By Amrit Subhadarsi, KIIT School of Law, Bhuvaneshwar
In this era of corporate governance reforms, it has become imperative for the Indian financial institutions to re-examine the existing methods of restructuring the companies that incur losses and are unable to function to their optimum capacity. Corporate debt restructuring definitely serves as a befitting mechanism to revive those companies that bear the brunt of unfavourable external conditions, such as the poor health of the economy and rising interest rates. This article evaluates the viability of Corporate Debt Restructuring in the Indian economy and the procedural framework that supports it.
CONCEPT OF RESTRUCTURING AND RELEVANCE TO INSOLVENCY
The concept of restructuring holds relevance in the context of insolvency when the company is in financial distress as restructuring of a company is done when the company essentially has a viable business but owing to external factors, it has a bad balance sheet and therefore incurs losses. These external factors may be factors such as government policy, change of interest rates, pressure on the domestic currency, among other factors. These situations are beyond the company’s control and when a company tends to have a bad balance sheet owing to such unfavourable conditions, it has to be given another opportunity to manage its assets and liabilities and therefore here the role of debt restructuring is important. The basic objective of debt restructuring is to ensure that the company’s business stays viable in the long term and the creditors in turn enter into different arrangements with the company. This is maybe with respect to foregoing a part of the loan, or exchanging a part of the debt for equity shares in the company, which is also referred to as the debt equity swap, or creditors agreeing to a fixed moratorium period where both the company and the creditors agree to refrain from taking any action against each other during the fixed period. The concept of corporate debt restructuring is part of the external restructuring mechanism of the company where it has to ensure that it has the assets to back the restructuring program because once the company enters into the zone of insolvency, it loses its separate legal identity.
Corporate Debt Restructuring (CDR) can take a variety of forms. The plan can provide for conversion of debt into equity, preference shares convertible into ordinary shares, adjustment of secured creditors’ rights, a compromise in which creditors waive a part of their claims or extend term of their debts, modification of Inter Creditor Agreements (ICAs), valuation and settlement of contingent claims or even the distribution of assets and discharge of liabilities of members of a group of companies where these have become inextricably entangled making it difficult to establish the assets and liabilities of any individual company within the group.[i] The restructuring of the company involves different stages such as execution of a standstill agreement, where both the parties mutually agree to refrain from taking any kind of action to enforce their claims for a certain period, after which information about the company’s financials is gathered. The next stage is that of preparation and consideration of proposals .Meanwhile, it is necessary to keep the company trading, for which purpose it might need additional funding and therefore the lenders during negotiations may agree to a higher rate of interest to support the additional funding.
BASIC PRINCIPLES OF CORPORATE RESTRUCTURING
The legal regime for corporate debt restructuring in India is based on the INSOL principles.[ii] The International Association of Restructuring, Insolvency and Bankruptcy Professionals is a federation of national association of lawyers and accountants who specialize in turnaround and insolvency proceedings. These principles are:
- Where a debtor is found to be in financial difficulty, all creditors should cooperate with each other and execute a standstill agreement between themselves and the company in order to allow access to the relevant information provided by the debtor so that they can evaluate proposals for resolving the debtor’s financial difficulties.
- During the standstill period, all creditors should agree to refrain from taking steps to enforce their claims against or to reduce their exposure to the debtor. However, the creditors are entitled to expect that their position with respect to other creditors will not be prejudiced.
- The debtor should not take any action which might adversely affect the prospective returns to relevant creditors (either collectively or individually) as compared with the position at the Standstill Commencement Date.
- Co-ordination between the creditors and the debtor should be facilitated by selection of one or more representative co-ordination committees and by appointment of professional advisers to assist such committees and where appropriate, the creditors taking part in whole process.
- During the standstill period, the debtor should allow the creditors and their representative committees, reasonable access to all relevant information about the company’s assets, liabilities, business and prospects in order to ensure that proper evaluation of the restructuring package is made.
- Proposals for restructuring should reflect the applicable law at the time which governs such arrangements at the Standstill Commencement Date.
- Information obtained by creditors for the purpose of evaluation of the restructuring package should be made available to all relevant creditors and should, unless already publicly available, be treated as confidential.
- If additional funding is provided during the standstill period, the repayment of such funding should be accorded priority status as compared to other claims of relevant creditors.
