Corpsec & Insolvency and Bankruptcy Hotline: Framework for Resolution of Stressed Assets – “Take Two”

Key Takeaways

• The revised framework provides for a phased applicability of the norms, basis aggregate exposure of the borrower. Accounts with highest outstanding dues to be dealt first.
• Emphasis on early recognition and periodic reporting of stressed assets by all financial institutions.
• Complete freedom and independence to financial institutions to develop their own policy to deal with stressed assets and individualized resolution plans to standardize such assets in case of single lender.
• Requirement for majority consensus in case of multiple banking arrangements or consortium lending for deciding the terms of a resolution plan.
• Short time frame of 210 days to implement a resolution plan.
• Adverse financial consequences on financial institutions for failed resolution plans, by way of incremental increase in provisioning requirements.
• All erstwhile RBI mechanisms to deal with stressed assets withdrawn.

The gross nonperforming assets (NPAs) as a percentage of gross advances of scheduled commercial banks in India had increased from 2.4%¹ in 2008 to 10.8% as of September 2018². While the Financial Stability Report of Reserve Bank of India (“RBI”) does indicate a slight improvement in asset quality of banks, with the gross NPA ratio of Scheduled Commercial Banks (SCBs) declining from 11.5% in March 2018 to 10.8% in September 2018 and having further declined to 9.3% as of March 2019³, there is still a long way to go before we can allow ourselves a breath of relief.

The RBI has in the past issued several instructions aimed at resolution of stressed assets in the economy such as the Corporate Debt Restructuring, Sustainable Structuring of Stressed Assets, Flexible Structuring of Existing Long-Term Project Loans. In February 2018, with the intention to issue a harmonized and simplified framework for resolution of stressed assets, the RBI had issued the Resolution of Stressed Assets – Revised Framework (“2018 Framework”) in supersession of all the erstwhile instructions for resolution of stressed assets. For our analysis of the 2018 Framework, please see here.

The 2018 Framework was challenged on the grounds that applying a 180-day limit to all sectors of the economy without considering issues faced by each sector was equivalent to treating unequal’s equally and hence arbitrary and discriminatory. The Supreme Court had in April 2019 quashed the 2018 Framework stating that RBI can direct banking institutions to move under The Insolvency and Bankruptcy Code, 2016 (“IBC”) in terms of Section 35AA of the Banking Regulation Act, 1949 (“BR Act”) only on two conditions being complied with, namely, (i) that there is a Central Government authorisation to do so; and (ii) that it should be in respect of specific defaults⁴.

ANALYZING KEY FEATURES OF THE REVISED FRAMEWORK

Considering the decision by the Supreme Court, the RBI on June 7, 2019, notified the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 (“Revised Framework”). All the earlier frameworks for lenders to deal with stressed assets has been withdrawn⁵ with effect from June 7, 2019 and the Joint Lenders’ Forum (as a mandatory mechanism for resolving stressed assets) has been discontinued.

Objective and Applicability: The RBI’s objective is to ensure that lenders focus on early recognition, reporting and time-bound resolution of stressed assets. The Revised Framework is applicable not only to scheduled commercial banks (excluding regional rural banks), but also to all India term financial institutions (i.e. NABARD, NHB, EXIM Bank and SIDBI), small finance banks and systemically important NBFCs. However, the Revised Framework will not apply in the following situations:

1. Projects in which the date of commencement of commercial operations has been deferred – restructuring in respect of these projects will continue to be as per paragraph 4.2.15 of the Master Circular dated July 1, 2015 on ‘Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances’;
2. Rehabilitation of certain micro, small and medium enterprises (MSMEs)⁶ – in respect of such MSMEs, only the early identification and reporting portion as well as parts of the prudential norms attached to the Revised Framework which are not in derogation of RBI’s circular on MSME Sector – Restructuring of Advances⁷ (dated January 1, 2019) will apply;
3. Restructuring of loans in the event of natural calamity – such restructuring, including asset classification and provisions will continue in accordance with extant instructions⁸ (and not the Revised Framework);
4. Borrowers directed to IBC by RBI – the Revised Framework shall not apply to borrower accounts in respect of which the RBI has directed lenders to initiate insolvency proceedings under the IBC, in these cases lenders will have to follow the specific instructions provided by RBI.

Status Quo for Provisions and Limited Grandfathering of Older Resolution Plans: The Revised Framework prohibits lenders from reversing provisions maintained as on April 2, 2019 in respect of a borrower, unless the reversal is a result of an asset classification upgrade or recovery or resolution after following the instructions of the Revised Framework. As regards, existing resolution plans (as on June 7, 2019), the Revised Framework allows such resolution plans to be implemented only if they meet the requirements and conditions provided under the Revised Framework.

