Resolution of Stressed Assets in India- An Analysis of the New Framework

Anand Tripurari and Ayushi Mishra analyse the framework revolving around the resolution of fixed assets in India.

Introduction

The Reserve Bank of India (“RBI”) vide notification dated February 12, 2018 released the Revised Framework for Resolution of Stressed Assets (“New Framework”) and devolved the old framework/ guidelines such as the Framework for Revitalizing Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership Outside SDR, Scheme for Sustainable Structuring of Stressed Assets and Joint Lenders Forum (JLF) (“Old Framework”) with instant effect. RBI has done away with a plethora of schemes and made the process more uniform, leaving it to the wisdom of the credit rating agencies to a large extent. Now all the new restructuring/ resolution cases as well as existing structures (that are initiated but not yet fully implemented) will be governed by the New Framework. The word ‘implemented’ with respect to implementation of a resolution plan is now defined under the New Framework. This demonstrates a shift in the approach of RBI while dealing with Non-Performing Assets (“NPA”). Until recently, RBI had been focusing more on the resolution of stressed assets however, the New Framework has been enacted with an intention to supplement the Insolvency and Bankruptcy Code, 2016 (“IBC”) and enforce the resolution of stressed assets within stipulated timelines.

The New Framework is currently only applicable to scheduled commercial banks (except regional rural banks) and All India Financial Institutions such as the Export-Import Bank of India, National Bank of Agriculture and Rural Development, National Housing Bank and Small Industries Development Bank of India (“Lenders”). The framework has not been extended to Non-Banking Financial Companies (“NBFC”) unlike the Old Framework.

Overview of the New Framework

(i) Introduction of New Definitions

The New Framework has introduced definitions of two terms namely, default and restructuring. The term default, which was never defined by RBI before is now defined as non-payment of debt when whole or part of instalment or amount of debt has become due and not repaid by debtor/ corporate debtor.

The term restructuring conveys the same meaning as was understood before and is defined as an act of Lender during a financial difficulty faced by the borrower, of granting concessions, modification of terms of advances/ securities which may include alteration of repayment period/ repayable amount/ amount of instalments/ rate of interest/ roll over of credit facilities, sanction of additional credit facilities, enhancement of existing credit limits and compromise or settlement where time for payment of settlement amount exceeds three months.

(ii) Applicability of the New Framework

For accounts with aggregate exposure of INR 2000 crores and above, the New Framework will only be applicable for resolutions which are initiated under Old Framework but not implemented and are in default as on March 1, 2018 (“Reference date”). In case the default exists as on March 1, 2018, the resolution plan must be implemented within 180 days from March 1, 2018 and if default occurs after March 1, 2018, then resolution plan is required to be implemented within 180 days from date of such default. For example, if an account is undergoing strategic debt restructuring and Lenders have already converted the debt into equity but not divested the same in favor of the new investor and there is a default as on March 1, 2018, then such a transaction will be governed by the New Framework and would require formulation of resolution plan under the New Framework within stipulated timelines.

The New Framework is inapplicable to resolutions which are: (a) completely implemented under Old Framework and have completed the specified period provided there is no further default; or (b) completely implemented under Old Framework but have not completed the specified period provided no such accounts are in default during the specified period. If default occurs during the specified period, Lenders are required to initiate a resolution plan failing which an insolvency application under the IBC will be initiated. It must be noted that every default after the expiry of specified period is treated as a new default.

Further, the New Framework on the whole is not applicable to (a) revival and rehabilitation of Micro small and medium enterprises; (b) restructuring of loans in event of natural calamity; or (c) where borrowers have committed fraud, malfeasance or willful default, they remain are disqualified for restructuring, provided the existing promoters are replaced by new promoters and company is completely delinked from former promoters/ management. The third condition has been inserted keeping in mind the latest amendment under IBC wherein, any promoter in management or control of corporate debtor is ineligible to submit a resolution plan if he has committed preferential transaction, undervalued transaction, fraudulent transaction or extortionate credit transaction.

(iii) Obligations of Lenders under New Framework

Lenders are required to identify stress in loan accounts immediately on default by classification of stressed assets into SMA-0 (1-30 days), SMA-1 (31-60 days) and SMA-3 (61-90 days). The 90 days is a grace period before an account is labelled as an NPA and the idea is to pressurize the borrower to pay from the first day of detection of any irregularity in timely payments. Failure on part of the Lenders with an intention to mask the actual status of the accounts may lead to supervisory enforcement actions by RBI including higher provisioning norms, monetary penalties and direction by RBI to file insolvency application under the IBC. This is aimed at refining the governance standard among Lenders and making them accountable for funding approved by them.

