Debt Restructuring in India (1/2): Recent Challenges
By Ganesh Gopalakrishnan (Research Fellow, National Institute of Public Finance and Policy, New Delhi) and Urmika Tripathi (Legal Consultant, REDD Intelligence)
Introduction
The Insolvency and Bankruptcy Code, 2016 (“IBC”) is the primary legislation for the restructuring and resolution of distressed businesses in India. Currently, India has suspended the initiation of corporate insolvency resolution processes under the IBC till 25 December 2020 (with an option to extend the suspension until 25 March 2021). Further, an amendment to the IBC deems that no application can be filed, at any time in the future, for the initiation of a corporate insolvency resolution process in respect of any defaults that take place during this period. These steps are motivated by the objective of protecting firms hit by the COVID-19 pandemic from the threat of insolvency and subsequently, winding up or liquidation.
Debt restructuring, security enforcement and recovery mechanisms for creditors
During this period of suspension, creditors may instead revert to other restructuring, recovery and security enforcement frameworks. Some of these frameworks precede, and are independent of, the IBC. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) and the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (“RDDB Act”), are examples. The SARFAESI Act allows creditors to enforce their security interest without requiring them to approach a court or a tribunal for a judicial order. The RDDB Act provides a framework for creditors to approach the jurisdictional Debt Recovery Tribunal (“DRT”) for recovery of dues. It is another matter that recovery proceedings under the DRT are generally regarded as commercially unviable on account of their prolonged nature and frequent occurrences of delays.
One of the alternatives to the corporate insolvency resolution process is a scheme of arrangement under the Companies Act, 2013 (“Companies Act”). Under the Companies Act, any debt restructuring scheme requires, inter alia, an approval by 75% of each class of affected creditors (by value) and affected shareholders. Upon receiving the requisite approvals and a green light from various Indian regulatory bodies, the scheme is submitted to the National Company Law Tribunal (“NCLT”) for its approval. Once approved by the NCLT, the scheme is binding on the company, and its creditors and members. Owing to judicial delays and large costs associated with this process, a scheme of arrangement is not a popular method of debt restructuring in India. This largely leaves the ‘Prudential Framework for Resolution of Stressed Assets’ (“Prudential Framework”) issued in 2019 by the Reserve Bank of India (“RBI”) – India’s central bank – as the most viable option for restructuring in India, at present.
Challenges under the Prudential Framework
The Prudential Framework sets out directions for early identification, reporting, and resolution of stressed debt accounts that apply to specific creditors regulated by the RBI. These initially included scheduled commercial banks, certain designated financial institutions, small finance banks, asset reconstruction companies and systemically important non-banking financial companies (“NBFCs”). Creditors covered by the Prudential Framework must undertake a prima facie review of the borrower account within thirty days of a payment default, and collectively decide on the strategy for resolution. The Prudential Framework then fundamentally presents two methods for creditors to approach a stressed asset.
First, creditors may inter se choose to implement a resolution plan for the distressed asset within defined timelines. This resolution plan must be in line with each creditor’s board-approved policy for resolution of stressed assets. If a resolution plan is to be implemented, the creditors are required to enter into an inter-creditor agreement (“ICA”). Any decision by creditors needs to be approved by lenders representing 75% of the total outstanding debt by value and 60% of lenders by number. Dissenting creditors are entitled to a payment that cannot be less than their pro rata shares in the liquidation value of the borrower, calculated as the estimated realisable value of the assets of the borrower. ICAs also usually contain a standstill provision barring its signatories from pursuing individual enforcement actions till the restructuring process is under way.
Second, if the creditors elect against pursuing a resolution plan, then the creditors are free to pursue legal proceedings for insolvency or recovery against the borrower. Under normal circumstances, this typically takes the form of initiation of the corporate insolvency resolution process against the borrower under the IBC.
