Turnaround specialists can help turn failing firms around if legal hazards are kept out of their way

The IBC pivoted the paradigm towards resolving corporate distress via the National Company Law Tribunal (NCLT). The IBC aims to redress only the capital structure, leaving operational problems unaddressed.

Delays in adjudication are another big problem; they accelerate value erosion: key customers defect, accredited vendors switch, employee churn is high, cannibalization of equipment is rampant, maintenance is absent and parts of plant and machinery have to be scrapped.

Thus, forward-thinking boards now seek turnaround specialists. Regrettably, India’s legal architecture thwarts such engagements. Several modern practitioners eschew the immersive role of a KMP, preferring instead to serve as independent consultants to shield themselves from the company’s prior improprieties.

The laws, however, do not view such professionals merely as external consultants. The Companies Act of 2013 features an array of definitions that scare turnaround specialists: ‘control,’ which includes control of management or policy decisions; the term ‘key managerial personnel’ with its various connotations; ‘manager,’ denoting any individual directing the company’s affairs irrespective of job title; and ‘officer,’ which extends to individuals whose directives the board obeys.

These definitions act as impediments to the engagement of turnaround specialists. A nuanced interpretation of the terms ‘manager’ or ‘officer,’ coupled with the definition of ‘control’ place designations such as ‘turnaround manager’ or ‘chief restructuring officer’ in the realm of regulatory scrutiny. Further, although turnaround mandates are inherently holistic, delineating their scope in an engagement letter inadvertently portrays the specialist as a KMP, thereby imputing liability on such professionals for prior transgressions.

A couple of finance ministry notifications exacerbate that risk. A 9 May 2023 notification states that proxy directorship or actions taken in similar capacity on behalf of another person in a company will be construed as an activity under the Prevention of Money Laundering Act (PMLA).

It does not take much imagination for a zealous regulator to stretch the applicability of the term ‘in similar capacity.’ Thus, a turnaround professional risks being deemed a director or KMP under the Companies Act and be subject to PMLA provisions.

A notification of 3 May 2023 states that financial stewardship on behalf of a client, including the management of money, securities, assets or operations (or of a company on the whole), will be considered as an activity under PMLA. A turnaround manager would have to engage in such activities, but may recoil from an assignment if it risks landing in the PMLA’s clutches.

The problem is magnified if the turnaround manager is part of a larger firm, as then the liability of an antecedent transaction of the company in need of a rescue may fall on members of that larger firm.

The recent admission of India’s first shareholder class action under Section 245 of the Companies Act worsens the situation. The NCLT looks at damages that span past, present and future acts, and holds a panoply of professionals liable. Among them, auditors are the most vulnerable, as any improper or misleading statement they make could be scrutinized by shareholders. However, the standardization of audit practices can mitigate this risk.

Turnaround professionals are exposed as they are immersed in day-to-day operations. Moreover, turnaround strategies are situational, so few aspects of it are amenable to standardization. Also, their actions are visible to several stakeholders, including shareholders, who may deem these decisions incorrect. In contrast, other consultants incur negligible risk as their advice is typically not disclosed to shareholders.

To tackle this problem, the government must enact carve-outs, exempting turnaround professionals from these strictures and notifications, barring cases of fraud and gross negligence. Other stipulations may be specified for their independence—they must be unrelated to promoters or directors, for example, or have no audit relationship.

If nothing is done, we face destruction of enterprise value, misallocation of capital, the spectre of job losses, bigger haircuts for lenders and an ever-increasing number of pending cases at the NCLT.

The author is an INSOL fellow & interim leader.