Insolvency and Bankruptcy Code

Why distressed is a different sport

Once default is on the table, the going-concern assumption cracks, and that assumption is the foundation under every DCF and multiple you've built. Value stops being "PV of cash flows to shareholders" and becomes "who stands where in the queue when the estate is carved up." Your tools become the debt documents, the security package, and the statutory waterfall. Equity, last in every queue, turns into something stranger: an option.

India's IBC in one page (the 2016 revolution)

Before the Insolvency and Bankruptcy Code, 2016, an Indian lender chasing a defaulted borrower wandered for years among DRTs, SARFAESI, BIFR and civil courts while promoters kept control. The IBC inverted the game, and now creditors take the keys. Here's the outline you need to know (parameters as of mid-2026, so check against IBBI updates):

• Trigger: a default of ≥ ₹1 crore lets a financial creditor (Section 7), an operational creditor (Section 9), or the company itself (Section 10) file for the Corporate Insolvency Resolution Process (CIRP) at the NCLT (National Company Law Tribunal).
• On admission, a moratorium (Section 14) freezes suits and enforcement. The board is suspended, and an insolvency professional (IRP, then RP) runs the company. Promoters are out of the driver's seat.
• The Committee of Creditors (CoC) controls the outcome. It's financial creditors only, voting by debt share. A resolution plan, in which someone buys or restructures the company, needs ≥66% of the CoC vote. Section 29A bars defaulting promoters and their associates from bidding for their own company back, and that clause is what gave the IBC teeth.
• Timeline: 180 days + one 90-day extension, with a 330-day outer limit including litigation. That limit is honored imperfectly, and large cases have run far longer.
• No plan means liquidation (Section 33), with distribution per the Section 53 waterfall. MSMEs have a pre-packaged track, and the framework keeps evolving.

The Section 53 waterfall (rank it from memory)

1. CIRP and liquidation costs, in full, first.
2. Workmen's dues (24 months) pari passu with secured creditors who relinquished their security to the estate.
3. Other employees' wages (12 months).
4. Unsecured financial creditors.
5. Government dues (2 years) pari passu with any unpaid secured balance after security enforcement.
6. Remaining debts (operational creditors' residue).
7. Preference shareholders.
8. Equity shareholders, last, after everyone.

Try a mini-example. The estate realizes ₹6,000 crore. The claims are costs ₹200 crore, workmen (24m) ₹300 crore, relinquishing secured creditors ₹7,000 crore, employees ₹100 crore, unsecured financial ₹2,000 crore, government ₹900 crore, operational ₹1,500 crore, and equity's book value of ₹1,200 crore. Now distribute. Costs take 200, leaving 5,800. Tier 2's claims total 300 + 7,000 = 7,300 > 5,800, so it exhausts the estate pro-rata. Workmen get 5,800 × 300/7,300 ≈ ₹238 crore, secured creditors get ≈ ₹5,562 crore (79% recovery), and everyone below gets zero. Look at what happened to equity's "₹1,200 crore of book value". It was never real once tier 2 went unpaid. Book equity is an accounting residual, and it holds no place in the queue.

What do creditors recover, and how does Chapter 11 compare?

Now calibrate your optimism with base rates. Across all resolved CIRPs, financial creditors have recovered roughly a third of admitted claims cumulatively, ~31 to 33% through FY25 (pull the latest IBBI quarterly newsletter, ibbi.gov.in, for the live number). The dispersion is enormous: Essar Steel ≈ 90%, Bhushan Steel ≈ 63%, DHFL ≈ 40%s, Videocon ≈ 5% (approximate). Meanwhile equity in resolved cases is routinely extinguished or written down ~95 to 100%. Jet Airways' shares traded for years during its saga before the Supreme Court ordered liquidation in late 2024. That's a standing museum exhibit of hope mispricing a queue.

For the cross-border shelf, here's the US mirror in one paragraph. Chapter 11 ≈ CIRP with the polarity reversed. Existing management usually stays (debtor-in-possession), and new DIP financing jumps the queue. A plan needs class-by-class approval subject to cramdown, and the absolute priority rule (the waterfall) governs, though senior classes sometimes gift value down the stack to buy speed. Chapter 7 ≈ liquidation, and Section 363 sales ≈ quick asset auctions. Senior secured creditors have historically recovered ~70 to 80¢ on the dollar and unsecured ~30 to 45¢ (Moody's studies, cycle-dependent). It's the same physics in a different court culture.

Equity as an option (the Merton insight)

Economically, the shareholders of a levered firm hold a call option on the firm's assets with strike = the face value of debt. At maturity, if assets > debt, they "exercise", paying the debt and keeping the rest. If not, they walk away under limited liability and hand the keys to creditors. The option lens makes three consequences obvious:

1. Distressed equity trades above zero even when assets < debt, because an out-of-the-money option still has time value. A ₹3 stock of an insolvent firm is an option premium priced for lottery outcomes. Calling it "cheap" misreads it. Practice P10 works this numerically.
2. Volatility transfers value from creditors to shareholders. Option value rises with volatility, so shareholders near insolvency rationally prefer riskier bets, and so do the managers serving them. That behaviour is known as "asset substitution", and it's the reason covenants exist, along with the IBC's instant suspension of the board.
3. Every promise of "equity value after restructuring" must survive the waterfall first. Dilution from debt-to-equity conversion typically leaves old shareholders with 0 to 5% of the new company even in successful resolutions.

One last note. Serious distressed investing is a credit skill: buying the debt at the right rung of the queue, which is Moyer's textbook territory. It falls outside the program's core. Your mandate here is defensive. Recognize the situation, respect the queue, and never mistake an option premium for a valuation.