CORPORATE DEBT RESTRUCTURING: THE INDIAN MECHANISM
The Corporate Debt Restructuring Mechanism (CDR) in India was established in 2001 when the Reserve Bank of India came up with CDR guidelines to be followed by Banks and financial institutions. The Corporate Debt Restructuring (CDR) Mechanism is a voluntary non-statutory system based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA) and the principle of approvals by super-majority of 75% creditors (by value) which makes it binding on the remaining 25% to fall in line with the majority decision. The CDR Mechanism covers only multiple Banking accounts, syndication/consortium accounts, where all Banks and institutions together have an outstanding aggregate exposure of Rs.100 million and above. It covers all categories of assets in the books of member-creditors classified in terms of RBI’s prudential asset classification standards. Even cases filed in Debt Recovery Tribunals/Bureau of Industrial and Financial Reconstruction/and other suit-filed cases are eligible for restructuring under CDR.[iii] Reference to CDR can be made either by a company or a Bank or financial institution where the Bank or financial institution has a 20% share in the term loan or the working capital. Such reference to the CDR Cell can be made either by the Bank or financial institution or by the company after consultation with such Bank or financial institution.
There are important terms in the CDR process which needs to be identified such as the Debtor Creditor Agreement and the Inter Creditor Agreement. The debtor creditor agreement is an arrangement between the debtor company and the creditor by means of which both parties agree to refrain from taking action against each other with respect to each other’s claims. Every such arrangement or agreement has a standstill clause which prescribes that for a period of 90 or 180 days , no legal action will be undertaken by both parties, and the debtor will also provide the creditor timely information regarding his financial condition. Besides, the borrower needs to undertake that during the ‘stand still’ period the documents will stand extended for the purpose of limitation and that he would not approach any other authority for any relief. Furthermore, the Directors of the company will not resign from the Board of Directors during the ‘stand still’ period. However, the standstill clause is applicable to the borrower or lender only with respect to civil action and not criminal action. Inter Creditor Agreements (ICAs) are necessary to be entered into among creditors to ensure that individual creditors’ rights are protected and no one is prejudiced at the expense of the other. These agreements also stipulate that if 75% of the creditors agree to a debt restructuring package by value, then it is also binding on the remaining creditors.
The CDR Guidelines classify borrowers into four categories in order to determine the standard terms and conditions applicable under the CDR mechanism. These categories are based on the causes of the distress faced by the borrower-corporate and the actions of its Promoters and Directors. The main benefit which the lender derives from the debt restructuring package is that it is significantly able to reduce the growing number of non-performing assets on its balance sheet and therefrom one of the main reasons for rise in CDR by Banks, is to reduce the growing number of non – performing assets especially in case of public sector Banks.
STRUCTURING OF CDR IN INDIA
The CDR mechanism in India has a three tier structure, namely:
- CDR Standing Forum
- CDR Empowered Group
- CDR Cell
CDR Standing Forum
This Forum is a representative body of all Banks and financial institutions participating in the debt restructuring process. This Forum includes different financial institutions and scheduled Banks and excludes regional rural Banks, non-Banking financial companies and co-operative Banks. One responsibility of this Forum is to lay down policies to be followed by the empowered group and the CDR Cell and to ensure timely implementation of the CDR package. A platform is given to both creditors and borrowers to amicably settle their disputes. The standing Forum can review decisions of the empowered group and the CDR Cell. The standing Forum comprises of Banks such as ICICI, SBI, IDBI and the chairman of the Indian Banks Association. Most of the big financial institutions in India that lend money to companies are permanent participating members of the standing Forum.
CDR Empowered Group
The CDR Empowered Group considers the preliminary report of all requests of restructuring, submitted to it by the CDR Cell. After the Empowered Group decides that restructuring of the company is prima-facie feasible and the enterprise is potentially viable in terms of the policies and guidelines evolved by the Standing Forum, the detailed restructuring package is worked out by the CDR Cell in conjunction with the Lead Institution, which is the institution that has the highest exposure in the concerned company.[iv] The Empowered Group examines the viability of the restructuring package and later on gives its opinion as to whether the package is feasible within 90 days or 180 days. If however, the restructuring package is not granted then the creditors have the option of exiting the arrangement, and seeking their own enforcement measures for recovery of their dues.
The CDR Cell is the first receiving authority for applications for CDR to be performed and it analyses the applications received and if it is of the prima facie opinion that CDR package should be granted, then permission is given. The CDR Cell should give its opinion within 30 days of receiving the application and then refer it to the Empowered Group for its suggestion. If the empowered group is prima facie satisfied about the validity of the package, then restructuring is granted, else, the creditor can use other methods for recovery of their dues. The CDR Cell after receiving the application for CDR, looks into various aspects such as the financial health of the company, the role of corporate governance in decision making, and then forwards the application to the empowered group with its own suggestion. If the Cell finds the restructuring to be valid, it will prepare the rehabilitation plan with creditors and if necessary, can engage experts from outside.
