Reserve Bank on Monday (June 8, 2015) released Strategic Debt Restructuring scheme which paves way to ensure more ‘skin in the game’ of promoters. While unveiling the new scheme, RBI has invited reference to its circular dated Feb 26, 2014 on “Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP)”. In terms of above guidelines, the general principle of restructuring should be that the shareholders bear the first loss rather than the debt holders. With this principle in view 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;
- Transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of company. This will enable a change in management control, should lenders favour it.
The above options are introduced in the scheme, as 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. In such cases, change of ownership will be a preferred option. Henceforth, the Joint Lenders’ Forum (JLF) have a duty to actively consider such change in ownership under the above Framework issued vide the circular dated February 26, 2014.
The restructuring package allow banks both under JLF and CDR mechanism, to stipulate the timeline during which certain viability milestones (e.g. improvement in certain financial ratios after a period of time, say, 6 months or 1 year and so on) would be achieved. The JLF need to conduct periodical review of 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, which will have the following features:
- 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 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;
- Provisions of the SDR would also be applicable to the accounts which have been restructured before the ‘Strategic Debt Restructuring scheme’ introduced provided that the necessary enabling clauses, as indicated in the above paragraph, are included in the agreement between the banks and borrower;
- 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 well documented and approved by the majority of the JLF members (minimum of 75% of creditors by value and 60% of creditors by number);
The norms for SDR states that 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. Upon post conversion, all lenders under the JLF must collectively hold 51% or more of the equity shares issued by the company;
The conversion price of the equity shall be determined as per the guidelines given below:
- (a) 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):
- (b) Market value (for listed companies): Average of the closing prices of the instrument on a recognized stock exchange during the ten trading days preceding the ‘reference date’ indicated at (ii) below;
- (c) 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.
The lenders relish many exemptions on acquisition of shares of Borrower Company under SDR scheme. They will not have to worry about holding more than 20% stake as acquisition of shares due to such conversion will be exempted from regulatory ceilings/restrictions on Capital Market Exposures, investment in Para-Banking activities and intra-group exposure. Equity shares acquired under the scheme are also exempt from mark-to-market rules for 18 months and therefore banks need not make provisions if the market price falls. The conversion of debt into equity in an enterprise by a bank may result in the bank holding more than 20% of voting power. The SDR norms exempt banks from maintaining investor-associate relationship in terms of ‘Guidelines on Compliance with Accounting Standards (AS), as the lender acquires such voting power in the borrower entity in satisfaction of its advances under the SDR, and the rights exercised by the lenders are more protective in nature and not participative. RBI communiqué in this regard said that Banks should ensure compliance with the provisions of Section 6 of Banking Regulation Act and consider appointing suitable professional management to run the affairs of the company.
The new framework allows bank to bring strategic international investor in a sector and banks must divest their holdings in the equity of the company in favour of ‘new promoter’ (domestic as well as overseas) as soon as possible. The ‘new promoter’ should not be a person/entity/subsidiary/associate etc. from the existing promoter/promoter group and they should have at least 51 percent 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 percent, the new promoter should own at least 26 percent of the paid up capital or up to applicable foreign investment limit whichever is higher. The above relaxation to non-resident investor is subject to a condition that banks are satisfied that with this equity stake the new promoter controls the management of the company.
In addition to conversion of debt into equity under SDR, banks may also convert their debt into equity at the time of restructuring of credit facilities under the extant restructuring guidelines. However, Equity shares of entities acquired by the banks under SDR shall be assigned a 150% risk weight for a period of 18 months from the ‘reference date’ as per the extant capital adequacy ratio. On divestment of banks’ holding to a new promoter, the account may be upgraded to ‘Standard’. Banks may also refinance the existing debts of the company considering changed risk profile of the company without treating the exercise as ‘restructuring’ subject to banks making provisions for any diminution in fair value of the existing debt on account of the refinance. The provisions against such account can be reversed only after principal and interest on all facilities are fully satisfied as per terms of payment during that period. However, if the bank has no longer any exposure to the borrower the provision may be reversed/absorbed as on the date of exit.