The International Monetary Fund recently stated that Indian corporate entities are among the highest leveraged entities in the Asia Pacific region. Recent data show that non-performing assets (NPAs) have risen alarmingly from 2.2% to 3.8% of the total loan

portfolio of Indian lenders, and greater difficulties are predicted in the medium term, owing to factors such as rising interest rates, margin retention, foreign exchange costs and a perceived policy “stasis”, all of which have slowed growth and made repayment more expensive.

Many Indian companies are grappling to find options to manage their potentially troubling debt obligations. The limited success of such options raises questions on their effectiveness.

Some of the options being considered by borrowers and lenders involve refinancing the debt with offshore debt and/or equity infusion, which have been hard to come by, partly due to regulatory challenges. The external commercial borrowing route has narrow applicability for refinancing of rupee loans and has not found significant patronage. Further, refinancing is only advantageous if better terms are available, and in the rupee context, lower interest rates have been difficult to procure within the Indian market.

Given that refinancing options are proving to be both elusive and challenging illiquid borrowers that are considering restructuring of their loans are likely to suffer exacerbating stress.

CDR mechanism

“Restructuring” refers to the grant of unusual concessions – such as relaxations in repayment periods or moratoriums on interest repayments – by lenders. Recent hikes in provisioning requirements – from 2.75% to 5% for restructured loans – have drawn criticism from some banks, which say that restructured loans have almost been brought on par with bad loans. These policies could discourage lenders from turning to restructuring. Where syndicated or consortium financing is involved, debtors need to involve multiple creditors in the restructuring mechanism. The corporate debt restructuring (CDR) mechanism caters to such restructuring initiatives.

CDR is a voluntary, non-statutory process which provides for the referral of an account to the CDR Cell for the formulation and implementation of a restructuring plan, with the consent of 75% of creditors by value and 60% of creditors by number. The decision of the “supermajority” of the lenders to enter CDR is intended to bind the remaining lenders as well. The legal basis of CDR is in the inter-creditor agreements (ICAs) and the debtor-creditor agreements which the participating creditors are required to execute, and will bind them inter se.

Challenges

CDR appears to be geared towards Indian banks, with non-banking financial companies (NBFCs), asset reconstruction companies (ARCs) and foreign banks being only entitled to join on a case-to-case basis, and corporate debt providers being wholly excluded. Even when the requisite majority of creditors have agreed to implement a scheme, dissenting creditors sometimes have commenced legal proceedings against borrowers despite having signed the ICA.

In addition, since NBFCs, ARCs and foreign banks are not a part of the permanent CDR mechanism, they may have little influence over the process. They contend that restructuring packages are often drawn up without their input, and are unsuitable for their requirements and risk profiles. Such entities are thus forced to effectuate their commercial and statutory remedies to recover their loans, ultimately derailing the rehabilitation package.

Further, as uncertainty and delays in approval of CDR proposals lead to deterioration in the asset classification, lenders may consider bowing out of the CDR process and seeking repayment/recovery by more time-efficient means.

Moreover, data indicate that one round of CDR may not be enough, with about `330 billion (US$5.6 billion) worth of debt restructured in 2012 having failed or being on the verge of failing.

Thus, it may now be wise to test alternative processes for restructuring debt. For example, under section 391 of the Companies Act, 1956, “classes” of creditors of a company could agree on a scheme of arrangement with the company, to restructure its debt. Once threefourths in value of a class of creditors have consented, courts could enforce the scheme on the dissenting minority. The court’s power to intervene may have significantly influenced the success of many restructuring processes.

Increasing NPAs have deleterious effects on the economy as a whole. The rehabilitation of debt results in borrowers generating income, creating jobs and forming a fundamental part of the economic fibre. Debt restructuring is a discretionary accommodation provided by lenders that should, ideally, receive only sparing use. What is needed is an inclusive process that accounts for the views of all stakeholders with the purpose of rehabilitating a company that is facing temporary financial challenges and to avoid such challenges becoming permanent.

Disclaimer: This article was first published in the June 2014 issue of the India Business Law Journal magazine. It has been authored by Jeet Sen Gupta, who is a partner, Deep Roy, who is an associate partner and Divya Srikanth, who is an associate at Economic Laws Practice (ELP), Advocates & Solicitors. They can be reached at jeetsengupta@elp-in.com, deeproy@elp-in.com or divyasrikanth@elp-in.com for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. The contents of this article/update are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.