Section 230 of the Companies Act 2013 includes a new provision for companies proposing a merger or acquisition, to disclose to the National Companies Law Tribunal in an affidavit, their past or present scheme of debt restructuring and particulars thereof, which scheme must have the consent of not less than 75 per cent of the secured creditors by value. The details to be submitted to the Tribunal include a creditor’s responsibility statement; safeguards for the protection of other secured and unsecured creditors; an auditor’s report that the fund requirements of the company after restructuring shall conform to the liquidity test; a statement where the company proposes to adopt the CDR guidelines; and a valuation report of the Company assets.[v]
PREVAILING TRENDS IN INDIA’S CORPORATE DEBT RESTRUCTURING MECHANISM
- So far as the recent trends are concerned, many infrastructure companies, particularly in the iron and steel sector, occupy more number of CDR lists than any other company. One of the important reasons for this is that the manufacturing sector has been receiving low demand in a slowing economy, which in turn puts high pressure on the profitability of such companies and increases their chances of running into losses. Asset quality at Scheduled Commercial Banks has been deteriorating owing to economic slowdown, delayed clearances of various projects and aggressive expansion by corporates during the high growth phase.
- Another trend is that recent surveys show that public sector Banks have been more lenient in leading consortium of Banks for sanctioning of the CDR packages as compared to private sector Banks. For instance, Chennai-based Indian Overseas Bank has the most restructured assets (9.7% of total), followed by Central Bank of India (8.39%). In comparison, restructured assets of ICICI Bank, HDFC Bank and Axis Bank are below 2%.[vi] However, rise in the grant of CDR packages by the public sector Banks has not helped their cause as this has not impacted the rising rate of non -performing assets in such Banks.
- One of the major disadvantages of the current practice in CDR is that the provision relating to the Promoter-Director’s personal guarantee to the entire CDR process is frequently subject to misuse. A committee headed by B. Mahapatra, Executive Director of RBI had recommended that the provision providing Promoter-Director’s liability is to be determined by such Director sacrificing 15% of what the Bank does, needs to be changed so that the contribution made by such Director is not linked to the Bank’s sacrifice but to the diminution in the fair value of the Company.
- Another major disadvantage is that in the restructuring package, where debt equity swap is often a part, liberal conversion of debt into equity is often allowed by the Banks which often puts them in a disadvantageous position. For instance, earlier before the RBI framed rules regarding conversion of a part of the debt into equity, the Companies were gaining unfair advantage by pricing the equity shares at a higher price, and providing the preference shares to the Banks, with very limited voting rights. Earlier, there wasn’t any kind of restriction on the limit upto which debt could be converted into preference shares. However, presently only a 10% limit for debt equity swap with respect to preference shares is permitted. For instance, in 2010, Bheema Cement, got a restructuring package approved for itself and rescheduled its repayment of loans, in return for shares of the company and zero interest preference shares.
- The small Banks that are in the consortium along with large lenders, usually complain that their interests are not taken care of, because the nature of the arrangement is that if 75% of the creditors by value agree to a debt restructuring package, then it is binding on the remaining 25% creditors.
- Realizing the gravity of the problem of rise in approval of CDR packages of a growing number of corporate, the RBI has framed new rules with respect to debt restructuring. According to the new rules, Promoters of the company have been asked to bring in more equity to the company, to be deposited in a fresh escrow account till the company is revived. Similarly, Promoters have been asked to suffer first losses instead of Banks. Similarly, Banks have been given new rights such as the right to complain to the Institute of Chartered Accountants of India (ICAI) if such auditors who have provided for clean balance sheets of companies are found out. Moreover, Banks have the right to organize themselves in the form of a Joint Lending Forum (JLF) to protect their interests even before the debt becomes a non performing asset.[vii] This Forum will work with the borrower to put the loan back on track and can also invite central or state government officials if a change in policy is required.
- Recently, the infrastructure company Lanco Infratech Ltd, engaged in sectors like power, real estate, construction, got itself a revived debt restructuring package approved by both private and public sector lenders involving Rs 11,155 crore and conversion of Rs 3024 crore loan into equity. The Banks and financial institutions agreed to the CDR package on 27th December 2013. The lenders included Allahabad Bank, Bank of Baroda, Canara Bank, Axis Bank, Andhra Bank, ICICI Bank, Oriental Bank of Commerce, Punjab National Bank, among others. The eventuality of lenders converting the majority of Rs 3,024 crore of loans into equity and gaining control over the company takes place if the company fails to service the restructured loans and defaults on repayments as agreed under the CDR package in seven years.[viii] The option of conversion of debt into equity will allow the lenders to gain control with a stake of 65.83% after expansion of their equity base.