Further, the New Framework mandates placement of Board approved policies by Lenders for resolution of stressed assets. This Board approved policy must be immediately put in place as the weekly and monthly reporting by banks was to begin from February 23, 2018. The weekly reporting of default and monthly reporting of credit information and non-performing assets with Credit Repository of Information on Large Credits (“CRILC”) is for accounts with aggregate exposure above INR 5 crores.

It must be noted that the New Framework does not set out a mechanism for Lenders to compulsorily come together or the decision of majority lender being binding on the minority unlike the JLF guidelines where banks were to mandatorily form a committee as soon as an account was reported as SMA-2 by lenders to CRILC. However, it is evident from the NCLT Mumbai order in Standard Chartered Bank v. Ruchi Soya, (2017) that JLF proceedings pending against a corporate debtor have no bearing on cases initiated under the IBC. Further, inter-creditor agreements will gain much significance now since, the resolution plan under the New Framework will require consent of all Lenders.

(iv) Structure & Implementation of a Resolution Plan

As soon as there is a default, all Lenders are required to singly/ jointly remedy the default by formulating a resolution plan even if default is in the account of the borrower with one of the Lenders. Despite there being no restriction on a Lender curing the default singly, it is a non-viable option since a resolution plan will be considered ‘implemented’ under the New Framework only when (a) borrower is no longer in default with any Lenders; (b) all related documentation is completed by all Lenders in case resolution plan envisages restructuring; and (c) capital structure and changes in terms and conditions of existing loans are duly reflected in books of all Lenders in case resolution plan envisages restructuring. Since the implementation of a resolution plan is only when all Lenders are on same page, it is advisable for banks to proceed jointly with curing the default by borrower.

It is important to note that in case of accounts with aggregate exposure from the lenders above INR 100 crores but less than INR 2000 crores, currently, there is no timeline prescribed for implementation of the resolution plan and there is no instruction to refer to such accounts under the IBC, upon failure of resolution plan or occurrence of further default. However, for accounts with aggregate exposure between INR 100 crores to INR 2000 crores, RBI has proposed to announce reference dates over a two year period for implementation of the resolution plan.

A resolution plan may feature actions/ plans/ reorganization for (a) regularizing of account by payment of all overdue by borrower; (b) sale of exposure to other entities or investors; (c) change in ownership of the borrower; or (d) restructuring.

Any resolution plan with accounts having aggregate exposure of INR 100 crores and above involving restructuring or change in ownership will require one independent credit evaluation and other such similar accounts with aggregate exposure of INR 500 crores and above will require two independent credit valuations of all the fund and non-based facilities. It is noteworthy that the role of credit rating agencies under the New Framework has enhanced manifold and credit evaluations of large accounts have been left to the wisdom of these agencies by RBI. It will help Lenders ascertain credit risk with a specified account and be an indicator for defaulting borrower.

As far as implementation of a resolution plan is concerned, a credit opinion of RP4 or better from one of the two credit rating agencies with respect to the debt availed by the borrower. A credit rating of RP4 and above can only be obtained when debt facilities/ instruments are considered moderately safe for timely service of financial obligations and the credit risk is moderate. The new symbols for ratings have found place for the first time under the New Framework and looking at the current scenario, it is difficult for borrowers to obtain such high credit ratings and consequentially we will have very few resolution plans.

(v) Miscellaneous

The New Framework provides for a ‘Reference Date’ which is the date on which Lenders will approve the restructuring plan for a particular account. There is anxiety that they may be multiple Reference Dates set by the Lenders in absence of a coordinated approach for formulating a resolution plan like the JLF.

There is also a new pricing mechanism for issuance of shares to the Lenders for which a pricing formula has been prescribed for any disinvestment by Lenders pursuant to implementation of change in ownership of the borrower. The accounts undergoing change in ownership will have to satisfy the requirements of definition of ‘control’ under Companies Act, 2013.