Early Identification of Stressed Accounts: Similar to the 2018 Framework, the RBI has provided for early identification of stressed accounts and classifying them as special mention accounts. Lenders are also required to provide reports on a monthly basis to the Central Repository of Information on Large Credits of credit information and instances of classification of an account as stressed on all borrowers with which such lender has an aggregate exposure of INR 50 Million or above (“Exposure Threshold”) and report instances of default by borrowers above the Exposure Threshold on a weekly basis.

Implementation of Resolution Plan: Firstly, lenders are required to create a board-approved policy for resolution of stressed assets. Secondly, lenders, must undertake a prime face review of the defaulting borrower’s account within 30 days of a default by the borrower (all types of lenders mentioned above, except systemically important NBFCs) (“Review Period”). During the Review Period, a lender may finalise its resolution strategy and choose to initiate insolvency or recovery proceedings.

In the event that a resolution plan is proposed to be implemented and the relevant borrower has multiple lenders, all lenders are required to enter into an inter-creditor agreement (“ICA”) within the Review Period. Such ICA must be approved by lenders representing 75% by value of total outstanding credit facilities and 60% of the lenders by number.

While the Revised Framework illustrates clauses, which may be included in an ICA (e.g. rights and duties of majority / dissenting lenders, treatment of lenders etc.), it mandates that the resolution plan should provide that dissenting lenders are paid at least the “liquidation value”⁹.

The Revised Framework requires resolution plans to be implemented within 180 days from the end of the Review Period based on the following categorization, and the Review Period to commence no later than (i) a particular ‘reference date’ (if the borrower is in default on such reference date) or (ii) the date of the first default by such borrower after the ‘reference date’. This categorization is as follows.

The RBI has provided an indicative set of items which the lenders’ resolution plan can cover, including any action, plan or reorganization, such as regularization of the borrower account by payment of all overdues by the borrower, sale of exposures to other entities or investors, change in ownership and “restructuring”¹⁰.

Conditions for Implementation of Resolution Plan:

Not all resolution plans can be implemented. The determination of whether a resolution plan involving restructuring or change in ownership of borrower accounts can be undertaken will be based on an independent credit evaluation (“ICE”) of a borrower’s “residual debt”¹¹ by credit rating agencies directly engaged by lenders¹². In cases where the aggregate exposure of lenders to a borrower is INR 1 Billion or more, an ICE is required and where the aggregate exposure is INR 5 Billion or more, 2 ICEs are required. The relevant number of ICEs¹³ should provide a credit opinion of RP4¹⁴ or higher for the residual debt in order for such resolution plan to be considered for implementation. Therefore, any acquisition in lieu of the Revised Framework which would be outside the IBC prescribed mechanism, resulting in a change of control would have to satisfy the RP4 criteria. Prospective investors interested in acquiring a stressed asset should keep in mind these additional requirements which come into play for a restructuring under the Revised Framework.

In addition to the aforementioned requirements for implementation of resolution plans, there are also implementation conditions depending on whether (i) the lenders will continue to have exposure to such borrower or (ii) whether they will exit by assigning such exposure to a third party or provide for recovery action. In the latter case, when the resolution plan involves exit by assigning the exposure to a third party such as an asset reconstruction company, the resolution plan will be deemed to be implemented only if the exposure is fully extinguished, in other words, a partial transfer to an asset reconstruction company may not work. In the former case, where the resolution plan does not involve restructuring / change in ownership, the resolution plan is deemed to be implemented if there is no default with any of the lenders on the 180^th day from the end of the Review Period.¹⁵

Alternatively, for situations in which lenders will continue to have exposure to a borrower, the resolution plan involving restructuring / change in ownership is deemed to be implemented only if the following conditions are satisfied:

1. the borrower is not in default with any of the lenders;
2. the new capital structure and/or changes in the terms of existing loans is reflected in the books of all lenders; and
3. all documentation between the borrower and the lenders, creation / perfection of security is completed in consonance of the resolution plan.

Delays in Implementation of Resolution Plan: The Revised Framework requires lenders to make additional provisions if a viable resolution plan is not implemented within the prescribed timelines – (i) 20% of the total outstanding if the resolution plan is implemented 180 days from the end of the Review Period; and (ii) 35% (20% + 15%) of the total outstanding if the resolution plan is implemented 365 days from the commencement of the Review Period. Such additional provisions must be made by all lenders that have exposure to the relevant borrower and will need to be made even if the lenders have already initiated recovery proceedings, unless such proceedings have been completed. While the total provisions are capped at 100% of the total outstanding, the additional provisions shall be made over and above the higher of (i) the provisions already held, or (ii) the provisions required to be made as per the asset classification status of the borrower account.