- In the year 2012, Neesa Leisure Ltd, engaged in the hospitality sector, got a CDR package approved for itself and according to a public sector lender, the total exposure of Banks has been Rs 400 crore. The lenders with significant exposure to NLL included ICICI Bank, Axis Bank and the Small Industries Development Bank. In March 2012, the rating agency ICRA downgraded its term loan servicing ability and non-convertible debentures. The profits of the company had slowed down owing to factors such as rise in interest and financing expenses, large funding commitments on capital expenditure, and delay in one of its proposed IPOs. The fund infusion from the company’s Promoters was also not as positive as had been expected.
- In 2013, Gammon India Ltd, the engineering and construction company, got itself a CDR package worth Rs 13,500 crore approved. The main reason identified by lenders was lowering profits and delay in getting project approvals. The depreciation of the rupee also had an impact on major infrastructure companies that already had been battling high borrowing costs which has made it difficult for them to repay their loans. Delays in seeking mandatory government approvals for execution of projects have affected the company’s debt servicing ability. Clearly, these factors were outside the company’s control and hence approval for a CDR package was granted. In Gammon India’s case, Banks had a fund based exposure of Rs 3500 crore and leading lenders were ICICI Bank ltd and Canara Bank Ltd.[ix]
- Wockhardt’s case, the pharmaceutical company, is an example of how companies through proper planning can use the CDR mechanism to bring their business back on track. The Company approached the lenders for approving a CDR package led by ICICI Bank. The lenders included domestic lenders, Foreign Currency Convertible Bond (FCCB) holders among others. Most secured loans were given by domestic lenders. The huge debt of Rs 3800 crore and difficult market conditions forced Wockhardt to take the CDR route in 2009. The company had to sell its non-core nutrition and animal health businesses to generate Rs 790 crore that was required under the CDR arrangement. However, the sale of these businesses helped the company to garner Rs 1297 crore of cash, which along with adequate amount of equity infusion by the Promoters helped the company revive its profits.
Some examples of CDR in India
The idea behind Corporate Debt Restructuring is to make sure that viable companies which are facing a temporary financial distress owing to external factors are given a chance to revive their business. This procedure is helpful for lenders for reasons like reduction of non-performing assets on their balance sheets. Presently, however, there exist a lot of issues which need to be addressed such as Banks’ inability to address asset quality issues owing to lack of infrastructure, misuse of CDR provisions by companies by offering preference shares with limited voting rights to Banks in the debt equity swap mechanism, lack of clarity as to the opinion of the smaller Banks in the consortium of Banks approving a CDR package, among other issues. The Reserve Bank of India has an important role to play in paying heed to the smaller Banks’ concerns and changing the present rules which provide for approval by 75% creditors by value of a CDR package, which is binding on the other creditors. RBI has already framed new rules in 2012 to allow Banks to exercise further rights under the CDR programme. However, there exist other issues like foreign lenders reluctance to be a part of the CDR process along with Indian Banks, because they feel that the process is more favorable to Indian lenders. The RBI needs to frequently review cases coming up for CDR to check misuse and also frame guidelines with respect to control of asset quality of Banks owing to approval of large number of CDR packages. Another important issue is that, the new CDR guidelines do not provide for sector-specific lending and provide broad guidelines, and therefore this might lead to unfair priority sector lending to few areas leaving out the rest.
Edited by Raghavi Viswanath
[i] Roy Goode, PRINCIPLES OF CORPORATE INSOLVENCY LAW 481 (4th ed., 2011)
[ii] Supra., note 1, p. 476
[iii] About us, Genesis of CDR Mechanism in India, available at http://www.cdrindia.org/aboutus.htm, last seen on 16/03/2014
[iv] Rajat Sharma, What is Corporate Debt Restructuring?, Sana Securities Blog, available at http://www.blog.sanasecurities.com/what-is-corporate-debt-restructuring-cdr/, last seen on 16/03/2014
[v] S.230 (2)(c), Companies Act, 2013
vi RBI makes it tough for firms to get away with loan default, The Financial Express, (27/02/2014), http://www.financialexpress.com/news/rbi-makes-it-tough-for-firms-to-get-away-with-loan-default/1229732, last seen on 16/03/2014
vii Dinesh Unnikrishnan, Gammon India’s Corporate Debt Restructuring cleared, Livemint, (04/07/2013), http://www.livemint.com/Companies/HOIdTcBPI73tZG04H8uyGO/Gammon-Indias-corporate-debt-restructuring-cleared.html, last seen on 16/03/2014