[The following post is contributed by Dhanush. M, a 4th year studnent at the Jindal Global law School]
The rapid growth of non-performing assets (NPAs), especially with regard to public sector banks (PSBs) is a major hurdle to the sustenance of the banking system. This prompted the Reserve Bank of India (RBI) to issue a paper in early 2014 titled “Framework ForRevitalising Distressed Assets and Their Restructuring” for early detection, rectification and restructuring of stressed accounts under Special Mention Account (SMA) category.
The categorisation of the SMA account was as follows: (i) “SMA-0”, where principal or interest payment has not been overdue for more than 30 days but the account has been showing incipient stress; (ii) “SMA-1” where principal or interest payment from an account is overdue between 31-60 days; and (iii) “SMA-2” where principal or interest payment is overdue between 61-90 days.
RBI has set up the Central Repository of Information on Large Credits (CRILC) to collect, store and disseminate data on all borrowers' credit exposures including SMAs having aggregate fund and non-fund based exposure of Rs. 50 million or more. RBI has advised the banks that if an account is reported by any of the lenders to CRILC as SMA-2, they should mandatorily form a committee to be called Joint Lenders’ Forum (JLF) if the aggregate exposure (AE) (fund based and non-fund based taken together) of lenders in that account is Rs 1000 million and above.
Strucutre of a JLF
The formation of a JLF will be mandatory in accounts having AE of Rs.1000 million and above; in other cases also the lenders will have to monitor the asset quality closely and take corrective action for effective resolution as deemed appropriate. The lender with the highest AE will convene the JLF at the earliest and facilitate exchange of credit information on the account. In case there are multiple consortium of lenders for a borrower (e.g. separate consortium for working capital and term loans), the lender with the highest AE will convene the JLF.
It is mandated that all the lenders should formulate and sign an Agreement incorporating the broad rules for the functioning of the JLF. The Indian Banks’ Association (IBA) has prepared a Master JLF agreement and operational guidelines for JLF which can be adopted by all lenders.
The JLF may explore various options through the Corrective Action Alan (CAP) to resolve the stress in the accounts. The first option may involve rectification, by obtaining a specific commitment from the borrower to regularise the account so that the account comes out of SMA status or does not slip into the NPA category.
The second option may involve the possibility of restructuring the account if it is prima facie viable and the borrower is not a wilful defaulter. Restructuring an account would involve a commitment from promoters for extending their personal guarantees along with their net worth statement supported by copies of legal titles to assets may be obtained along with a declaration that they would not undertake any transaction that would alienate assets without the permission of the JLF.
To effectuate restructuring, the lenders in the JLF may sign an Inter Creditor Agreement (ICA) and also require the borrower to sign the Debtor Creditor Agreement (DCA) which would provide the legal basis for any restructuring process. A “stand-still” clause popularly referred to as a “moratorium” could be stipulated in the DCA to enable a smooth process of restructuring.
The “stand-still” clause does not mean that the borrower is precluded from making payments to the lenders, but prohibits the parties from taking recourse to any other legal action during the “stand-still” period. This would be necessary to undertake the necessary debt restructuring exercise without any outside intervention, judicial or otherwise. The ICA may also stipulate that both secured and unsecured creditors need to agree to the final resolution.
The third option could involve the JLF deciding the most preferred recovery process to be followed, among the various legal and other recovery options available, with a view to optimising the efforts and results.
The decisions agreed upon by a minimum of 75% of creditors by value and 60% of creditors by number in the JLF would be considered as the basis for proceeding with the restructuring of the account, which will be binding on all lenders under the terms of the ICA. However, if the JLF decides to proceed with recovery, the minimum criteria for binding decision, if any, under any relevant laws/Acts would be applicable.
The JLF would consider the possibility of transferring equity of the company held by promoters to the lenders to compensate for their sacrifices, promoters infusing more equity into their companies, or transfer of the promoters’ holdings to a security trustee or an escrow arrangement until turnaround of company. This will enable a change in management control, should lenders favour it, where the loan of the distressed company is being restructured.
In case a borrower has undertaken diversification or expansion of the activities which has resulted in the stress on the core-business of the group, a clause for sale of non-core assets or other assets may be stipulated as a condition for restructuring the account, if under the Techno Economic Viability (TEV) study, which provides appraisal of technological parameters of a project and its impact on the financial viability of project, the account is likely to become viable on hiving-off of non-core activities and other assets.
