Private Equity in Distressed Assets: Legal Implications

Introduction

In recent years, distressed assets have emerged as a lucrative yet legally complex frontier for private equity investors. With the Indian economy experiencing credit stress and corporate insolvencies, PE funds are increasingly eyeing distressed companies particularly those undergoing resolution under the Insolvency and Bankruptcy Code, 2016 (IBC). But these transactions are not without risk.

This article explores the legal contours of private equity participation in distressed asset acquisitions. It covers the statutory framework, key case law, and evolving regulatory standards that govern such deals. The aim is to equip legal professionals, investors, and scholars with a clear understanding of both the opportunities and pitfalls in this niche investment domain.

Background and Legal Framework

 Key Concepts

Distressed Assets: Assets of companies facing insolvency or severe financial stress, often available at discounted rates during restructuring or liquidation.

Private Equity: Investment funds that acquire equity stakes in companies, typically for control or turnaround strategies.

Resolution Plan: Under IBC, a proposal submitted by a resolution applicant (including PE funds) to revive the corporate debtor.

Relevant Laws and Regulations

• Insolvency and Bankruptcy Code, 2016

  • Section 5(25) & 5(26) – Defines resolution applicant and resolution plan.

  • Section 29A – Ineligibility criteria to prevent defaulting promoters and their affiliates from re-entering control.

  • Section 32A – Grants immunity to the new management from past offences of the corporate debtor.

• SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

  • Governs disclosure, open offer obligations triggered by PE investments.

• FEMA & RBI FDI Norms

  • Regulates foreign PE fund participation in asset reconstruction and insolvency cases.

Why PE Funds Enter the Distressed Market

Valuation Arbitrage: Assets are available below market rates.

Control Premium: Insolvency process allows clean slate and control acquisition.

Regulatory Clarity under IBC: Legal route for acquiring assets with reduced litigation risk—if done right.

Legal Issues in PE Investment in Distress

Section 29A Ineligibility

PE funds linked to defaulting promoters may be disqualified from bidding under IBC.

Due Diligence Risks

Unseen liabilities, past frauds, or regulatory probes may surface post-investment.

Post-Acquisition Litigation

Even after NCLT approval, deals can face appeals or tax disputes.

SEBI Disclosure Norms

In listed companies, PE deals may trigger open offer obligations under takeover regulations.

Case Law Analysis 

ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta & Ors. [2021 SC]

Issue

Was ArcelorMittal ineligible to submit a resolution plan under Section 29A(c) of the IBC due to its past control over companies that were NPAs?

Rule

Section 29A(c) disqualifies any person connected to an account classified as a non-performing asset for more than one year before the submission of the resolution plan.

Application

ArcelorMittal previously held stakes in Uttam Galva and KSS Petron, both defaulting entities. Despite selling its shares later, it had not cleared the overdue debts at the time of submission, making it ineligible.

Conclusion

The Supreme Court upheld ArcelorMittal’s ineligibility but gave a last chance to cure it by repaying the NPAs. The case clarified that disqualification applies even through indirect control and is relevant for PE funds investing in distressed assets.

Challenges 

Section 29A Confusion: PE funds may get disqualified due to indirect links with defaulting promoters.

Post-Acquisition Risks: Litigations and tax claims may continue even after NCLT approval.

Regulatory Overlap: Unclear coordination between IBC, SEBI, and FEMA rules creates legal uncertainty.

Appeals Delay: Ongoing court challenges can delay deal closure and reduce asset value.

Limited Disclosures: Inadequate information hampers proper legal due diligence.

Suggestions

Clarity in Section 29A

Amend IBC to exempt passive PE investors with no control or promoter links.

Faster Plan Implementation

Limit post-NCLT challenges to prevent delay and ensure finality.

Specialised IBC Benches

Create dedicated benches for complex PE-related insolvency matters.

Due Diligence Toolkit

IBBI should issue a standard legal and compliance checklist for investors.

Conclusion

Law Before Leverage Distressed acquisitions is tempting entry points for PE funds but they are legal minefields. India’s IBC offers immense opportunities but also stringent compliance requirements. Legal risks continue after acquisition, and safeguards like indemnity clauses, corporate hygiene, and litigation planning are critical.

Sources

·       Insolvency and Bankruptcy Code, 2016 – Full Text

·       SEBI SAST Regulations, 2011

·       RBI FDI Policy 2024

·       ArcelorMittal Judgment – SCC

DISCLAIMER- This article has been submitted by Swastik Shetty, trainee under the LLL Legal Training Program. The views and opinions expressed in this piece are solely those of the author.