Analysis of the New Framework

Firstly, unlike the Old Framework, the New Framework does not provide for an asset classification benefit. The accounts can be upgraded only when all outstanding loans in the account demonstrate ‘satisfactory performance’ i,e, payments by the borrower are not in default at any time during the specified period or for large accounts with aggregate exposure of INR 100 crores and above, any upgrade will be subject to investment grade by credit rating agencies. Further, if the account does not show satisfactory performance during the specified period, it will be re-classified as per the repayment schedule that existed before the restructuring. This is likely to result in accelerated downgrade or higher provisioning. Lenders under the New Framework may continue/ upgrade the credit rating of the borrower as ‘standard’ after implementation of change in ownership pursuant to a resolution plan under the New Framework or under the IBC.

Secondly, the New Framework is inapplicable to NBFCs unlike the Old Framework. Further, there is lack of clarity with respect to its applicability on foreign lenders and debenture holders. However, given that historically, RBI has extended the applicability of similar circulars to NBFCs and considering NBFCs have extended credit facilities to borrowers alongside banks, the circular may cover NBFCs as well. Nevertheless, NBFCs will feel the indirect consequences of the New Framework if borrowers undergo resolution undertaken by Lenders in accordance with the revised regime.

Thirdly, there is likely to be a huge impact on the insolvency cases under IBC after the New Framework becomes effective. There is now a mandatory and time bound mechanism for referring cases under IBC for Lenders with large stressed asset accounts. Considering the Old Framework did not yield the desired outcome of reducing the NPAs, many industry experts along with RBI consider IBC to be much efficient, faster and less susceptible to misuse. The prudential norms on asset classification and provisioning will be applicable for any restructuring under the framework of IBC and the provisioning in respect of borrower entities that have been referred under IBC shall be as per the respective asset classification under the extant Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances norms. The New Framework will hence, require higher provisioning by banks thereby exerting pressure. This is especially excruciating for banks at the time when Punjab National Bank- Nirav Modi fraud has weakened the market capitalization of a number of Indian banks. Further, the cases that are currently under IBC will only be upgraded once all the outstanding loans and facilities demonstrate ‘satisfactory performance’ during the specified period which shall be deemed to commence from date of implementation of the resolution plan as approved by adjudicating authority.

Fourthly, to a certain extent there is lack of clarity on interface between IBC and the New Framework. RBI has not elucidated if an application under IBC can be filed by a financial or an operational creditor during the pendency of the restructuring under the New Framework or if despite a moratorium under IBC, resolution under the New Framework can take place. With respect to the first quagmire, there should not be any bar on filing an application under IBC during the period of resolution under the New Framework. The reason lies in the nature of the Revised Framework which is not mandatory but recommendatory in nature for the Lenders. Hence, any one Lender breaking free from the consortium of Lenders and filing an insolvency application alone under IBC would only be breaching the inter-creditor agreement governing the relationship and the decision making for the consortium. With respect to the second issue, Section 14 of IBC is very widely worded and would act as a statutory bar towards initiation of any resolution within the framework of the revised guidelines.

Lastly, the compulsory filing of applications under IBC after the stipulated time period would put all borrowers in the same basket and overlook cases of borrowers who may actually be facing financial crisis due to business / economic/ delay in payments cycle. This may impact the investment perspective. Further, it will leave no possibility for considering other revival channels available under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2003 and Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

Concluding Remarks

The gross NPA of public and private sector banks by end of September 2017 soared to INR 7,33,974 crores and INR 1,02,808 crores, respectively . In light of the same the New Framework happens to be focusing more on the outcome than the method with the resolute intention of the government to clean things up in one go. The key feature of the revised regime is that if a commercial solution is found which leaves a residual debt (includes both fund and non-fund based facilities) which meets a minimum rating requirement, then the banks can proceed to implement the resolution. The revised regime is much more stringent than the Old Framework and provides for a 180 day timeline within which the Lenders have to agree on a resolution plan or refer the accounts under IBC. The regime is likely to enforce credit discipline among both the borrowers and Lenders. The New Framework has put enormous responsibility on the Lenders who are now required to report default in a timely manner and track repayment which will prevent ever greening of stressed accounts.

After the commencement of the New Framework, it is more than likely for many more cases to go under IBC as there is a short window for Lenders and promoters to find a sustainable solution. Though the short window requires a unanimous sanction, IBC will act as a restraint for stakeholders to find the accurate solution since one or more of the banks in a consortium will be anxious to go to under IBC.