RBI proposes ownership shift in debt restructuring
09 June 2015
The Reserve Bank of India (RBI) has proposed a new framework for revitalising distressed assets of banks through a corrective action plan that envisages change of ownership and management as a part of restructuring of stressed assets.
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A meeting of senior officials of the Reserve Bank of India and five large lenders last week gave shape to framing steps to deal with truant borrowers. Christened the 'Strategic debt conversion', the new measure will automatically give lenders 51 per cent equity control in a company that fails to repay even after a second restructuring of debt.
As per the `Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders' Forum (JLF) and Corrective Action Plan (CAP)', proposed by the joint lenders forum and RBI, the general principle of restructuring should be that the shareholders bear the first loss rather than the debt holders.
With this principle in view and also to ensure more 'skin in the game' of promoters, JLF / Corporate Debt Restructuring Cell (CDR) may consider the following options when a loan is restructured:
- Possibility of transferring equity of the company by promoters to the lenders to compensate for their sacrifices;
- Promoters infusing more equity into their companies; and
- Transfer of the promoters' holdings to a security trustee or an escrow arrangement till the turnaround of company to enable a change in management control, should lenders favour it.
RBI noted that in many cases of restructuring of accounts, borrower companies are not able to come out of stress due to operational or managerial inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership will be a preferred option. Therefore, the JLF should actively consider such change in ownership.
Further, both under JLF and CDR mechanism, the restructuring package should also stipulate the timeline during which certain viability milestones (eg, improvement in certain financial ratios after a period of time, say, 6 months or one year and so on) would be achieved. The JLF must periodically review the account for achievement / non-achievement of milestones and should consider initiating suitable measures including recovery measures as deemed appropriate.
With a view to ensuring more stake of promoters in reviving stressed accounts and provide banks with enhanced capabilities to initiate change of ownership in accounts which fail to achieve the projected viability milestones, banks may, at their discretion, undertake a 'Strategic Debt Restructuring (SDR)' by converting loan dues to equity shares.
For this, the terms and conditions of the initial restructuring must incorporate an option to convert the entire loan (including unpaid interest), or part thereof, into shares in the company in the event the borrower is not able to achieve the viability milestones and / or adhere to 'critical conditions' as stipulated in the restructuring package. This should be supported by necessary approvals / authorisations (including special resolution by the shareholders) from the borrower company, as required under extant laws/regulations, to enable the lenders to exercise the said option effectively.
Restructuring of loans without the approval / authorisation for SDR is not permitted. If the borrower is not able to achieve the viability milestones and/or adhere to the 'critical conditions' referred to above, the JLF must immediately review the account and examine whether the account will be viable by effecting a change in ownership.
If found viable under such examination, the JLF may decide on whether to invoke the SDR, ie, convert the whole or part of the loan and interest outstanding into equity shares in the borrower company, so as to acquire majority shareholding in the company.
Provisions of the SDR would also be applicable to the accounts which have been restructured before the date of this circular provided that the necessary enabling clauses.
The decision on invoking the SDR by converting the whole or part of the loan into equity shares should be taken by the JLF as early as possible but within 30 days from the review of the account.
Such decision should be well documented and approved by the majority of the JLF members (minimum of 75 per cent of creditors by value and 60 per cent of creditors by number.
In order to achieve the change in ownership, the lenders under the JLF should collectively become the majority shareholder by conversion of their dues from the borrower into equity.
However the conversion by JLF lenders of their outstanding debt (principal as well as unpaid interest) into equity instruments will be subject to the member banks' respective total holdings in shares of the company conforming to the statutory limit.
Post conversion, all lenders under the JLF must collectively hold 51 per cent or more of the equity shares issued by the company.
The share price for such conversion of debt into equity will be determined as per the prescribed method.
RBI has asked all banks to include necessary covenants in all loan agreements, including restructuring, supported by necessary approvals / authorisations (including special resolution by the shareholders) from the borrower company, as required under extant laws/regulations, to enable invocation of SDR in applicable cases.
The JLF must approve the SDR conversion package within 90 days from the date of deciding to undertake SDR.
The conversion of debt into equity as approved under the SDR should be completed within a period of 90 days from the date of approval of the SDR package by the JLF.
For accounts which have been referred by the JLF to CDR Cell for restructuring, JLF may decide to undertake the SDR either directly or under the CDR Cell.
The invocation of SDR will not be treated as restructuring for the purpose of asset classification and provisioning norms.
On completion of conversion of debt to equity as approved under SDR, the existing asset classification of the account, as on the reference date indicated will continue for a period of 18 months from the reference date. Thereafter, the asset classification will be as per the extant IRAC norms, assuming the aforesaid 'stand-still' in asset classification had not been given.
Banks should ensure compliance with the provisions of section 6 of Banking Regulation Act and JLF should closely monitor the performance of the company and consider appointing suitable professional management to run the affairs of the company.
JLF and lenders should divest their holdings in the equity of the company as soon as possible. On divestment of banks' holding in favour of a 'new promoter', the asset classification of the account may be upgraded to 'standard'. However, the quantum of provision held by the bank against the said account as on the date of divestment, which shall not be less than what was held as at the 'reference date', shall not be reversed.
At the time of divestment of their holdings to a 'new promoter', banks may refinance the existing debt of the company considering the changed risk profile of the company without treating the exercise as 'restructuring' subject to banks making provision for any diminution in fair value of the existing debt on account of the refinance.
Banks may reverse the provision held against the said account only when all the outstanding loan / facilities in the account perform satisfactorily during the 'specified period' (as defined in the extant norms on restructuring of advances), ie, principal and interest on all facilities in the account are serviced as per terms of payment during that period.
In case, however, satisfactory performance during the specified period is not evidenced, the asset classification of the restructured account would be governed by the extant IRAC norms as per the repayment schedule that existed as on the reference date, assuming that 'stand-still' / above upgrade in asset classification had not been given.
However, in cases where the bank exits the account completely, ie, no longer has any exposure to the borrower, the provision may be reversed/absorbed as on the date of exit.
The asset classification benefit provided is subject to the following conditions that the 'new promoter' should not be a person/entity/subsidiary/associate etc. (domestic as well as overseas), from the existing promoter/promoter group. Banks should clearly establish that the acquirer does not belong to the existing promoter group.
The new promoters should have acquired at least 51 per cent of the paid-up equity capital of the borrower company.
If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is less than 51 per cent, the new promoter should own at least 26 per cent of the paid up equity capital or up to applicable foreign investment limit, whichever is higher, provided banks are satisfied that with this equity stake the new non-resident promoter controls the management of the company.