies.

In the case of fully owned undertakings being considered for divestment or

privatisation issues are more complex. We need to factor the original objective of

the investment and the extent to which the objective has been achieved. Govt. may

wish to impose certain special conditions on the prospective buyer, in fulfilment of

its objectives.

Usually Govt. undertakings are allotted large parcels of land well in excess of

their present & future needs. It is usual for Govt. undertakings to invest welfare

infrastructure that was justified at the time of investment. With passage of time,

these assets may have better alternative uses and therefore value.

Business valuation of Govt. undertakings also present many challenges. In

many cases the entity may need considerable investment towards technology &

equipment upgrades, to become profitable. Some entities may enjoy excellent brand

value in the market ( example BHEL). Sourcing & pricing policies may be skewed.

So present operational data may not present the true picture.

In certain cases the Govt. undertaking may be presently enjoying a monopoly.

However after divestment the buyer may or not have continued benefit of monopoly.

Once Govt. divests, it may not be willing restrict entry of competitors.

Valuation methodology should factor all these considerations.


Public sector, Disinvestment


1. Define PSU (Public Sector Undertaking)

2. Write a short note on disinvestment initiative in India.

3. Define Disinvestment and what are its objectives?

4. What do you understand by the term Majority Disinvestment?

14.6 SUMMARY

The government-owned corporations (> 51% shares held by Govt.) are termed

as Public Sector Undertakings (PSUs) in India. Some factors identified for poor

performance of PSU s were: Lack of autonomy & political interference, Problems of

AUDDEAUDDE

140 labour, personnel and management, Bureaucratic delays & procedural bottlenecks

in procurement, CAPEX & pricing decisions, Under–utilisation of capacity, Under

capitalisation, cost overruns, Political influence on locations, expansions . The

Government has taken a policy decision to move out of non-core businesses,

especially the ones where good private sector players were available. It is estimated

that Government has about Rs. 2 lakh crore locked up in PSUs. Unlocking these

funds by divestment not only makes available funds but also reduces bleeding of

funds. Government adopts primarily three different approaches to disinvestments

viz. Minority Disinvestment, Majority Disinvestment &Complete Privatisation. We

now look at issues involved in valuation of PSU assets - Partially divested – listed

companies & Fully Govt. owned undertakings.

In the case of companies with shares listed on the Exchange, free market play

decides the enterprise value of the asset. Tangible asset valuation can be done in

the same manner as for private companies. In the case of fully owned undertakings

we need to factor the original objective of the investment and the extent to which

the objective has been achieved. Government undertakings are allotted large

parcels of land well in excess of their present & future needs. With passage of time,

these assets may have better alternative uses and therefore value. In many cases

the entity may need considerable investment towards technology & equipment

upgrades, to become profitable. In certain cases the Govt. undertaking may be

presently enjoying a monopoly. However after divestment the buyer may or not have

continued benefit of monopoly. Valuation methodology should factor all these

considerations.


1. What are the aspects of PSU’s?


www.rbsa.in/plantmechanary

14.9 ASSIGNMENT

1. What do you understand by the term maturity disinvestment?


1. India.gov.in archives

2. BSE: www.bsepsu.com

3. PWC – The Public Sector Research Centre: www.psrc.pwc.com


Group discuss in during PCP days ‘Public sector undertaking’

14.12 KEY WORDS

Public sector, undertaking

886E260

ANNAMALAI UNIVERSITY PRESS 2017 - 2018

AUDDEAUDDE

annamalai university...2019/06/04 · m.k., power plant engineering, phi learning private...

Documents