Understanding the problem of Indian Banks going through unprecedent mounting growth in stressed loan portfolio, the Reserve Bank of India attempted to force banks to clean up balance sheets and came out with many regulatory steps viz; Strategic Debt Restructuring (SDR), Flexible Structuring of Project Loans (5/25) and Scheme for Sustainable Structuring of Stressed Assets (S4A) with the purpose of enabling banks to deal with such stressed accounts more effectively.
However, these frameworks did not address all situations and hence the Government of India promulgated an effective mechanism in the form of Insolvency and Bankruptcy Code-2016 (IBC-2016) to address the need for identifying the problem well in time, focus on a comprehensive turnaround and all stakeholders, be it financial or operational creditor or borrower i.e. the corporate debtor. Subsequently, RBI vide its June 7, 2019 Circular has also issued new guidelines titled ‘Prudential Framework for Resolution of Stressed Assets’ as per the provisions of Section 35AA of the Banking Regulation Act, 1949 for expeditious and effective resolution of stressed assets.
One of the contentious issues, frequently posing obstacles and pitfalls/challenges has been the Inter Creditor Agreement (ICA) transaction. With a view to empowering the IBC-2016, a committee namely Sashakt committee, formed under the Chairmanship of Sri Sunil Mehta (the then Chairman of PNB), recommended that the existing ICA incorporate revised voting threshold and other changes for decision making as this would enable expeditious implementation of the new prudential framework on stressed assets
The RBI has made the new framework and the ICA thereof mandatory in its June 7, 2019 Circular. As per the June7 Circular, the new framework is applicable to all stressed accounts with exposure of Rs.2000 Crores and above with effect from 7th June, 2019 whereas for all exposures of Rs.1500 Crores and above the implementation date is 1st January, 2020.
There is no denying the fact that the ICA has not moved the way it was thought to be. It has been a victim of passing the buck from one to other, taking a unilateral decision, quibbling and hair-splitting over who gets what and stands wherein the pecking order for the assignment of assets and may also be seen as a lack of co-ordination among the regulatory authorities.
The ICA is a broad framework and within that the signatories have to find a way to make it work rather than pull in different directions. The RBI June 7 Circular says ‘additionally the ICA may, inter-alia provide for the rights and duties of the most lenders, duties and protection of rights of dissenting lenders as well as treatment of lenders with priority in cash flows and treatment with differential security interest etc.
However, above points have left things open to interpretations and it has become difficult to customize to ICA. The ICA is also silent about the means and timing of payment of liquidation costs to dissenting creditors. Further, it is also not clear on the basis of rationale in permitting a dissenting creditor to become an assenting creditor during the implementation of the resolution plan. For example, if a dissenting creditor receives part payment in priority to the assenting creditor, the ICA is silent on the clawback in such a scenario.
It has also to be kept in mind that if the ICA does not receive the desired momentum, banks will switch over to National Company Law Tribunal (NCLT) but the adverse consequence of this will be burgeoning of cases referred to NCLT which is already overburdened. As per one reliable source of study (by E & Y), the stressed asset market in our country is supposed to be around 1.10 lac crore which in itself opens a humongous opportunity for foreign capital to participate either through the IBC or ARCs or through participation in ICA transactions. But Off-shore lenders do not have a seat at the ICA framework till now and this may become an issue if a company desires to source external borrowings and this risk gets priced into a loan. To substantiate we have examples of several Telcos have substantial foreign debts on their books.
There is a timeline of 210 days (180 days plus 30 days review period) for implementing the resolution of cases under the new framework. In case of failure of banks to adhere to the timeline, they have only two alternatives viz; either they send the company to the IBC or make additional provision (of 20%) and pursue resolution outside the IBC. It has been observed that many resolution processes have failed to culminate within the above timeline which has resulted in huge provisioning burden for banks. Despite several representations to the RBI for extension of timeline and allowing all categories of lenders, including mutual funds and pension funds to form part of the ICA, the RBI is not ready to budge and has upheld that the new framework under its June 7 Circular will remain in force in its original form.
The purpose of the ICA framework is to have a timely resolution so as to maximize the value of these assets. While being under the IBC proceedings, there have been cases of prolonged delays which erodes the value of these assets defeating the very purpose of resolution. The creditors need to have an integrated and coordinated approach to finalize a resolution strategy that optimizes economic value from the underlying business and assets, It can not be…one size fits all. However, as per the RBI’s new instructions, lenders are bound to sign an ICA if a resolution plan is to be implemented and the ICA is binding on all the creditors if it is approved by 75% of the lenders in terms of outstanding value and 60% by the number of lenders.
Another blind spot in the new framework vide RBI’s June 7 Circular is silence over those stressed accounts where outstanding is below Rs.1500 Crores. The ICA framework is thus restricted to a class of lenders. Further, the ICA is also silent about the means and timing of payment of liquidation costs to dissenting creditors. Also, it is not clear what the rationale is to permit a dissenting creditor to become an assenting creditor during the implementation of a resolution professional.
Another grey area of the ICA is that voting percentage gets determined as of the reference date. The ICA needs to factor in the fact that voting percentage may be dynamic if the lenders trade distressed debts. Further, the requirement for mandatory review of Resolution Professionals which envisage restructuring by an overseeing committee where the existing promoter is continuing. The rationale for this is not without ambiguity. It adds one more coating of bureaucracy and creates dubiety on the outlines of a resolution plan.
It is not that the new framework has been a total failure with respect to resolution. However, the problem persists in cases where companies are having weak balance sheets and who have undergone impairment losses in the recent quarters. The capabilities of these companies to remain as a functional/operating venture comes under threat irrespective of any amount of handholding to them and as result they have to be referred to the IBC.
Sanjay Kumar Singh
Chief Manager (Faculty),
State Bank Institute of Learning and Development, Panchkula
