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Industries in India have seen upsides and downsides over the last decade, influenced by policy decisions at home and the global economic downturn. In times of need, businesses usually look to banks and financial institutions for loans to meet their capital expenditure and working capital requirements. As a security for repayment of the borrowed debt, companies create encumbrances over assets of the company and in many cases over promoters’ assets in favour of the lenders. Companies have to pay timely interest as well as repay the principal amount within a specific timeline. When a company fails to repay the loan in time and there is delay or continuous default in servicing the interest that its assets are classified as Non- Performing Assets (NPA) by the lenders and the value of the defaulter company deteriorates rapidly over time. Declaring of NPA has a negative effect on the lender’s financial statement as well.
The usual practice by lenders is to take recourse to the remedies under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Recovery of Debts due to Banks and Financial Institutions Act, 1993. In a country where the courts and tribunals are already burdened and the list of pending cases grows longer each day, achieving a logical conclusion is time taking and recovery of money is inevitably delayed. If the asset value of the defaulter company has reduced over time, then also an order of sale of such assets may not be enough to satisfy the lender’s debt. Looking from the point of view of the industry, once the prime assets of a company are auctioned, what remains of the company is a hollow shell and promoters are no longer interested to revive the business.
Perhaps in order to achieve a balance, the Reserve Bank of India (RBI) has introduced various schemes and guidelines in the last couple of years to revitalise distressed assets for the growth of Indian economy and industry, apart from introducing other sectoral reforms. These debt restructuring schemes, as enumerated below, are convivial measures for both the borrower as well as the lender.
RBI has started this initiative in 2014 by introducing CRILC to the banking system to recognize stressed assets at an early stage and to finalise a restructuring package through Joint Lenders Forum (JLF) based on the borrower company’s Techo-Economic Viability (TEV)1.
CDR is a mechanism where the lenders to a concerned borrower/borrower group come together and form a JLF for restructuring the loan. The borrower may request the lender banks to form a JLF or the lender banks can form a JLF suo motu if the aggregate exposure is above Rs. 1000 million. CDR mechanism usually involves lowering of interest rates, extending time to pay off the loan etc.
In CDR, the JLF analyse the company’s business model to assess whether the problems faced by the company are temporary or permanent and whether company’s business model is viable. If the JLF decides to restructure the corporate debt, the borrower gets a breathing space.
Since inception of this scheme, 655 cases have been referred to the CDR Cell, out of which 530 cases were approved, the aggregate debt being Rs. 403004 crores. Till June, 2016 only 94 of such cases have exited CDR successfully; whereas 228 cases were withdrawn on account of failure. There are still many live CDRs, majority of them being borrowers operating in Iron & Steel and Infrastructure, which aggregates to around 40% of the total aggregate debt.
In 2014, change of management was envisaged by the RBI as a part of the restructuring of stressed assets. The SDR Scheme was prepared so as to pave way to initiate change of management in companies in distressed companies which fail to achieve the milestones under CDR. At the time of CDR, the JLF must necessarily incorporate an option in the loan agreement to convert the entire or part of the loan including the unpaid interest into equity shares if the CDR fails.
Loans restructured under the SDR scheme are not treated as NPA and banks have to make low provisions in most cases. This enables banks to report lower NPAs and higher profits for 18 months.
The decision of invoking SDR by converting the whole or part of the loan into equity should be approved by the majority of the JLF members and it results in the lenders acquiring at least a 51% ownership of the borrower. Since lenders’ entry into the borrower company is only to restructure it, the conversion of debt into equity is exempted from Regulation 3 and Regulation 4 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 i.e. the lenders do not have to make on open offer for listed borrowers. The conversion of debt into equity should be done at a ‘Fair Value’, as described in the Scheme, which in any case, cannot be lower than the face value of the shares. The pricing formula is also exempted from the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations.
The lenders have to divest a minimum of 26% shares of the borrower company to a new promoter within 18 months from the date of invocation of SDR. Thus, the lenders have the option to exit the borrower company gradually. However, the lenders have to grant the new promoters the ‘Right of First Refusal’ for the divestment of their remaining shareholding.
Many banks have already started invoking SDR and the greatest number of SDR has been invoked in Iron & Steel, Mining, Power Generation and Infrastructure sectors, which have been plagued sectors in India. As on date the success rate of SDR has not been very high even though lenders are going forward with the scheme. It is expected that by March, 2017 there may be 30 to 40 cases of invocation of SDR for aggregate debt of Rs. 145,000 crores.
RBI has also introduced a new scheme in September, 2015 whereby ownership of borrowing entities can be changed outside SDR – by way of sale of shares acquired by invocation of pledge by the lenders etc. Like in SDR Scheme, the new promoter should not be associated with the existing promoter/promoter group and should acquire at least 51% of the equity shareholding. If the new promoter is a non-resident, for sectors where the ceiling on foreign investment is less than 51%, the new promoter should own at least 26% of the equity shareholding. This scheme however does not enjoy the exemptions from SEBI regulations permitted under SDR guidelines as enumerated above.7
RBI has introduced the S4A scheme in June, 2016 and it is substantially different from the other restructuring schemes in order to ensure that adequate financial restructuring is done to give the borrower company a chance of sustained revival.
A borrower company has to meet various eligibility criteria to invoke S4A scheme, i.e. commencement of commercial operation; aggregate debt exposure of Rs. 500 crores; and sustainable debt of the company should not be less than 50% of the current funded liability according to the viability report. The lender bank has to separate the total debt of the borrowing company to sustainable and unsustainable debt based on the cash flow. The part of the loan which can be serviced through the existing cash flow of the company shall be considered as sustainable debt and the remaining part of the debt will be labeled as unsustainable.
The lenders by adopting a resolution plan thereafter can convert the unsustainable debt into equity/redeemable cumulative optionally convertible preference shares. The lenders shall have the option to convert a portion of the unsustainable debt into optionally convertible debentures subject to there will be no change in promoter of the borrower company.
All of the aforesaid schemes not only act to assist the lenders in clearing their books of accounts by getting rid of bad debts but also ensure that the company continues its perpetual existence, even if the persons controlling the company changes over time. The success of the schemes, including SDR will revive the distressed businesses and in turn will help the Indian economy and the lenders have to devise innovative methods and packages to make it a success as structuring the transaction ultimately rests in the hands of the banks and the financial institutions.
Sourav Ghosh is the Managing Partner at S. Jalan & Co., with extensive experience in General Corporate Practice, Litigation and Arbitration, with special focus on Infrastructure, Mining, Financial and Banking Practice and Real Estate Sector.
Mudrika Khaitan is Senior Associate with S. Jalan & Company, Kolkata involved in practice areas of banking, financial and insurance sector and general corporate advisory.
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