The Prudential Framework is addressed specifically to certain RBI-regulated entities and is silent on the participation by entities other than those it is specifically addressed to. However, credit portfolios of Indian borrowers (especially NBFCs) are often diversified with debts owed to non-RBI regulated entities like insurance companies and mutual funds – insurance funds are regulated by the Insurance Regulatory and Development Authority of India (“IRDAI”) and mutual funds are regulated by the Securities and Exchange Board of India (“SEBI”). Consequently, they are not bound to comply with the directions under the Prudential Framework, sign the ICA, nor participate in the resolution process.
Under normal circumstances, this means that insurance funds and mutual funds could independently initiate the corporate insolvency resolution process against the borrower under the IBC. If a filing for initiation of the corporate insolvency resolution process is admitted by the NCLT, the management of the corporate debtor vests in an interim resolution professional and a broad moratorium comes into effect that prevents enforcement of any security interest and effectively derails any other resolution process (including those under the Prudential Framework). As a result, the success of any resolution pursuant to the Prudential Framework is intrinsically tied to the number of creditors participating in that process and becoming signatories to the ICA. The issue of participation of creditors who are under the domain of sectoral regulators other than the RBI in the Prudential Framework, therefore, has important consequences.
This lack of clarity led to calls for the scope of the Prudential Framework to be expressly extended to other creditors. The RBI extended its application to certain other categories of creditors regulated by it such as regional rural banks and housing finance companies, but did not clarify the position of creditors regulated by other sectoral regulators (ostensibly as such an action may run the risk of being ultra vires the powers of the RBI). While some sectoral regulators like SEBI have clarified that mutual funds may participate in resolution processes subject to conditions (including that their exposures must be ‘side-pocketed’ i.e., segregate the ‘bad debt’ exposure into a separate portfolio to ringfence the good assets in the main portfolio), a formal framework remains elusive. IRDAI has reportedly permitted insurance companies to enter into the ICA, although it is not clear if any prerequisites have been attached. Sectoral regulators of the pension funds, including the Pension Fund Regulatory Development Authority and the Employees’ Provident Fund Organization have not issued any circulars in this regard. This is despite reports that several inter-regulator meetings have taken place to address this issue.
In addition, there have been instances of ‘rogue’ creditors independently initiating insolvency proceedings, potentially derailing the resolution process under the Prudential Framework. For example, during the course of Jindal India Thermal Power Limited’s out-of-court restructuring process under the Prudential Framework, banks holding 92% of the outstanding debt and representing 94% in number, entered into an ICA pursuant to the Prudential Framework. However, ICICI Bank proceeded to initiate a corporate insolvency resolution process under the IBC. The matter is currently sub-judice before the Delhi High Court and the judgment is likely to offer insights into the judicial perceptions about how the Prudential Framework interacts with the IBC in similar contexts, but these disruptions to the restructuring process are possible at present, at least in theory.
Conclusion
The last four years since the introduction of the IBC have shown that even the IBC processes, while quicker than the erstwhile recovery and enforcement mechanisms, also suffer from delays and often take much longer than the statutorily prescribed limit of 330 days. However, the alternative processes, such as the Prudential Framework and other existing mechanisms for restructuring and resolution of distressed companies outside of an insolvency resolution process under the IBC, also suffer from various shortcomings. Litigation and challenges by non-participating creditors, difficulty in reaching a consensus amongst creditors and inability to bind all creditors to out-of-court restructuring mechanisms continue to plague these processes.
According to an annual publication of the Insolvency and Bankruptcy Board of India (“IBBI”), the Indian market had been advocating for a hybrid resolution framework having features of both the court-monitored insolvency framework and out-of-court restructuring mechanisms. While any framework that is introduced is likely to complement the Prudential Framework and not substitute it in entirety, the priority must be ensuring that operational challenges with the Prudential Framework are addressed. The IBBI must also ensure that any new framework that is introduced presents clear alternatives for creditors and affected stakeholders especially when the circumstances of a particular transaction render the Prudential Framework an unattractive option.