The Reserve Bank of India (RBI) in its circular dated 26th February 2014, on Framework for Revitalising Distressed Assets in the Economy–Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan, envisaged change of management as a part of the restructuring of stressed assets. The circular states that 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) were advised to 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;
- Transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of the company. This will enable a change in management control, should lenders favour it.
Since it was observed that in many cases of restructuring of accounts, borrower companies are not able to come out of stress due to operational/ managerial inefficiencies, despite substantial sacrifices made by the lending banks, change of ownership through Strategic Debt Restructuring was mooted by RBI in its guidelines dated 08th June 2015.
These guidelines were reviewed, based on feedback received from stakeholders and RBI has on 25th February 2016 issued circular to partly modify, and also clarify, some aspects of the guidelines. In continuation of these efforts and in order to further strengthen the lenders’ ability to deal with stressed assets and to put real assets back on track by providing an avenue for reworking the financial structure of entities facing genuine difficulties, the RBI has on 13th June 2016 issued guidelines for a Scheme for Sustainable Structuring of Stressed Assets (S4A).
What is Strategic Debt Restructuring (SDR) Scheme?
The Strategic Debt Restructuring (SDR) has been introduced by RBI with a view to ensuring more stake of promoters in reviving stressed accounts and providing banks with enhanced capabilities for initiating change of ownership, where necessary, in accounts which fail to achieve the agreed critical conditions and projected viability milestones. The scheme gives the right to lenders, at their discretion, to undertake strategic debt restructuring by converting loan dues to equity shares. This scheme is based on the general principle of restructuring that ‘the shareholders bear the first loss rather than the debt holders.’
The SDR framework is also available to an Asset Reconstruction Company, which is a member of the JLF, undertaking SDR of a borrower company.
Features of SDR Scheme
- Restructuring of loans subject to option to convert entire loan into shares
At the time of initial restructuring, the lenders are required to incorporate, in the terms and conditions attached to the restructured loan/s agreed with the borrower, 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/authorizations (including a 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 said approvals/authorisations 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, i.e. 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;
- Decision to be taken by majority of lenders
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 above review of the account. Such decision should be approved by the majority of the JLF members (minimum of 75% of creditors by value and 60% of creditors by number). Provisions of SDR would also be applicable to the accounts which have been restructured before the SDR scheme came into being, provided that necessary enabling clauses are included in the agreement between the banks and borrower;
- Lenders jointly to own majority shares
Post the conversion, all lenders under the JLF must collectively hold 51% or more of the equity shares issued by the company. 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 shall be subject to the member banks’ respective total holdings in shares of the company conforming to the statutory limit in terms of Section 19(2) of Banking Regulation Act, 1949;
- New loan agreements to provide for SDR
RBI has directed that henceforth, banks should include necessary covenants in all loan agreements, including restructuring, supported by necessary approvals/authorisations (including the special resolution by the shareholders) from the borrower company, as required under extant laws/regulations, to enable invocation of SDR in applicable cases.
- Time limit for completion of SDR and conversion of loan to equity
JLF can have flexibility in the time taken for completion of individual activities up to the conversion of debt into equity in favour of lenders (i.e. up to 210 days from the review of achievement of milestones/critical conditions) as per the SDR package approved by JLF.
However, 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.
- Asset classification after SDR and divestment of holding
The invocation of SDR will not be treated as restructuring for the purpose of asset classification and provisioning norms. On completion of the conversion of debt to equity as approved under SDR, the existing asset classification of the account will continue for a period of 18 months from the reference date (the date of JLF’s decision to undertake SDR). Thereafter, the asset classification will be as per the extant IRAC norms, assuming the aforesaid ‘stand-still’ in asset classification had not been given. The benefit of ‘stand-still’ in asset classification will apply from the reference date itself. However, if the targeted conversion of debt into equity shares does not take place within 210 days from the review of achievement of milestones/critical conditions, the benefit will cease to exist.
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’. The asset classification benefit will be available to lenders provided they divest a minimum of 26% of the shares of the company (modified from 51% ab initio as required earlier) to the new promoters within the stipulated timeline of 18 months and the new promoters take over management control of the company. Lenders would thus have the option to exit their remaining holdings gradually, with upside as the company turns around. Lenders should, however, grant the new promoters the ‘Right of First Refusal’ for the subsequent divestment of their remaining stake.
- Divestment only to ‘new promoters’
The ‘new promoter’ (to whom the lenders divest their equity) should not be a person/ entity/ subsidiary /associate etc. (domestic as well as overseas), from the existing promoter/promoter group.
The new promoters should have acquired at least 26% (reduced from 51% as required earlier) of the paid up equity capital of the borrower company, within the stipulated timeline of 18 months and the new promoters take over management control of the company. If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is less than 51 percent, the new promoter should own at least 26 percent 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.
- Conversion price of the equity and exemption from SEBI Guidelines
(i) Conversion of outstanding debt (principal as well as unpaid interest) into equity instruments should be at a ‘Fair Value’ which will not exceed the lowest of the following, subject to the floor of ‘Face Value’ (restriction under section 53 of the Companies Act, 2013):
- Market value (for listed companies): Average of the closing prices of the instrument on a recognised stock exchange during the ten trading days preceding the ‘reference date’ indicated at (ii) below;
- Break-up value: Book value per share to be calculated from the company’s latest audited balance sheet (without considering ‘revaluation reserves’, if any) adjusted for cash flows and financials post the earlier restructuring; the balance sheet should not be more than a year old. In case the latest balance sheet is not available this break-up value shall be Re.1.
(ii) The above Fair Value will be decided at a ‘reference date’ which is the date of JLF’s decision to undertake SDR.
Pricing formula under SDR Scheme has been exempted from the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009 subject to certain conditions. Further, in the case of listed companies, the acquiring lender on account of the conversion of debt into equity under SDR has also been exempted from the obligation to make an open offer under regulation 3 and regulation 4 of the provisions of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
- Professional management to run the affairs of the company
Banks are required to explore the possibility of preparing a panel of management firms/individuals having expertise in running firms/companies who could be considered for managing the companies till ownership is transferred to the new promoters. In no case should the current management be allowed to continue without the representatives of banks on the Board of the company and without supervision by an entity/person appointed by the banks.
What is Joint Lender’s Forum?
RBI has advised banks to report, the details of accounts having aggregate fund-based and non-fund based exposure of Rs.50 million and above with them and showing signs of stress (accounts where principal or interest payment is overdue for more than 30 days or accounts showing signs of incipient stress), to Central Repository of Information on Large Credits (CRILC).
Where the principal or interest payment of an account reported to CRILC is overdue between 61-90 days and if the aggregate exposure (AE) [fund based and non-fund based taken together] of lenders in that account is Rs 1000 million and above, the lenders should mandatorily form a committee to be called Joint Lenders’ Forum (JLF) . Lenders also have the option of forming a JLF even when the AE in an account is less than Rs.1000 million and/or when the principal or interest payment is overdue for a period less than 61-90 days.
If there is an existing Consortium Arrangement for consortium accounts, then it will serve as JLF with the Consortium Leader as convener. For accounts under Multiple Banking Arrangements (MBA), the lender with the highest AE will convene JLF at the earliest and facilitate the exchange of credit information on the account. In case there is 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.
The lenders are required to formulate and sign an Agreement (which may be called JLF agreement) incorporating the broad rules for the functioning of the JLF. The JLF should explore the possibility of the borrower setting right the irregularities/ weaknesses in the account. The JLF may invite representatives of the Central/ State Government/ Project authorities/ Local authorities if they have a role in the implementation of the project financed.