Additional provisions can only be reversed in the following situations:

1. Resolution plan covers only payment of overdues – the borrower is not in default for 6 months from the date of clearing of overdues with all lenders;
2. Resolution plan involves restructuring / change in ownership outside IBC – upon implementation of the resolution plan;
3. Resolution is pursued under IBC – 50% of the additional provisions may be reversed on filing of the insolvency application and 50% upon admission of the borrower into the insolvency resolution process under the IBC; and
4. Assignment of debt / recovery proceedings are initiated – upon completion of the assignment / debt recovery.

Lender Disclosures and RBI’s Supervisory Review: Lenders are required to make ‘appropriate disclosures’ in relation to resolutions plans which they have implemented under the ‘Notes to Account’s portion of their financial statements. RBI has, at its discretion, the power to take stringent supervisory / enforcement action. This may be used to curb actions by lenders which are undertaken with an intent to conceal the actual status of borrower accounts or to “evergreen” stressed accounts. Such action may include ordering lenders to implement higher provisioning of such borrower accounts, and imposition of monetary penalties on such lenders.

DOES THE REVISED FRAMEWORK ADDRESS THE SUPREME COURT JUDGEMENT?

The most significant change brought about by the Revised Framework is that it does not direct lenders to move under IBC, if they fail to implement the resolution plan within the required timelines which was the bone of contention of the 2018 Framework. In fact, paragraph 5 of the Revised Framework provides that the Revised Framework is without prejudice to separate directions which the RBI may issue from time to time under Section 35AA of the BR Act for initiation of insolvency proceedings against specific borrowers under the IBC. Considering that the Revised Framework has been issued under the general powers of RBI to issue directions in respect of stressed assets, the validity of the Revised Framework should not be questionable. However, other concerns around the Revised Framework include the expectation to implement a resolution plan even before a default, requirement to make additional provisioning if the resolution plan is not implemented within the timelines (instead of approaching the National Company Law Tribunal) etc.

¹ RBI WPS (DEPR): 03/2014: Re-emerging Stress in the Asset Quality of Indian Banks: Macro-Financial Linkages, available at https://rbi.org.in/Scripts/PublicationsView.aspx?Id=15720

² December 2018 Financial Stability Report, available at https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=45862

³ June 2019 Financial Stability Report, available at https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR30667455E4187776477E806C5B46B3C5E621.PDF

⁴ Dharani Sugars and Chemicals Ltd. v. Union of India (UOI) and Ors. [2019]153SC L224 (SC)

⁵ The withdrawn instructions include the Framework for Revitalising Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership outside SDR, and the Scheme for Sustainable Structured of Stressed Assets

⁶ These are MSMEs covered under Circular No. FIDD.MSME & NFS.BC.No.21/ 06.02.31/ 2015-16 dated March 17, 2016

⁷ Notification No. DBR.No.BP.BC.18/21.04.048/ 2018-19 available at https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=11445

⁸ Master Direction – Reserve Bank of India (Relief Measures by Banks in Areas affected by Natural Calamities) Directions 2018 – SCBs dated October 17, 2018, available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11394&Mode=0

⁹ In the Revised Framework, “liquidation value” is defined as the estimated realisable value of the assets of the relevant borrower, if such borrower were to be liquidated as on the date of commencement of the Review Period

¹⁰ The Revised Framework describes “restructuring” as an act in which a lender grants concession to a borrower for economic or legal reasons to address a borrower’s financial difficulties. It also notes that “restructuring” normally involves modification of terms of advances / securities, including alteration of payment period / payable amount / amount of instalments / rate of interest, roll over of credit facilities, sanction of additional credit facility, compromise settlements involving settlement time periods exceeding 3 months

¹¹ “Residual debt” means the aggregate debt (fund based + non-fund based) envisaged to be held by all lenders, as per the resolution plan.

¹² Credit rating agencies’ fees should be paid by lenders

¹³ If lenders choose to obtain more than the minimum number of ICEs from credit rating agencies, all such ICEs should be RPF4 or better for the resolution plan to be considered for implementation

¹⁴ “RP4” is a symbol used to identify moderate credit risk where debt facilities / instruments are considered to have a moderate degree of safety regarding timely servicing of financial obligations. Debts are categorized for RP1 to RP7, RP1 debts being those with lowest credit risk and RP7 being those with highest credit risk

¹⁵ In case there is a default within such period, it is a fresh default and requires a fresh review by lenders

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