The abovementioned method of “out-of-court” debt restructuring popularly referred to as the “London approach” is beneficial to the extent that it is able to save transaction costs, particularly litigation costs involved in a case of restructuring by the court. However, there is a possibility of coordination problems between various lenders owing to their differing interests, which may delay the formation of a CAP at the earliest as in the instance ofdebt-laden Bhushan Steel, which had outstanding loans amounting to 40,000 crore, where there were several reports in the media as to the reluctance of certain private lenders in taking part in the revival plan.
Also, when dealing with the JLF, the bank can act in manner that caters to its short-term interests, as the JLF is required to arrive at an agreement on the option to be adopted for CAP within 30 days from the date of an account being reported as SMA-2 by one or more lenders.
The JLF should sign off the detailed final CAP within the next 30 days from the date of arriving at such an agreement. Therefore, it is recommended that the time period for the CAP be increased from 30 days as banks have to be very cautious when they are take an incremental exposure to stressed companies.
When funding is infused in a restructuring proposal and accorded priority status over other creditors, there is a strong possibility of legal complications arising when the original creditors have stipulated negative pledges as per the terms of the original loan agreement. The law in regard to negative pledge is that any later perfecting secured party would accordingly be subordinate to the negative pledgee, just as a later perfected secured party is subordinate to a prior one.
With regard to unsecured creditors like bondholders, restructuring by the JLF would adversely affect their interests as there is a risk that secured creditors would infuse more capital in distressed unviable firms, as secured creditors would stand to gain a from seeing a firm continuing as a “going concern” relative to the liquidation proceedings.
Also, in a scenario where a firm has defaulted on its bonds and its accounts are stressed but the JLF infuses more capital, then such actions would be considered invalid in law as the Bombay High in the case of M/s. Asian Power Controls Ltd. V/s. Mrs. Bubbles Goyal categorically stated that the only right an unsecured creditor has is seeking the winding up of the company and the law itself clearly says that merely because all the assets of the company are secured in favour of secured creditors, it is no ground to refuse winding up.
Due to the abovementioned reasons, there is a strong possibility that the JLF method of restructuring distressed assets may end up being very litigious.
To ensure that the lenders committee reaches early consensus, the JLF decision threshold should be revised to 60% in terms of value and 51% in terms of number as against the Framework’s 75% by value and 60% by number. To deal with any bondholder holdouts for restructuring of a company, the RBI may consider the possibility of inserting `Collective Action Clauses` which enables qualified majority of consent to bind other bondholders legally.
Further, if any lender does not participate in the meetings, the said lender should not be considered in the consensus estimation, and should attract a negative supervisory view. This would reduce the problem of banks “holding out” and speed up the process.
Also, tax breaks, in the form of exemptions from capital gains tax on hiving off non-core assets should be provided to promoters that initiate rectification under the SMA classification, as defined by the RBI, at the first signs of incipient stress. To resolve the legal complications associated with negative pledges when new funding is infused in a restructuring proposal, it is recommended that the JLF use arrangements such as transferring assets into new special-purpose vehicle companies or by the creditors “acquiring” assets either in the traditional sense or through repurchase structures.
Indian companies structure their investments through several related parties and subsidiaries. Therefore, the JLF needs to effectively scrutinize huge investments are undertaken in step down subsidiaries and related parties by a multi-tier structure. It is recommended that where investments in associates and subsidiaries are more than 25% of the net worth, while appraising the term loan / working capital requirements of the parent company, the detailed analysis of financials of associates and subsidiaries must be undertaken.
Effective restructuring of a distressed enterprise hinges greatly on the commitment of the board of directors to turnaround an enterprise. It is recommended that promoters and directors should not be permitted to float new ventures or take directorship in other companies. This must be a condition under debtor creditor agreement.
With regard to a “change in management” by the JLF, it would extremely difficult to implement management change, where promoters have controlled the management for a significant period of time. It is recommended that the JLF should consider taking assistance of specialised management agencies that can take over the companies that have productive assets and keep the assets in running condition.
I conclude by stating that early recognition of distressed assets would go a long way in solving the chronic problem of NPAs, but it is important to do so in a manner where the views of the relevant stakeholders are considered in a democratic fashion.
- Dhanush. M
 The concept of SMA category serves as a medium for early detection of stress in an account unlike the Non-Performing asset (NPA) model of monitoring stress, wherein banks only question the stress in an account where interest on a loan and/ or instalment of principal remained overdue for a period of more than 90 days in respect of a term loan.
 Master Circular - Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances (Available at (https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9009#CT94)
 Master Circular, as above.